Fiat Money is Logically Prior to Capital

A recurring theme of the blog concerns the enhanced social possibilities opened up by ‘sovereign currency’ – also called ‘modern money’ – by which is meant fiat money issued by sovereign government. The social possibilities opened up by sovereign currency follow from an understanding of Modern Monetary Theory (MMT), which makes clear that a currency-issuing government, especially one that permits the exchange rate to float, faces no revenue constraint. The constraints on such a government fall into two broad categories: real resource constraints and political constraints.

Kalecki’s skepticism regarding the maintenance of full employment under capitalism is one example of how political factors are sometimes argued to narrow social possibilities. In this connection, though, it is worth highlighting that Kalecki’s skepticism did not relate to the maintenance of full employment per se, but more specifically to full employment under capitalism. Even if Kalecki’s assessment could be proved correct, this would not preclude the pursuit of ongoing full employment. It would mean, rather, that the achievement of this goal would require a transcending of capitalism.

Kalecki, as a socialist, would presumably have supported a transcending of capitalism, so long as it was a transition to socialism. Such a transition is already possible in sovereign currency systems. Ultimately, sovereign currency, being a creature of the state, is logically (and historically) prior to capital. There could be no capitalism without the state. In contrast, there can of course be a state without capitalism; and, more to the point, there can be currency-issuing government without capitalism. Through the exertion of concerted political pressure from below, it is conceivable that currency-issuing government can be made accountable to the demands of the broader population rather than the narrow concerns of an elite that, for all its wealth, is only small in number. If general populations ever come to support full employment and other progressive social goals, the means for achieving them will already be at their disposal.

The logic of capital

To explain the meaning of the phrase ‘the logic of capital’, it is first necessary to spell out what is meant by the term ‘capital’. The term, in the way it is used here, was introduced by Marx. At the most fundamental level, capital is a social relation. It is a relation between people in which a social surplus produced in excess of the culturally determined subsistence requirements of the working class is privately appropriated by the capitalist class in a monetary form as surplus value. Here, the working class is defined to include all those who must attempt to sell their labor power (capacity to work) to an employer in exchange for a wage or salary, or who depend on the wage or salary of somebody who does. The capitalist class includes those who have no need to sell their labor power and can rely entirely on appropriated surplus value either directly (profit income) or indirectly as a share out of surplus value, for example in the form of interest or rent. Of course, for a lot of social research it would be useful to divide members of the working and capitalist classes into further sub-categories, but for present purposes the twofold distinction between a working class and a capitalist class is sufficient.

The flip side of the social relation capital is wage labor (including wage and salary labor). The social relation capital is predicated on the existence of wage labor. It is the feature that labor power can be bought and sold as a commodity that gives rise to the particular form that the social surplus takes under commodity production – surplus value. That is, the surplus takes a monetary – not just a physical or material – form.

In Marx’s theory, the value of a commodity is the socially necessary labor time required for its reproduction. The value of the commodity labor power is therefore the labor time required to reproduce the capacity to work of the working class. This is conceived as a culturally determined (not absolute) level of subsistence. Provided the working class can be reproduced in less labor time than is actually worked, a surplus will remain for the capitalist class in value form. This surplus value is the monetary equivalent of the labor undertaken in excess of what was strictly necessary to reproduce the working class.

‘Capitalism’ refers to an economic system in which the production of commodities for exchange under conditions of wage labor and private appropriation of surplus value is the dominant mode of production. We could imagine at one extreme pure capitalism, in which all production and exchange is dictated by commodity relations and the social relation capital. At the other extreme, there would be no wage labor or private appropriation of the surplus in value form. Labor power would cease to be a commodity. In between the two extremes are a wide variety of social possibilities that blend a mix of capitalist and non-capitalist features. There is no hard and fast rule for determining when a system is capitalist, but loosely speaking, the system is usually considered capitalist if capital is the social relation that dominates production.

Under capitalism, the motive for private-sector activity is profit. The reason for this is that, in the sphere of capitalist social relations, capitalists make the decisions over what and how much production takes place, and their decisions are made on the basis of expected profitability. Marx expressed this motive in terms of the ‘monetary circuit‘. In abbreviated form, the circuit is depicted in the temporal sequence M – C – M’. A monetary magnitude, M, will be converted by capitalists into commodities, C, for the purposes of production in an effort to obtain a larger monetary magnitude, M’, in exchange (M’ > M). In other words, capitalists will only be willing to make monetary advances to employ workers and acquire plant, equipment and raw materials if they expect to end up with a profit. This gives rise to another meaning of the term capital. In addition to the social relation, the term also refers to the accumulated value, at a given point in time, that is invested in production.

But now we have introduced another notoriously ambiguous term – ‘money’. In the present context, money can be defined as currency plus deposits. For Marx, monetary magnitudes are the equivalents of definite quantities of value (quantities of socially necessary labor). For example, if nominal income is $100 and total employment is reckoned at 100 hours of labor, $1 represents 1 hour of labor. Skilled labor is reduced to multiples of ‘simple’ labor in such calculations. If a commodity requires 10 hours of labor to produce, its value can be expressed equivalently as $10 or 10 hours of labor.

For Marx, under competitive conditions there is a tendency for profit rates to equalize across sectors. Free competition, here, refers to the mobility of money capital, and has no necessary relation to the neoclassical notion of perfect competition between small price-taking firms. Competition, in Marx’s sense, requires the free flow of investment dollars between the various branches of commodity production on the basis of profitability.

Because of the tendency for profit rates to equalize across sectors under competitive conditions, the price of a commodity in exchange will generally differ from its value. Nevertheless, Marx held that, in aggregate, the sum of all values (total value) will equal the sum of all prices (total price), total surplus value will equal total profit, and the average value rate of profit will equal the average price rate of profit.

In Marx’s analysis, constant capital (plant, equipment, raw materials) is the result of past labor (‘dead labor’). In initiating new production, capitalists combine dead labor with ‘living labor’. This initiation of production requires capitalists to make monetary advances in the form of constant capital (c, dead labor) and variable capital (v, wage payments to living labor). These advances are risky for capitalists because they are made with no guarantee of a profit at the end of the process. The advances will be made on the basis of expected profitability, but these expectations might be disappointed, and the expected profits not realized in monetary form.

So capitalist investment decisions depend on expected profitability. Under pure capitalism, social benefits and costs would be assessed purely on this basis. This is what is meant by ‘the logic of capital’. Since profitability depends on effective demand, and effective demand for a particular commodity is contingent on income distribution, a purely capitalist social system would be receptive to the desires of the community only to the degree that these desires were expressed through private spending decisions. The poor would have few means to express their desires for various goods and services – e.g. education, health care, basic amenities – because supplying for these needs would not be profitable for capitalists, who (as mere currency users) are captive to competitive imperatives and in no position to indulge altruistic impulses. Similarly, the employment of society’s accumulated plant, equipment, infrastructure, knowledge and technology would be decided by capitalists strictly on the basis of expected profitability.

Society is logically prior to capital

Of course, in reality, society does not allow itself to be completely dictated to by the logic of capital. Even where the logic of capital is allowed to operate, its influence is attenuated. Workers and capitalists alike are freed in some degree to act according to broader considerations. Regulatory measures delimit the socially acceptable scope and nature of competition. For instance, in advanced economies, the abolition of child labor not only exempts children from the rigors of wage labor but frees capitalists to behave more humanely than would be feasible (for capitalists) in the absence of such an abolition. Society also alters the distribution of income produced under market conditions through the introduction of tax-transfer measures and broadens considerably the goods and services produced through public sector activity, as well as through subsidies and tax breaks for particular kinds of private-sector activity and not-for-profit production.

Given that society ultimately determines how much leeway will be given to behavior driven by the logic of capital, this post could just as easily have been entitled “Society is Logically Prior to Capital”. It is conceivable for society to exist without capital, and it has existed without it in the past. Society is therefore not contingent on capital for its existence, and could do without it altogether if it so desired. To the extent it allows capital, it can do so on its own terms.

From the perspective of Marx’s analysis, the reality of a mixed economy does not alter anything fundamental to the determination of value. Marx’s explanation of value pertains only to goods and services produced as commodities for exchange in markets. Clearly, the government’s fiscal deficit adds to realized aggregate profit, but the way it does so is through the impact of government expenditure and taxation on the level of demand for goods and services produced as commodities. Provided this production occurs under competitive conditions – which, again, for Marx means free mobility of money capital – prices will tend to move to levels determined by cost price (c + v) and the average rate of profit. Government expenditure will act just like any other component of demand in its effects on prices and output. Taxes will act like other withdrawals from the circular flow of income, which subtract from the overall level of demand.

Although society can be regarded as logically prior to capital, the present focus is somewhat narrower and more specific. The suggestion is that society’s choice of monetary regime is logically prior – and not contingent on – capital. Society is logically prior to money, and society’s chosen system of money is logically prior to capital. Further, the choice of monetary regime will influence the degree to which society is able to remain master over the dictates of capital.

Social implications of alternative monetary regimes

We have seen that it is clearly possible for society in a monetary economy to conduct itself along principles not entirely dictated by the logic of capital. We know it is possible because in monetary economies there has been, in varying degrees, a mix of private and public sector activity, redistribution of market incomes, and regulations defining the permissible limits of competitive profit-making behavior. But it also seems likely that the autonomy society retains for determining its preferred private-public mix will vary with the monetary system it erects. It seems, on the basis of MMT, that a modern monetary system – meaning a system in which government issues the currency and preferably allows the exchange rate to float – offers greater flexibility than some other regimes when it comes to the range of social alternatives that could be sustained without ultimately running into insurmountable opposition from the capitalist class.

The gold standard, a commodity-backed monetary system such as Bretton Woods, the common currency arrangement of the European Monetary Union (EMU), and fixed exchange rate regimes all impose greater constraints on the type of social arrangements that are sustainable in monetary economies. The obstacles imposed under these alternative regimes can be warded off for a time – and indeed have been, sometimes for decades, in the introduction of various welfare-state measures – but ultimately the logic of capital undermines the ongoing viability of these alternatives to narrow profit-driven behavior, simply because capitalists if they can help it will impede anything not directly serving their economic interests. These same pressures have been allowed to hold sway also in modern monetary systems since the breakdown of Bretton Woods, though in this case MMT indicates that the constraints have been self-imposed and in many cases imaginary, in that they are based on a misunderstanding of the possibilities opened up by sovereign currency.

One critical difference concerns interest rates on public debt. In a modern monetary system, interest rates are ultimately a policy variable. The market cannot dictate the terms on which a sovereign currency issuer creates its own liabilities. The maturity of the public debt that the government issues and the rate of interest it pays on its debt are both strictly matters of policy. This means that, in a modern monetary system, markets cannot in themselves inhibit democratically determined courses of action, irrespective of the expected return (however conceived) of the productive activity set in motion by the government policy. Such activity can only be inhibited by markets if, by design, market pressures are allowed to have an impact. These pressures might be allowed in the form of self-imposed constraints on government spending, or they might be introduced deliberately through policy design (e.g. the democratic process might indicate a market-based solution such as a carbon emissions trading scheme). By contrast, in other monetary systems, markets can exert greater influence on interest rates on government debt, particularly in the case of trade-deficit nations.

A consequence of this difference is that fiscal policy, subject to no revenue constraint in a modern monetary system, is more restricted in alternative monetary regimes. For this reason, a modern monetary system seems to offer greater freedom to determine through democratic means the appropriate mix of public and private sector activity.

These considerations can briefly be related to Kalecki’s skepticism over the possibility of maintaining full employment under capitalism. In contrast with a modern monetary system, in more limited regimes capitalists are in a stronger position to dictate the terms under which productive activity takes place. If they oppose a government’s attempt to maintain full employment, market influenced hikes in interest rates on government debt and market imposed constraints on fiscal policy can come into play. In a modern monetary system, it is different. Even though capitalists are still likely to oppose full employment, they could not prevent a determined democratically elected government from pursuing the will of the general population. The operative factor would then become the strength of the democratic pressure exerted by general populations for full employment relative to the political power of the capitalist class.

It is perhaps this aspect of sovereign currency (or fiat money more generally) that is resisted by gold standard enthusiasts. Under sovereign currency with an exchange rate that floats, capitalists are unable to dictate the mix of public and private activity in the same way they can attempt to influence it under more restrictive monetary regimes. However, all this really means is that, in principle, the desired mix of public and private activity can be determined democratically, as an expression of the will of the community as a whole, rather than the will of a particular class. There would be nothing to prevent a community from expressing a desire for small government and a private-sector dominated market economy under a modern monetary system. It is in this sense that the social possibilities under a modern monetary system are truly open.

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