Capitalism is an inherently unstable
system. It is cyclical in nature. Precariously balanced between
inflation and deflation, boom and bust, growth and depression.
Inflation
Inflation is commonly portrayed as a
“rise in the cost of living”. It is measured by the government in
two ways: the Consumer Price Index (CPI) and Retail Price Index
(RPI). These measures track the prices of commodities.
On one level, inflation is the result
of supply and demand. Recent fires in Russia have led the Russian
government to stop exporting grain. This shortage of grain will
increase the value of grain in world markets, causing the price, and
that of other products such as bread, to be inflated. Conversely,
were there to be an increase in the supply of grain, its value would
fall, and the price would be deflated.
But this supply and demand can only
partially account for inflation and deflation. Were grain to be as
common as grains of sand, it would not become worthless. There is
still labour invested in the sowing and harvesting of grain, still
labour invested in the grinding of grain into flour, and the baking
of flour into bread. The absolute value of an item is determined by
the labour power invested in its production.
However, with industrialisation, the
amount of labour needed to make bread has fallen. Whereas in the
past, bakers would spend ten minutes kneading dough to make a single
loaf of bread, now vast machines can knead hundreds of loaves of
bread at once. Bread can be made without being touched by a human
hand. This increase in the supply of bread will at first make the
capitalist more money – he has more bread to sell. But as the
market becomes flooded with mechanical bread its value will fall, its
price is deflated. We then have very cheap bread, but less people
employed to make it, and less people employed means a reduction in
the ability of our workers to buy the commodities!
So what else can determine the changing
price of a commodity?
This rise in the cost of commodities
can also be expressed as a fall in the value of money. If the money I
have in my pocket can be exchanged for less of a given commodity,
either the price has gone up, or my money has lost its value.
Therefore we can either say that the cost of a commodity has risen,
or the buying power (value) of my money has fallen. As the value of
money decreases, the relative value of other commodities increases.
As we saw, with an increase in the
supply of grain, the price of grain would fall. But what if there was
an increase in the amount of money? Suppose we used gold coins as
money, and there was suddenly discovered a new gold mine, with so
much gold that it was just laying around in great piles like sand.
Our grain seller will now want a lot more gold for his grain. Thus as
the value of our gold currency falls, the value of grain is inflated.
This is also true with paper money. If the Bank of England prints
more and more money, the value of the paper money will fall.
So far we can say two things:
As the supply of a commodity increases,
its value decreases. (Less money is needed to buy the commodity) -
Deflation
As the supply of money increases, its
value decreases. (More money is needed to buy the same amount of a
commodity) - Inflation
The reverse of each of these statements
is also true.
(So:
The supply of money and the value of
money are inversely proportional.
The supply of commodities and the value
of commodities are inversely proportional.
The supply of money and the value of
commodities are proportional.
The value of money and the value
commodities are inversely proportional.)
The supply of Money
If the supply of money affects its
value, how do we account for changes in the supply of money? Examples
of increases in supply are easy to find.
In Zimbabwe, what began as inflation in
food prices caused by land reforms, soon spiralled into monetary
inflation. Inflation rose from an annual rate of 32% in 1998, to an
official estimated high of 11,200,000,000% in August 2008 according
to the country's Central Statistical Office. As of November 2008,
unofficial figures put Zimbabwe's annual inflation rate at 516
quintillion per cent, with prices doubling every 1.3 days. This
inflation was largely the result of the Zimbabwean government simply
printing money.
The Bank of England, during the
financial crisis, increased the supply of money through quantitative
easing. The bank did not print more money, but created it
electronically. This was then used to buy bonds from commercial
banks, increasing the amount of capital, with the intention of
refinancing them. This refinancing would stop banks failing and
encourage them to lend money to businesses.
Quantitative easing is a last resort
method, used when interest rates are at, or very near, zero. Interest
rates are a tool used to change the amount of money available in an
economy. If interest rates are low, money is easy to borrow, if
interest rates are high, borrowing is more expensive and people
prefer to save.
So how is supply reduced?
One way to reduce the supply of money,
and thus reduce inflation, is to raise interest rates. This affects
people in two ways. As money becomes more expensive to borrow, people
are less likely to use credit cards etc. The amount of interest they
pay on mortgages will also increase; reducing the amount of money
they have to spend on other commodities. High interest rates will
also encourage people to save any spare money they have, as they will
be able to earn money in high interest saving accounts.
There is also an important factor in
high interest rates for our capitalists. While one sector of the
capitalists will suffer a fall in the amount of commodities they are
able to sell, the financial capitalist will be very happy. The
financial capitalist will see the value of his capital rise. He will
earn money from the mortgages of his debtors and earn more interest
payments on the capital he has invested.
So the central banks have a difficult
path to tread. They need low and stable inflation so that commodity
prices are affordable and still bought by the public. They also need
to ensure that inflation does not become influenced by the value of
money – money must retain its value. Interest rates must also be at
a level that allows lending to the consumer, but also ensures a
return for the investor. The most effective way of ensuring a supply
of money to the consumer to spend is through the extension of
affordable credit.
Credit
One of the fundamental contradictions
of capitalism is that of overproduction. As machinery is introduced
and commodities are made more cheaply, more and more can be produced.
As more are produced their value falls. To maintain profits the
capitalist needs to sell ever-increasing numbers of his commodity.
The problem comes to a head because not only are his profit margins
squeezed, but also the ability of the consumer to buy all these extra
commodities falls as many of our workers have lost their jobs because
they have been replaced by machines. Eventually the capitalist
producing the commodities goes bust and the economy goes into
recession, allowing the cycle to start all over again.
In order to mop up the over produced
commodities and avoid recession, credit is extended to the workers.
This does not create the same inflationary pressures as printing
money (outlined above), because whereas increasing the supply of
money reduces the value of the money, increasing the supply of credit
is built upon the belief that the credit will eventually be paid
back. Money is not created; rather the economy becomes driven by
fictitious capital. This fictitious capital retains its value because
everyone engaged in the system believes that it will eventually be
paid back and made real.
The capitalist wins three times over
through credit:
- By using credit, the worker will not, at first, demand higher wages
- Credit allows over production to seem to be cancelled out
- Credit allows the financial capitalist to earn money from the debts of the workers.
But as we have seen, the massive
extension of credit at the end of the 20th Century used to avoid a
crash, created a bubble that led to a different kind of crash in the
21st Century.
Brilliant article Tim!
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