World economy: Scandal rocks world financial system

"The credit system appears as the main lever of overproduction and over speculation in commerce solely because the process of reproduction, which is elastic in its nature, is here forced to its extreme limits.

"And it is so forced for the reason that a large part of the social capital is employed by people who do not own it and who push this thing with far less caution than the owner, who carefully weighs the possibilities of his private capital, which he handles himself… The credit system accelerates the material development of the forces of production and the establishment of the world market. To bring these material foundations of the new mode of production to a certain degree of perfection is the historical mission of the capitalist system of production. At the same time credit accelerates the violent eruptions of this antagonism, the crises, and thereby the development of the elements of the disintegration of the old mode of production… It develops the incentive of capitalist production, the accumulation of wealth by the appropriation and exploitation of the labour of others, to the purest and most colossal form of gambling and swindling, and reduces more and more the numbers of those, who exploit the social wealth. On the other side, it constitutes a transition to a new mode of production. It is this ambiguous nature which endows the principal spokesmen of credit… with the pleasant character of swindlers and prophets." [Karl Marx, Capital, Vol 3, Chapter 27.]

Although modern capitalism is infinitely more complex than in Marx’s day, these lines, written more than 100 years ago, explain the reality behind the recent spate of financial scandals and collapse more than the millions of words which have tumbled out of the mouths and from the pens of capitalist commentators and economists. Credit in a capitalist economy, says Marx, extends a boom beyond its ‘natural cycle’ like a piece of elastic which is sometimes stretched to breaking point.

WorldCom Swindlers

An essential part of this system is the "pleasant character of swindlers and prophets" who engage in the "purest and most colossal form of gambling". However, the daily litany of financial collapses – Enron, Global Crossing, WorldCom, Xerox, Vivendi – has thrown up modern swindlers – Kenneth Lay of Enron, Bernard Ebbers of WorldCom – who make the swindlers of Marx’s day appear like house burglars compared to bank robbers. Even the Daily Mirror in London, have been forced to concede: "How Karl Marx must be rubbing his hands with glee and saying ‘I told you so’." [29 June 2002.]

The vast majority of capitalist commentators, however, are rushing to the defence of their system – "US capitalism down, not out" [Financial Times]; or "This is no crisis of capitalism, as longed for by the old left" [Polly Toynbee, The Guardian, London]. Others hammer away on the theme that capitalism "is the best system we have", while some, in a grotesque echo of the infamous Gordon Gecko in Oliver Stone’s Wall Street, have even proclaimed that "greed is good" [Samuel Brittan, Financial Times].

All of this is done to mask the fear of the capitalists and their hirelings that the whole house of cards, which was built up in the 1990s, is facing collapse. This boom was, we have to remember, proclaimed as a "new paradigm" that would stretch into the indefinite future. The notion that the collapse of these companies indicates no more than that there are a "few rotten apples" is the reverse of the truth. The whole barrel of apples, as well as the barrel itself, are rotten and are on the verge of falling apart. The very character of the 1990s boom ensured this.

As always with capitalism, which is a system which works blindly, this is now only becoming fully evident because of the exhaustion of this boom. In the words of Warren Buffett, the US’s richest and best known ‘investor’, "it’s only when the tide goes out that we can see who’s been swimming without their costumes on". When the Asian crisis broke in 1997, US economic commentators growled about Asian ‘crony capitalism’. Fortune, the US business magazine, warned its readers of the perils of investing in South-East Asia: "You can’t trust the companies, you can’t trust the governments, you can’t trust the analysis, you can’t even trust the mutual fund managers." Asia 1997, the US today!

The much vaunted neo-liberal Anglo-Saxon model for capitalism which was supposed to be far superior to Asia or Europe, let alone crisis-ridden Japan, now lies in ruins. The parasitical character of this model – decisions on the basis of shareholder pressure and value, the colossal process of mergers and acquisitions amounting to at least $1 trillion in Europe and the United States alone in 1999 – is clear. It has now produced the world’s largest bankruptcy (Enron) and the world’s greatest accounting fraud (WorldCom). In addition to this, the two largest acquisitions in history, Vodaphone-Mannesmann and AOL-Time Warner, have "destroyed hundreds of billions of dollars of shareholders’ funds." [The Guardian, 27 June, 2002.]

Will Hutton, former editor of The Observer in London, and defender of ‘European capitalism’ against the US model, remarks acidly about this process: "The majority of mergers and takeovers in this stock market dominated economy (the US) have proved destructive; few had any value and most lower it. Between 1993 and 2000, Wall Street had brought 3,500 small hi-tech companies to the stock market; even before the dotcom bubble had burst, more than half were trading below their initial offer price or had gone bust. While dividend distributions have doubled as a proportion of profits, investment in the core of American business was troublingly low, the US has less invested capital per employee than France or Germany".

In fact, the US manufacturing base in the 1990s went through the same process of ‘hollowing out’ as Britain had earlier through the mad Thatcherite de-industrialisation policies. The giants in the US, largely financially driven and slaves to ‘shareholder value’, have done everything to maximise the share value of a company, including lining the pockets of the chief executives (CEOs). Indeed, the ‘captains of industry’ (‘non-industry’ in reality) in the 1990s made Gordon Gecko appear as a simpering liberal in comparison.

The capitalist commentators comfort themselves with the notion that all booms bring with them ‘overheads’ (read swindling on a massive scale). This is only revealed when the boom goes bust, beginning with the end of the tulip mania of the Seventeenth Century through to the 1929 Wall Street Crash. Yet, never in history has financial chicanery, fraud and ‘crony capitalism’ taken place on such a scale as during the boom of the 1990s. Even The Guardian has been compelled to comment: "It is becoming clear that the late 1990s were actually about unchecked greed and corruption. It was a time when many turned a blind eye and levels of corporate governance and auditing clearly became, in many cases, lax."

The term "lax" is a massive understatement when applied to the recent examples of financial scandals. Accountants are the alleged watchdogs of industry, yet as accountancy firms like Andersen, are complicit in the cover-up which allowed the perpetuation of massive fraud, in the case of Enron for instance. The huge fees which are paid out to accountancy firms, which are themselves multinationals, ensures their complicity in the fraud which is taking place.

CEOs, with more than 50 per cent of their salary in the US paid in ‘stock options’, also have an interest in ensuring a rise in the share price, which in turn ensures a rise in their income. This led to the covering up of a $4 billion ‘black hole’ in the case of WorldCom. They still ascended the golden staircase of capitalism. This all helped to boost shares to unprecedented levels of 30, 40 or even 50 times the real value of assets.

Massive wage differentials

No matter; the salaries of the bosses soared in an unprecedented fashion. In 1980, a chief executive in the US made $42 for every $1 earned by one of his or her blue-collar workers. By 1990 that had stretched to $85 and by 2000, chief executives were earning $531 for every $1 taken home by an ordinary worker! Jay Lorsch, of Harvard Business School, who originally propounded the ‘bad apple’ theory, but who has been subsequently forced to modify it, comments on the behaviour of chief executives: "I am more and more coming to the conclusion that there has been a huge shift in the values and goals of chief executives in the past 20 years from building great companies to their celebrity status and personal wealth. They have become these John Wayne, larger than life people and they are starting to believe their own clippings."

The average industrial worker has been impoverished, relatively speaking, and many in real terms. But the majority of voters in US elections have also lost out in the share collapse which has taken place. Fifty per cent of those who voted in the last US elections own stocks and shares. The drop in share prices will have affected them but the process has not finished yet. In 1996, the chairman of the Federal Reserve, Alan Greenspan, attacked the "irrational exuberance" of investors in equities. Since then, the value of shares at one stage went up by 50 per cent from the level of 1996. Even with the recent drop it has still not returned to the 1996 level. This indicates that further drops in equities are likely which will not be compensated for completely by a rise in house prices.

What these events have underlined is the completely false picture of the boom of the 1990s which was presented by capitalist economists at the time and which, unfortunately, took in some alleged ‘Marxists’. US capitalism, they said, had initiated a new long-term phase of growth, stretching into the indefinite future and buttressed by an unparalleled growth in the productivity of the US in particular. All of this has now been shown to be bogus, with profits artificially inflated and the balance sheet of companies ‘poisoned’. The much vaunted ‘productivity miracle’ was accepted as a fact at the time, but the CWI and the Socialist Party in Britain argued strongly against in written material.

Of course, the ruling class try to comfort themselves with the idea that all these developments are so much ‘froth’ because the ‘fundamentals’ of the US and world economies remain ‘healthy’. They are whistling in the dark to keep up their spirits. Indeed, in the last few months the majority of capitalist economists have claimed that not only is the ‘worst’ over but in fact we have gone through the "recession that never was". Comparing the world economy to an aeroplane, they argued that rather than landing – a recession – it merely experienced "touch down" on the runway and was poised once more to soar into the heavens. This is an entirely false picture of economic events in the last 12 months. Not only has there been a considerable slowdown in the growth of the world economy but the increase in world trade contracted from 12 per cent to almost zero in 2001. This is an even bigger drop than in the recession of 1990-92. The OECD now expects employment in the advanced capitalist countries to fall this year for the first time in two decades.

US economy key

The US economy is still the key for the prospects of the world economy. US consumers, we have to repeat, were the consumers of last resort, which managed to bale out the world even through the Asian financial crises of 1997, the financial collapse of Russia in 1998, the problems of Brazil in 1999 and even during the latest slump. They sucked in imports from the rest of the world and more importantly, foreign investors were happy to pour money into the US markets to cash in on booming hi-tech industries. Now, they are deterred from pumping more money into the US economy. One ‘global economist’ has commented: "We thought it was a bubble but perhaps the whole thing was overstated. The dollar bull market was just plain wrong."

The huge current account deficit of 4.3 per cent of US gross domestic product in the first quarter of 2002 (and it is on course for a record 5 per cent deficit) was plugged by the $1 billion a day which foreign investors poured into the US markets. However, the recent depreciation of the dollar, precisely because the ‘fundamentals’ of the US economy are far from sound, threatened to go into freefall without the intervention of the Bank of Japan and probably, behind the scenes, other central bankers as well. The dollar is now almost at parity with the euro and could slide to an even lower level in the next period.

Consequently, the financiers have hailed the ‘resurrection’ of the formerly ‘despised’ euro. The Financial Times triumphantly declared: "For the proud parents of the bullied child (the euro) this is a happy time. The day of their euro has come." However, the rise in the euro is a mixed blessing for the European capitalists as it drives up the costs of European exports to the US market which is crucial to a euro zone that is mired in economic stagnation and rising unemployment (for the working class the introduction of the euro saw the bosses increase prices of goods and services). Japan has also been affected with the devaluation of the yen being partially cancelled out by the drop in the dollar.

The real concern however is if the dollar was to go into freefall that could trigger a world financial crisis which in turn could choke off even the first ‘shoots’ of a claimed recovery in the world economy. The collapse of equities and the decline of the dollar, which will push up the price of imports into the US, are bound to have an effect on the famed propensity of the US population to consume at ever faster and faster rates.

Some capitalist commentators have taken comfort in the fact that US manufacturing industry appears to have slightly improved in the past period. However, this is largely accounted for by the rebuilding of stocks with a slight improvement in employment, particularly in temporary workers. The US, in effect, is now suffering from triple deficits: households in debt, the government in debt and the nation as a whole in debt. Will the consumer be allowed to continue ‘consuming’? If Greenspan has his way this will continue to be the case as the Fed has pursued a policy of reducing the cost of credit with rates of interest below inflation.

Booming housing market

The boom in the housing market in Britain and the US in particular is a factor in allowing house owners to borrow against the increased value of their house and hence to continue to spend. On the other hand, the deflation of equities, which could drop even further, as argued above, could convince consumers, particularly in the US, to pull in their horns and rebuild their savings. Combined with the ‘hot money’ which went into the US in the recent period now leaving for the safer and more lucrative haven of Europe, it is little wonder that the Financial Times sums up the prospects of the US economy with the headline: "The Eagle is landing". The fear of a further collapse was summed up in the comments of a British stockbroker "too young to have experienced the 1974 slump but old enough to have worked through the 1987 crash. He asked not to be named, as his views conflict with those of his firm. ‘On the record the background in the global economy is not too bad. There’s irrational pessimism. Off the record, it’s fucked.’"

Once more, capitalist economists have begun to worry about the dreaded ‘double dip’ in the US economy, which they dismissed up to recently. This would be "dreadful for Germany and Japan, both of which have weak domestic demand and so dependent on the States for demands for their exports." [Hamish McRae, The Independent.] Having raised this spectre, McRae then dismisses it: "The danger is small." Other capitalist economists, however, are using the same terms as the Marxists that this crisis is not ‘episodic’ but is ‘systemic’.

Crucially, profits and investment have dropped in the last two years and are now stagnant. This is the situation in Japan: "Weak capital investment in Japan" [Financial Times] and "Investment fall wreaks permanent damage" [Financial Times, in relation to the British economy]. The latest report from Experian, the business information company says that "the average return on capital of companies fell to 8.37 per cent. This compared with 9.05 per cent the previous quarter and 10.84 per cent in the first quarter of last year. Peter Brooker, a director of Experian, which has analysed the profitability of 2,000 businesses generating three-quarters of the UK’s non-financial GDP, said: ‘While the economy has continued to grow, it has been at the cost of profit margin and job losses’…

"Profitability among engineering companies dropped from 6.93 per cent to 4.81 per cent year-on-year, taking the decline to about 60 per cent over three years. However, the sharpest fall in returns was among motor dealers, hit by price-cutting by manufacturers which also triggered a drop in used car prices. Here, return on capital declined by more than a third during the year to 6.16 per cent." [Financial Times, 6 July, 2002.]

At the same time the same journal comments: "The ratio of household debt to incomes is at an all-time high". This is against the background of large-scale redundancies of failing firms, particularly in the ailing telecoms and technology sectors of industry. Motorola and Cap Gemini Ernst and Young, for instance, have between them cut almost 12,500 jobs because of the continuing slump in this industry.

If the US economy should go into a tail-spin – a slump or serious recession – it will tip over countries and even regions of the world economy, which are either in economic meltdown – Argentina – or threaten to lever others over the abyss, like Brazil, Uruguay and Paraguay in Latin America. The same thing could happen to Turkey, which stands between Europe and Asia. When Argentina collapsed, most of Latin America seemed to avoid the same fate. The ruling classes of Latin America, as well as the US ruling class, congratulated themselves that they had avoided a situation similar to the Asian crisis of 1997-98, when countries followed one after the other into financial panic and collapse.

‘Moral Hazard’

The US ruling class in particular mouthed phrases about avoiding ‘moral hazard’, code for state interference in the so-called ‘free working of the market economy’. Now, however, they are confronted with the shades of Asia afflicting Latin America as a financial and economic domino effect spirals out from the basket case of Argentina to the rest of the continent. Uruguay has seen a significant drop in its gross domestic product since 1998. Brazil, on the other hand, seemed to have benefited initially from Argentina’s difficulties, with the depreciation of the Brazilian currency the Real and increased exports.

But the other side of the equation in Brazil was the dramatic rise in public sector debt from 34 per cent in 1987 to 49 per cent in 1995 and now standing at 55 per cent of GDP. Only a minority of this debt is held abroad but a significant section is linked to the dollar. Brazil’s total external debt, which is less than 50 per cent of GDP, is, moreover, primarily to the private sector in the West. At the same time this total is more than 310 per cent of exports of goods and services, raising the possibility that Brazil will never be able to pay off its debt. Real growth in the economy dropped from 4.4 per cent in 2001 to 1.5 per cent in 2002.

Added to this is the ‘danger’ of the victory of Lula and the Workers’ party (PT) in the elections in October. Panic stations appeared to grip the ruling class in Brazil and internationally despite the fact that Lula, and his vice-presidential candidate, a leading Brazilian industrialist, assured businessmen that a PT government would pursue a strictly orthodox financial policy. However, the PT has never been in power at national level and is therefore an unknown factor. The capitalists fear that pressure from an aroused working class can be exerted on a Lula-led government to carry through radical measures, particularly if it takes power against the background of financial and economic meltdown.

The US ruling class officially appears set to employ the same hands off policy towards Brazil and the rest of Latin America as they did until recently to Argentina. The US Treasury Secretary, the economic backwoodsman O’Neill, declared in June: "More support for Brazil is a mistake". However, his office ‘clarified’ this statement, effectively disowning O’Neill.

The Bush administration, despite disclaimers to the contrary, is one of the most interventionist in recent US economic history. It has ploughed in huge liquidity, through the measures of the Fed in cutting interest rates, tax cuts, increases in military spending, etc., in the aftermath of September 11. It is currently using pressure through the IMF to prevent the slide in the dollar. It provided, through its influence in the World Bank, the IMF, etc., resources to bail out Turkey last year. Now faced with a further economic and political crisis, with the prospect of the pro-Islamist party coming to power in Ankara, the IMF has rushed in to approve a loan of more than $1 billion to further bail out the country.

Indeed, one of the consequences of this crisis worldwide is the compulsion felt by different capitalist governments to sin against the ‘non-interventionist’ creed which was supposed to be the ‘holy of holies’ of seamless globalisation. Now, with the crisis in just its first stages, the capitalists are touching the economic gear stick which threatens to throw it into reverse. Even the newly installed right-wing regime of Chirac in France has intervened, behind the scenes, in the collapse of the media conglomerate Vivendi, and is examining the possibility of renationalising privatised France Telecom.

This is the music of the future in the event of a serious economic recession or slump. It is an indication of the uncertain period for capitalists that they move out of equities into the ‘safe haven’ of so-called real assets: property, gold, mining shares and long-term securities in the form of bonds. Whether or not this betokens a new deep slump of capitalism or a serious recession, a double dip, remains to be seen. A leading share analyst in Britain has predicated stagnation in equities for the next 10 years á la Japan. Stephen King, the managing director of economics at HSBC, has pointedly written: "Although policy is currently supportive for growth, it may ultimately be the case that the legacy of the late 1990s bubble will serve to generate only a hesitant and fragile economic recovery". This means that the economic future for the foreseeable period is one of stagnation, rising unemployment, of a contraction in living standards for significant sections of the population.

The fall out from the deflation of the 1990s bubble has already been felt in the pensions sector. Millions of workers in the US and in Europe, as well as significant sections of the middle class, have had the prospects of a relatively secure future snatched away as the pension funds have lost billions. At the same time the ruling class, faced with a so-called demographic time bomb – people living longer – as part of the general offensive against the living standards of the working class, are attempting to extend the age of retirement for women and of men. This will mean that a major battle by workers in defence of past gains is posed.

New ‘watch dogs’

After every series of major financial scandals which seems to either accompany or sometimes trigger a crisis, the cry goes up from the capitalist commentators that financial ‘watchdogs’ have not done their job in sounding the alarm bells about the financial improprieties of companies. The Financial Times, in relation to Enron, wrote: "The [Enron] board also failed to ask questions about conflicts of interest that harmed shareholders’ interests. Executives were allowed to run off-balance-sheet partnerships that realised hundreds of million of dollars at Enron’s expense." [8 July, 2002.]

Their solution is to appoint further ‘watchdogs’. After the 1929 Wall Street Crash, the US Congress passed the Securities Exchange Act of 1934. But as John Galbraith comments in his book The Great Crash of 1929 it was "not at that time especially necessary. Markets and financial adventures were then and for a long while after restrained not by the SEC but by the memory of what happened to so many in 1929."

However, these ‘controls’ did not deter the "prophets and swindlers" in carrying out greater and greater fraud later, no more than appointing ‘watchdogs’ to watch over the ‘watchdogs’ will today. The capitalists will find ways to circumvent any restrictions placed on them. The very minimum that should be demanded by working people – who pay for these swindlers – is the opening of the books of big business to committees of workers, trade unionists and representatives of consumers. So-called ‘business secrets’ should be abolished. They are a means of keeping the dark secrets – financial chicanery – hidden from public gaze. When we are all ‘whistle blowers’ about the financial cheating and crimes of big business, then there will be no need for any more ‘whistle blowing’.

This financial crisis is already having an impact on working people. Jobs are being lost as companies implode and millions face losses in their savings and pensions. The call for the defence of jobs and the taking into public ownership of companies cutting employment needs to be taken up by the labour movement. Above all the demand that only the rich should pay for this crisis needs to be heard, and the state should guarantee decent pensions for all.

Capitalism offers a period of insecurity and uncertainty. It is a blind system, with even its ‘experts’ consulting the ‘tea leaves’ for predictions for the future. Lodged in the situation today in the world economy is the possibility of another devastating slump along the lines of 1929. On the other hand, a period of stagnation, of deflation, of an extended period of economic depression with only small anaemic growth in production and a growth in the social malignancy associated with this, of poverty, rising unemployment, increased class conflict, etc., is possible. We must be prepared for a change in the situation, which will present big opportunities for socialists and Marxists.

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July 2002