2020s >> 2023 >> no-1431-november-2023

In The Return of Inflation (just published by Reaktion Books) Paul Mattick (the son, not the father) gives a potted history (there are only 146 pages of text) of inflation. The word dates from the middle of the 19th century. He cites an American book of 1855 complaining that an ‘inflation of the currency makes prices rise’ and comments ‘here it is the quantity of paper currency that is inflated; later the term settled into its present-day meaning of an increase in prices’. True, but the word still retained its first meaning for a further eighty or so years. The change of meaning from describing a cause to describing its effect doesn’t help, especially as a rise in the general price level can result from other reasons such as supply not being able to keep up with demand in a boom or a fall in the value of the money-commodity (when there was one).

He provides a useful section in which he explains how ‘inflation’ (as it has come to be defined) is measured by a rise in a consumer price index based on the prices of a changing basket of goods and services that consumers typically buy and discusses the limitations of this. In fact, today ‘inflation’ means a rise in some index of consumer prices, but this can come about for other reasons than an over-issue of the currency; from an increase in the price of something that enters into the cost of production of all consumer goods, energy for instance.

At the end of chapter 4, after explaining that, due to increasing productivity, you would expect prices to fall and noting that in the 19th century this did tend to happen and that even in the 1920s and 1930s prices fell during the slump stage of the business cycle, Mattick poses the question of why this has not happened since WW2. On the contrary, the general price level has continuously increased. In Britain prices today are more than 50 times higher than what they were in 1939 and are still rising. It is similar in other countries. Certainly something that needs explaining.

The Quantity Theory of Money

This monetary theory, referred to by Mattick simply as the Quantity Theory, keeps cropping up throughout the book. It says that the general price level is determined by the amount of money in circulation, so that if the amount of money is increased this will lead to a rise in prices. It was originally put forward when ‘money’ meant gold (or silver) and paper notes convertible into it at a fixed rate. Its proponents, known in Britain as the Currency School, based their case on what had happened there when, during the Napoleonic Wars, paper notes were not convertible into gold, and so many of them were issued that prices rose.

They argued that the same thing would happen when convertibility was restored, and framed legislation to restrict the amount of bank notes that could be issued without being backed by gold. They were opposed by the Banking School, whose main proponent, Thomas Tooke, produced evidence, as Mattick notes, that showed that this had not happened after convertibility was restored and could not have happened; if too many notes were issued (if their number was inflated) what would happen would be that gold coins would drop out of circulation and be turned into bullion (demonetised into gold bars) leaving the price level unchanged. In other words, it was the amount of prices to be realised that determined the quantity of money (gold and paper notes together) in circulation, the exact opposite of what the Quantity Theory posited. Marx, Mattick adds, accepted Tooke’s findings and rejected the Quantity Theory. He regarded banking legislation based on it as mistaken, such as the 1844 Bank Act which gave a monopoly in the issue of bank notes to the Bank of England and restricted the amount it could issue to not much more than the amount of gold it had in its vaults.

Inconvertible paper money

By the end of the 1930s in most countries gold coins had ceased to circulate and the currency was composed entirely of bank notes issued by a central bank together with lesser denomination token coins. This situation, where the currency was just inconvertible paper notes, was discussed by Marx who accepted that in this circumstance the Quantity Theory could apply: if more such notes were issued than the prices to be realised of goods and services in the economy required, the result would be a depreciation of the underlying value of the notes and a consequent rise in the general price level, ie £1 would buy less than it did. Mattick mentions this but only in passing, even though it must clearly be of some relevance in any explanation of the continuous rise in the general price level since 1939.

An inconvertible paper currency in itself does not have to lead to a rise in the general price level but does place the onus of getting right the amount to issue on those responsible for issuing the notes. If they get it broadly right there won’t be a persistent rise in prices. But the temptation is always there to use their position to issue money to fund government spending, or to passively make it available to commercial banks in a way that still leads to an excess issue.

Keynesianism fails

Another change in usage that has occurred since the 19th century, but which Mattick does not mention, is a change in the meaning of ‘money’. Since the 1930s it has commonly been extended to include commercial bank loans.

Keynes went along with this and taught that controlling the amount of the currency (which only the state can do) was relatively unimportant and that the monetary authority could safely make available what was needed including by the government. He argued that the way out of a slump was government intervention to encourage spending, as by transferring money from the rich to the rest and by the government itself spending on infrastructure projects (or even digging holes in the ground and filling them up again). This appeared to work for nearly three decades after WW2 in the sense that no big slump occurred even if a rise in the general price level did. However, put to the test when the post-war boom came to an end in the mid 70s, Keynesianism led to ‘stagflation’; prices continued to rise despite slump conditions whereas before the war they would have fallen due to declines in production and trade.

As in his previous writings Mattick is good on why Keynesianism was mistaken:

‘From the Keynesian point of view, government spending is just an expansion of demand, or an additional investment in future production (…) Once we remember that the goal of capitalist production is the earning of a return on investment, however, things look different (…) Capital is not produced but consumed by governments; state spending does not solve the problem of insufficient profitability. It is an expense of the capitalist economy’ (p.110).

Monetarism too

Following the failure of Keynesianism in the 1970s, the monetary authorities heeded instead the theories of ‘Monetarism’ as propounded by Milton Friedman. This was an attempt to revive the Quantity Theory of Money but since in the meantime the definition of ‘money’ had typically expanded to include bank loans it was, rather, more a Quantity Theory of Bank Loans: that bank loans play a key role in determining the price level. (Already in the 1920s this had been dubbed the ‘Bank Deposit Theory of Prices’ by the Classical economist Edwin Cannan). This was clearly a different theory to the classical formulation but its application in the 1980s arguably did bring the rate of rising prices down even if inflation continued, though it certainly didn’t end the slump; in fact unemployment rose to record post-war levels. As Mattick notes, ‘the money supply turned out to be difficult to control, swelling and shrinking in response to the needs of businessmen and bankers’ (p.67).

The objections to the original Quantity Theory of convertible paper currency were seen to apply to Friedman’s quantity theory of bank loans. Bank lending depends on the state of the economy. It goes up in a boom and down in a slump. Neither the state of the economy nor the level of prices is intrinsically controlled by the level of bank lending. It’s effectively the other way around. Governments have tried and are still trying to control bank lending by varying short-term rates of interest (the government can’t control long-term rates); after the crash of 2008 keeping them low in an unsuccessful bid to encourage expansion and, currently, increasing them in the hope that this will reduce the rate at which prices are rising,

Inflation or recession

Mattick’s explanation of the continuous rise in the general price level since 1940 is that ‘inflation ha taken the place of recession’ (p. 123), that ‘all this extra money has provided an alternative to the deflationary depressions of the past’ (p. 120). He is not the only student of Marxian economics to take this position. His argument is that in a slump the price level would normally fall because of reduced overall demand for goods and services (as it did up to the end of the 1930s) but that governments’ monetary policy has prevented this, in his view initially to avoid a workers’ revolt and, later, to keep them happy with jobs, pensions and other payments.

He says the extra cost of providing education, health services, unemployment and sick pay — all needed to maintain a trained and fit profit-producing workforce— will have had something do with the continuous post-war rising prices because governments chose to partly finance this by issuing more money. This is sometimes called ‘printing’ more money but the process is not so simple as that, as Mattick explains in regard to what happens in the US (it’s essentially the same in other countries):

‘The Federal Reserve puts money into the economic system when it purchases treasury bonds (and other securities) in what is called “open market” operations (it withdraws money from the system by selling Treasuries). It pays for them with Federal Reserve notes — “liabilities” in accounting talk, IOUs against Federal securities which can always be sold. It is these notes — government debt — that circulate throughout the economy’ (p. 66).

Central bank notes are a part of the government’s debt but only a very small part of it. Although the initiative to create new money comes from the central bank the whole banking system is involved. This gives rise to the illusion that it is the commercial banks that create new money whereas in fact they are only circulating what the central bank created. Unfortunately, Mattick seems to accept that commercial banks can create new money. He writes, for instance, of what a bank can do when an amount of money is deposited with it:

‘The money can be loaned as a note — another form of IOU — or in the form of a new deposit, in the borrower’s name, in the loaning bank; thus the original money lent to the bank can appear in two or more different deposits, each of which can be used to make payments by banknote. In this way … banks can enlarge the supply of money’ (pp.22-3).

But this can’t be. If $1,000 is deposited in a bank, the bank can lend most of this, say $900, in the form of a bank account which the borrower can draw on. There will be now be two bank deposits, one of $1,000 and the other of $900, totalling $1,900, but one is an asset (the initial deposit) and the other a liability (a loan to the borrower). It should be clear that no more than the initial amount of $1,000 can be spent. If together the amount withdrawn by both deposit holders comes to more than this, the bank wouldn’t be able to honour the excess. Banking is in fact based on the fact that the initial depositor is not going to withdraw more than $100. What banks do is increase spending by lending already existing money that might otherwise lie idle – in essence, commercial banks circulate money but don’t invent it out of nothing.

Despite this error, Mattick provides a good description of how capitalism works:

‘The goal of production in this mode of social organization is not actually “growth” — the enlarged production of consumable goods — but enterprises’ competitive accumulation of control over social resources in the form of money: capital accumulation’ (p.145).

He points out that taxation is not ultimately a burden on the workforce:

‘Wages are also taxed, but if we think of wages as the amount of national income that the class of wage-earners accept in return for their work, it is clear that the amount taken as tax could just as well have been retained by their employers’ (pp 89-90).

Mattick is neither a professional nor an academic economist; which is probably why his book is written in simple English and easy to follow, though the last chapter in which he argues that capitalism has become ‘a sort of Ponzi scheme’ differs in this respect from the rest. All in all, though, with some minor caveats it can be recommended for those seeking to learn more about ‘inflation’.

ADAM BUICK

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