Ben Bernanke's Big Blunder - Part 1

Ben Bernanke's claim to fame is his analysis of the 1930's Depression. His central thesis, like that of Milton Friedman, is that the Depression, if not caused, was at least made much worse by wrong-headed policies by the US Federal Reserve. The Federal Reserve, in line with orthodoxy of the time, had acted to restrict money supply. In so doing, it caused a credit crunch, raised interest rates, and set off a period of destabilising deflation. Bernanke, especially seeing a similar process unfold in Japan over the last 20 years, has been determined not to make the same mistake. In doing so, he has made another. Bernanke has misunderstood the nature of the conjuncture, and thereby applied the wrong medicine. The consequence is going to be a financial crisis that makes 2008 pale by comparison.

Its actually doubtful whether loose money policies would have made much difference in preventing, or cutting short, the Depression. According to Kondratiev, the US was about ten years out of synch with other developed economies in relation to the Long Wave. European economies came out of a Long Wave boom around 1914-20. That led to the onset of a period of stagnation that dragged on in Europe throughout the 1920's. The 1920's, were, for the US, however, a period of continued boom. The adoption of Fordist methods of mass production enabled the US to begin to dominate global output of a large number of goods. This was a period of rapid US ascendancy, when it also began to build up its navy for the purpose of challenging Britain for the position of global hegemon.

US exports ballooned in the 1920's, bringing with it large inflows of gold from Europe in payment. In accordance with the rules of the Gold Standard, this influx of gold resulted in the US inflating its economy further. Interest rates fell, and money supply increased, though not by as much as the increase in GDP, which undermines the claims of the Austrian School that the US Depression was the consequence of a “Crack-Up Boom” caused by too much money printing. But, the lower interest rates etc. in the context of an economy still enjoying the advantages of the Long Wave Boom, an economy that was rapidly revolutionising the means of production, that was experiencing high rates of profit, and an ability to sell its goods worldwide to realise those profits, in the context of the prevailing free trade, did enable the US to enjoy a period that went down in history as “The Roaring Twenties”.

As I've written elsewhere - 1929 And All That – The Depression was not caused by the 1929 Stock Market Crash. Indeed, as described above, the Long Wave downturn was already well established, in Europe, by 1929. By the early 1930's, Europe was into the Winter Phase of the cycle. The conditions existed for the rate of profit to rise, new types of technology had created the potential for new commodities to be produced, that were high value, high profit commodities, that would lower the overall organic composition of capital, and thereby set in place a tendency for the rate of profit to rise, similar to the processes Marx describes. New technology created the conditions for new productive techniques that would also raise productivity, and lead to a rise in the production of relative surplus value.

But, because the US was 10 years behind Europe, it suffered its conjunctural shift only in the late 1920's. The 1929 Stock Market Crash, although fuelled by the large amounts of speculation that resulted from the low interest rates, that flowed from the huge excess of supply of capital over its demand, created by the high rate and volume of profit for US companies, was also in large part a symptom of that conjunctural shift. That meant those profits could no longer be realised, it meant the gains in relative surplus value, achieved by Fordism, through the revolutionising of production, were disappearing. In short, the low interest rates, that had been caused by an excess supply of capital over its demand, were going to end whatever the Federal reserve did.

Even if lower interest rates were in the gift of the Federal Reserve, its not clear why with falling or no profits, and difficulty in selling their output, firms would choose to invest simply because interest rates were lower. The only basis upon which that could work would be if not just demand, but profitable demand expanded. As Keynes put it, under those kinds of conditions, simply printing money and lowering interest rates is just like pushing on a string. Unless, demand is pulling on it from the other end, it simply bunches up, sits as money hoards, as the velocity of money slows down. Alternatively, as happened in the 1970's under similar conditions, firms utilise loose money conditions to increase prices without increasing output. In other words, it leads to stagflation.

But, for the reasons set out elsewhere - Interest Rates – interest rates are not in the gift of the Federal Reserve or any other central bank. Interest rates are a function of the demand and supply of capital. Interest rates have been in a secular down trend since 1982, not because central banks have forced them ever downwards, but because the supply of capital has been rising relative to demand.

But, that is not to say that central banks are powerless, far from it. High rates of profit that create an excess supply of capital create the conditions under which interest rates fall, but central banks, and the state can adopt policies that are either constructive or destructive. Because I believe that Bernanke has misread the conjuncture, he has followed policies that are destructive rather than constructive.

If 2008 had been a harbinger of the onset of a new 1930's style Depression, then Bernanke's response might have been defensible – though for the reasons set out above, I don't think it would have worked. But, it wasn't. 2008 was not 1929, and this is not the 1930's. The 1930's was a period of Long Wave downturn, today is a period of Long Wave Boom. It may not feel like such in the US, UK and parts of Europe, but that is because these economies are in long-term relative decline compared to China, Asia, and parts of Latin America and Africa. But, in part also the economic malaise in the US, UK and parts of Europe, is itself also a consequence of wrong-headed economic policies.

In 2008, when the Financial Meltdown occurred, rapid action by central banks to provide immediate liquidity to curtail a Credit Crunch was justified. But, in reality, that Financial Meltdown was a consequence of those wrong-headed policies that had been used over the previous 20 years. A rising rate of profit, during the 1980's and 90's, created the basis for low and falling interest rates. But, that was on the basis not of rapidly expanding economies, but of firms able to reduce costs. Low interest rates, rather than stimulating new amounts of large-scale investments, instead financed continued consumption, as workers stagnant wages were supplemented by an explosion of private debt, in the form of ever higher mortgages, credit card debt, student debt and so on. That in turn meant that many old industries, where the organic composition of capital was high, and consequently the rate of profit was low, were able to cling on to existence. Some of them like GM and GE branched out into finance themselves.

This is one reason that when the boom started after 1999, these economies, particularly the US and UK, were badly placed to take advantage of it. Marx never did, but some Marxist economists wrongly assign the tendency for the rate of profit to fall as the cause of capitalist crises. It isn't a cause, in fact its a symptom. The law basically stated is this, capitalist development raises productivity, so fewer workers are needed to process a given amount of material. Unless the value of the material falls by a larger amount than the quantity processed, it will mean that the proportion of constant capital to variable capital rises. As it is only the variable capital that creates surplus value, this means the rate of profit must fall. So,


C 1000 + V 1000 + S 1000 = E 3000, Rate of profit s/c+v = 1000/2000 = 50%.

If the surplus value is all invested, but in proportion 6:4, rather than 1:1, then,

C 1600 + V 1400 + S 1400 = E 4400, Rate of profit 1400/3000 = 46.66%.

But, besides all of the many caveats that Marx gives to this law, which show how it can be counteracted, this assumes that capital will simply keep investing in the same old industries, and all of them will continue to have a rising organic composition of capital. That is not at all how capitalism has developed. For example, suppose demand for the above commodities were fairly well satisfied, which is also the implication of this rising level of productivity. There is no reason that the surplus value produced in this industry should simply be reinvested in it. On the contrary, Marx sets out why that will not be the case.

We can imagine that the above formula is for a firm that was producing pocket calculators, for example. But, what if it decided to use the surplus value instead to produce a new-fangled gadget, just coming on to the market, like an Apple computer, back in the 1980's? The numbers produced will be low, the amount of constant capital used also low, whereas the value of variable capital, in the form of very skilled, educated workers will be very high. The computers will sell at high prices, with high profit margins. We might then have:

Calculators - C 1200 + V 800 + V 800 = E 2800, Rate of profit = 40%. (This is simple reproduction, the £2000 of capital now invested 6:4).

Apple Computers – C 200 + V 800 + S 800 = E 1800, Rate of profit = 80%.

Now the average rate of profit over all is 1600/ 3000 = 53.33%.

And, in fact, as Marx says this is precisely what we see with capitalist development. There can be long periods when nothing much changes, and during which the organic composition of capital rises, and rate of profit falls. Then there are periods of rapid technological change, whole new products and industries arise, where the organic composition of capital is low, and where the rate of profit is high, which then acts to drag up the rate of profit in the economy as a whole. These latter periods are precisely those periods that coincide with the Long Wave Spring.  Not only is it the case that, Marx says that there is no minimum rate of profit, in the way there is a minimum level of wages, but he also says that, beyond a certain size of capital, it can grow more as a result of a low rate of profit, than a small capital can with a high rate of profit.  But, also the process of capitalist development itself ensures that in periods of Long Wave Boom, particularly the conjuncture between the Winter and Spring Phase, a vast array of new technologies, new products, and new industries arise where the organic composition of capital is low, and profits are high.  Capital automatically gravitates towards them, and away from the old industries.  That is exactly what happened in the late 1930's, and into the new boom that began in the late 1940's.

Much of the restructuring and reallocation of capital that should have gone to these new types of industries in the 1980's and 90's, did not occur, particularly in the US and UK, meaning those economies were not in a position to take advantage of the new boom, to rapidly expand these new profitable industries. In fact, in Britain, the economic policy of Thatcherism was based on the opposite, it fostered low-wages and high debt, which in turn held back the movement of capital into those areas, and instead acted as a protectionist measure for all of the backward, small-scale, inefficient firms that cannot survive without poor wages subsidised by high debt, and Welfarism.

It was that dependence on continued consumer spending financed by debt, in turn based on inflated property markets, and other asset markets, that led to the Financial Meltdown of 2008  in the first place. But, if a quick and substantial injection of money printing could be justified to prevent an immediate collapse of the banking system in 2008, a continuation of that policy did not at all follow. But, that is what has happened with QE.

Forward To Part 2