How Larry Summers proved Marx was right about everything — (And why this is not necessarily good news)

by Jehu

In honor of Larry Summers’ likely failed attempt to be the first in line to sniff Ben Bernanke’s chairman’s seat at the Federal Reserve Bank, I am going to look at his paper on Gibson’s Paradox. If he is successful in replacing Bernanke as head counterfeiter at the Fed, the paper might hold some clues to his future policy actions. Or, at least that is my theory — we will see what develops.

1. Background

So what is Gibson’s paradox, and why was Larry Summers interested in it in the 1980s? According to Wiki:

“Gibson’s Paradox is the observation that the rate of interest and the general level of prices are positively correlated”

Rows of gold barsThe alleged paradox at the heart of the positive correlation between prices and interest under a commodity money regime is simple, but has far reaching implications: Unlike the predictions of mainstream economics, the empirical evidence shows that as prices increase, so does the rate of interest; and as they decrease, so does the rate of interest. As Sam Williams explains in a blog post,

“The “paradox” involves a major contradiction between marginalist economic theory on one hand and the actual history of prices and interest rates under the gold standard on the other.

The question of “interest” involves the holiest of holies of economics, the nature and origin of surplus value. The marginalists confuse the rate of interest, which is only a fraction of the total profit, with the rate of profit. They falsely claim that if the economy is in equilibrium, there will be only interest and no profit. They therefore make their task of explaining away surplus value much easier by first reducing the total surplus value, or profit—which is divided into interest and profit of enterprise—plus rent, into interest alone.

According to traditional marginalism—not the marginalism of Keynes in his “General Theory”—there is a natural (long-term) rate of interest whose purpose is to equalize investment and savings. According to the marginalists, interest arises because capital is scarce. The scarcer capital is, the higher will be the rate of interest. By “capital” the orthodox marginalists mean real capital. In traditional marginalist theory with its quantity theory of money, money is treated as a mere means of circulation that passively reflects the value of the commodities it circulates much like the moon reflects the light of the sun.”

Gibson’s paradox, Williams explains, is only a paradox because it fundamentally contradicts neoclassical theory of money:

“However, Gibson’s “paradox” is no paradox at all according to the theory of the industrial cycle based on Marx … The observed fluctuations of prices and interest rates under the international gold standard behave exactly as my Marx-based theory predicts they should.”

However, understanding this so-called paradox is not as simple and straightforward as it first appears: The problem is further complicated not only by the fact that commodity money behaves exactly as Marx predicted, it turns out that fascist state issued debased valueless inconvertible fiat (fiat, for short) does not behave the way Marx predicted commodity money behaves. Now, this would not be a problem for theory except we haven’t had a commodity money standard of price in our economy since 1971 when Nixon withdrew from the Bretton Woods agreement and stopped redeeming Washington’s valueless dollars for gold.

Thus it appears a core category of economic analysis, prices, no longer behaves as predicted by labor theory — prices no longer reflect the values of the commodities to which they are attached. And that, my friends, is a really big problem for labor theory analysis of the entire mode of production.

2. Barsky’s and Summers’ Findings

Barsky and Summers first set out to prove that there was a Gibson paradox, which is to say commodity money behaves exactly as Marx said it does. In Section I using the available empirical data from 1730 to 1938 they show the paradox does apply solely to a commodity money price regime.

They demonstrate, first, that the consistency of Marx’s theory with the observed empirical data is not spurious, i.e., accidental. Second, they show this behavior breaks down whenever the commodity money regime is relaxed or abandoned, as during war-time. Third, they show the relation between prices and interest is weaker during non-gold standard peacetime periods than it is during gold standard periods. For instance the behavior was weaker when, “the post-1921 gold standard was closely “managed” by central banks and encumbered by formal and informal restrictions limiting convertibility.” The paradox disappeared altogether during periods of war.

Without acknowledging it, Barsky and Summers concede Marx was completely correct in his description of the behavior of prices and interest and the relation between the two according to the empirical evidence compiled and analyzed by Summers and Barsky. Mind you, this is not the argument of worthless Marxist academics like Moseley, Kliman or Dumenil, we are speaking of Larry Summers, former treasury secretary of the United States. His conclusion is that valueless fiat money does not behave like commodity money and whenever it replaces commodity money the relation between prices and interest described by Marx breaks down.

Which is to say, under a fiat money regime the law of value is no longer expressed in the movement of prices and interest rates. We are dealing with an entirely different animal than that described by Marx in Capital — an animal whose behavior must be understood on its own terms. You cannot simply transpose Marx’s analysis on the operation of the mode of production today without adjusting for the fact that valueless fiat does not behave like commodity money and is designed precisely to behave differently.

Next, Barsky and Summers turns to the question of whether the relation between prices and interest described by Marx continues today.

“An important question, and a frequent source of confusion, is whether or not Gibson’s paradox persists into the post—World War II period.”

Their conclusion is that it does not and they identify the culprit, Richard Nixon:

“The complete disappearance of Gibson’s paradox by the early 1970s coincides with the final break with gold at that time.”

Which is to say, once commodity money was removed as the standard of prices, the mode of exchange no longer functions as described by Marx in Capital. So how does it function? This leads Barsky and Summers to what they call “A Theory of the Real Price of Gold and the World Price Level” in Section II.

First, let me make a point here. The phrase, “the real price of gold” is an oxymoron akin to talking about “the real price of the euro”. Since gold is a money just like the dollar, euro or the yen, it is senseless to attempt to define its “price”. Gold, like dollars, yen, euros or any other currency, has an exchange rate with these other currencies just as they have with each other. When Barsky and Summers put forward a “theory of the real price of gold”, they are merely putting forward a theory of the exchange rate of gold with some currency or currencies in general. Had they explained this directly, section II could have been reduced to this:

“The exchange rate of gold to dollars is the reciprocal of its so-called price in dollars.”

If the “price” of an ounce of gold is $1,300, the exchange rate between gold and dollars is one ounce of gold is equivalent to 1300 dollars. This, however, is not as far as it goes: in the exchange rate,

1 oz. gold = 1,300 dollars,

the expression is reversed according to labor theory. In the relation between gold and dollars, gold is the universal expression of value and dollars are a relative form, like euros and yen. The proper way to write the equation is, therefore:

1,300 dollars = 1 ounce gold, or 1 dollar = 1/1300th ounce of gold

Which is to say, one ounce of gold is the “price” of 1,300 dollars. 1,300 dollars or 1,000 euros or 130,000 yen each have a price in the market of 1 ounce of gold. However, even this expression, while correct from the viewpoint of gold, is absurd from the viewpoint of dollars, euros and yen. 1,300 dollars, 1,000 euros and 130,000 yen have no value of their own, and only symbolically represent an ounce of gold. So, we cannot say 1,300 dollars has a price of 1 ounce of gold, but 1,300 dollars represents 1 ounce of gold.

Since under the present monetary system the dollar is not pegged to some definite quantity of gold, the value represented by a dollar necessarily fluctuates from moment to moment. If the so-called “price” of gold should change from 1,300 dollars to 1,270 dollars, then 1 dollar would no longer represent 1/1300th of an ounce of gold, but 1/1270th of an ounce of gold.

The so-called price level measured in gold or some other commodity money can be expressed symbolically in dollars, euros or yen. These valueless symbols, however, are not actual values, but symbols or tokens of value. So, for instance, the price denominated in dollars of a car can go from $2000 in 1971 to $74,000 in 2013 and still represent the same value — 57 ounces of gold. On the other hand a day’s average labor power may cost $28 in 1971, but $152 in 2010, while the value represented in these wages has fallen from 0.8 ounce of gold to 0.12 ounce of gold.

So when Barsky and Summers say they are presenting a “theory of the real price of gold” we are in fact getting their theory of how the quantity of dollars representing 1 ounce of gold is determined. They take as their starting point the gold standard, where the dollar was pegged to some definite quantity of gold. (This originally was 20.67 dollars to one ounce of gold). They then discuss how this model is influenced by the “real rate of return”.

Under a gold standard monetary system anyone can enter a bank and redeem their valueless token dollars for gold at the standard rate of 20.67 dollars to one ounce. Prices, therefore, can be thought of as so many units of gold expressed in the form of some token currency — in the form of a placeholder standing in for physical quantities of gold. To say a commodity has a price of $20.67 is identical with saying the commodity has a price of one ounce of gold insofar as the $20.67 is a promise to pay its holder one ounce of gold should she care to redeem it. The “real price of gold” is, therefore, simply the quantity of dollars the state sets as the equivalent of one ounce of gold. This physical standard of prices is what Barsky and Summers humorously call the “general price level”.

Okay. Fine. Whatever. Have it your way, Larry.

Having defined the so-called ‘general price level’, Barsky and Summers now explain that gold can last in a hoard a long fucking time. It’s not like strawberries or conch shells. Since it can survive long periods without disintegrating and since gold has few uses beyond store of value, the stock of gold held by society accumulates over time. It is the demand for the existing stock of gold, not demand for new flows of gold that counts in analysis. (This is not completely accurate, but I will let it pass for the moment.) Thus the willingness to hold gold in a hoard depends on the rate of return the holder of the gold could realize by directly employing it as capital or by loaning it out as money-capital. This rate of profit stands outside Barsky’s and Summers’ model and is given. A hoard of gold has zero rate of return; it is a dead lump of mostly useless metal sitting in a vault. Whatever use this hoard can be put to to create surplus value is outside the scope of the discussion of gold itself.

Gold, Barsky and Summers tells us, is held in two forms: monetary and non-monetary. This is a significant point, because, it seems, Barsky and Summers assume hoarding is NOT a monetary form of gold. Unlike Marx’s theory, neoclassical theory assumes that when gold is sitting in a vault it is not money unless the vault is a bank holding it as reserve for loans. This is an important difference because in neoclassical theory money is only means of exchange; it’s role as store of value is not pertinent. Since in neoclassical theory there is no such thing as value, there would be nothing to store.

Thus, when neoclassical theorists talk about money and labor theorists talk about money, they are each referring to a different thing. It appears that what a neoclassical theorist means by money is money-capital only — money in circulation. One thing that might be noticed is that since neoclassical theory only considers money-capital as money, profit must be a component of price. Or, what might be the same thing, since profit is considered a component of prices, only money that serves as money-capital is money.

Okay, enough of that.

So what did Barsky and Summers find out with all their equations and whatnot? Their calculations showed,

“a rise in r will cause the monetary gold stock to increase at the expense of the nonmonetary stock…”

Which is to say, when the rate of profit increases, money flows out of hoards and into circulation as money-capital exactly as labor theory predicts.

“Thus the rise in prices will be associated with an increase in the monetary gold stock…”

They continue,

“Our approach also accounts for the coincidence of the Gibson paradox observation and the gold standard.”

Which is to say, the results produced only apply to a commodity money, not valueless inconvertible state issued fiat.

Having established that at least during the gold standard period labor theory was fully vindicated by the empirical evidence, Summers and Barsky turn their attention to the present post-gold standard period. They state,

“Omitting the monetary demand for gold, we see that the theory continues to hold in the same fashion. Thus an important test of the model is to see how well it accounts for movements in the relative price of gold (and other metals) outside the context of a gold standard. The properties of the inverse relative prices of metals today ought to be similar to the properties of the general price level during the gold standard years. We focus on the period from 1973 to the present, after the gold market was sufficiently free from government pegging operations and from limitations on private trading for there to be a genuine “market” price of gold.”

Don’t be fooled here by Barsky’s and Summers’ mangled presentation. This is not about the “relative price of gold”, but about the exchange value symbolically represented in dollars, euros or yen. Which is to say, what we have here is the key to unlocking the whole mystery of fascist state economic policy. The inverse of changes in “the relative price of gold”, is the fluctuation of the exchange value represented in a fixed quantity of a  currency.

Although, I admit, most of what Barsky and Summers describe here is almost complete gibberish to me, I can understand enough of it to follow their discussion. In figure 4, they compare “the (log) inverse real gold price and our estimate of the expected pretax real interest rate.” Which is to say, they compare the value symbolically represented by dollars to their estimate of the pretax average rate of profit. It turns out that the variation of real interest rates is responsible for much of the movement in the relative price of gold, i.e., the quantity of exchange value represented by a dollar.

To break this down in the simplest possible terms: What Barsky and Summers found is that the movement of gold prices can be explained by the average rate of profit. When profits fall, gold rises in price; when profits rise, gold falls in price. In a depression, for instance, the price of gold tends to rise as the profits fall, and vice versa.

One unspoken but highly significant implication of this finding is that it is possible for us to identify periods of economic expansion and depression by plotting changes in GDP in physical units of gold once we grasp Summers’ and Barsky’s argument. To give an example how easy this is, you may have seen this chart which I have posted before:


At the far left side of the chart you will see the unmistakable footprint of the Great Depression measured in gold. The following two collapses in GDP are the 1970s depression (1971-1980) and the present depression (2001-present). Larry Summers says this chart is valid and he proved in his 1988 paper that the chart above faithfully reflects underlying economic reality as described by labor theory.

So why have you never heard about the Greater Depression of the 1970s? A depression that was many times larger and longer than the Great Depression? And why do you not know we have been in a depression since 2001 that is even greater and longer than the one in the 1970s? The answer to these questions is simple: Marxist academics have fallen down on the job — their analysis is totally screwed up.

What Barsky and Summers show is true for gold and nonferrous metals, is, in fact, true for the entire world market as well. Another way to put this: In periods of expansion, a fixed quantity of dollars represent a greater quantity of gold. While in periods of depression, that same quantity of dollars represent a smaller quantity of gold. Again, dollars do not behave like a commodity money. A commodity money like gold will be moved into circulation during expansions and out of circulation during depressions. But since fiat currency has no value, it does not respond to expansions and depressions by such movements. Instead prices fall during expansions and rise during depressions.

Now why is all of this long discussion important? Simple: Barsky and Summers proved that once the dollar was detached from gold, prices were detached from values. All of the analysis based on value must, therefore, take this into account. And not only must analysis take into account that values are no longer expressed in prices, analysis must also take into account that:

  1. the rate of surplus value is no longer expressed in the rate of  interest;
  2. the value of labor power is no longer expressed in wages;
  3. money-capital is now detached from money; and,
  4. The mode of exchange was detached from the mode of production.

In a word, there is no longer a definite and fixed relation between the law of value and the operation of the mode of production.

Can you folks in the Marxist academy get this through your thick fucking skulls? I’ll repeat it again, for those of you who are too dumb to grasp what has happened: when the state replaced gold by fiat dollars it suppressed the expression of the law of value. Fiat dollars do not behave like commodity money and have to be accounted for separately in your research. If you do not account for fiat in your empirical work, the fascists know more about how the mode of production is operating than you do — you are operating up a blind alley.  Which means all the empirical work undertaken by Marxists since 1971 is trash, garbage, bullshit, worthless — forty fucking years of “garbage in-garbage out”. The worst part is that asshole Larry Summers has been laughing at your useless calculations since at least 1988!

Now it is possible that, as Sam Williams said in the quote cited above, bourgeois economics doesn’t realize,

“The observed fluctuations of prices and interest rates under the international gold standard behave exactly as my Marx-based theory predicts they should.”

Which is to say, it is possible that Summers never realized he was proving through his review of the empirical data that labor theory is completely valid. It is possible Larry Summers really is as dumb as he looks. But I ain’t going to bet the house on it. It seems to me the Summers was conceding to labor theory that its basic assumption about the operation of the mode of production was correct, because he also realized, at the same time, that by ending the gold standard the fascist state had bought a few more decades of life for the capitalist mode of production.

This is an idea I will pursue in the final part of this series.