In 1847, large amounts of money had gone into the speculative purchase of shares, but also into other illiquid assets such as land and property, as well as the purchase of commodities, by merchants, to be sold in distant, overseas markets. The initial spark to the crisis came not from an overproduction of capital or commodities, but an under production. A crop failure created a shortage of agricultural products, which, now, had to be imported from Europe, and were paid for with gold from the Bank of England.
That should have presented no problem given Britain's large trade surpluses, and gold reserves. However, in 1844, the government had passed The Bank Charter Act, whose principles were based on the false monetary theories of Ricardo, as described by Marx in A Contribution To The Critique of Political Economy. Ricardo confused gold as commodity, with gold as money, and also confused money with currency/money tokens/standard of prices.
Ricardo failed to understand that money, like capital, is not a thing, but a social relation. It is the universal equivalent form of the value of commodities. Ricardo saw all gold as money, and, consequently, the more gold a country had (or silver where it was the money commodity) the more money it had. But, as Marx sets out, no matter how much gold a country has, because money is only that amount of it that is the equivalent of the value of commodities to be circulated, whether a country has a large or small quantity of actual gold is irrelevant. In fact, in the role of this universal equivalent, of indirectly measuring the value of commodities, no physical gold is required at all. The measurement is made only in relation to ideal or imaginary gold.
Ricardo considered all gold to be money, and, thereby, as David Hume had set out, in his Quantity Theory of Money, the physical total of commodities is measured by the total quantity of gold/money. The greater the proportion of the latter to the former the higher the level of prices. This, of course, required Ricardo to, logically, abandon his Labour Theory of Value, which determined the value of commodities, including gold, by the labour-time required for their production.
Had Ricardo applied that theory, as Marx sets out, it would have been obvious to him that not all gold constitutes money, and so the Quantity Theory was nonsense. If the value of all other commodities is equal to 1 million hours of labour, and a gram of gold has a value of 100 hours of labour, then, its clear that only 10,000 grams of gold constitute money, i.e. represent an equal amount of social labour-time, no matter whether the country has 1 million grams, or only 100 grams of gold.
Ricardo, on the basis of his false theory, believed that, if the country had an excess of gold, commodity prices would rise. In consequence, commodities would be imported and gold exported, to pay for them, restoring prices, and vice versa. So, when, in 1847, the crop failure caused an import of agricultural products, and outflow of gold, the Bank Act required the Bank of England to also reduce the bank notes in circulation that acted as tokens for this gold. The consequence was that the amount of currency in circulation was reduced. Firms began to hoard cash and to demand cash payments, reducing or stopping commercial credit between themselves, which, of itself, caused a sharp slowdown in economic activity.
Firms, in need of cash, began to discount bills of exchange in their possession for cash, which meant the merchant banks and discount houses had to borrow more from the Bank of England, pushing up market rates of interest. A credit crunch, like that of 2008, ensued. Large numbers of speculators who needed cash to meet calls on their stock purchases did not have it, and could not borrow it. Stock prices crashed.
Yet, as Marx and Engels describe, the economic crisis that ensued was a consequence of this financial crisis that had been caused by the Bank Act, and the false theory that lay behind it. That was shown by the fact that, when parliament suspended the Bank Act, that was enough to stop the hoarding of cash, which flowed into circulation, the credit crunch ended, the circulation of commodities resumed at a pace, and the uptrend, began in 1843, proceeded to run until around 1865.
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