Chapter 15 : Money and Capital

The Keynesians see the economy as a money economy and tend to forget that it is a money-making economy. In their view money appears as a mere instrument of manipulation for turning insufficient into sufficient social production. An excessive monetary growth by way of credit expansion and deficit-financing may lead to inflation, just as credit contraction and too little money tend to be deflationary. To avoid both excesses, there must be the “right” quantity of money; and it is the government’s function to arrange for this “right quantity.” Fiscal policies are in a way also monetary policies, as they merely allocate the “right quantity” of money in the direction most conducive to economic stability and growth. But in order to understand the dynamics of the mixed economy it is necessary to understand the relationship between money and capital.

Well into the nineteenth century different nations adhered to different metallic money standards – silver, gold, or both simultaneously. The precious metals were originally used not only as media of exchange but also as a convenient and relatively indestructible store of wealth. Whether gold or silver were produced within the money-using economies or appropriated abroad by colonizers and adventurers, the quest for gold in pre-capitalist times was mainly a quest for money. The individual’s wealth, as well as the wealth of nations, was reckoned in terms of money, which meant quantities of gold and silver. Money was amassed for its own sake rather than for capitalization in other forms of material wealth. The capitalist system adapted this mercantilist money system to its own, different ends.

As capital, money is both money and more than money. Although capital is conceptually money, this category embraces not only gold but all other commodities as well, for any commodity can take the place of money by expressing its commodity-value as a money-value. The owners of capital are not trying to amass a particular commodity – gold in this case – but to accumulate the money-values of their capitals, which may take on any physical shape. Amassing money, even in the form of gold, would yield them nothing beyond the monetary hoard. Money yields additional value only when it is applied in a productive enterprise. The capitalistic accumulation of money presupposes the accumulation of capital, even though the accumulation of capital requires an initial accumulation of money.

Capital employs labor: if money is to function as capital it must first cease to be money and be turned into instrumentalities that put laborers to work. These instrumentalities, the means of production, are commodities with a value, or rather price, expressed in money terms. By themselves, these means of production are as unproductive as money is in its money form. They become productive only in the labor process. The labor not only reproduces the existing capital, and therewith its value in its money expression, but also produces a surplus which turns capitalist production into capital formation. This is again expressed in money terms by adding the capitalized surplus to the previously existing capital; but, as before, the addition of “money” implies the addition of means of production in a continuous capital expansion process.

Accumulated capital represents money values which have the form not of money but of commodities and capital. Capital is reproduced only gradually, for the means of production deteriorate, or become obsolescent, only over a number of years. The slow depreciation of capital is calculated in depreciation charges which, together with all other costs, are added to the prices of commodities to be realized in the market. Commodities offered on the market must be bought with money, but, since the commodities which are bought or sold on the market at any given time represent only a fraction of the total capital in existence, only a fraction of the total wealth of society need exist in monetary form.

Commodity exchange, or the circulation of commodities from one place to another, does not require a monetary medium. It is actually carried on by human labor and the means of transportation utilized by labor. What money mediates and circulates are not commodities but property claims attached to commodities. However, it is only by way of such property claims that the actual production and distribution process is carried on. This need not involve a specific type of money, however; any medium able to designate the various claims and counter-claims in the exchange process will do as well as any other.

As money, gold enters neither production nor consumption; therefore, the labor and capital expended in its production yields no surplus. The gold producers themselves, of course, profit by gold production, just as other capitalists make profit in other branches of production; but from the point of view of society as a whole, monetary gold constitutes an expense of the circulation process. The less gold is needed as a medium of exchange, the less expensive is the exchange process. The corresponding saving in the production costs of gold can be applied to other, profitable, ends. Although money as gold was once the very incarnation of all wealth and power, in capitalism it is a cost of circulation. For this reason there was from the very beginning of capitalist development a strong tendency to change the medium of exchange from its material into an ideal existence, i.e., to replace commodity money with symbolic money.

The same development which led to the quite general adoption of the gold standard also witnessed the emergence of new and different categories of media of exchange, such as bank notes and checking money. There were then both physical and nonphysical means of payment; the latter were brought into some relation to the former by means of a gold backing which served as a safeguard against the over-issue of token money. With the extension of credit institutions the monetary system became increasingly more complex. Bank credits became the principal medium of payment and standard money began to play a subsidiary part.

This development gave rise to the notion that the credit and debit system supercedes the money system. Although the concept of money, it has been said, is dependent on that of debt – for every sale of goods and services gives rise to a “debt” through the interval between purchase and sale – the concept of debt is not dependent on that of money, for a debt can be canceled by another debt without recourse to money. Bank credit can thus exist without money. All debts, however, are reckoned in terms of money. And even if payments are made and received by check, and these checks cancel each other in the clearing system of the banks, these transactions involve other transactions in the production and exchange process in which currency serves as a medium of exchange. Moreover, business is not carried on in order that businessmen’s claims on one another may be mutually canceled, but in order to make profit. Receipts must be larger than expenditures; money must be made. Any quasi-monetary system of payment is merely an instrument to facilitate the making of money. To see in the credit and debit system of payments a form of money is to see money only as a medium of exchange. But though capitalist exchange is an exchange of commodities and of services treated as commodities, money is here more than a medium of exchange because commodity exchange itself is merely a means for the augmentation of capital.

The wealth of nations and the property of individuals can be expressed in terms of money and in terms of their physical possessions. But this wealth does not exist twice, once as real property and once as money. One may have either the one or the other. A business enterprise may be bought or sold for a certain amount of money. Money is here not a medium of exchange but is itself exchanged for property; it is the equivalent of real things – of property. To be exchangeable, money assets cannot differ from real assets. In this respect it is not correct to say that bank credit can exist without money, for the credit granted is granted for a collateral which represents money, even though this “money” has for the moment the form of real property.

In capitalism, money exists as capital, which appears in fixed or in “liquid” form. In its “liquid” form it may have the shape of commodity-money (gold), or the shape of token-money representing either gold or any other commodity that comprises material wealth. Since all real assets are potential money assets and all money assets are potential real assets, businessmen need not differentiate between quasi-money and real money. Both function equally well in settling exchange relations between business firms. But this is so only because real money as well as quasi-money are both covered by real capital assets. Where there are no real capital assets, credit money does not apply. Of course, there is always the risk that seeming real assets, which serve as collateral for credit money, may turn out not to be real; in which case the courts will finally have to settle debts based on “quasi-property.”

Behind monetary transactions stand the capital values of business firms, not only in their monetary expression but also as material entities in their commodity form. The wage-earning (and salaried) classes do not generally have this kind of collateral. But they may have personal property on the security of which they can borrow money. These classes sell their labor-power as commodities for money. They get paid after their work performances in daily, weekly, or monthly intervals. The labor already per formed is the commodity that is remunerated. Short of their savings, the total money income of the wage-earners equates with the total prices of the commodities they buy. There is, then, an exchange of commodities against commodities. The money mediating this exchange is here a mere accounting device, and as such need not have commodity form.

Usually, the value of money is measured by its de facto command over goods and services. For instance, the value of a pound, or of a dollar, is determined by what one can buy for one pound, or for one dollar. This leaves open the question why this is so. There must be something about a pound or a dollar which equates with something that adheres to the commodities which they can buy. From the standpoint of the objective theory of value, an answer is easily found. If gold is money and gold is a commodity, the costs of producing the gold contained in a dollar, or in a pound, are then considered equal to the production costs of the commodities which they are able to buy – modified, of course, by the changing demand and supply relations of the market.

Money thus has in theory a commodity-value equal to its production costs. Actually, this is not the case. The commodity-value of gold diverges from its money-value, although monetary author it is may set the same price for both. Furthermore, commodity-money comprises only a fraction of the total money supply; even under the rule of the gold standard, the actual convertibility of paper into gold affected only a small portion of the total money in circulation. To the extent that money has a non-commodity form, it cannot derive its value from its production costs. To be sure, non-commodity money may be evaluated in accordance with the labor costs of commodity money; but any such evaluation is a deliberate act. And since at present money in most nations is fiat money, it is clear that – at least nationally – money possesses purchasing power without having commodity-value.

Since the quest for money is now a quest for capital, modern monetary history reflects the history of capital formation. The more extensive use of commodity-money refers to an earlier stage of capitalistic development, characterized by a less-integrated production and marketing system. Capital was less concentrated and operated less routinely; the intervals between purchases and sales were more sporadic than under modern conditions. People preferred metallic money not only because they were used to it, but also because the accumulation of capital generally presupposed the hoarding of money. Money had to retain its value, a condition best assured by maintaining its commodity form. Besides, gold had been the money standard for too long to be easily displaced by mere symbolic money. The circulation of gold coins and the assurance that paper was convertible into gold supported a general confidence in the stability of the monetary system and the value of currencies.

The early preference for commodity-money found its international extension and most important rationale in the “automatism” of the gold standard as the “regulator” of the international exchange economy. The gold standard tied the value of the various national monetary units of account to their gold values and to one another by fixing the price of gold. A dollar represented a certain quantity of gold, as did the British pound and other gold-standard currencies. If one pound could be bought for four dollars, this meant that the gold content of one pound matched that of four dollars. Actually, of course, the exchange of currency was and is not that clean-cut, since prices for different currencies fluctuate with the changing supply and demand of different currencies in the foreign-exchange market. But these differences average out over time in the multitude of exchange transactions. The foreign-exchange market provides an international clearing mechanism. Since debits and credits between national claims may not balance, residual claims are settled by gold shipments in order to reach a complete, if temporary, payments balance.

Only part of newly-mined gold serves monetary purposes. Another part – probably less than half of total production – serves non-monetary needs in the arts and industry. In order to maintain the fixed price of gold, its supply must not exceed the demand; as long as the output of gold exceeds the industrial market demand, the excess must be bought for monetary purposes whether or not it is actually needed. In recent times, it has been found necessary to sell gold on the private market to maintain its fixed price. A steadily increasing demand for gold drove the price beyond its fixed limit, forcing England and the United States to meet the demand by selling some of their monetary gold on the London gold-exchange.

Like money itself, the gold standard was not meant to facilitate the international circulation of commodities in any physical sense; its purpose was to express and secure the property claims attached to the commodities and capital entering the world market. International monetary transactions had to be covered by commodity money for this was the only realistic form in which property claims could be settled.

The gold standard was an agreement between governments during laissez-faire capitalism; as such it was a conscious intervention in the market mechanism. Yet it was conceived as a self-regulatory system parallel to the self-regulatory market mechanism. Nationally, the gold standard implied that the central banks had to keep the value of their monetary unit at par with that of other gold-standard currencies by keeping a sufficient gold reserve. The maintenance of such a reserve set a definite limit to the creation of credit-money. The gold standard was then an instrument to circumscribe the expansion and contraction of credit and therewith the inflationary or deflationary tendencies which find expression in rising or falling prices. Under the rule of the gold standard, a disparity between supply and demand in the foreign-exchange market led to a flow of gold from one country to another: gold flowed to nations with a favorable balance of trade from nations with an unfavorable balance. It was assumed that the drain of gold from a particular country would reduce its economic activity and thus lead to deflation and lower prices, while the influx of gold into another country would stimulate economic activity and thus lead to inflation and higher prices. Because prices would be low in countries losing gold and high in countries gaining gold, trade would shift from the latter to the former. This shift in trade would again reverse the gold movements. It was through the effects of gold movements on the level of prices that the gold standard was adjudged an international equilibrium mechanism.

As an “equilibrium mechanism,” however, the gold standard was as inefficient as the market itself. The assumed close connection between gold stocks and domestic prices did not exist: prices did not fall or rise because of gold movements from one country to another. At times, some nations experienced what seemed to be an unendingly favorable balance of trade and payments, while others were not able to overcome unfavorable balances regardless of their deflationary policies. At any rate, the First World War practically ended the gold standard by interrupting and dislocating the international capital and commodity market. Governments borrowed and issued money in complete disregard of their gold reserves. They paid for necessary imports with gold; so gold accumulated in nations able to sell. After the war, nations left the gold standard either by necessity or by design. By means of currency inflation, governments rid themselves of the enormous debts they had piled up during the war and kept consumption down in order to re-capitalize their industries. In some countries runaway inflation finally threatened to destroy all economic activity, at which point, of course, government-decreed money reforms brought it to an end, thus providing the circulating media with sufficient stability to function in the exchange and capitalization process once again.

It should be clear that it is not the mere availability of credit – due to the influx of gold – which induces new investments and creates conditions of prosperity, but the expected profitability of investments as indicated by the existing profitability of capital. And it is not the contraction of credit – due to an outflow of gold – which issues into capital stagnation, but a lack of profitability of the existing capital, which destroys incentives for new investments and therewith the demand for credits.

An increasing capitalization of production increases the productivity of labor and therewith the competitive ability of an enlarged capital. Where credit expansion leads to capital investments, it also leads to a cheapening of production relative to the production of countries with a lower rate of capital formation. By being able to sell at lower prices, the more-productive countries invade the markets of the less-productive nations. It is therefore not true that credit expansion must always lead to inflationary prices. With a sufficient increase of productivity the supply can match and exceed the demand and can thus not only prevent a rise in prices but even lower them. Instead of losing gold because of adverse trade positions, rapidly expanding economies may increase their gold reserves and thus their money supply in accordance with their credit policies. With a declining profitability of capital, both investments and credit transactions decline. This does not necessarily bring about an increase in sales through foreign commerce, for even the low prices of nations with a contracting economy may still be matched by the prices of nations enjoying a higher productivity in expanding economies. There will then be no influx of money from abroad to stimulate the economic activity of the relatively stagnating nations.

Moreover, with the establishment of the world market the conditions of prosperity, stagnation, and depression became world-wide phenomena. While these conditions affected different nations to different degrees, none remained unaffected. All capitalist nations tended to expand credits in good times and contract them in bad. In its credit expansion, each nation was limited by the size of its gold reserve. In times of depression there was no pressure on the gold reserve since demand for investment credits was low. At such times, nations would simply wait for a turn of events and engage in an intensified competition for markets and gold.

Despite the gold standard’s disappointing results, only reluctantly, and under the pressure of the Great Depression, was it finally abolished. But since commodity-money was still necessary for settling international payments balances, an international gold exchange mechanism was substituted. Though gold still flows between nations, these flows need not affect domestic money supplies. As gold is now regarded simply as a special kind of money, as international money, gold movements need no longer determine national monetary policies. Inflation and deflation result from government decisions to expand or contract the money and credit supply. Precisely for this reason, some adherents of an unrestricted market economy distrust the present arrangement and long for a return to the “automatism” of the gold standard.

The fact that any decline in economic activity shows up as a money-contraction gave rise to the notion that such declines were caused by shortages of money and that these, in turn, were the result of limits set to credit expansion by the rules of the gold standard. Keynes, we recall, held that the gold standard was largely responsible for the crisis conditions which followed the First World War. He felt that the liberal argument against mercantilisms as a system bound to a senseless accumulation of gold lost all its force and meaning because it was precisely the laissez-faire gold competitive pursuit and competitive appetite for the precious metal. ^[1] For with strict adherence to the gold standard, there was no “orthodox means open to the authorities for counteracting unemployment at home except by their struggling for an export surplus and an import of the monetary metal at the expense of their neighbors,” which tended to contract both domestic market and international trade. Keynes advocated freeing national money and credit policies from the requirements of the international gold standard.

It is quite obvious, however, that the existence of the gold standard did not prevent a rather rapid capital formation at the turn of the century; and it is equally obvious that when the gold standard was abolished, the rate of capital accumulation was reduced rather than hastened. Clearly, the expansion and contraction of capital production did not depend on the existence or nonexistence of the gold standard.

An economy with a growing population, growing production and growing productivity will have a continuous increase in the quantity of money. This increase is modified by the application of non-monetary forms of exchange and by the decline of the level of prices due to the increasing productivity of labor. The development of the banking and credit system was a powerful means for speeding up the capital formation process. Not only were widely-dispersed money had resources centralized in large money pools, but under the fractional reserve system these pools provided a wide base for a multiple credit expansion. And while credit allowed for an accelerated extension of industrial and commercial activities, the expansion of production thus fostered allowed for, and demanded, further extensions of the credit system. This reciprocal process implied a steady displacement of commodity-money by credit-money.

However, if banks could create credit at will, the value of money would soon be lost. When the money supply is limited, so is the extension of credit. And with the supply of gold limited, the supply of money and credit was also limited. Cutting loose from gold freed the way for an independent national money policy designed to enhance economic activity through credit expansion, inflation, and deficit-financing.

While there is general agreement that the value of money is measured by its purchasing power, different notions prevail regarding the factors that alter this power. Most popular was the idea that changes in the volume of money would lead to alterations in the general price level. This was an application of the supply-and-demand theory of prices to monetary theory: quantities of money were contrasted with quantities of commodities. The quantity theory of money includes the principle of velocity, that is, that the same unit of money functions in more than one exchange trans action. Aside from the historical fact that an expanding economy also expands its money supply, the velocity of money varies with the increase or decrease of economic activity. If there is a downward trend in the circuit velocity of money this indicates real market disturbances rather than monetary difficulties, even though such a trend will intensify these disturbances on its own account.

In the quantity theory of money, money appears as an independent economic force determining the expansion and contraction of business activities, the rise and fall of prices, and the increase and decrease of income. Actually, the growth of production and incomes does not depend on the presence of any definite amount of money; more money or less may expand the scales of production and income. Moreover, prices are not high or low because more or less money circulates, but more or less money circulates because prices are either high or low. It is clear that if all prices should suddenly double, the existing money supply must also be doubled, for otherwise half of the circulating commodities could not be sold. And if all prices should suddenly fall by half, only half of the existing money supply would be required to clear the market. But doubling the money supply will not double, nor halving it reduce, the volume or value of commodities. The prices of commodities and services, though expressed in money terms, are not determined by but determine the quantity and velocity of money.

It is of course true that if money were commodity-money (e.g., gold) exclusively; its buying-power would vary like other commodity prices. A smaller or larger quantity of money would exchange with larger or smaller quantities of other commodities. A shortage of money would raise its value relative to other commodities, which would induce increased gold production – and this, in turn, would end the money shortage. If gold production could not be increased, this would merely mean that fewer quantities of gold would have to give expression to larger quantities of other commodities. However, the price of gold is fixed and money, which was based on gold solely to the extent of the fractional gold reserve, is at present entirely freed from its gold connection. Under these conditions, increasing the quantity of money beyond the extent of its “normal” growth within the rising market transactions would only mean to change the money expression of constant commodity-values. Assuming an “inflationary” situation in which all prices rise, all commodities would have higher numbers on their price-tags, but otherwise nothing would be altered. There would be no point in increasing the quantity of money.

However, if some prices should rise faster than others under inflationary conditions, a situation of advantages and disadvantages will arise. To be sure, some commodity prices always fall or rise relative to others because of the effects of increasing productivity, or because of changes in the competitive market situation. Such regular price changes do not refer to inflationary or deflationary conditions, which affect the general price level rather than particular commodity prices.

Although inflation affects the general price level, the price of some commodities changes more than others. Wages, for instance, rise less under inflation than do the prices of other commodities. As wages form part of the prices of commodities entering the market, a rise in wages due to inflation can be compensated for in this price. The prices of commodities are set after the labor costs incorporated in them have been settled or paid. A rise in the cost of labor, therefore, cannot prevent a still faster rise in the prices of commodities; so that, relative to the commodities it produces, the cost of labor power would have been reduced.

In this way, general inflation can raise particular prices at the expense of others. But the increase or decrease of money influences economic activity only by creating changes in the distribution of income. Because wages are more sluggish in their movements than commodity prices, inflation leads to higher profits and therewith, to a more rapid turnover of goods and a higher rate of capital formation. Insofar as this keeps up the level of employment, inflation appears preferable even to the workers, for deflation may mean large-scale unemployment. Inflation does not suit all capitalists, nor does it suit those social layers who live on fixed incomes and thus suffer when prices increase. There are, then, social groups interested in inflation and others opposed to it, and these groups wage political struggles for either one or the other monetary policy.

Inflation is usually defined as a condition in which the money income rises faster than the real income, i.e., where there is too much money relative to the available goods. Under conditions of full employment, it is said, inflation occurs when expenditures for goods and services grow faster than potential output. On this assumption, inflation can be stopped either deliberately or automatically – deliberately, by the conscious contraction of the money supply on the part of the monetary authorities, and automatically, because according to bourgeois theory the increasing demand for money raises the rate of interest, which in turn decelerates the expansion process.

It is quite clear that prices will rise with a shortage of commodities and fall when there is a glut on the market, whatever the money supply may be. With given incomes, this merely means that people will be able to buy less at some times and more at other times. What some lose thereby others will gain. The social demand can be smaller than the social supply, but, except as a mere desire, it cannot be larger, for what is not there can be neither bought nor sold. An injection of money under conditions of a limited supply cannot increase the actual demand; it merely increases the prices of the available commodities. The supply can be increased only through additional production; and this depends not on the quantity of money but on the profitability of capital.

In fact, monetary authorities determine the quantity of money by their decisions, mediated through the banks, to make money available for loans and investments. The supply of money is a matter of policy and not the unwilled result of uncontrolled economic events: economic difficulties may be resolved by deflationary or inflationary means. Both these means conform to capitalistic principles; if at a given time one is chosen instead of the other, it is because it appears to be more effective and politically more viable.

A period of extensive capital formation need not be inflationary when sustained by a sufficient profitability based on an increasing productivity. Likewise, a period of economic stagnation is not necessarily deflationary. It usually is so, however, because the preceding stage of expansion leaves a mass of capital and productive capacity too large for other than conditions of accelerated capital expansion. The excess results in idle capacity and idle workers; prices collapse through intensified competition; and the whole system contracts. During a period of retrenchment the system slowly restructures itself until conditions of profitable capital expansion are restored. Because investments decline (or cease altogether) during periods of depression, there are not only idle resources but also idle money, i.e., money unable to find profitable employment. Paradoxically, it is this idle money (and credit) which provides the surface impression of a general money shortage. Such a situation does not call for additional money, but for the restoration of profitability which will strengthen the inducement to invest.

Inflation results from monetary policies designed to improve the profitability of capital internally and so enhance its competitive capacity externally. Deflation, which can have the same effect, was the method most used in the past to overcome crisis conditions. It was not so much submission to the rules of the gold standard which contracted the economy as it was the deflationary process itself which upheld the rules of the gold standard. In other words, it was the principle of laissez-faire, of nonintervention in the economy, and reliance on “automatic solutions” for business slumps, which explain the earlier preference for non-monetary means to combat a state of decreasing profitability. Not money, but capital itself was devaluated and destroyed, in order to make room for a more concentrated and more productive capital structure. Real wages were cut without much concern for social consequences.

But depressions lost their “curative” power, or at any rate, became intolerable. Under twentieth-century conditions the deflationary process of “recovery” became increasingly more untenable because of the social convulsions it tended to release. Inflation became the preferred, if not unavoidable, way to react to depressions and to maintain levels of economic activity consistent with social stability. Inflation of varying intensity is now resorted to under conditions of full employment as well as of unemployment – under conditions of stagnation as well as of expansion. The depreciation of money has been consistent and universal, though the rate of depreciation has varied, often widely, for different nations. When prices rise faster than income destined for consumption (particularly wages), a greater part of total production can be turned into additional capital. While people without capital are victimized by the depreciation of money, the owners of capital preserve and augment theirs by the same process, provided, of course, they are able to realize their profits through market sales. But one good thing may lead to another: profit realization is itself enhanced by the inflationary process. Depreciating money is more rapidly spent than stable money.

The depreciation of a national currency makes capital not only more profitable but also more competitive internationally. However, as the power to devaluate is given to all independent nations, the devaluation of money in some countries leads to devaluation in others. In the end, it will again be the real capital structure, and not the money structure, which determines the relative competitive capacities of different nations.

Through government purchases with borrowed money the public debt is monetized and, with the exception of that part of the monetized debt which may be hoarded, increases the social demand. The process of debt-financing has been an inflationary process in both Europe and America. The purchasing power of the American dollar declined by more than a third in the first twelve postwar years, and to that extent deprived long-term lenders of part of their interest and part of their principal. It deprived all people with more or less fixed incomes of part of their income. This loss can hardly be offset by wage increases, unless wage rates are based on, and actually move with, a cost-of-living index, which is rather the exception than the rule. Monetary inflation has been institutionalized and “has become subject to an institutionalized operation of control by the government and all receivers of private income, among whom the financially potent private enterprises maintain a privileged position.”^[2] Inflation is then another form of subsidization of big business by government. It is merely one of the techniques by which income is transferred from the mass of the population into the hands of government-favored corporations.

Government intervention in the market economy is most pronounced in times of war. Inflation is used to reduce consumption by reducing the buying-power of money, so that a greater part of total production may be freed for the war effort. It is not much different in times of “peace,” when a great amount of government-induced production is needed to compensate for a declining rate of private capital formation. The substitution of government-induced demand for an inadequate market demand has been an inflationary process. This obviously contradicts the notion that inflation results from the existence of too much money relative to the available commodity supply. In an economy requiring government-induced demand, the market demand could not possibly exceed the supply.

Inflation has different effects when it is used to enhance the expansion of capital and when it is used mainly to finance government-induced production. In the first case, it distributes income in a way conducive to capital formation; in the second, it sustains the expenses of government-induced production. It is generally assumed that government spending in a full employment situation will have inflationary effects because it increases the amount of money relative to the actual mass of produced commodities. This would not be so under conditions of unemployment and unused resources, it is said, because government spending would then en large the insufficient demand without pressing on the supply. Under such conditions, government spending need not be inflationary. But as there would be no need for compensatory government-spending in a full employment situation, we need not consider the first case. As to the second, the argument clearly rests on a misunderstanding of the character of the capitalist economy.

Although governments can create new money at will, they do so within the framework of the private enterprise economy. The central banks are agencies governments use to manufacture and control the money supply. They can alter the deposit-creating powers of the commercial banks by changing the discount rate (i.e., the rate of interest at which the central bank lends money to the commercial banks), by changing the legal reserve ratio for deposit money, and by buying and selling government bonds on the capital market. It is the banking system as a whole which creates additional means of payment through an increase in reserves as determined by the monetary actions of the central banks. Banks are thus both businesses and social institutions for the creation and allocation of money. They are in the fortunate position of profiting both as business enterprises and as the delegated instruments of monetary policies. They draw profits and interests not only from the money deposited with them, but also from the multiple amounts created by the fractional reserve system and the growth of reserves by the money-creating practices of the central banks.

Although it is the government which increases the money supply, it does not use this money directly to increase the market demand through government purchases. It finances its expenditures out of taxes and borrowings on the capital market. As far as the private contractors of government orders are concerned, the government-created demand is as good as any other. The government pays them money which must retain its value long enough for the private contractors to regain the value expended in the production of government orders and make the customary profits. If their returns were less than their expenditures because of a too rapid devaluation of money, they would find themselves in a state of disinvestment. Inflation must therefore be a controlled inflation; and it is controlled because it is based not on the government printing presses but on government borrowings restricted by legally set limits to the increase of the national debt.

Idle money and newly-created money are channeled through the banking system into industrial production to government account. But the large bulk of the products thus brought forth are neither capitalized new means of production nor additional marketable commodities; they appear as materialized expenses of government and as such reduce the total mass of private profit relative to the total mass of the existing capital. Prices are then raised to secure the customary profits, and the increase in prices necessitates additional money. Without this additional money the fall of the average rate of profit, clue to the increase of non-profitable government induced production, would lead to a further decline of private capital production; it would thus in some measure, and possibly decisively, undo the increase of economic activity through government-induced demand. It is then necessary to allow for a continuous increase in prices by a continuous increase in the money supply. It is not, as has been assumed, the pressure of an increased demand on a supply caused by government-induced production which leads to inflation. Rather, inflation is the means by which the non-profitable character of government-induced production by way of deficit-financing finds its partial compensation in higher prices.

“Normally,” capital formation indicates a residual surplus of total production after the requirements of total consumption have been met. Accumulation consists of added capital-producing means of production. This occurs in decreasing measure when total production incorporates an increasingly larger share of products which cannot serve as capital-producing instruments of production. Total production, whatever its character, is “marketable,” either in the actual commodity-market or through government purchases; but part of the money realized, which should take on the form of capital, does not do so. And this is because part of the existing non-consumption demand is a demand not for profit-producing capital, but for government purchases which do not include productive capital, or do so only incidentally. Although the total supply may match the total demand, the rate of capital formation declines.

Nonetheless, although accompanied by a low or stagnating rate of private capital formation, the increase in production itself may be formidable. Thus the economy may appear quite prosperous. The fact remains, however, that private capital formation finds itself in a seemingly insoluble crisis; or, rather, that the crisis of capital production which characterizes the twentieth century has not as yet been solved. When viewed from the perspective of profit production, the present differs from the past in that deflationary depression conditions have been supplanted by inflationary depression conditions. In a deflationary depression, production declines because part of the producible commodities cannot be sold profitably, thus preventing the realization of profits and their transformation into additional capital; whereas in an inflationary depression production continues, despite its lack of profitability, by way of credit expansion.

Controlled inflation is already the continuous, if slow, repudiation of all debts, including the national debt. It spreads the expense of non-profitable government-induced production over a long period of time and over the whole of society. Although government-induced production increases the scope of production, it can not increase the profitability of private capital as a whole and thus restore for it a rate of growth that would make a compensatory government-created demand unnecessary. Capitalist profits can be increased only by increased productivity and an increasing quantity of capital capable of functioning as capital, and not by the mere availability of means of payments manufactured by government.

1. The General Theory, p. 349.

2. P. K. Crosser, State Capitalism in the Economy of the United States, p. 104.