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This page constitutes commentary on a thought-provoking and insightful article by Antal Fekete. The original can be found at Dr. Fekete's web site, and elsewhere on the internet.

Markup by Frederick N. Chase using only i) emphasis (red, bold, underline, or font size) and ii) bracketed pink commentary.

Fekete asserts lasting damage to the means of production (“vampirism by the financial sector sucking the blood of the producing sector”) via oscillating interest rates. He lays out support for this thesis in two articles and reprises them in a third:

1. FIAT CURRENCY: DESTROYER OF [INDUSTRIAL] CAPITAL

2. FIAT CURRENCY: DESTROYER OF LABOR

3. THE ANTI-GOLD GOSPEL ACCORDING TO FRIEDEN (reference)

The first two of these are included, highlighted, below.

In this trio of articles, Fekete asserts:

(The following is a work in progress.)

· Financial capital (e.g., 30-year T-bonds) is different from industrial (productive) capital. This is despite both being of value and being interconvertible.

· Financial capital is bad, except when serving merely as a medium of exchange (money).

· Productive capital is an assemblage of capital goods and trained labor sufficiently localized and harmonized so as to be adding value to its input, producing goods or services

· Varying long-term interest rates hurt industries ( the more capital-intensive, the more the damage), BOTH when rates increase AND when rates decrease.

· Long bond values have been rising (interest rates falling) since the early 1980s.

· Marginal productivity of industrial capital is determined by the prevailing interest rate.

· Capricious changes in marginal productivity, whether up or down, destroy industrial capital.

Decreasing long-term interest rates represent

· decreasing income for existing industrial capital. (Relaxed accounting standards allow this to go unreported.)

· a loss of existing industrial capital. (There is no requirement to report this loss.)

· increasing cost to retire existing long-term debt.

· increasing present value of future earnings. However, in the context of Mergers and Acquisitions or bankruptcy, this capital gain is not accounted.

After long-term interest rates have decreased

· new competitors arise (Southwest Airlines impacting Delta or Northwest is probably a recent example) whose industrial capital (airplanes, computers, even labor) costs less per year.

· plants are idled as the marginal productivity of capital increases.

Increasing long-term interest rates represent

· increasing income for existing industrial capital.

· a gain of existing industrial capital.

· decreased marginal productivity. In theory, this allows less-efficient plants to be created or brought back online. However, previously idled plants will have deteriorate and been vandalized. Skilled workers will have found other jobs.

After long-term interest rates have increased

· xxxxxxxxxxxxxxx

A cycle of decreasing then increasing long-term interest rates does not leave you where you started: when the marginal plants are closed, capital “is not committed to remarry its previous partner” and capital “goes abroad to look for a new labor partner”.

Asserted without proof:

· The only known way to stabilize interest rates is via a gold standard.

· There was no bond speculation under the gold standard.

Keywords: Gibson's Paradox; linkage, bond speculation .

FIAT CURRENCY: DESTROYER OF [INDUSTRIAL] CAPITAL

Captains of American industry should issue a Mayday call

Antal E. Fekete

Gold Standard University Live

aefekete@hotmail.com

Summary for the busy executive

The true story of de-industrialization in America has never been told. The boat of American industry has collided with the iceberg of falling interest-rate structure. The damage to capital is great and the boat is sinking. Auto manufacturing could go the way of TV and VCR manufacturing that went down in the 1980’s without the captains knowing what has hit them. Commentators blamed the demise on Asian sweatshops, on American consumer preference for services, and on the alleged rigidity of foreign exchange rates. These explanations reflect warped official thinking as well as the false teachings of mainstream economics. The true explanation can be found in the phenomenon of ‘linkage’ that translates falling interest rates into falling prices. There is a vicious process of destroying industrial capital under a falling interest-rate structure. This observation also shows the way out. Remedy is to be found not in more flexibility of foreign exchange rates but a return to the system of fixed exchange rates. The only known way to stabilize interest rates is an immediate return to the gold standard. During this presidential election year we have, for the first time in half-a-century, the possibility to debate the merits of the gold standard, thanks to Dr. Ron Paul’s candidacy for the Republican nomination. The challenge is enormous. Conventional wisdom maintains that falling interest rates are good for capital. They are not. They are lethal. Fiat currency is the destroyer of industrial capital.

Financial capital: vampire of productive capital

Fiat currency is a thoroughly toxic agent as it insidiously destroys capital through the destabilization of the interest rate structure. More precisely, the capital of industry is surreptitiously siphoned off to enrich bond speculators. Financial capital has become the vampire sucking the blood of productive capital. Here is what happens. The rate of interest measures the marginal productivity of capital. As I shall point out, capricious changes in marginal productivity, whether up or down, destroy productive capital to no better end than to prop up and perpetuate a reactionary and unconstitutional monetary regime that has the effect of exploiting savers, producers, and consumers alike for the benefit of simonious politicians, corrupt bankers, and parasitic bond speculators.

A primer on productivity

There is a great deal of confusion in the public’s mind about productivity. For example, it is widely assumed that an increase in the marginal productivity of capital [industrial capital – plant & equipment] is beneficial to society. This is wrong. Just the opposite is true. An increase in the marginal productivity of capital means that a lot of industrial plant and equipment has become submarginal, is idled, making its labor complement superfluous. Unemployment is the result. Some people who understand this believe that the opposite, decreasing marginal productivity, is beneficial to society for the opposite reason: formerly idled plant and equipment are now pressed into service, relieving unemployment. Wrong again. Idled capital that has not been properly maintained is brain dead. It will not be revived by falling interest rates. Making capital submarginal is an irreversible process.

Fiat currency drives capital and jobs abroad

It is a mistake to blame „Asian sweatshops” for increasing unemployment. America has coexisted with cheap Asian labor for its entire history. The latter was a benefit rather than a threat to American prosperity under the gold standard. It only became a threat under fiat currency, since gyrating interest rates caused the divorce of American capital and labor. Capital goes abroad to look for a new labor partner. As it migrates, well-paid American jobs migrate with it never to come back. Notice that the exportation of American jobs would not have occurred if the interest-rate structure in America had been stable, as under the gold standard, bonding the partnership between labor and capital.

Marginal productivity

Let’s see what is meant by marginal productivity and expose the popular misconceptions about it. Each individual plant and equipment has its own productivity. It can be calculated as the annualized percentage of increase in value added: output minus input. We rank all plants and equipment in existence according to increasing productivity. Those at the low end of the productivity spectrum will be left idle since the opportunity cost of employing them would be too high. There is a cut-off point marking the marginal item in the productive apparatus of society. It is that (variable) piece of equipment or individual plant that is still employed in productive activity, but all others with a lower productivity are idle. The productivity of the marginal item is called the rate of marginal productivity of capital (for short, marginal productivity). If marginal productivity increases, productive plant and equipment become submarginal and get laid off, resulting in a divorce between labor and capital. The labor complement of submarginal capital also gets laid off causing unemployment. On the other hand, as marginal productivity falls, certain previously submarginal plants and equipments will become productive again ― in theory. In practice, however, capital is looking for new labor partners. Since it is not committed to remarry its previous partner, under our fiat currency system capital will migrate abroad in search of cheap labor. In effect, both industrial capital and jobs are exported.

The rate of interest

Marginal productivity is determined by the rate of interest. The latter is that rate at which the stream of income payments from coupons plus the payment of principal at maturity amortize the (variable) market price of the bond. This means that the rate of interest is determined by the bond market. Hence, it is a market phenomenon. Moreover, it varies inversely with the bond price, since the present value of an income stream varies inversely with the rate of interest (or, saying it differently, capitalizing the same stream of payments at a lower rate of interest results in a higher capital value).

Clearly, bonds compete with industrial capital as an investment outlet to produce income. Because of this competition marginal productivity can be identified with the ceiling of the rate of interest. To see this in more detail look at the arbitrage of the capitalists. They will not let the two rates deviate from one another. If the rate of interest is higher, they will sell industrial capital and put the proceeds into higher-yielding bonds. Even if they can’t sell, at the very least they stop production and capital maintenance, abolish depreciation quotas and use the savings to buy the low-priced bond. If consequently the rate of interest drops, that is, bond prices rise, then capitalists take profit in selling the bond, buy new industrial plant and equipment and start production again. Either way, the arbitrage activities of the capitalists will close the gap between the rate of interest and the rate of marginal productivity.

Opportunism of Keynes

Keynesianism is no science. At best it is (in Ayn Rand’s words) a “gigolo of science,” forging political capital out of bad-mouthing the gold standard and the regime of fixed exchange rates. It advocates the management of the national currency, ostensibly to manage the national economy for the benefit of society. In fact it is running the national economy into the ground. Keynesianism is based on the insane but appealing concept that driving the international value of the national currency down is beneficial to the export industry. It ignores the fact that even if you could derive ephemeral advantages through this ploy of „beggaring thy neighbor”, deteriorating terms of trade could not be talked out of existence. If America exported x and imported y having the same value of z dollars, then after the devaluation of the dollar by, say, 50 percent, America would have to pay for importing y the sum of 2z dollars. In other words, America has to export twice as much of x in order to import just the same amount of y as before devaluation. America’s terms of trade has deteriorated by a factor of 2. Worse still, the terms of trade for America’s competitors has improved by a factor of 2. America is selling its national wealth on the cheap. Far from enriching the country, devaluation is impoverishing it. No wonder America has been on skid row ever since it has embarked on a policy of perpetual dollar-devaluation euphemistically called the floating dollar. Keynesianism is an unreconstructed mercantilist system. It is hard to see how mainstream economists and financial journalists have found it possible to treat it with respect.

The culprit: destabilization of interest rates

Keynes attributes deflation and depression to the ’contractionist tendencies’ of the gold standard. He says the gold standard puts a squeeze on prices. The government should relieve tightness in the economy by deficit spending, and the banking system should monetize the resulting government debt. This is called ’contra-cyclical monetary policy’. Keynes correctly recognizes the cumulative effect in the contraction of the economy once prices start falling, but he attributes it to the wrong cause: the vanishing of private demand which he wants to compensate with stepped-up public spending. In reality, the industry’s loss of pricing power and the subsequent downwards spiral of prices is not due to vanishing demand. It is due to the weakening of capital structure, bankrupting producers. To see this we have to provide a more sophisticated analysis of the effects of destabilizing interest rates than hitherto given.

The gold standard is sacrificed in order to make unbridled government spending possible. In Keynes’ one dimensional world this may have the effect of increasing prices, but it is all to the good as it is thought to revive the economy. However, the world is not one-dimensional and abolishing the gold standard has another effect: increasing interest rates. Bond prices and interest rates are destabilized.

What caused the Great Depression?

Keep in mind that there was no bond speculation under the gold standard. Disingenuously, mainstream economists stone-wall this fact thereby doing great disservice to the cause of science. They have blocked research on the detrimental consequences of the removal of the gold standard. Nobody has exposed the cause: destabilization of interest rates, and the effect: the Great Depression. The Keynesian dogma that it was caused by a deflation-prone gold standard is almost universally accepted.

However, the very opposite is true: the Great Depression was caused by sabotaging the gold standard. When the ownership of and trade in gold was banned by F.D. Roosevelt in 1933, the biggest competitor of government bonds, gold, was forcibly removed. Bond prices rose and interest rates fell precipitously. As we shall presently see, prices are bound to follow interest rates down. Falling prices triggered a downward spiral. The depression was on. The root cause was “moral cannibalism” (again, borrowing a phrase from Ayn Rand), the confiscation of the gold of the people. Mainstream economics is stone-walling that fact as well.

Paying out phantom profits

We shall now show how falling interest rates translate into falling prices. Contrary to conventional wisdom, falling interest rates squeeze profits. Mainstream economists teach that falling rates are salubrious to business. However, they fail to distinguish between a low and a falling interest rate structure. Falling interest rates reveal that past investment in physical capital has been made at too high a rate in view of lower rates now available. The difference between the two rates hits the profit margin, and hits it badly. There is no way getting around the fact that falling interest rates make the cost of servicing debt, contracted earlier, more onerous.

1. The present value of outstanding debt rises. [E.g., bonds a Company had issued are more expensive to redeem, unless callable on predefined terms.]

2. Firms with zero debt are not exempt either. The value of industrial capital falls across the board as new capital could now be financed at lower rates. [A smaller bond issue now buys new capital plant or equipment, shifting the buyer's decision toward new and away from used.]

Relaxed accounting standards under fiat currency allow firms to get away without reporting capital losses [on industrial capital] in the balance sheet incurred in the wake of fluctuating [falling] interest rates. However, a loss is a loss, reported or unreported. If the loss is not reported, the firm is paying out phantom profits in dividends, compounding capital losses and hastening collapse.

Linkage

Critics find the statement that the present value of outstanding debt rises as the rate of interest falls counter-intuitive. Yet it is just the flipside of the statement that the market price of a bond rises as the rate of interest falls ― a mathematically and empirically well-established fact of life.

Critics also object saying that losses in the liability column are offset by gains in the asset column. Falling interest rates, while increasing the present value of debt (hence causing capital losses) also increase the present value of future earnings which, they say, generate capital gains. The trouble with this argument is that it ignores the accounting rule that prohibits putting value on assets higher than historic costs, forcing the accountant to disregard any increase in anticipated future earnings. He has no choice: the accountant must charge [This would be in the context of Mergers and Acquisitions or bankruptcy, not in the context of a quarterly report to shareholders.]the increased cost of potential liquidation against assets without making allowance for increased future earnings due to falling interest rates.

As profits are squeezed, firms are forced to retrench. They reduce inventory, causing prices to fall. We conclude that falling interest rates translate into falling prices[I think of this as a transitory effect.]. This is the missing link that all the great theorists on interest from Eugene Böhm-Bawerk to Knut Wicksell have missed. They observed the operation of linkage as it forced interest rates to follow ― apart from leads and lags ― the same path upwards or down as do prices. They could even prove that rising or falling prices caused interest rates rise or fall, and that rising interest rates caused prices to rise, too. But for all their efforts they failed to find the missing piece of the jigsaw puzzle: the proof that falling interest rates caused prices to fall as well. Our argument above furnishes the missing piece. This, we believe, is a major break-through in theoretical economics, making nonsense out of Keynesian prattle to boot.

Linkage

Cause	Effect	Comment
Interest Rates rising	Prices rising
Interest Rates falling	Prices falling	...falling interest rates squeeze profits. The present value of outstanding debt rises. Fekete's “major break-through”. As profits are squeezed, firms are forced to retrench. They reduce inventory, causing prices to fall. ...the accountant must charge the increased cost of potential liquidation against assets without making allowance for increased future earnings ....... The Airline example. ...capital-intensive industries. (In the 'GOSPEL' article he addresses why in 2008 prices are not falling.)
Prices rising	Interest Rates rising
Prices falling	Interest Rates falling

Why aren’t airline wreckages investigated?

As linkage is activated, falling interest rates pull down prices. The deflationary spiral is on. Falling prices squeeze profits more. Many firms see their capital melt away. They fold in spite of falling interest rates.

The same forces that worked in the Great Depression are also at work today. When interest rates switched from rising to falling mode in the early 1980’s latter-day Icarus, the airline industry, was flying high. There was no Daedalus around to warn Icarus that he was flying too high, in view of being one of most capital-intensive industries. Falling interest rates were considered an incentive to increase operational altitude. Airlines went into debt to the hilt in financing spanking new fleets of planes. Then airlines, like Icarus, started falling out of the sky one after another. Among the victims was the American flagship, Pan American, as well as Swissair, envy of the industry and widely considered the best-managed airline that has ever cruised the skies. What caused these and other airlines to nose-dive just when they were getting ready to enjoy the ‘benefits’ of falling interest rates? Plenty of ad hoc reasons were offered, none of them convincing.

Airlines were blown out of the sky because falling interest rates wiped out their capital. Governments take great pains to investigate the wreckages of airliners meticulously. Experts find and reassemble even the smallest pieces of the wreckage in a hangar in search for clues of the cause of the crash. This effort is praiseworthy. There is much to be learned from each and every air disaster. Curiously enough, governments never investigate the wreckages of airlines, lest the true causes of the air disaster be learned. The true causes are: the regime of fiat currency, and our faulty accounting system that allows the suppression of capital losses due to falling interest rates. So much for Keynesianism as a government ideology.

This example also illustrates that capital gains in the asset column can’t compensate for capital losses in the liability column. Why did Swissair fall out of the sky if it could capitalize its higher future earnings due to falling interest rates? Because it couldn’t: before it would have been able to collect the expected higher earnings, it had crashed (financially, anyhow).

Risk-free profits in bond speculation

Keynes’ recipe makes the profits of bond speculators risk free. Contra-cyclical monetary policy calls for open-market purchases of bonds by the central bank. This makes central bank action predictable. Bond speculators take advantage of it and they forestall the central bank. They buy the bonds first, only to dump them at higher prices later, after the central bank has completed the purchase of its quota. Risk-free profits create an artificial demand for bonds, and a falling tendency in interest rates. They are responsible for deflation. The dinosaur of the one-half quadrillion dollar strong derivatives market is a monument to the folly of Keynesianism making bond speculation risk-free. Under the gold standard interest rates and bond prices are stable, and there is no risk-free speculation.

Contra-cyclical or counter-productive?

As our analysis shows, the counter-productive central bank monetary policy is responsible for the falling interest-rate structure, the deflationary spiral, and the depression. Keynes’ so-called contra-cyclical monetary policy turns out to be an unmitigated disaster. The central bank wants to combat falling prices through open-market purchases of bonds. But the new money it creates in the process does not flow to the commodity market to prop up prices there as hoped for by the central bank. Instead, it flows to the bond market where speculators, teased by the lure of risk-free profits, use it for bullish bond speculation. Interest rates fall; linkage makes prices fall, too. The deflationary spiral continues one level higher.

Most analyst take it for granted that the decline in the value of the dollar will cause interest rates to rise. However, logic dictates that the value of dollar bonds should fall before the value of the dollar. That’s not what has been happening. The dollar has been falling for the past few years yet bond values, as measured by the 30-year T-bond, continued their march upwards that had started in the early 1980’s. The explanation is that the allure of risk-free profits sent the demand for bonds soaring so that it has far surpassed the vanishing demand for dollars. Paradoxically, there is a rising demand for dollar bonds and a falling demand for dollars. That is Greenspan’s conundrum. Risk-free profits in the bond market suggest that a continuation of the regime of falling interest rates, with all its deflationary implications, is more likely in the future than a new bout of price rises. Be that as it may, we can be sure that the price for central bank follies will have to be paid by the sacrificial lamb: the producers, regardless whether interest rates fall or gyrate.

Confusing capital and credit deliberately

In the vast literature of mainstream economics there is not one sentence written about the deleterious effects of destabilizing interest rates on the value of industrial capital. This stems from a deliberate confusion between capital and credit. In the view of mainstream economists any talk about ‘capital decumulation,’ or the destruction of industrial capital in the wake of destabilizing interest rates, is arrant nonsense. After all, both credit and capital can be created at will, by a click of the mouse. The possibility that the dissipation of industrial capital might figure among the causes of the Great Depression is not even considered.

Capital strikes back. The apparition stuns non-believers and capital-deniers. The admonition to them is: “If you don’t use your eyes for seeing, then you will use them for weeping.” (F.W. Foerster.)

Reclaiming our destiny from the usurpers

The market share of General Motors was 46% in 1980. Today it is 24% and falling, in spite of great improvements in productivity. Neither Ford nor Chrysler is doing any better. In 1980 the rate of interest was sixteen percent; it went as low as four. Having collided with the falling interest rate structure, the ship of industrial capital is sinking.

Captains of American industry should issue a Mayday call and rally to Ron Paul’s plank to restore the gold standard in America. The writing is on the wall: the regime of fiat currency, in the maintenance of which the Federal Reserve has a vested interest, is going to finish the job of de-industrializing America ― unless we reclaim our destiny from the usurpers, and return to the regime of stable interest rates and constitutional money.

References

By the same author:

Kondratieff Revisited, May, 2001

Deflation or Runaway Inflation? July, 2001

The Economic Consequences of Mr. Greenspan, December, 2001

Japan’s Finest Hour, January, 2002

Revisionist View of the Great Depression, I-II, March, 2002

The Black-hole of Zero Interest Revisited, August, 2002

The Wrecker’s Ball of Swinging Interest Rates, September, 2002

The Central Banker as the Quartermaster-General of Deflation, January, 2003

A Bubble That Broke the World, June, 2003

Stop Greenspan from Plunging America into a Depression! June, 2003

Tainted Research, June, 2003

How to Protect One’s Pension with Gold, August, 2003

The Gold-Demonetization Hoax, August, 2003

Gold Is the Cure for the Job-Drain! September, 2003

The Decoy of the Falling Dollar, February, 2005

The Decoy of the Falling Dollar Revisited, May, 2007

The Shadow Pyramid, November, 2007

Fiat Currency: Destroyer of Labor, to appear

These and other papers of the same author can be accessed at: www.professorfekete.com

A. E. Fekete

December 8, 2007.

FIAT CURRENCY: DESTROYER OF LABOR

Labor Leaders should issue a Mayday call

Antal E. Fekete

Gold Standard University Live

aefekete@hotmail.com

Summary for the busy execitive

Labor vitally depends on the state of industrial capital. Wage rates cannot increase except in consequence of an increase in the per capita quota of invested capital. Conversely, a decrease in that quota means capital decumulation that lowers wage rates, ultimately leading to unemployment.

The regime of fiat currency has destabilized the interest-rate structure with the result that bond speculators can siphon off capital from the balance sheet of productive enterprise surreptitiously. There are laws against computer-hacking. There are no laws against hackers entering the balance sheet of industrial enterprise surreptitiously, and making off with illicit gains through risk-free profits in bond speculation.

The resulting insufficiency hurts labor even more than it hurts capital. Owners of capital can protect themselves through exporting their remaining funds to low-wage countries. The trouble is that well-paid industrial jobs are exported along with capital, never to return. American labor is stuck with low-paid service jobs such as flipping hamburgers. The outlook is even bleaker. As interest rates keep falling, even hamburger-flipping may go the way of steel-making. Mass unemployment, directly attributable to fiat currency destabilizing the interest-rate structure, is a real threat.

Invisible arson

If a part of your industrial plant burns down, you have to report the capital loss in the balance sheet and charge the loss against future earnings. Intangible capital loss is caused by falling interest rates, because it reveals that past investment in physical capital has been made at too high a rate as shown by lower rates now available. There is no way getting around the fact that the cost of servicing debt, contracted earlier at a higher rate, is made more onerous by the falling interest-rate structure. The present value of outstanding debt rises, because capitalizing the same stream of payments at a lower rate of interest results in a higher capital value. Yet nobody is reporting a capital loss when falling interest rates decimate the value of industrial capital, and nobody makes provision for replenishing impaired capital by charging the loss to future earnings. Society lives in a fool’s paradise thinking that it can eat into capital, no tightening belts is necessary, and the day of reckoning will never dawn.

Why is there no requirement to report capital losses due to falling interest rates, and why is the firm allowed to get away without putting aside a loss reserve to compensate for losses arising out of the falling of interest rate structure? Why is a loss caused by real fire treated differently from a loss caused by invisible fire? Could it be part of the “invisible arson” to cover up the footprint of the central bank’s counter-productive monetary policy, namely, open-market purchases of bonds?

To be sure, the introduction of out-and-out fiat money in 1971 was invisible arson, without flames and smoke, but all the greater devastation of the capital of productive enterprise. Mainstream economists have „forgotten” to investigate the untoward consequences of the regime of fiat money, especially the damage it has caused through the destabilization of interest rates.

It is incumbent upon labor leaders to demand that damage caused by capital losses be repaired whether they were caused by real fire or by the invisible arson of falling interest rates. In either case capital supporting laborers in production has been impaired and unless the loss is charged to future earnings, wage rates will be squeezed and ultimately the economy will succumb to unemployment. Owners of capital should not be allowed to bolt for greener pastures, leaving labor behind in the lurch.

Silent textbooks

Textbooks on accounting do not mention the need for setting aside loss reserves to repair capital in the wake of falling interest rates. Hundreds of codes that have been written since Luca Pacioli invented double-entry book-keeping are silent on this subject as well. Why? The answer to this question is found in the fact that a move in the rate of interest used to be akin to continental drift: it would take decades before changes were noticeable. There is an additional problem. The decline in interest rates, if it ever occurred, was necessarily limited under the gold standard. Savers would never let interest rates fall indefinitely. They would step in, sell the overpriced government bond and would not buy them back until the trend in interest rates were reversed. The rate of change was accelerated after the 1971 introduction of global fiat currency.

A rapid decline of interest rates was previously unthinkable. Moreover, the decline could not continue indefinitely, as gold withdrawals would sooner or later put an end to it. But this obstruction had been removed by the regime of fiat currency. Bondholders and depositors could no longer withdraw gold. The lack of obstruction to stop the fall of interest rates means that businessmen, once lethargic, stay lethargic. They understood what the threat of interest rates falling further meant for them. No matter how low interest rates were, they would not look attractive as further fall would make their investment fail. This is the conundrum of the deflation in Japan, where interest rates still keep falling from very low levels. Mainstream economists say that it is a reflection of the high saving propensities of the Japanese people. This is, of course, nonsense. It is the reflection of the lethargy of the Japanese businessmen. They do not see the light at the end of the tunnel. They do not see an end to the decline of interest rates.

By 1971 accounting was politicized. It was not in the interest of the powers that be to alarm producers about dangers threatening them by virtue of fiat currency. Book-keeping rules were relaxed accordingly. The transition from the gold standard to irredeemable currency was hailed as a positive development, all benefits and no setbacks. The greatest con-job in all history was to foist the fiat dollar on an unsuspecting world.

Anti-industrial revolution

Labor leaders should also demand an answer to the broader question: in whose interest does the U.S. government maintain a reactionary monetary regime, that of fiat currency with a one-hundred percent mortality rate, as proved by history? The introduction of this regime could be described, in the words of Ayn Rand’s Atlas Shrugged, as the “anti-industrial revolution,” the effect of which is the de-industrialization of America as shown by the disappearance of the apparel industry, shoe industry, steel industry, VCR and TV set manufacturing industry, with the auto industry not too far behind.

It is no use trying to explain the demise of these industries in America with „progress” in the international division of labor. It is no use trying to compare it to the demise of the horseshoe industry and candle-making in the 19^th century. When horseshoe production was abandoned, no American jobs were exported. In the present instance steel jobs are exported and now steel has to be imported. Why? Because the “paper aristocracy” of America finds the export of paper (read: paper money) more profitable than the export of steel.

The government and politicians take credit for “job-creation”. But the truth is that the jobs created are mostly make-believe jobs. What has been hailed as a heroic job-creation program appears, in the present light, a miserable effort at damage-control by the same government that has destroyed well-paid industrial jobs in the first place through the introduction of an unconstitutional and anti-labor monetary regime.

Savior or saboteur?

This regime was originally promoted as a savior of labor. „Thou shalt not push down this crown of thorns on the brow of labor; thou shalt not crucify mankind on this cross of gold!” cried William Jennings Brian during his failed presidential election campaign in 1896. These words have reverberated until 1933 when F.D. Roosevelt hit the war-path to knock out gold money for once and all. He sabotaged the constitutional monetary regime of the United States by grabbing people’s gold. It is important to understand why Roosevelt’s monetary tinkering was anti-labor, in spite of it being promoted as a move to raise prices and to restore full employment.

By 1932 there were signs that the severe recession was over. During the presidential election campaign rumor-mongers spread the word that Roosevelt, once elected, was planning „to go off gold”, following the example set by Britain. Roosevelt never issued a denial and, after elected, he made himself unavailable for direct questioning. Apparently he was relishing the prospect of a banking crisis that was developing in the wake of those rumors. He could grab much dictatorial power if the country lay prostrate financially on Inauguration Day, which is exactly what has happened. Was it all planned? Be that as it may, after inauguration he railroaded unconstitutional monetary legislation through a servile Congress, including the incredible measure of confiscating the gold of the people and writing up its value afterwards.

The ‘profit’ from the government’s arbitrary measure of marking up the value of confiscated gold was taken right out of industrial capital. In 1935 Supreme Court justices McReynolds, Van Devanter, Sutherland, and Butler wrote their minority opinion criticizing the majority in the case Nortz v. the United States, re: reneging the promise on gold certificates issued by the U.S. Treasury.

“These were contracts to return gold left on deposit; otherwise to pay its value in currency… We conclude that, if given effect, the enactments here challenged will bring about confiscation of property rights and repudiation of national obligations. Acquiescence in the decisions just announced is impossible; the circumstances demand a statement of our views. To let oneself slide down the easy slope offered by the course of events and to dull one’s mind against the extent of danger… that is precisely to fail in one’s responsibility.

“Just men regard repudiation and spoilation of citizens by their sovereign with abhorrence; but we are asked to affirm that the Constitution has granted power to accomplish both. No definite delegation of such power exists; and we cannot believe that the far-seeing framers, who labored with hope of establishing justice and securing the blessings of liberty, intended that the expected government should have authority to annihilate its own obligations and destroy the very rights which they were endeavoring to protect. Not only is there no permission for such actions; they are inhibited. And no plentitude of words can conform them to our charter.

“The federal government is one of delegated and limited powers which derive from the Constitution. It can exercise only the powers granted to it. Powers claimed must be denied unless granted… The fundamental problem now presented is whether recent statutes passed by Congress in respect of money and credits were designed to attain a legitimate end. Or whether, under the guise of pursuing a monetary policy, Congress really has inaugurated a plan primarily designed to destroy private obligations, repudiate national debts, and drive into the Treasury all gold within the country, in exchange for inconvertible promises to pay, of much less value.

“Considering all the circumstances, we must conclude they show that the plan disclosed is of the latter description and its enforcement would deprive the parties before us of their rights under the Constitution. Consequently the Court should do what it can to afford adequate relief… The end or objective of the Joint Resolution [of June 5, 1933] was not “legitimate”. The real purpose was not ‘to assure uniform value to the coins and currencies of the United States’, but to destroy certain valuable contractual rights…

“It was not intended to give Congress the power under the law to repudiate the obligations in question… No such power was ever granted by the framers of the Constitution. It was not there then. It was not there yesterday. It is not there today. We are confronted with a condition in which the dollar may be reduced to 50 cents today, to 30 cents tomorrow, to 10 cents the next day, and to 1 cent the day after…

“Under the challenged statutes it is said that the United States has realized profits amounting to $2,800,000,000. But this assumes that gain may be generated by legislative fiat. To such counterfeit profits there would be no limit; with each new debasement of the dollar they would expand. Two billions might be ballooned indefinitely ― to twenty, to thirty, or what you will.

“Loss of reputation for honorable dealing will bring us unending humiliation. The impending legal and moral chaos is appalling.”

Prophetic words! As a consequence of gold confiscation the recovery of 1932 aborted and the economy was plunged into the deepest depression ever. The value of government bonds shot up and interest rates started plunging. Industrial capital was decimated. The value of productive capital did not disappear without a trace. It was illicitly transferred to financial capital in the form of risk-free profits from bond speculation. It was arson that burnt down the industrial landscape, and made laborers fugitives on their home ground. Roosevelt was the invisible arsonist, as sentenced by the minority of dissenting justices on the Supreme Court of the United States in 1935. Today the saboteur is celebrated as the savior.

Risk free bond speculation

The duplicity involved is unprecedented. In a Memo Roosevelt stated: “Speculation, where [participants] could earn money without work, was the pipe dream… which led to growth of special interest that did not coincide with the interest of the nation as a whole. We cannot allow economic life to be controlled by a small group of men… tinctured by the fact that they can make huge profits, not from production but from lending money and marketing securities… we cannot tolerate this opportunistic, selfish attitude…” [So maybe he was well-intended but deceived.]

It would be a mistake to believe that with the Great Depression behind us, the issue is settled. Far from it. An even greater scourge is upon us. The interest-rate structure is still acting as the wrecker’s ball on the economy. Falling interest rates still make it possible for speculators to derive risk-free profits or ‘counterfeit profits’ in the words of the dissenting justices.

In fact, Roosevelt’s monetary legislation is ultimately responsible for making bond speculation risk free. Speculators take their clues from the open market purchases of bonds by the Federal Reserve (Fed). They know the Fed has to buy the bonds in the open market. All the bond speculators have to do is to forestall [foretell?] Fed action. They buy just before the Fed does, and sell just after. In this way they can consistently derive risk-free profits. Roosevelt created a situation which is a thousand times worse than what he has condemned. The “huge profits” to which Roosevelt referred to in his Memo were at least not risk-free. Roosevelt’s confiscation of people’s gold introduced an era of relentlessly rising bond prices, offering risk-free profits to bond speculators.

The worst part of the arson is that it is self-perpetuating. The fall in interest rates if [is] open-ended. No matter how low they go, the threat that interest rates may go even lower acts as a deterrent to businessmen to take out the loan. Every attempt at recovery is nipped in the bud. By contrast under a gold standard a fall in interest rates is self-limiting. It is resisted by the savers who will progressively withdraw gold as rates fall. For this reason under a gold standard there is no bond speculation. Bond prices and interest rates are stable.

Gold, the protector of the people

We must understand that gold is the only competitor that government bonds have. Savers, if not satisfied with the rate of interest offered by the government on its bonds, can hold on to the gold coin of the realm. Once gold is confiscated, the safest place to park one’s savings is the government bond. People are at the mercy of the government and adventurers in government. Gold is the protector of the people against financial dictatorship.

Similarly, if it the rate of interest is pushed too far down by the banks, savers can register their protest by putting their savings into gold with the resulting squeeze on bank reserves. Paper currency is no substitute for gold coins in this regard. If dissatisfied savers had withdrawn their money from the bank and parked their savings in paper money, they would have been jumping from the frying pan into the fire: exchanging a low rate for zero rate. They would have acted contrary to purpose. The only effective way to protest low interest rates is to sell the overpriced bond and keep the proceeds in gold coins until interest rates rise. At that time savers could buy back their bonds at a lower price. Therein we find the rationale for gold. This is what gold coins are for: to give savers clout so that they may not be at the mercy of the banks and the government.

Grabbing the gold coin of the savers is highway robbery. What the Roosevelt administration did to them was even worse. It made people helpless in the face of the banks’ design to plunge them into permanent debt slavery. As Roosevelt forcibly removed the gold coin, there was an additional effect: destabilizing the rate of interest. Freed from competition, the price of government bonds soared and interest rates plunged. As explained above, plunging interest rates eroded capital values across the board. The weakening capital structure meant that firms lost pricing power. Prices fell together with interest rates. Falling prices caused interest rates to fall more. A vicious circle was set in motion. The effect was cumulative. The devastation of their capital by falling interest rates bankrupted firms, exacerbated by the domino-effect. Financially healthy firms were knocked down by the fall of the financially weak. The Great Depression hit the nation and the world.

The World in the Grip of a Mistake

Keynes was ready with an explanation: the Great Depression was caused by the “contractionist bias” of the gold standard. Government propagandists took over from him and wore down upright monetary economists who made a case for maintaining the constitutional monetary standard. Through bribe, blackmail, and attrition upright monetary economists were eliminated from the scene. If allowed to write ‘without fear and favor’, they would have alerted the world that permanently falling interest rates not only plunge the economy into deep depression, but also kill any recovery attempt in the bud. No matter how low interest rates are, the prospect of a further fall will prevent businessmen to take the loans. That is why a permanently falling interest rate structure must be avoided at all hazards. Under the regime of fiat currency there is no guarantee that the fall will hit bottom, precisely because of the presence of risk-free bond speculation. By contrast, under a gold standard, rising bond prices invite profit-taking. Bondholders will sell, and stay invested in the gold coin of the realm. They will not buy back the bonds until interest rates come back to acceptable levels. The ‘black hole of zero interest’ is cordoned off. The gold coin in the hands of the people is a sine qua non of a durable monetary system. Without it both runaway inflations and deflations are possible.

The world has been in the grip of a colossal mistake, the belief that

· the gold standard was the cause of deflation and that

· gold is the enemy of labor.

The economic damage caused by this mistake has been enormous. But it has also served as camouflage for the real culprit: the regime of fiat currency. The amount of taxpayer money wasted on the altar of Moloch defies counting. There is no way to calculate the cost of all the counter-productive and self-defeating government measures inflicted on the nation and on the world. The damage caused by the consequences of destabilizing foreign exchange and interest rates is incalculable. The chief loser was labor. In order to see this clearly we must look at their effect on the marginal productivity of labor.

Marginal productivity

Each worker has his or her productivity measured by the annualized percentage of value added to the product as it is passing through the production process. If we rank all workers in the labor force according to increasing productivity, we find that those at the low end of the spectrum may be left idle. For example, some pensioners still wanting to earn wages may be too old to qualify. Similarly, people with physical or mental handicap could be judged unfit for industrial employment.

At the same time it should be pointed out that many handicapped people can still find industrial employment, provided that they are productive enough. However, it is not heartlessness to observe that the responsibility to provide meaningful occupation for handicapped people without means of self-support, in order to help them to become useful members of their community, rests with charity rather than industry. For example, charitable foundations could be established that created public parks and employed wardens, or to train handicapped people to become self-supporting as street vendors, etc. At any rate there is a marginal worker in the labor force who is still employed but others with a lower productivity are not because the opportunity cost of employing them is too high.

The productivity of the marginal worker is called the rate of marginal productivity of labor (for short, marginal productivity of labor). The person playing the role of the marginal worker may of course change, even change frequently and with it changes the rate of marginal productivity of labor. Contrary to popular misconception, an increase in the marginal productivity of labor is not a blessing. It means that that some productive workers have been reclassified as submarginal and lost their jobs. This happens routinely whenever industrial capital is eroded, plants and equipment are taken out of production as a result of insufficient capital maintenance and inadequate depreciation quotas.

Obstruction to capital accumulation

The opposite case is that of falling marginal productivity of labor. Generally it is a welcome development as it is beneficial to society. It has the effect of making submarginal labor productive. We could describe it as equipping laborers with optimal tools so that their contribution to the social product is maximized. It is important to understand that to make the beneficial decline in the rate of marginal productivity possible, further accumulation of capital is necessary. Hitherto submarginal workers can then find employment, thanks to more or better tools made available to help them become more productive. As a byproduct, more physically or mentally handicapped people, along with many others, could find meaningful industrial employment as unskilled or semi-skilled laborers.

As long as no obstacles are erected in the way of capital accumulation, there will be no unemployment. The presence of unemployment in society necessarily implies that obstructions to capital accumulation exist, as not all workers eager to earn wages are given the necessary tools to make their work productive. In a free labor market there is a tendency to make the marginal worker and the least productive worker to be one and the same person.

Capital accumulation pilloried

In the real world there are many obstacles in the way of capital accumulation, which prevent the least productive workers from finding employment. The reason for this unfortunate state of affairs is mainly ignorance and envy. Capital accumulation is pilloried as proof of the uncontrolled “acquisitiveness of the capitalists”. It is hardly ever looked at from the point of view of its beneficial effects on labor. Virtually all these obstacles have been created by a misguided effort to help the indigenous through the wrong means, with the result of leaving them worse off than they would be without the “help”. Taxing enterprise and industry to raise revenues in order to fund direct payments to the able-bodied unemployed is the worst offender. This also includes the so-called “unemployment insurance” whereby the industrious is being taxed to subsidize the indolent. In so far as it is an obstruction to capital accumulation, unemployment insurance has the effect of increasing unemployment. In the absence of these schemes capital would be accumulated and suitable tools would be put in the hands of the unemployed. Similar arguments can be made to condemn a host of misguided labor laws and payroll taxes, including compulsory health insurance schemes. However, this is not the problem we want to discuss presently. This must be left as a topic for another occasion. Here we want to discuss the problem what happens when capital already accumulated is being eroded and necessary repair is not made in time. In particular, we want to investigate the problem of falling interest rates causing the marginal productivity of capital to rise.

Devastation caused by falling interest rates

Why do falling interest rates make the marginal productivity of capital rise? As we have seen above, falling interest rates reveal that the capital in place has been financed at too high a rate of interest, in view of lower rates now available. The present value of debt rises. Firms with no debt are not exempt either. Falling interest rates decimate the value of all industrial capital already in place, in view of the lower cost of installing new capital.

As the rate of marginal productivity of capital rises, plant and equipment are idled. Their labor complement is idled, too. This is tantamount to an increase in rate of marginal productivity of labor. The conclusion is that falling interest rates make the marginal productivity of both capital and labor rise, with the unemployment of capital and labor as the obvious results.

The Great Depression was not caused by “vanishing consumer demand”, but by a fatal weakening of the capital structure of industry, which can be traced back to the confiscation of the gold coin by Roosevelt. The capital from the balance sheet of productive enterprise did not disappear without a trace. It was siphoned off by financial enterprise: it showed up as the illicit capital gains of the bond speculators.

Exactly the same process can be observed today. Bond prices have been increasing since the early 1980’s, rewarding bond speculators with obscene profits. These profits did not come out of nowhere. They were siphoned off the balance sheets of productive enterprise. As measured by the yield of 30-year Treasury bonds, interest rates fell from 16 to 4 percent. Many observers say that the fall is over and we are in for a steep rise, in view of the falling international value of the dollar. However, there is reason to be cautious with jumping to conclusions. It is possible for the value of the dollar to fall while the value of dollar bonds rises. The fall in the rate of interest as measured by the yield of T-bonds may well continue, following the example of Japan. Worse still, the rate of decline may accelerate. This would mean more precipitous destruction of capital, more bankruptcies, more deflation, even a fully blown depression is not impossible.

The finest hour of American labor

This presidential election year presents a unique opportunity for American labor leaders. If they rallied to the plank of Dr. Ron Paul, advocating Constitutional money and the rehabilitation of the gold standard, they would make history. It would be the finest hour of American labor to put an end to this reactionary, unconstitutional, anti-labor experimentation with the regime of fiat money. History is littered with the debris of fiat currencies. All of them were hailed in their time as the wave of future. To no avail: they have all found their resting place in the garbage heap of history. But not before they have inflicted enormous economic pain, especially on working people. The present experiment is no exception.

The government of the United States has apparently abandoned its traditional role of protecting labor. Its insane experiment with fiat currency has a higher priority than the welfare of labor. The government has abdicated its Constitutional responsibility to retain a system of checks and balances. In delegating unlimited power to the Fed, it undermined the ideal of limited government. Remember, the power to create money out of nothing is unlimited power. The government ignores the economic dangers that go with the experiment of fiat currency. The Fed has a bag of tricks to combat deflation and depression, but they are all counter-productive: they make the economic malady worse, not better. In particular, the Fed seems to be blissfully unaware of the extreme danger lurking behind a falling interest-rate structure: the danger of depression as the capital of productive industry is being plundered by scavengers, speculating risk free on the further rise in the price of government bonds. Every dollar of profit made by bond speculators comes out of capital values supporting industrial labor.

Academia and financial journalism have embraced a servile attitude of Fed worshipping. “Don’t bite the hand that feeds you.” The public is completely unprepared for the coming depression caused by the collision between the falling interest-rate structure and industrial capital, and its effect on the economy in general, and labor in particular.

Labor leaders should issue a Mayday call: the boat of industrial capital is sinking, captain and crew bailing out. America is being de-industrialized through the corrosive fiat money regime, and is in danger of disappearing as an economic and financial world power. Labor leaders should support the only presidential candidate, Ron Paul, who understands the problem and has the right plan to deal with it. The de-industrialization of America must stop at once. This means a return to the regime of stable interest rates and constitutional money.

References

By the same author:

Fiat Currency: Destroyer of Capital, December, 2007

Gold Is the Cure for the Job-Drain, September, 2002

The Root Cause of Unemployment, I-II, January, 2007

These and other articles of the same author can be accessed at: www.professorfekete.com

Memo from F.D. Roosevelt to Trade Commissioner Landis, Nov. 14, 1933, as quoted in Blog #28, comment on Floyd Norris’ column in The New York Times entitled “Fear at the Fed”, December 12, 2007.

A. E. Fekete

December 17, 2007.