Why is money more valuable than the paper on which it is printed? Monetarists link the value of money to its supply and demand, believing the latter depends on the total value of the commodities it circulates. According to Prabhat Patnaik, this logic is flawed. In his view, in any nonbarter economy, the value we assign to money is determined independently of its supply and demand.
Through an original and provocative critique of monetarism, Patnaik advances a revolutionary understanding of macroeconomics that highlights the "propertyist" position of Karl Marx and John Maynard Keynes. Unlike the usual division between "classical" economists (e.g., David Ricardo and Marx) and the "marginalists" (e.g., Carl Menger, William Stanley Jevons, and Léon Walras), Patnaik places "monetarists," including Ricardo, on one side, while grouping propertyist writers like Marx, Keynes, and Rosa Luxemburg on the other. This second group subscribes to the idea that the value of money is given from outside the realm of supply and demand, therefore making money a form in which wealth is held. The fact that money is held as wealth in turn gives rise to the possibility of deficiency of aggregate demand under capitalism.
It is no accident that this possibility was highlighted by Marx and Keynes while going largely unrecognized by Ricardo and contemporary monetarists. At the same time, Patnaik points to a weakness in the Marx-Keynes tradition—namely, its lack of any satisfactory explanation of why the value of money, determined from outside the realm of supply and demand, remains relatively stable over long stretches of time. The answer to this question lies in the fact that capitalism is not a self-contained system but is born from a precapitalist setting with which it interacts and where it creates massive labor reserves that, in turn, impart stability to the value of money. Patnaik's theory of money, then, is also a theory of imperialism, and he concludes with a discussion of the contemporary international monetary system, which he terms the "oil-dollar" standard.
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Prabhat Patnaik, a well-known radical economist, holds the Sukhamoy Chakravarty Chair at the Jawaharlal Nehru University, New Delhi. He has written extensively on macroeconomics, development economics, and political economy. His books include Accumulation and Stability Under Capitalism and The Retreat to Unfreedom.Excerpt. © Reprinted by permission. All rights reserved.:
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It is an intriguing aspect of our daily life that intrinsically worthless bits of paper, which we call money, appear to possess value and are exchanged against useful objects. The purpose of this book is to examine the social arrangement underlying this fact. While this social arrangement is none other than the entire social arrangement underlying capitalism, there is a point in starting our investigation from the "money end." This is because an important part of the overall social arrangement that may not always be apparent when we start from the concept of "capital" emerges with greater clarity when we take money as the starting point of our analysis; this part relates to the fact that capitalism cannot exist, and never has existed, in isolation as a closed, self-contained system, as has been commonly assumed in much of economic analysis. In other words, a better route for understanding the totality of the social arrangement underlying capitalism is to start with a simple question: What breathes value into these intrinsically worthless bits of paper? Th is question is in turn part of a more comprehensive question: What determines the value of money, irrespective of whether it consists of intrinsically worthless bits of paper or of precious metals? To this question there have been two basic answers in economics. The first proposition of this book is that one of these answers, the one given by what constitutes "mainstream" economics at present, cannot stand logical scrutiny. I therefore begin with a critique of "mainstream" economics and, in particular, the notion of "equilibrium" central to it.
A Critique of the Mainstream Notion of Equilibrium Mainstream economic theory takes market clearing as its point of reference. In its perception, the flexibility of prices, which characterizes markets in the ideal type of a capitalist economy, ensures the equalization of demand and supply at a set of equilibrium prices. The endowments an economy has and whose ownership is distributed in a certain manner among the economic agents are fully utilized in producing a set of goods whose supply exactly equals the demand for them at this set of equilibrium prices. It follows that there is no question of any involuntary unemployment in such an economy, in the sense of an excess supply of labor at the prevailing wage rate, in equilibrium. Tastes, technology, the magnitude of endowments and their distribution across the economic agents, and the "thriftiness conditions" (to use Joan Robinson's phrase), or what some would call the "time preference" of the economic agents, determine the equilibrium prices and outputs in this world of "rational" agents, where firms maximize profits and individuals maximize utilities.
This mainstream notion of equilibrium, however, is logically tenable only in a world without money, which is why it cannot be a logically valid description for a capitalist economy. This is because in a world with money, according to this conception, the market for money must "clear" at a certain price of money in terms of the nonmoney goods. This can happen only if the excess demand curve for money is downward sloping with respect to the "price of money." For a given supply of money, in other words, the demand for money must vary inversely with the price of money. The price of money being the reciprocal of the price level of commodities in terms of money, this implies that the demand for money must vary directly with the price level of commodities. Mainstream economics took this for granted, because it saw money only as a medium of circulation, so that the higher the value of the goods that have to be circulated, the greater is the demand for money. Since, with output at the full employment level, the value of the goods (and hence the value of the goods to be circulated) depends on their price level, the demand for money has to be positively related to the price level.
The role of money as a medium of circulation ensured this. The problem, however, is that money is a form of wealth, too. It cannot be a medium of circulation without also being a form of wealth, since even the former role requires that money be held, however fleetingly, as wealth. And as the form-of-wealth role of money is recognized, it becomes clear that the demand for money must also depend upon the expected returns from other forms of wealth holding. If the demand for money depends upon expectations about the future, then there is no necessary reason why the demand curve for money should be upward-sloping with respect to the price level, as required by "mainstream" theory, since any change in the price level cannot leave expectations unchanged.
To get out of this quagmire, mainstream theory has taken two alternative routes. One is to refuse, quite stubbornly, the form-of-wealth role of money and to see money only as a medium of circulation. The other is to recognize the form-of-wealth role of money but to assume that expectations are always of a kind that does not create any trouble for the theory, at least with regard to the existence and stability of equilibrium. The first is the orthodox route of the Cambridge constant, k, or, what eff ectively comes to the same thing, a constant income velocity of circulation of money (subject to long-run autonomous changes), which is much used even today in bread-and-butter empirical work belonging to the monetarist genre. The second is the route of the "real balance" effect, whose validity depends, among other things, on the assumption of inelastic price expectations.
Both these routes, however, are blocked by logical contradictions. The Cambridge-constant route is blocked by the obvious contradiction that money cannot logically be assumed to be a medium of circulation unless it can also function as a form of wealth. And if it can, then there is no reason why it should not actually do so. And if it does, then we cannot assume a Cambridge constant k. The second route is blocked by the contradiction that inelastic price expectations presuppose some anchorage to prices, the existence, that is, of some prices that are sticky, and in a world of flexible prices there is no reason why this should be the case. It follows that there is simply no logically tenable way of erecting a theoretical structure in conformity with the "mainstream" perception in a world with money, and hence for a capitalist economy.
Because of this there has been an alternative tradition in economics, which I call the "propertyist" tradition, that has always seen the value of money as being fixed outside the realm of demand and supply. At this value, fixed from outside the realm of demand and supply, individuals habitually hold money balances in excess of what is required for the purpose of circulation: Money constitutes both a medium of circulation and a form of wealth holding. In such a case, Say's law cannot possibly hold. If wealth can be held in the form of money, then the possibility of ex ante overproduction of the nonmoney commodities arises. And this ex ante overproduction gives rise to actual output contraction, not just of the nonmoney commodities but of money and nonmoney commodities taken together, precisely because the price of money in terms of commodities is fixed from outside the realm of demand and supply, so that price flexibility cannot be assumed to eliminate this ex ante overproduction.
It follows, then, that the recognition of the role of money as a form of wealth holding, the recognition of the fact that its value cannot be determined within the realm of demand and supply but must be fixed from outside this realm, and the recognition of the possibility of generalized overproduction or—what comes to the same thing—of involuntary unemployment in the Keynesian sense, are logically interlinked and constitute the propertyist tradition. By contrast, the denial of each of these phenomena, is also logically interlinked, and constitutes the Walrasian-monetarist tradition that remains the mainstream.
Within the propertyist tradition, there are two main contributions. One is of Marx, who had not only explicitly noted the untenability of explaining the value of money in terms of demand and supply, but had also provided an alternative explanation for it through his labor theory of value. He had underscored both the existence of a "hoard" of money at all times as a form of wealth holding in a capitalist society, and had recognized, against Ricardo, who had been a believer in Say's law, the possibility of ex ante generalized overproduction as a consequence of this fact. But neither Marx himself nor his followers pursued this fundamental contribution of Marx any farther; they preferred instead to follow exclusively the other major theoretical discovery of Marx, namely the one relating to his theory of surplus value. This is why another three-quarters of a century had to elapse before the same themes had to resurface during the Keynesian revolution through the writings of Kalecki and Keynes, among others, who constituted the second main group of contributors within the propertyist tradition.
There were major differences, of course, between Marx and Keynes in the specifics of their theories. While Marx invoked the labor theory of value to explain the determination of the value of money, Keynes believed that the value of money vis-à-vis the world of commodities was fixed through the fixing of the value of money vis-à-vis one particular commodity, namely labor power (to use Marx's term). The fact that the money wage rate was fixed in the single period, which was Keynes's focus of analysis, is what gave money a finite and positive value vis-à-vis the entire world of commodities. And the fixity of money wages was not a cause for market failure, as has been generally supposed, but the modus operandi of the market system itself in a capitalist economy that necessarily uses...
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