By any standards, Monday 29 September was a bad day for world capitalism. News that the US Congress had voted down the $700 billion bail out, despite Treasury Secretary Henry Paulson having pleaded for it literally “on bended knee”, sent stock markets around the world tumbling. US stocks recorded their biggest one day fall since the Black Monday crash of October 1987.
Meanwhile, the cull of insolvent banks gathered new pace. One financial commentator in London spoke in stunned disbelief of the news that five banks had failed by lunchtime. These included the sixth largest lender in the US, Wachovia, previously considered safe enough to have earlier been touted as a potential saviour of Morgan Stanley. Outside the US, failing banks in Britain, Belgium, Germany and Iceland had to be rescued by takeovers, capital injections, or by partial or outright nationalisation.
All in all, a bad day, but not the first and most certainly not the last we will see before the economy touches the bottom of this crisis. Asked how many of the 8,500 banks in the US would survive, Ken Lewis, Chief Executive of Bank of America, answered bluntly but not too reassuringly, “about half”. European banks are in little better shape.
Congress initially voted “no” to the deal fearing a backlash from angry US voters, but also because some right wing republicans still cling to the view, as expressed by Republican Congressman, Jeb Heensarling, that this type of “state interference” in the “free” market is “the slippery road to socialism”.
Such views are now in a minority among the capitalist establishment in the US, and beyond. Governments, including those right wing governments that most enthusiastically embraced neo-liberalism, have been forced to swallow hard, and accept that the alternative to the injection of hundreds of billions of dollars of state money in an attempt to recapitalise the banks, and pump credit back into the system, is financial meltdown, and an economic recession that would be of the order of what happened in the 1930s.
Between 1928 and 1933, there were about 11,000 bank failures in the US. It was the fear that there could be a repeat, that gave Congress no real option but to return, and put through a revamped version of the Paulson package.
Despite the protestations of some unreconstructed neo-liberals, this form of state intervention has nothing to do with socialism. The state is prepared to use tax payers’ money to buy up the toxic debris of non-performing debt packages, that have been spread through the world financial system. The debts are being nationalised but, where possible, anything that is profitable is being merged, or sold off for a song to rival institutions.
Nor is this an entirely new development, even for the recent epoch of neo liberalism, and financial deregulation. When the US Savings and Loans institutions (Building Societies} collapsed at the end of the 1980s, the state intervened, with effective nationalisation and a $153 billion bailout.
Sweden’s financial markets were deregulated in 1985. Within a few years, there was a massive pile up of non-performing loans, and the banking sector had to be rescued. The government took over two of the seven leading banks. It also dumped billions of Swedish Krona into a “bad” bank.
One difference then – apart from the more containable scale – was the fact that future growth in the US, and world economy generated a pick up in asset prices, and these institutions were able to recover. The state was able to resume “normal service”, and return them to private ownership.
This time, the prospects for world capitalism, even allowing that a Congress backed bail out offers a safety net of sorts, are not so rosy. Even if a deep slump is avoided, it is likely that a recession will be followed by a prolonged period of stagnation. The bursting of Japan’s economic bubble at the end of the ‘80s was followed by a lost decade of stagnation and deflation. A similar scenario – or worse – could now face world capitalism. This is the price that is likely to be paid for the speculative frenzy and the bubble driven growth of the past decade and a half.
Economists are now laying the entire blame for current woes, at the feet of the financial speculators, and placing their hopes for a better future in their new mantra of financial regulation.
It is beyond doubt that speculation and greed, especially in the shadow - and shadowy - financial markets, have played an important role in bringing things to where they are.
Helped on by cheap credit, a financial bubble continued to expand in the years leading up to the credit crunch - and so long as it kept expanding, even the riskiest venture seemed failure proof. Leveraging, where an initial capital sum is backed by a much bigger loan to make an investment or a buy out, reached unheard of levels, in some cases of as much as 100 – 1. Leveraging allows a high percentage return on the initial capital, as long as things go well; so, in the good times, financial institutions found themselves scrambling in the leveraging race, to keep up with the profit bonanza. But in the bad times, leveraging means that a small contraction leads to a mighty bust.
Profits, and with them, enormous bonuses for those at the centre of all this, were also boosted by the idea that the new, and ever more complex vehicles that were invented to package financial transactions were loss proof. Credit instruments, packaged according to complex computer formulae, which in turn were based on underlying premises – or credit ratings – that turned out to be wrong, were sold as foolproof investments.
For years, and especially during the first years of this century, the buzz word for speculators was ‘securitisation’. Packages of derivatives, written on other derivatives, but ultimately based on un-payable mortgage, and other debts, were bundled together, and sold on. From a small sideshow in the financial markets, we moved quickly to the position where two thirds of household borrowings were “securitised” in this way. But, as most economists now admit, and as the credit crunch testifies, this risk dispersal has turned into risk contagion, and the toxic effects are being felt worldwide.
But this is not just a problem of a few out of control speculators who can be controlled by regulation. Some degree of speculation is inherent in the financial system, where stock markets have always been a form of gambling, and where there have long been futures markets, and other ways of betting to make money. What we have witnessed recently is simply this system taken to its extreme.
The financial institutions, and those who run them are there to make money - as much money as they can. Even as the Paulson rescue package was being debated in the US Congress, Wall Street was searching for ways to profit from it. Some firms were lobbying to throw in all forms of bad investments, not just mortgages. Others were resisting any suggestion that top salaries be curtailed, hinting that they would not take up the money offer if this was made a condition.
It is not possible to control what you do not own. Regulation without ownership is no answer. Anyone who doubts this, should just take a glance at the supposedly heavily regulated energy sector in the UK where the private owners are able dictate terms, and enjoy huge returns.
This crisis may be centred, for the moment, in the financial system, but it is a crisis of the system as a whole, not just a problem of unfettered money markets. The speculative financial frenzy, and the huge explosion of credit are symptoms of the underlying weakness of capitalism.
The past two decades have seen a phenomenol rise in the global power of finance capital. In 1980, the total of global financial assets was roughly equal to world GDP. By 2005, they were 3.7 times world GDP.
This increasing dominance of finance capital, as well as its increasing concentration on short term, and speculative investment, is a sign of the lack of confidence of the capitalist class as a whole in the future of their system. There has been a lack of investment in the wealth producing industrial, and manufacturing sectors, and in research and development. Instead, capital has chased short term gains, sometimes as short term as the huge bonus payments awarded for every deal. All the frantic wheeling and dealing in the financial markets has had much more to do with the redistribution of value, than with the creation of new value.
Emergence of China
The growth in the world economy since the start of the ‘90s has been based on the interlocking factors of cheap money - and therefore debt - low inflation, and cheap labour. Taking these in reverse order - the emergence of China, and to a lesser extent of India, and Russia, roughly doubled the world workforce, adding about 1.5 billion new workers. With no corresponding increase in the amount of capital invested in the system, the result has been a lowering of wage costs, and a huge increase in profits.
China in particular, has become the world’s workplace for basic consumer goods, that are produced and sold cheaply, because of low wages, and slave labour conditions. The flood of cheap Chinese goods onto the world market has kept inflation down, while, at the same time, China’s phenomenal development has boosted the demand for, and also the price of raw materials, and in this way has helped ward off the opposite threat of deflation.
Credit, and mushrooming debt, has sustained the market for the goods that have poured out of China. This market has centered in the US, where US citizens have acted as the world’s consumers of last resort, borrowing the money that has allowed them to keep on buying. They have been able to do so on the strength of successive bubbles, firstly the dramatic rise in share prices – the dot. com boom – and, more recently, the bubble in house prices.
The dollar remained strong, despite a huge trade defecit, only because part of the Chinese surplus - and more recently that of other countries, including the oil producing states - was recycled back to the US, some of it into the now troubled US financial companies. A quarter of the Chinese reserves have been invested in US government linked institutions, including Fannie Mae and Freddie Mac. In turn, a strong dollar kept imports cheap, and maintained purchasing power.
Now, as the problems in the financial markets overspill into the real economy, this delicate balance threatens to quickly unravel. Stagnant wages, dearer credit, and higher commodity prices are all factors that, alongside growing uncertainty, will impact heavily on consumer spending in the US and elsewhere.
There is evidence that many householders in the US at first, responded to crippling mortgage debt by using their credit cards to pay bills rather than lose their homes. All this points to a dramatic reining-in of consumer spending, as workers try to pay off loans and replenish savings.
It is not so long ago that economists were assuring us that the emergence and complete integration of China and India into the globalised economy would guarantee continued growth, up to the economic horizon and beyond. Then, when the credit crunch hit, there was a new ‘line’ – that China and India were ‘de-coupled’ from the rest of the world economy and would escape the crisis. More recently, the exponents of “de-coupling” have gone silent.
There have been sharp stock markets falls in China, in India and in Russia, where the stock market has been closed down on several occasions, in order to prevent stocks going into freefall. The Russian government has had to pump billions into the banking system, while the Indian government has been forced to spend $7 billion of its reserves to support the rupee. Despite an earlier $500 billion bail out, the Chinese Banks, according to David Smith in his book, The Dragon and the Elephant, are still regarded by many economists as “an economic catastrophe waiting to happen”.
Any fall in purchasing power in the major economies must inevitably impact on Chinese exports and then on the domestic Chinese economy. Already China’s export volume growth has halved this year. A fall in the dollar would further have a futher impact, making Chinese – and other imports – more expensive in the US. It would also devalue the dollar holdings of China, Russia, the Gulf States and other surplus nations. But a withdrawal from the dollar by these countries’ massive Soverign Wealth Funds could cause the dollar to plummet further and would exacerbate the problem.
The crisis has already extended to the real economy. Figures for the Eurozone show that its economy as a whole contracted in the second quarter of this year, and there are few signs of any improvement since. Ireland, previously Europe’s strongest economic performer, is the first Eurozone country to formally declare itself in recession. The Japanese economy also contracted in the second quarter and could now be in recession. On an annualised basis, both retail sales and industrial production in the US are already negative, and most economists now predict minus growth for the economy as a whole by the end of this year.
One danger for capitalism is that this becomes an interlocking crisis, where one set of problems can cause new problems which, in turn, can aggravate the original difficulties. This feedback effect was felt in the early stages of the Japanese crisis, where the banks reacted to the property slump by cutting lending. The economic slowdown then set off a second wave of defaults.
Today, with tight restrictions on credit, with inter-bank lending rates up to record levels, making what credit there is more expensive, it becomes more difficult and costly for companies to borrow money. If this continues – and the desperate measures being taken to lubricate markets with government money are an attempt to avert this – the recession is likely to be deepened and prolonged.
Charles Morris, in his book, The trillion dollar meltdown points out that, although most companies, through a combination of high profits and little capital spending, came through the growth years with large cash balances, there was a “tail” of bad corporate debt amounting to some $5.7 trillion by the end of 2006. A tightening of credit in the context of a recession could worsen this situation, leaving banks facing a new wave of debt defaults, this time from corporate rather than individual borrowers.
The measures that are being taken to try to prevent the financial system crumbling under the weight of bad debt can themselves pose other problems down the line. Billions that are spent trying to recapitalise banks and place a ‘cordon sanitaire’ around non performing loans leave less to be spent elsewhere. This makes it harder for governments to loosen their budgetary strings or take other reflationary measures to try to spend their way out of a deep recession.
It is impossible to say with certainty how deep or prolonged the coming recession will be. But the one certainty that economists now agree on is that there is still plenty of bad news to come.
These events have already delivered a powerful ideological blow against the advocates of capitalism. Their ideological offensive against the working class movement and against the ideas of socialism has been derailed. It will be some time before we hear again about the “end of history”, or the “end of the state”, or the “absolute supremacy of the free market” or any other such neo-liberal mantras.
It is the pundits and apologists of capitalism who are now on the retreat, trying to find new justifications for a system that patently does not work. It is time for the working class movement, which has been in ideological – and organisational - retreat, to resume the offensive.
The case for a socialist alternative to the madhouse economics of capitalism can now be made in a way that will be understood, accepted and taken up by the working class. The personal fortunes of the 15,000 wealthiest tax payers in the US add up to $384 billion. Why should the taxes of working class people be used to bail them and their system out?
Why should nationalisation be an economic sickbed for ailing capitalist institutions? If bankrupt companies can be taken over almost at a whim, why can profitable firms not be also be nationalised? Why can they not be then be placed under democratic workers’ management so that the money they generate can be used for the benefit of society as a whole, not to line the pockets of the already super rich. The events that are now dominating the headlines day by day are providing an unanswerable case for socialism.