## Inflation (1)

I have described the nature of prices. On this basis, it is obvious that the price of any individual commodity, depends on two things 1) the value of the commodities whose price is being measured, and 2) the value of the money that is the unit of measurement. If the value of money is constant, and the value of any commodity rises, then its price will also rise, because it will require more money to exchange with it as an equal amount of value, and vice versa. If the value of any commodity is constant, but the value of money rises, then the price of the commodity will fall, because less money now has to be exchanged with it to represent the same amount of value, and vice versa.

However, things are slightly different when we come to look at the general price level, which is not just a matter of the value of commodities, but the quantity of them being circulated, and the money used to circulate them. That comes down then to four things 1) the average value of each commodity, 2) the number of commodities to be circulated, 3) the value of money, and 4) the velocity of circulation of the money. This last is the number of times any individual piece of money is used in a given time, e.g. in a year a single £1 coin might be used to make ten individual £1 purchases, thereby it has circulated £10 of value.

However, because any society as described in the link above, has a limited amount of labour-time to expend, if the value of commodities rises in general, i.e. productivity falls, so more labour-time is required for their production, this does not result in an overall increase in the amount of value produced. If a society has 1 billion hours of labour-time to expend, and produces 1 billion units, the value of each unit is equal to 1 hour. If 1 hour is equal to £1, and the velocity of money is 1, it requires £1 billion to circulate those units. If, productivity falls by half, the society still only has 1 billion hours to expend. It now produces 500 million units, but their value is still 1 billion hours, equals £1 billion. The value of each unit is now 2 hours, equals £2, and so £1 billion is still required to circulate these commodities. However, if the money is gold, and is affected by the same fall in productivity its value too will have doubled. If £1 previously equalled 2 grams of gold, now it will equal only 1 gram of gold. So, in terms of the amount of gold that has to be handed over, things will be as they were before i.e. 2 grams of gold will exchange for 1 unit of production.

It is this relation of the value of one commodity to the quantity of the money commodity that is the real price. In this case, then its clear that there is no inflation of prices, the same amount of gold continues to be exchanged for a unit of production as before. What is different is that the amount of production has fallen, i.e. the society has become less wealthy in the real sense that it now has fewer use values produced.

However, if the value of the money does not rise then the nominal money prices will double. By the same token, if the value of commodities remains constant, but the value of the money drops by half, the nominal money prices will double. For example, when Spain began to bring back stolen gold from the Americas, it reduced the value of gold in Spain, so prices rose there. The same thing happened with commodity prices in Europe, when new gold fields in California, Australia and Alaska were opened up, which required much less labour-time to produce gold than was previously the case.

But, as Marx points out, when precious metals are replaced by money tokens, such as bank notes, this reality can be obscured. A paper note, or a metal token, has very little value, and yet represents a certain amount of gold with a lot of value. If the value of gold rose, or the value of commodities fell, so less gold was needed in circulation, it was naturally withdrawn, to be hoarded, exported or melted down for bullion as I describe here – Marx, Gold and Money. But, that is not the case with money tokens, precisely because they have no or little value themselves. Marx says,

“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.”

This is the basis of inflation. The paper tokens, or nowadays the credit money in circulation represent a certain quantity of the money commodity – gold – which in turn should not be fetishised, because it only represents a certain amount of social labour-time. In other words, the total value of commodities in circulation represents a certain amount of social labour-time required for their reproduction. If gold is the money commodity, then the value of gold in circulation has to be equal to this same amount of labour-time, divided by the velocity of its circulation. The gold simply represents an equal amount of social labour-time, its physical embodiment in a form that can be used for exchange. On that basis, gold is not needed at all. All that is required is some universally accepted token that equally represents the same amount of social labour-time as the gold it has replaced.

However, as Marx points out here, if more of these tokens representing social labour-time are put into circulation than are required to circulate these commodities, one of two things must happen. Either, the velocity of circulation of each token must slow down, or else the value of each token will fall. The velocity of circulation can slow down, if general economic activity slows down, so fewer transactions occur, and each money unit then performs fewer transactions. Moreover, depending on other conditions, so long as the tokens are felt to still be stores of value, they can themselves be hoarded. But, in general the velocity of circulation tends to be determined more by technical considerations. For example, new banking technology means that payments can be made much faster using electronic transfers.

In short, if the value of commodities remains constant – they require the same amount of labour-time to produce – then increases in the supply of these money tokens/credit, will cause the value of the money tokens to fall, and so this will result in higher nominal money prices – inflation. On the other hand, if the opposite happens, as Engels describes in relation to the 1847 crisis, described in Part 6, and money is drained from the system, which is what happened as a result of the 1844 Bank Act, then a deflation of prices sets in, nominal prices fall, which causes people to hoard money even more, and it causes a credit crunch, as short term interest rates are forced up, as happened in 1847, and happened in 2008.

As Marx and Engels point out this kind of financial crisis, caused in the realm of money has to be separated from an actual economic crisis, which also appears to arise from a lack of money, but has other causes within the realm of production and circulation. In the next part, I'll explain what this means for the current situation.

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