“FOR many a decade past, the history of industry and commerce is but the history of the revolt of modern productive forces against modern conditions of production, against the property relations that are the conditions for the existence of the bourgeois and of its rule. It is enough to mention the commercial crises that, by their periodical return, put the existence of the entire bourgeois society on its trial, each time more threateningly. …In these crises, there breaks out an epidemic that, in all earlier epochs, would have seemed an absurdity - the epidemic of over-production. Society suddenly finds itself put back into a state of momentary barbarism… And why? Because there is too much civilisation, too much means of subsistence, too much industry, too much commerce. … And how does the bourgeoisie get over these crises? On the one hand, by enforced destruction of a mass of productive forces; on the other, by the conquest of new markets, and by the more thorough exploitation of the old ones. That is to say, by paving the way for more extensive and more destructive crises, and by diminishing the means whereby crises are prevented.”
-- The Communist Manifesto (1848)
“THE contradictions inherent in the movement of capitalist society impress themselves upon the practical bourgeois most strikingly in the changes of the periodic cycle, through which modern industry runs, and whose crowning point is the universal crisis. That crisis is once again approaching, although as yet but in its preliminary stage; and by the universality of its theatre and the intensity of its action will drum dialectics even into the heads of the mushroom-upstarts of the new, holy Prusso-German empire.”
-- Karl Marx, 1873 (Afterword to the second German edition of Capital Volume I)
CAPITALISM has learned to live with crises and through crises; but some of them are epochal. Such was the Great Depression (GD) of 1930s. Will the one that is currently unfolding prove to be another?
Take a look at the timeline of disaster appended at the end of the pamphlet. You will see how it started as a mild drizzle and high wind back in late 2006 and gradually gained strength to become a gale storm. No developed country was spared, none of the numerous measures taken by the Bush Administration and financial authorities of the G-7 over more than a year worked, and in late 2008 something like a category five hurricane devastated the world of high finance. Veteran Nobel laureate Paul Samuelson had good reason to observe, "This debacle is to capitalism what the fall of the USSR was to communism."
Proximate Causes
To put it very simply, titans like Lehman Brothers, AIG Insurance, Fannie Mae and Freddie Mac failed because at the hour of need they could no longer raise money from the market to roll over their short-term debt.
Being over-exposed to the sub-prime mortgage market and relying too much on derivatives -- instruments derived from the performance of some distant asset—hence the generic name “derivatives” -- they suffered huge losses and lost the trust of the market. Investors became reluctant to lend money even to these prestigious financial institutions. Failing to meet their obligations, essentially they went bankrupt, though in most cases they were rescued by the government.
The "sub-prime mortgage market" or "sub-prime loans" refer primarily to housing loans to those who could hardly afford them and in which the initial interest rate was sub-prime (very low) to begin with, but escalated over the duration of the mortgage on the assumption that as the borrower progressed career-wise there would be an increased capacity to pay instalments. The sub-prime loan instruments were then "diced and sliced" (i.e. mixed up with other more viable loans) and the resultant derivatives were sold on by the original mortgage institutions to other banks and financial institutions. Thus emerged a shadow banking system. The new breed of derivatives generated by dicing and slicing of sub-prime and other risky loans were expected to distribute the risks among many financial institutions and thereby minimise the risks shouldered by each.
This strategy allowed financiers to circumvent regulations and generate easy credit by taking high risk bets and offloading the risks on to others. When, with the collapse of the housing bubble and an avalanche of defaults by sub-prime borrowers, the 'bets' began to go wrong, the pyramid of deals began tumbling down. More than once during 2007 and 2008 the US government sought to stem the tide by helping indebted homeowners, but in vain. The whole process snowballed and led to the September 2008 debacle followed by generous bailouts.
Strange as it may seem now, the high risk strategy involving excessive sub-prime loans and an endless web of securitisation or derivatives-creation was not restricted or regulated by any public or private authorities. Rather, this strategy was praised as a sure way to prosperity -- both for the firm and for the country. Announcing its 2005 Annual Awards -- one of the securities industry's most prestigious awards – the International Financing Review (IFR) said, "[Lehman Brothers] not only maintained its overall market presence, but also led the charge into the preferred space by ... developing new products and tailoring transactions to fit borrowers' needs.... Lehman Brothers is the most innovative in the preferred space, just doing things you won't see elsewhere."
Yes, Lehman became too smart and that's why it met the fate it did, calling back the memory of Nobel-prized Long Time Capital Management (see section "Explosion of Credit and Speculation Today"). Similarly, the US as the leader of the global North blazed the trail in these "innovative" activities, reaped the highest profits for some years and is now paying the highest price for economic adventurism.
The weeks-long earthquake was followed by an aftershock that was mild in dollar terms but took a heavy toll of confidence and legitimacy. Wall Street broker Bernard (‘Bernie’) Madoff, former president of NASDAQ, recently confessed to pulling off the biggest fraud in history, a $50 billion dollar scam. For almost four decades he built up a clientele that included many multi-millionaires and billionaires from Switzerland, Israel and elsewhere, as well as the US’s largest hedge funds. To put up a veneer of genuineness, Madoff imposed rigorous conditions on potential clients, such as recommendations from existing investors. Madoff’s standard message was that the fund was closed…but because they came from the same background (board members of Jewish charities, pro-Israel fund raising organizations or the ‘right’ country clubs) or were related to a friend, or existing clients, he would take their money. He embezzled the entire money, and paid the returns due to the old investors from new cash flow. He only dealt with a limited clientele of multi-millionaires and billionaires who kept their funds in for the long haul; the occasional withdrawals were limited in amount and were easily covered by soliciting new funds from new investors fighting to have access to Madoff’s money management.
Bernard Madoff’s game plan is called Ponzi scheme after Charles Ponzi, an Italian-born American immigrant who promoted an investment plan in 1918-1920 that traded postal coupons. Rather than paying investors from legitimate investment returns, Ponzi used to pay out early investors with money collected from new investors. He was found guilty and imprisoned in 1920. In Madoff's case the rug-pulling was provided by the huge losses suffered by some of his clients in other, i.e., non-Madoff investments in the wake of the financial crisis. When many of these clients sought to sell some of their apparently performing Madoff assets to help offset other losses, the scam exploded.
Madoff’s long-term, large-scale fraud was not detected by the Securities and Exchange Commission (SEC) despite its claims of at least two investigations. As a result, there is a total loss of credibility of this watchdog. The swindle has further eroded confidence in the markets. It has drawn as much anger for the money lost as for the fact that the world’s smartest swindlers on Wall Street were completely ‘taken’ by one of their own. Their self-image that they are so rich because they are so smart was utterly shattered.
But the most serious impact of the revelation lies in the growing awareness that the United States government too manages its finances largely on the Ponzi principle. Since 1985 it has been importing more than it exports. That is to say, as a nation it consumes more than it earns. The fallout is that for years on end its national debt has been soaring. As existing debt matures, these are repaid by issuing new debt, i.e., US Treasury Bills. Interest payments on existing debts are also made by selling new debt to investors. If – as happened with Madoff – a large number of US creditors want their money back, the era of American "deficits without tears" will come to an end. In such a scenario, the world’s biggest debtor -- just like Orange County (US) in 1990s and Iceland recently – runs the risk of bankruptcy.
(Acknowledgement: this section is partly based on “Bernard Madoff: Wall Street Swindler Strikes Powerful Blows for Social Justice” by James Petras, available on his website)
A total meltdown has been prevented – well, for now. But thanks to highly efficient networking by IT-enabled services and thorough integration of financial markets, the contagion spread at electronic speed all across the planet and soon affected the real economy too. Financial institutions, in the US and Europe in particular, still have no idea of what they are sitting on. That is to say, they do not have any estimate of the reliability of their assets base, which include unknown but large quantities of toxic securities. This has led to a reluctance of banks to lend to each other and to private individuals or firms. Liquidity in the real economy has thus dried up leading to a slowdown, which is further aggravated by declining consumption on the part of US citizens shaken by foreclosures and end of credit-dependent spending spree. And thanks again to successful globalisation, (in the sense of capital's success in the "conquest of new markets and... more thorough exploitation of the old ones") this time around there is no country like the erstwhile Soviet Union to escape from the grip of crisis.
The National Bureau of Economic Research in US has recently announced that a contraction had actually begun in December 2007. At 12 months, the recession is already the longest since the 16-month slump that ended in November 1982. The US economy shed 533,000 jobs in November -- the largest monthly job loss since December 1974 -- bringing the year's total to 1.9 million. The latter figure surpasses the 1.6 million jobs lost in the 2001 recession. The extreme volatility of commodity prices in world trade in the recent past was an important indication of the turbulence in the global economy.
According to a survey published in December 2008 by the Chinese Ministry of Human Resources and Social Security, more than 10 million migrants are out of work. A recent public security report published by the Chinese Academy of Social Sciences (CASS) said that the global financial crisis has caused the closure of 670,000 small- and medium-sized firms in China, many of them labour-intensive ones based in coastal regions. Since September, the number of minor criminal cases in the Yangtze and Pearl river deltas was up 10 per cent on the same period of 2007. The first half of this year might well see more social unrest triggered by the financial crisis, the report said. President Hu Jintao and Premier Wen Jiabao have called on officials to maintain social stability and help cope with the financial crisis.
World trade is projected to fall next year for the first time since 1982 and capital flows to developing countries predicted to plunge 50 per cent, the World Bank said in a forecast released 9 November 2008. Developing countries will grow at an average rate of 4.5 per cent next year — a pace that almost constituted a recession, given the need of these countries to grow rapidly to generate enough jobs for their swelling populations. "You don't need negative growth in developing countries to have a situation that feels like a recession," said Hans Timmer, who directs the bank's international economic analyses and projections. As the World Bank's experts struggled to find a historical parallel to the slump, they said it had more in common with the GD than with the severe recessions of the 1970s or 1980s.
The UN’s World Economic Situation and Prospects 2009 estimates that the rate of growth of world output which fell from 4.0 per cent in 2006 to 3.8 per cent in 2007 and 2.5 per cent in 2008 is projected to fall to -0.5 per cent in 2009 as per its baseline scenario and as much as -1.5 per cent in its pessimistic scenario.
Well, can we call this a depression? Given the highly sophisticated monetary management techniques and huge levels of state intervention extensively resorted to these days, traditional distinctions between a recession and a depression have become largely superfluous. To avoid unnecessary academic hairsplitting, we have used the term “depression economics” after Paul Krugman to mean a broadly depression-like situation. The IMF in its November 2008 forecast said that output in advanced economies would contract on a full-year basis for the first time since World War II. A number of countries have already seen capital flight and currency depreciation of such severity that they have been forced to turn to the IMF (Iceland, Ukraine, Pakistan) or enter into emergency financial arrangements (Hungary, South Korea).
US Treasury Secretary Ben Bernanke put up a sombre face and told the law-makers at the peak of the September crisis that if the government did not save the (financial) markets then there might not be any financial markets in the future. He was speaking the truth. Bush and other hardcore neo-cons were compelled to change their stance and agree to a bailout package that is remarkable both for its sheer size and the opposition it evoked. Here is an assessment given by frequent CNBC commentator, Barry Ritholtz on his blog:
2008 Bailout versus Other Large US Government Projects
It should be noted that Ritholtz’s figure of $4.6165 trillion as total bailout amount might be an understatement. According to New York Times (October 18, 2008) the all inclusive bailout figure was already "an estimated $5.1 trillion” by October -- and it is growing!
As widely reported in the press, the "Emergency Economic Stabilisation Act of 2008" was passed in the face of tremendous opposition. At one time, calls and emails from constituencies to the Congress were running as high as 300 to 1 against the bailout. There were many street demonstrations too. Some 400 economists, including two Nobel Prize winners, opposed it. The package was then 'sweetened' in the Senate by granting another $110 billion in tax relief and renewable energy incentives to get enough House vote for passage.
The basic opposition against the bailout is that it transfers huge amounts of public money into the hands of private financiers responsible for the catastrophe instead of punishing them. The message goes out that the executive fat cats of Wall Street can earn themselves royal fortunes through reckless – often illegal – business practices and then get away scot-free when their firms go down, bringing untold miseries to their customers. Moreover, it leads to a spiralling public debt. Even the actual implementation of the $700 billion bail-out of the US banking system has already been seriously questioned by the Government Accountability Office (GAO). It is being carried out without adequate oversight and monitoring, the Congressional watchdog observed, and added that the Treasury "has no policies or procedures in place for ensuring the institutions... are using the capital investments in a manner that helps meet the purposes of the Act."
As for other rich countries, by early December 2008, finance ministers from all 27 European Union countries met to discuss proposals for a stimulus plan totalling 200 billion Euro (250 billion dollars). At the moment central banks in US and Europe are heading towards zero interest rates. In India a series of stimulus packages including interest rate cuts have been announced to arrest the pronounced downturn, with hardly any tangible results.
China too launched an economic stimulus package worth nearly $600 billion. Unlike the bailout packages in the West, here the stress is on investments in domestic infrastructure and lowering of exchange-rate. The latter measure is vehemently opposed by the OECD countries because that will make Chinese products cheaper and more competitive. China on its part insists it has every right to use the exchange rate as a tool for boosting the economy when many other countries are pushing their currencies down. It believes that it can make the biggest contribution towards a fast turnaround of the global economy by sustaining China's own growth – in whatever way it can.
Even after the rescue operations, credit markets are still fundamentally broken. Economists have also pointed out that at bottom it is more a problem of solvency than a mere credit crunch. The assets of colossal financial institutions have depreciated in a big way on account of massive fall in the value of the loans (including securitized loans) they have advanced. Therefore, flooding the system with debt liquidity will not help; it may indeed be counter-productive.
When the Emergency Economic Stabilization Act of 2008 was passed, the US Chamber of Commerce did not express any great optimism. It merely said, "With the American economy on life support, Congress took the necessary step to stop the bleeding." Well, the bleeding was indeed controlled (not stopped altogether) but the patient's condition did not improve. Recently in Delhi, Joseph Stiglitz likened the bailout packages to giving mass blood transfusion to a patient who was haemorrhaging internally.
TODAY it is no longer a story of a mere "credit lock" or problems in the “new” or “FIRE” sectors; the rot has already reached the roots of old economy. Still, since the epicentre of the tremor and its aftershocks lies in the financial sector and given the supreme importance of this commanding sector, our investigation into the causes of the crisis should begin from here.
At one time the role of credit – of dealers in credit or financiers – was basically to “grease the wheels” of industry and commerce which turned out real goods, infrastructure and services. But gradually their role expanded. In Capital, particularly in "Book III" which discusses "The Process of Capitalist Production As a Whole", Marx dwells at length on a vast range of subjects like the role of credit, relation between money capital and real capital, fictitious capital and speculation and so on, which are directly relevant to the topic before us.
“... [A] large portion of this money-capital”, Marx says, “is always necessarily purely fictitious, that is, a title to value – just as paper money.” [Capital Volume III, p 509] He speaks of “a new financial aristocracy, a new variety of parasites in the shape of promoters, speculators and simply nominal directors; a whole system of swindling and cheating by means of corporation promotion, stock issuance and stock speculation” and of “fictitious capital, interest-bearing paper” which “is enormously reduced in times of crisis, and with it the ability of its owners to borrow money on it on the market.” (Capital, Vol. III, p 493). If this sounds contemporaneous, so would the anxiety expressed by the British "Banks committee" – a predecessor of various expert committees and monetary authorities of our day – exactly 150 years ago regarding the fact that “extensive fictitious credits have been created” by means of discounting and rediscounting bills “in the London market upon the credit of the bank alone, without reference to quality of the bills otherwise.” (ibid, p 497, emphasis ours).
Junk securities, then, are no invention of our Wall Street-wallahs! In Marx we also find the following passages which, with a bit of updating as suggested in square brackets, may help us understand what happened in September-October 2008:
“Ignorant and mistaken bank legislation, such as that of 1844-45, can intensify this money crisis. But no kind of bank legislation can eliminate a crisis.
“In a system of production, where the entire continuity of the reproduction process rests upon credit, a crisis must obviously occur – a tremendous rush for means of payment – when credit suddenly ceases and only cash payments have validity. At first glance, therefore, the whole crisis seems to be merely a credit and money crisis. And in fact it is only a question of the convertibility of bills of exchange [add here the modern credit instruments– AS] into money. But the majority of these bills represent actual sales and purchases, whose extension far beyond the needs of society is, after all, the basis of the whole crisis. At the same time, an enormous quantity of these bills of exchange represents plain swindle, which now reaches the light of day and collapses; furthermore, unsuccessful speculation with the capital of other people; finally, commodity-capital which has depreciated or is completely unsalable, or returns that can never more be realized again. The entire artificial system of forced expansion of the reproduction process cannot, of course, be remedied by having some bank, like the Bank of England, [today we would perhaps say the US Federal Reserve] give to all the swindlers the deficient capital by means of its paper and having it buy up all the depreciated commodities at their old nominal values. Incidentally, everything here appears distorted, since in this paper world, the real price and its real basis appear nowhere …” (ibid, p 490, emphasis added).
However, it was only with the advent of modern imperialism, a parasitic and decaying system marked by new features like all-round monopolisation, export of capital outweighing export of commodities, the rise of the financial oligarchy etc. that money capital metamorphosed into finance capital and attained a much more influential position:
“Imperialism, or the domination of finance capital, is that highest stage of capitalism in which the separation [“of money capital … from industrial or productive capital”] reaches vast proportions. The supremacy of finance capital over all other forms of capital means the predominance of the rentier and of the financial oligarchy; it means that a small number of financially 'powerful' states stand out among all the rest.”
“… [The] twentieth-century marks the turning point from the old capitalism to the new, from the domination of capital in general to the domination of finance capital.” (Lenin in Imperialism; emphasis added)
Now what is finance capital? Basically it is the coalescence of bank capital and industrial capital, said Lenin, and today perhaps we should include commercial capital as well. This coalescence, however, internalises a good amount of tensions and contradictions between the different sectors which maintain their special identities and interests. Modern banks, Lenin showed, concentrated the social power of money in their hands, and began to operate as “a single collective capitalist”, and so “subordinate to their will not only all commercial and industrial operations but even whole governments.” Also important in this context was the three-way “personal link-up" between industry, banks and the government.
Elaborating on the new stage, Lenin wrote:
“The development of capitalism has arrived at a stage when, although commodity production still ‘reigns’ and continues to be regarded as the basis of economic life, it has in reality been undermined and the bulk of the profits go to the 'geniuses' of financial manipulation. At the basis of these manipulations and swindles lies socialised production, but the immense progress of mankind, which achieved this socialisation, goes to benefit... the speculators.”
This separation of money capital from productive capital and this supremacy continued to grow, with the result that today we see “a relatively independent financial superstructure … sitting on top of the world economy and most of its national units”. That is to say, there is now an “inverted relation between the financial and the real”, where “the financial expansion feeds not on a healthy real economy but on a stagnant one” (Paul Sweezy, “The Triumph Of Financial Capital”, Monthly Review, June 1994).
The relative weight of the financial sector in the globalised international economy thus increased steadily all through, but very disproportionately since the 1980s, facilitated by neoliberal deregulation and the information revolution. Of this, by far the largest and fastest growing component is made up of speculation and other reckless activities: derivatives trade, hedge fund activities, sub-prime loans (see glossary in Appendix II) and so on. According to the Bank of International Settlements, as of December 2007, the total value of derivatives trade stood at a staggering $516 trillion. This has grown from $100 trillion in 2002. Thus, this shadow economy is 10 times larger than global GDP ($50 trillion) and more than five times larger than the actual trading in shares in the world’s stock exchanges ($100 trillion).
Trade in derivatives and generally in stock and currencies involve the self-expansion of money capital. As Marx had pointed out, making money out of money without going through troublesome production processes has long been a cherished ideal of the bourgeoisie and in recent decades that ideal has been ‘brilliantly’ put into practice. This is where speculative activities differ essentially from the role played by finance capital, originally defined as “bank capital, i.e., capital in money form, which is ... actually transformed into industrial capital” and is operated by “financial oligarchies” (Lenin in Imperialism, chapter III, “Finance Capital and the Financial Oligarchy”).
In the present context, speculation is trade in financial instruments with the goal of making fast bucks; or to be more precise, buying and selling of risks. Commercial banks, investment banks and insurance companies deal in both industrial financing and speculation – in real life the two categories are thus lumped together – but in terms of specific economic role performed they are very different. Traditional credit and production-oriented finance capital serves the real economy – agriculture, industries, services, where wealth is produced and people get jobs – whereas speculative capital produces no real wealth.
As we have seen, top bankers in the mid-19th century cautioned about “extensive fictitious credits” and Marx talked of "over-speculation". John Maynard Keynes in the mid-1930s warned, “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” (The General Theory of Employment, Income and Money).
Despite the warnings, and whatever the social costs, speculation has been highly rewarded by the state and other institutions of the capitalist class. Because decaying capitalism or imperialism discovered in it one of the most – if not the most – lucrative escape routes from the crisis of overproduction/over-accumulation that resurfaced since 1970s. In 1997 the Nobel Memorial Prize in Economic Science was awarded to America’s Robert Merton and Myron Scholes, who had just developed a model for pricing “derivatives” such as stock options. This model or technique was expected to help speculate ‘scientifically’ and reap mega profits safely. It was a different story though, that the Long Term Capital Management – a hedge fund where Merton and Scholes were partners and which worked according to the prized technique – found itself on the verge of collapse within a year the prize was awarded, and was rescued by the New York Federal reserve.
Acting in the same spirit, financial authorities in the US ignored grave warnings from eminent economists and persistently declined to impose any regulation on hedge funds. Thus Alan Greenspan said in 2004:
"Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient."
But as Warren E. Buffett observed five years ago, derivatives are “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” Mass destruction indeed, as we now find, both in terms of capital values destroyed and the number of people financially ruined or affected across the world! As Martin Wolf of the Financial Times aptly observed, “The US itself looks almost like a giant hedge fund. The profits of financial companies jumped from below 5 per cent of total corporate profits, after tax, in 1982 to 41 per cent in 2007.”
In addition to bourgeois scholars including acting and former chief economists of IMF, some organic intellectuals of the financial oligarchy have also been warning about the debacle for quite some time past. Prominent among them is George Soros. “I have cried wolf three times” – he says (in a promo of his latest book The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means) and we must say he really did – “first with The Alchemy of Finance in 1987, then with The Crisis of Global Capitalism in 1998, and now [in his new book]. Only now did the wolf arrive.”
He explains why he is so worried:
“… [The] current crisis differs from the various financial crises that preceded it. …the explosion of the US housing bubble acted as the detonator for a much larger ‘super-bubble’ that has been developing since the 1980s. The underlying trend in the super-bubble has been the ever-increasing use of credit and leverage. Credit – whether extended to consumers or speculators or banks – has been growing at a much faster rate than the GDP ever since the end of World War II. But the rate of growth accelerated and took on the characteristics of a bubble when it was reinforced by a misconception that became dominant in 1980 when Ronald Reagan became president and Margaret Thatcher was prime minister in the United Kingdom….
“The relative safety and stability of the United States, compared to the countries at the periphery, allowed the United States to suck up the savings of the rest of the world and run a current account deficit that reached nearly 7 percent of GNP at its peak in the first quarter of 2006. …” This inevitably led to the crash, he notes. (The Crisis and What to Do About It, The New York Review of Books, December 4, 2008)
So the ace speculator castigates excessive deregulation and dependence on debts and deficits, correctly pointing his finger at what we had identified (see Liberation, December 2003, “Mighty Achilles and His Vulnerable Heel”) as the soft underbelly of US imperialism. However, he describes the surface froth all right, but fails to relate it to the underlying crosscurrents that work it up.
If we are to do that, we must turn to the author of Capital.
BEFORE we proceed, however, we should recall that Karl Marx had to take leave of the international proletariat before he could systematically work up a comprehensive theory of capitalist crisis. Capital Volumes II and III, Theories of Surplus Value and Grundrisse were not made ready for publication in his lifetime; nor could he take up his plans for investigating various other facets of capitalist economy and polity. Naturally there is a wide array of differing interpretations of Marx’s theory, with Luxembourg for example differing with Lenin, and Ernest Mandel arguing against Paul Sweezy and others. Available space does not permit us to review the rich and continuing debate among these schools; we can only present here in barest outline what we believe to be the basic Marxian approach towards understanding capitalist crises.
Take a look at the quotation from the Communist Manifesto with which this pamphlet begins. Marx and Engels talk of an “epidemic of overproduction”. This is overproduction of commodities relative to effective demand: more is produced than can be sold. Thanks to inadequate purchasing power of the masses, a big chunk of commodities remain unsalable and drag their owners (producers/traders) down to ruin. This characteristic feature of capitalism led Marx to remark, “The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses as opposed to the drive of capitalist production to develop the productive forces as though only the absolute consuming power [as distinct from purchasing power – A Sen] of society constituted their limit.” (Capital Volume III p. 484)
The problem thus appears simply as a realisation crisis and prompts one to ask: why on earth do practical men of business commit the folly of producing more than they can sell?
Going deeper, we find that crises occur not because capitalists are fools, nor do they fall from the blue. They are produced in course of trade/business cycles resulting from a complex interplay of several partially independent variables, the most important being movements in the average rate of profit. As Marx showed in Part Three of Volume III of Capital, over a period of time and in the economy as a whole, this rate tends to fall. Here is how, in brief.
We all know that capitalists are prone to use more and better machinery to boost production and save on labour costs. In Marxist economic theory this is known as increasing the ratio of constant capital (plant and machinery, raw materials, various fixed assets, etc) to variable capital (capital expended on purchasing labour power – “variable” because this part, unlike the “constant” part, grows beyond its own value, i.e., creates surplus value in the process of production) – a ratio which is called the organic composition of capital. Since live labour is the source of surplus value or profit, replacing labour by machinery means a proportionate decrease in the rate of profit for every unit of total (constant plus variable) capital employed. Suppose a capital worth Rs. 100 crore comprised Rs. 60 crore in constant and Rs. 40 crore in variable capital and the rate of surplus value was 50%. The amount of surplus value was therefore Rs. 20 crore (50% of Rs. 40 crore expended on variable capital) and the rate of profit (calculated on total capital of Rs. 100 crore) was 20%. After say 10 years, the organic composition is increased – constant capital is raised to Rs. 80 crore and variable capital slashed to Rs. 20 crore. The rate of surplus value remaining the same, the amount of surplus value would be Rs. 10 crore (50% of Rs. 20 crore) and the rate of profit 10%.
The illustration is deliberately simplified, but the fact remains that increase in the organic composition of capital and a downward tendency of the average rate of profit, conditioned by the former, are the general laws of development of the capitalist mode of production. However, reduced rate of profit can go hand in hand with increased mass of profit if the total magnitude of capital on which profit is earned is sufficiently increased. And that is what usually happens in real life. As Marx puts it,
“…the same development of the social productiveness of labour
This has another consequence that has acquired much practical-political importance in the current context of development debate:
“… as the capitalist mode of production develops, an ever larger quantity of capital is required to employ the same, let alone an increased, amount of labour-power. Thus, on a capitalist foundation, the increasing productiveness of labour necessarily and permanently creates a seeming over-population of labouring people. If the variable capital forms just 1/6 of the total capital instead of the former 1/2, the total capital must be trebled to employ the same amount of labour-power. And if twice as much labour-power is to be employed, the total capital must increase six-fold.” [ibid, emphasis added]
We thus see that the tendential law of falling rate of average profit does not operate in a simple, linear fashion. It is realised only in course of cyclical movements of capital, through breakdowns and restorations of equilibriums. It has its own “internal contradictions” and unleashes a slew of countervailing forces or “counteracting influences”, such as more intense exploitation of labour, depression of wages below value, cheapening of the elements of constant capital, relative over-population (the “reserve army” of unemployed), foreign trade (skewed terms of trade and imperialist super profits), expansion of share capital – and to this list prepared by Marx we must add more modern techniques like monopoly pricing. We should therefore view the law “rather as a tendency, i.e., as a law whose absolute action is checked, retarded and weakened by counteracting circumstances” (ibid, pp 234-35).
Our stress on the tendency of the average rate of profit to fall – which Marx regarded as “in every respect the most important law of modern economy and the most essential for understanding the most difficult relations” (Grundrisse, p 748) – should not lead one towards a monocausal understanding of economic crises and business cycles. Crucial other causes are also there, such as anarchy of the capitalist mode of production which, inter alia, periodically upsets the conditions of equilibrium between the two main sectors – one producing consumer goods and the other producing capital goods – of capitalist economy. Marx also discussed several auxiliary factors which influence the specific courses and peculiar features of particular crises. More important among them are: movements in wage levels, competition among capitalist concerns, fluctuations in raw material prices, expectations (or “confidence”, to use a more modern term), movements in interest rates and financial turmoil, trends in international trade, and so on. A composite study of all these, and of other factors discovered in post-Marxian experience and research, is needed for seeking out the truth from the mountains of facts and data that are easily available; what we are attempting here is only an initiation.
The exposition of “the internal contradictions of the law” takes Marx to a discussion of certain “contradictory tendencies and phenomena” which “counteract each other simultaneously”. He mentions a number of such contradictory features – such as falling rate of profit alongside the growing mass of capital, enhanced productivity alongside higher composition of capital – and declares,
“These different influences may at one time operate predominantly side by side in space, and at another succeed each other in time. From time to time the conflict of antagonistic agencies finds vent in crises. The crises are always but momentary and forcible solutions of the existing contradictions. They are violent eruptions which for a time restore the disturbed equilibrium. …” (ibid, p 249, emphasis added)
Here we have the most concise description of the essential role of crises as an inbuilt mechanism of capitalism that, up to a point, prepares the way for a new upturn, just as a forest fire can prepare the woodland for a new period of growth. To explain how, Marx makes another move ahead in his exposition.
Where bourgeois economists see the surface phenomenon of commodity glut during depression, Marx lays bare the deeper substance of overproduction/over-accumulation of capital and shows how this comes about:
“A drop in the rate of profit is attended by a rise in the minimum capital required by an individual capitalist for the productive employment of labour… Concentration increases simultaneously, because beyond certain limits a large capital with a small rate of profit accumulates faster than a small capital with a large rate of profit. At a certain high point this increasing concentration in its turn causes a new fall in the rate of profit. The mass of small dispersed capitals is thereby driven along the adventurous road of speculation, credit frauds, stock swindles, and crises. The so-called plethora of capital always applies essentially to a plethora of the capital for which the fall in the rate of profit is not compensated through the mass of profit — this is always true of newly developing fresh offshoots of capital — or to a plethora which places capitals incapable of action on their own at the disposal of the managers of large enterprises in the form of credit. This plethora of capital arises from the same causes as those which call forth relative over-population, and is, therefore, a phenomenon supplementing the latter, although they stand at opposite poles — unemployed capital at one pole, and unemployed worker population at the other.
“Over-production of capital, not of individual commodities — although over-production of capital always includes over-production of commodities — is therefore simply over-accumulation of capital.”(ibid, p 250-51; emphasis added)
Such a situation naturally leads to an unseemly scramble among capitalists:
“So long as things go well, competition effects an operating fraternity of the capitalist class … so that each shares in the common loot in proportion to the size of his respective investment. But as soon as it no longer is a question of sharing profits, but of sharing losses, everyone tries to reduce his own share to a minimum and to shove it off upon another. The class, as such, must inevitably lose. How much the individual capitalist must bear of the loss, i.e., to what extent he must share in it at all, is decided by strength and cunning, and competition then becomes a fight among hostile brothers. The antagonism between each individual capitalist’s interests and those of the capitalist class as a whole, then comes to the surface … (ibid, p 253; emphasis added)
In the age of imperialism this is replicated on an international scale, with nation states engaged in fierce battles over who is to bear the brunt of the huge losses. Costs of crises are spread differentially according to the economic (including financial), political and military prowess of rival states. Imperialist war – being the fastest method of this destruction – appears on the horizon as a real or potential ‘solution’ to capitalist crisis.
In whatever manner and through however fierce a struggle the losses may be distributed among individual concerns (and among different states or trade-and-currency blocs on the international plane), the overriding need for returning the system to some kind of equilibrium has to be fulfilled. And that is fulfilled through destruction of part of capital values:
“…the equilibrium would be restored under all circumstances through the withdrawal or even the destruction of more or less capital. This would extend partly to the material substance of capital, i.e., a part of the means of production, of fixed and circulating capital, would not operate, not act as capital… The main damage, and that of the most acute nature, would occur … in respect to the values of capitals. That portion of the value of a capital which exists only in the form of claims on prospective shares of surplus-value, i.e., profit, in fact in the form of promissory notes … is immediately depreciated by the reduction of the receipts on which it is calculated. … Part of the commodities on the market can complete their process of circulation and reproduction only through an immense contraction of their prices, hence through a depreciation of the capital which they represent. The elements of fixed capital are depreciated to a greater or lesser degree in just the same way. … definite, presupposed, price relations govern the process of reproduction, so that the latter is halted and thrown into confusion by a general drop in prices. This confusion and stagnation paralyses the function of money as a medium of payment, whose development is geared to the development of capital and is based on those presupposed price relations. The chain of payment obligations due at specific dates is broken in a hundred places. The confusion is augmented by the attendant collapse of the credit system, which develops simultaneously with capital, and leads to violent and acute crises, to sudden and forcible depreciations, to the actual stagnation and disruption of the process of reproduction, and thus to a real falling off in reproduction.” (ibid, pp 253-54)
But all this does not, by itself, mean the end of the world. Once the necessary devaluation has been accomplished and over-accumulation eliminated, ‘normal’ accumulation can go on:
“…the cycle would run its course anew. Part of the capital, depreciated by its functional stagnation, would recover its old value. For the rest, the same vicious circle would be described once more under expanded conditions of production, with an expanded market and increased productive forces.” (ibid, p 255)
But what is normal need not be permanent. Expanded capitalist reproduction is intensified reproduction of all its contradictions and within the recurring cycles reside the seeds of violent destruction of the system:
“The highest development of productive power together with the greatest expansion of existing wealth will coincide with depreciation [devaluation] of capital, degradation of the labourer, and a most strained exhaustion of his vital powers. These contradictions lead to explosions, cataclysms, crises, in which by momentous suspension of labour and annihilation of a great portion of the capital, the latter is violently reduced to the point where it can go on.... Yet these regularly recurring catastrophes lead to their repetition on a higher scale, and finally to its violent overthrow” (Grundrisse, p 750, emphasis added).
As noted earlier, credit plays a dual role in the process of production and circulation. Drawing attention to a basic contradiction of capitalist accumulation, Marx observed: “The credit system appears as the main lever of over-production and over-speculation in commerce solely because the reproduction process, which is elastic by nature, is here forced to its extreme limits, and is so forced because a large part of the social capital is employed by people who do not own it and who consequently tackle things quite differently than the owner, who anxiously ways weighs the limitations of his private capital in so far as he handles it himself.”
A very realistic explanation of why the financial institutions behave so irresponsibly with their customers’ money, isn’t it? Marx goes on:
“This simply demonstrates the fact that the self-expansion of capital based on the contradictory nature of capitalist production limits an actual free development only up to a certain point, so that in fact it constitutes an immanent fetter and barrier to production, which are continually broken through by the credit system. Hence, the credit system accelerates the material development of the productive forces and the establishment of the world-market. …At the same time credit accelerates the violent eruptions of this contradiction — crises — and thereby the elements of disintegration of the old mode of production.” (ibid, p 441, emphasis added)
DO the theoretical expositions in Capital tally with the actual working of capitalism today?
Behind the familiar crisis symptoms – we learned in our brief dialogue with Marx – lurks a complex interplay of myriad forces, the most important being the tendency of the average rate of profit to fall with rising organic composition of capital and increasingly skewed distribution of income and wealth. There is no dearth of data supporting this: data showing, for example, falling profit rates and stagnant/declining wage levels vis-à-vis corporate profit explosion in recent decades.
Marx also shows that capital’s frantic endeavour to overcome inherent constraints like mass poverty and inadequate demand leads to artificial credit-induced expansion. But this false prosperity built on debt always bounces back in the shape of sudden contraction or crisis, much like a rubber band getting stretched and snapping back. This phenomenon, witnessed much more vividly today than in Marx’s time, is called a bubble – something that is empty and without substance; a hollow growth that is transient by definition. Bubbles in other words result from efforts to “grow the economy” by means of debt, faster than is warranted by the underlying flow of new values generated in production and get deflated sooner rather than later.
Such was basically what happened in the “roaring twenties” that ended with the Wall Street crash of October 1929. But the more sophisticated and widespread the credit market, the greater is the degree to which “forced expansion” (as Marx called it) can be induced and the more devastating must be the inevitable crash whenever it comes. This is precisely what we see today.
As a strategy to counter the economic slump that started in 1970s, the working people of America were encouraged – or goaded, if you will – to keep up their consumption levels with easy credit made available through aggressive credit card promotions, new and reckless mortgage practices, and other means. This policy had a great political benefit too: the enslavement and immobilisation of the proletariat in credit chains. In fact a good many workers in the US find themselves practically incapable of going on strike because they are “just one check away from homelessness”, which means that if they do not get wages even for a month, they stand the risk of mortgage foreclosure, i.e., losing their mortgaged homes.
As Lenin showed in “Imperialism and the Split in Socialism” long ago the imperialist bourgeoisie had devised the tactic of creating a stratum of workers’ aristocracy in their countries by bribing the latter with small fragments of super profits earned in colonies, i.e., by paying them relatively better wages. Today they have improved the tactic further. They now give out huge loans while restricting wages, imposing on the workers a modern version of debt bondage and, with that, the ideological enslavement of consumerism. The “American way of life” ensures high demand for all sorts of consumables and the US economy keeps running with astronomical current account and fiscal deficits – with borrowed money, that is.
The collapse into recession was thus delayed no doubt, but at the same time and in the same measure the latter was made more inevitable and more intense. As of November 19, 2008, the total U.S. federal debt was $10.6 trillion, about $37,316 per capita. The catastrophe had to strike, and did strike. A premonition was felt when the “dot-com” or “New Economy” stock market bubble burst in 2000. The US economy went into recession and it was weakened further by the 9/11 attacks. In order to allay the fears of financial collapse, the Federal Reserve lowered short-term interest rates. But employment kept falling through the middle of 2003, so the Fed kept lowering short-term lending rates. For three full years, starting in October of 2002, the real (i.e., inflation-adjusted) federal funds rate was actually negative. This allowed banks to borrow funds from other banks, lend them out, and then pay back less than they had borrowed once inflation was taken into account.
This “cheap money, easy credit” strategy created a new bubble – this time based in home mortgages. This “great bubble transfer” involved a further expansion of consumer debt and an enormous profit explosion in the finance sector achieved through extension of mortgage financing to riskier and riskier customers. There were lots of what insiders call “ninja” loans — no income, no job, no assets.
Monthly Review editor J. B. Foster gives us a penetrating analysis of the whole process:
“…the theory [was that] new “risk management” techniques had devised the means (hailed – bizarrely – by some as the equivalent of the great technological advances in the real economy) with which to separate the weaker from the stronger debts within the new securities. These new debt securities were then “insured” against default by such means as credit-debt swaps, supposedly reducing risk still further.”
But this proved illusory. The payments on sub-prime debt faltered, slowly at first, then in a massive way. The other side of the problem was that, “as a result of the completely opaque securitization process, no one knew which debts were bad and which were good. Credit markets froze because the banks and other financial institutions were ceasing to lend since the borrowers could not be counted on to pay them back….
“Under these circumstances, no matter how many hundreds of billions of dollars in liquidity were poured into the financial sector, nothing happened. All those with money, including the banks, were hoarding. The U.S. was printing dollars like mad and flooding the financial sector with liquidity, but rather than loaning out money capital the banks were stuffing it in their vaults, or more precisely using it to purchase Treasury bills, creating a kind of revolving door that negated the attempts of the government.” For the time being “a complete meltdown” was prevented “by injecting capital directly into banks in return for preferred stock (a partial nationalization of banks), guaranteeing new debt of banks, and increasing deposit insurance.
Thirdly, Marx and Engels taught us to understand crises from the standpoint of historical materialism and revolutionary dialectics. On the one hand, crises are not only not avoidable, they are essential to the law of motion of capital. They constitute capitalism’s inbuilt mechanism for spontaneously and ruthlessly eliminating excess or over-accumulated capital, so that “the cycle would run its course anew”. On the other hand, they achieve this in a manner that paves the way for more extensive and more destructive crises, and diminishes the means whereby crises are prevented (Communist Manifesto) and leads finally to the “violent overthrow” of the rule of capital (Grundrisse).
However, the exact trajectory of this progression depends on the peculiar features and severity of a particular crisis as well as other attending factors, both economic and political. The fierce fight among capitals (big corporations) and national blocks of capital (nation states) that a crisis engenders may, for example, lead to local or global wars. Thus the GD was overcome in the normal course by the mid-1930s only in part; for the rest, it produced fascism and led to – or should we say merged into – the Second World War. What will happen this time round nobody can tell at this point in time, but certainly we can indicate some special features, broad trends and possible scenarios.
THE most important message from the unprecedented financial catastrophe and its aftermath is that global capitalism’s strategic response to the crisis of 1970s has failed. That was a three-pronged strategy comprising deregulation/neoliberalism or market fundamentalism, globalisation and financialisation. Since these have been the three pillars on which post-1970s capitalism stood – and, in a certain sense, and in certain parts of the world, flourished – the extensive damage they have suffered have left the whole imposing edifice tottering.
After a so-called golden age of capitalism (roughly a quarter century after World War II), the crisis of overproduction struck back with a vengeance. Old remedies like relying on the military-industrial complex and the war economy were proving to be inadequate or counter-productive. As a study released by the Centre for Economic and Policy Research, Washington, in May 2007 showed, after an initial demand stimulus, the effect of increased military spending turns negative by about the sixth year. With the US economy burdened with growing ‘defence’ spending for decades on end, by 1990 the value of the weapons, equipment, and factories devoted to the Department of Defence was 83% of the value of all plants and the equipment in American manufacturing. A clear case of military industries crowding out civilian industries, this led to severe economic weaknesses. There was no question of abandoning military Keynesianism, of course. The highly powerful military-industrial complex would not have allowed that. But other means had to be sought out.
Capitalism’s first major response at this juncture was Thatcherism of late 1970s and Reaganomics of early 1980s, which was soon exported to the underdeveloped countries as Structural Adjustment Programme. Essentially this was a programme of neoliberal restructuring aimed at reinvigorating capital accumulation. Its two major planks were (a) removing state regulations on the growth and flow of capital and wealth, and (b) radically reducing taxes with a view to redistributing income from the poor and middle classes, so that the rich can invest and reignite economic growth. But reduced incomes of the poor and middle classes dampened demands, while not necessarily inducing the rich to invest more in production. Rather, what the rich did was to channel a large part of their enhanced wealth to speculation.
The second major response was globalisation, which basically meant breaking down of state barriers resulting in more rapid and closer consolidation of the global capitalist economy, with China and Soviet bloc countries now fully integrated into it. A major component of this was international relocation of production and business process outsourcing (BPO). By the middle of the first decade of the 21st century, roughly 40-50 per cent of the profits of US corporations began to be derived from their operations and sales abroad, especially in China. But globalization actually exacerbated the problem of overproduction by adding to productive capacity. For example, in the wake of dot-com bubble in 2000, the New York Times reported on one of the many excesses of the period:
“In the last two years, 100 million miles of optical fibre – more than enough to reach the sun – were laid around the world as companies spent $35 billion to build Internet-inspired communications networks. But after a string of corporate bankruptcies, fears are spreading that it will be many years before these grandiose systems are ever fully used.”
Numerous other hiccups in the working of globalisation – even from the viewpoint of the bourgeoisie – have been widely discussed. As for financialisation, it moved from one bubble-bust cycle to another before meeting the recent crippling setback.
Not that these three sets of responses came one after the other in a planned manner. They emerged as interconnected, inter-aided pragmatic measures and gradually dovetailed into one another in such a way that now it appears as one indivisible whole. This is why the body blow to financialisation has seriously undermined the credibility of neoliberalism and globalisation also. The notion that the market behaves itself and corrects itself without government intervention has crumbled and contagion – the spread of the crisis across the globe more quickly and devastatingly than ever – has become the most visible and dreaded face of globalisation.
The financial crisis and depression economics have appeared as sort of “add-on”s to the already raging food, energy and environment crises. We have long been witness to a process of financial capital systematically destroying and usurping third world agriculture under the aegis of the WTO and IMF. And now with rising joblessness and further reduction in public outlays in agriculture in countries like India, food availability for some 90% of world population will decline further, adding to what Lenin once called “inflammable material in world politics”.
The recent drop in petroleum prices is not an unmixed blessing either. For one, it reduces income and consumption in petroleum-exporting countries. Moreover, if the present price level points to the unsavoury role of speculative trading during the earlier period of rising prices, it also constitutes probably the most telling confirmation of falling demand with falling industrial and commercial activities.
Again, financial difficulties will prompt corporations and nations to put on hold costly climate protection measures. UN Secretary-General Ban Ki-Moon has warned the world against backsliding in the fight against climate change as it battles the financial crisis, saying “When the world has recovered from the economic recession, it will not have recovered from climate change.”
This mix-up of multiple crises makes the present juncture potentially very challenging – both in economic and political terms – to the continued rule of capital. And of course, the more so because the flag carrier itself, already old and battered in many battles, is now caught rudderless in a Typhoon on the high seas.
Like the present crisis, the GD also was “made in the US”. But when the latter struck, the US was already in the first phase of gaining economic supremacy in the capitalist world and it was not assailed by any political or military crisis. In the present case, that country was already in a historical phase of slow, long-term decline in economic prowess (measured in terms of share in world GDP, trade and manufactures; savings rate etc) particularly relative to emerging economies like China. Just consider the fundamentals: growing fiscal and budget deficits, persistently declining competitiveness of US industries, unbearable costs of the Iraq war, the weakening dollar, and so on, to name only the more glaring distortions.
In the 1970s Americans had a savings rate of over 10%. Now it is zero. In the 1970s America still had a very strong manufacturing sector. Now it is down to less than 15% of US GDP. In a word, the mind-boggling sums spent on unproductive areas like militarism and speculation has exacted a very high “opportunity cost”- things not done because the money/resources were spent on something else – in terms of neglected infrastructure and other requirements for the country’s long term economic health.
Most important, US leadership of the capitalist world has long been exercised through Wall Street’s status of being the undisputed centre of international finance with the dollar as the international currency. The recent blow has badly weakened that. Of course, no single currency is yet in a position to completely replace the dollar as international medium of exchange. But a partial shift to the Euro and other hard currencies had already begun since the early years of this century and, depending on how the crisis plays itself out, this trend may grow and threaten the rule of King Dollar.
This threat looks all the more serious in the context of the ever-growing American national debt. As on November 19, 2008, the world's richest country owed a whopping $10.6 trillion to others. Most other countries keep a good portion of their reserves in the US dollar, which they in turn invest in financial securities issued by the US government, considered to be very safe. Thanks to the high demand, the returns offered on these securities are low, which in turn ensures that interest rates in the US are also low. The low interest rate in its turn encourages more and more Americans to borrow and buy goods and services that exporting countries have to offer. And when that happens, countries like China and Japan earn US dollars, which are again invested in the financial securities issued by the US government. When one set of financial securities becomes due for repayment, it issues new financial securities to repay the holders of the old securities. So, money brought in by the newer investors is used to pay off the older investors. That is what makes it a Ponzi scheme, officially called deficit financing. The US government can keep doing this because the major exporters are ready to keep recycling the dollars they earn through US banks and the US economy and reinvesting in the US government securities.
But sooner or later a correction to this distortion or maladjustment is unavoidable. The towering mountain of debt raises the question of America’s ability to meet its obligations. If the doubt about the stability of the US economy worsens, the worldwide demand for US dollars would decline, causing the dollar exchange rate to plummet. American imports would decline, dampening the surge of consumption and slowing the very growth engines of exporting countries like China and many others. The whole world would once again pay dearly for American instability.
This problem is further compounded by ever-growing fiscal deficits. The latest Congressional Budget Office (CBO) release of the updated Fiscal Year 2009 budget numbers showed a $1.2 trillion deficit for the fiscal year (8.5% of GDP). However, a closer examination of the report shows that these numbers are dramatically underestimated. Some estimates put the deficit at $2.2 trillion for the fiscal year or nearly 100 per cent higher than is being reported. In fact, the deficit will finish the fiscal year at an astonishing 15.5 per cent of GDP! Federal spending will rise to 32 percent of GDP.
Moreover, the US has been suffering from a political crisis of legitimacy and leadership while finding itself burdened with an over-extended military juggernaut and a Vietnam-like situation in Iraq. No doubt the election of a very popular president has appeared as a much-needed political bailout package for the American elite, but nobody expects a miracle from Barack Obama. The present crisis is therefore widely seen as the precursor of a shift in global power balance – a shift towards greater multipolarity marked particularly by the rise of the East.
While Vladimir Putin has been vocal about this for quite some time past, with the onset of the crisis even men like Tony Blair, Ban Ki Moon and Peer Steinbruck have expressed similar views. The US authorities too have recognised this in an intelligence department forecast.
But that should not be understood in a mechanistic way to mean the decline of the US alone. Apart from the EU and Japan, Russia and China too are severely affected. Russian resurgence and the country’s capacity to challenge the US on many issues depended largely on high prices of its fuel exports; now with a huge drop in that income it is in for a serious rouble trouble. Every nation is, and will be, fighting for itself in its own way and the results cannot be predicted. To take one example, for the last few years the global economy has been running on two engines, the U.S. on the consumption side and China on the production side, together keeping the entire global economy afloat. Now it will be interesting to watch how the dovetailed economies of “Chimerica” – as economic historian Niall Ferguson has called it – respond to the crisis and which side scores greater gains at the cost of its contender-partner.
On the occasion of the 30th anniversary of Sino- American trade relations, both countries have expressed the desire for further improving these relations even as the blame game on economic policies goes on. Early in January 2009 a couple of stinging commentaries on the official Xinhua news agency accused US officials of trying to shift guilt for tumbling stock markets and collapsing pension funds and house prices away from their own desks. Developing nations have served as "windshields" to a US economy battered by the global financial maelstrom, yet it is blaming them for a problem caused by its own policies, one lead article commented.
Some early indications of the struggle among world powers to shift the burden of the crisis on to one another and to the third world were expected from the mid-November White House summit of heads of G20 nations. Shortly before the meeting, Nicolas Sarkozy said that it was necessary to rebuild the entire global financial and monetary system, “the way it was done at Bretton Woods.” “Times have changed”, he added: “now the Euro and other currencies have a place in world financial exchanges, a new reality that should be reflected in new rules.” Many leaders called for new rules and tougher regulations together with restructuring the IMF. But just on the eve of the Summit President Bush announced, “The crisis is not a failure of the free-market system, and the answer is not to try to reinvent that system.” It would be a “terrible mistake” to allow “a few months of crisis” to undermine faith in free market capitalism, he observed. In the event it was the US position that prevailed and attempts at a new Bretton Woods system were stymied and the voice of Third World muted. But for a two-paragraph indictment of the United States as the perpetrator of the financial crisis, the Summit declaration remained vacuous.
However, conflicts among big powers and regional entities are growing. US hegemony is getting challenged from different quarters. Hailing the victory of Barack Obama, the European Union said in a unanimously passed resolution: “we want to renew our friendship with the United States, but this time not as junior partners.” In the wake of the financial crisis European leaders have met separately and the leaders of China, Japan and South Korea also held a rare joint meeting to work out how best to cushion Asia from the global recession.
Like inter-imperialist contradictions, those between rich and poor nations are getting intensified. If in certain cases (as in the G20 negotiations) these contradictions are found lumped together, in Latin America the antagonism between imperialism and the third world remains very much focused. The recent expulsion of Israeli Ambassador from Venezuela comes as a continuation of political confrontation. The six Latin America and Caribbean countries that subscribe to Bolivarian Alternative for the Americas (ALBA) – Cuba, Venezuela, Bolivia, Nicaragua, Honduras and Dominica – had already founded an ALBA Bank to finance regional social programs and Venezuela has recently created joint banks with Iran, Russia and China, the latter with $12 billion in commitments.
Last year, as stock markets crashed and a global credit squeeze threatened global economies, some of the Latin American governments pushed ahead with plans for a new financial architecture.
At an international conference of political economists in Caracas on October 8-10, entitled “Responses from the South to the global economic crisis”, Hugo Chavez said the people of the world “no longer support” the privatised banking system while Ecuador’s economic policy minister Pedro Paez said society must “reclaim the leading role that has been kidnapped by the centres of political and economic power … the capitalist system is not the only option.”
Proposals for a new financial system also emerged from the conference, which include: (a) states in the region should take immediate control of their banking systems, without indemnification, according to the principle of the new Ecuadorian constitution, Article 290.7 of which states that “nationalisation of private debt is prohibited”, (b) monetary coordination should be strengthened to avoid a war of “competitive devaluations”, which would undermine the integration process of Union of South American Nations (Unasur – a South American integration process begun in 2007 that envisages a new continental currency) and obstruct a regional response, (c) immediate implementation of Bancosur (The Bank of the South), which should become “the heart” of the transformation of the existing network of banks, (d) establish exchange controls to protect reserves and prevent capital flight, (e) following the principle of assisting the people and not the bankers, social programmes must be maintained, (f) the present juncture should be seen as an opportunity for the countries in the region to get rid of the IMF and the World Bank, and to begin creating a new international financial architecture.
The crisis is also leading to the further intensification of the contradiction between the bourgeoisie and the working class and that between imperialism and socialism on the ideological plane. The world proletariat thus faces a new set of challenges and opportunities.
In theory, the revolutionary proletariat understands the dual roles or functions of periodic crises – temporarily, restoring equilibrium through destruction and ultimately, bringing the end of capitalism nearer.
As for an assessment of the present one, is it only a crisis, however serious, of neoliberalism and the financial sector as distinct from a systemic crisis of capitalism as such? Can it therefore be “solved” by resurrecting Keynesianism and founding new regulatory institutions – say something like a Bretton Woods II?
The class-conscious proletariat rejects all such patently bourgeois notions that are doing the rounds in the context of the setback to monetarist and neoliberal theories. A hundred years ago Lenin identified in finance capital the core and crux of imperialism and this is a hundred times truer today. The credit system now works like a kind of central nervous system through which the overall circulation of money capital – to and from firms, sectors, countries and regions – is coordinated; a serious damage to this system certainly imperils the whole organism of capital. But the proletariat also knows that without adequate subjective preparation of the revolutionary forces under the leadership of communist party, even the best of objective situations does not lead to revolution and socialism. So it does not indulge in speculation about collapse of capitalism. It senses the challenging opportunities opened up by the crisis and takes up the tasks in hand with redoubled energy, keeping a close, constant watch on changes in the situation.
Everywhere capitalists are now trying to pass on the burden of the crisis to the shoulders of the working messes, who are fighting back. The recent victorious struggle waged by workers of a Chicago-based factory – workers and their families occupied the closed concern and compelled the employers and the state to concede their just demands – is an inspiring case in point. All sections of the working people as well as the intelligentsia and other strata are – and will be – coming out in the struggle to defend their basic economic and political interests. To unite with, organise and lead them is the obvious first task of the working class.
But this cannot be done without fighting against the defensive outlook spread by reformist and reactionary trade unions as well as other organisations in the name of “difficult situation” and “defensive struggle”. Dialectically there is an element of offence in every defence, and vice versa. The working masses should be enlightened on the fact that the new onslaughts of capital actually stem from its weakness, its grave problems, not its strength. A really broad, militant unity of toilers can generate a heroic resistance, mobilise new allies from non-proletarian strata and bring the day of ultimate victory nearer – to instil this confidence among the masses is a foremost duty of the most advanced class.
Second, the crisis is universal but the working class must formulate its fighting slogans in accordance with conditions in each particular country. As opposed to the bourgeois state’s policy of “bail out the rich and boot out the poor”, it should uphold policies like imposing punitive fines on financial swindlers so as to pay up the common people who have lost their money, direct state initiative in job creation and other measures for improving people’s purchasing power as the basic means of mitigating the decision. In other words, the proletariat should be seen to be fighting not just for its narrowly conceived economic demands, but for the overall interests of the nation. In this hour of crisis it should, in the words of Communist Manifesto, “rise to be the leading class of the nation, must constitute itself the nation... though not in the bourgeois sense of the word.”
Third, the working class should vigorously utilise the present situation, when everybody is discussing the limits of capitalism and irrelevance of Marxism, to hold high the banner of socialism as the only real – and achievable – solution to the burning problems of the day. This campaign must include a live exposé of social democracy as a defender of capitalism, while uniting with the mass following of social democratic and other left-of-the-centre parties.
Global experience in the age of imperialism, which Lenin defined as moribund monopoly capitalism under the domination of finance capital, brilliantly confirms and enriches the Marxist-Leninist explanation of business cycles and capitalist crisis. Guided by this revolutionary ideology, the world proletariat must surge forward at the head of the fighting millions in struggles for immediate relief as well as the ultimate goal of liberating all humankind from the clutches of capital.
2007
February–March: Subprime market in trouble with several subprime lenders declaring bankruptcy, announcing significant losses, or putting themselves up for sale.
March 6: Ben Bernanke, quoting Alan Greenspan, warns that the Government Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac, were a source of "systemic risk" and suggest legislation to head off a possible crisis
April 18: Freddie Mac fined $3.8 million by the Federal Election Commission as a result of illegal campaign contributions, much of it to members of the United States House Committee on Financial Services which oversees Freddie Mac.
June 20: Merrill Lynch seized $800 million in assets from two Bear Stearns hedge funds that were involved in securities backed by subprime loans.
July 19: Dow Jones Industrial Average closes above 14,000 for the first time in its history.
August 6:American Home Mortgage Investment Corporation (AHMI) files Chapter 11 bankruptcy.
August 9: French investment bank BNP Paribas suspends three investment funds that invested in subprime mortgage debt. This would be followed by many credit-loss and write-down announcements by banks, mortgage lenders and other institutional investors. The European Central Bank pumps 95 billion euros into the European banking market.
August 10: Central banks coordinate efforts to increase liquidity for first time since the aftermath of the September 11, 2001 terrorist attacks. The United States Federal Reserve (Fed) injects a combined 43 billion USD, the European Central Bank (ECB) 156 billion euros (214.6 billion USD), and the Bank of Japan 1 trillion Yen (8.4 billion USD).
August 14: Sentinel Management Group suspends redemptions for investors and sells off $312 million worth of assets; three days later Sentinel files for Chapter 11 bankruptcy protection. US and European stock indices continue to fall.
August 16: Countrywide Financial Corporation, the biggest U.S. mortgage lender, narrowly avoids bankruptcy by taking out an emergency loan of $11 billion from a group of banks.
August 31: President Bush announces a limited bailout of U.S. homeowners unable to pay the rising costs of their debts. Ameriquest, once the largest subprime lender in the U.S., goes out of business.
September 17: Former Fed Chairman Alan Greenspan says "we had a bubble in housing" and warns of "large double digit declines" in home values "larger than most people expect."
September 30: Affected by the spiraling mortgage and credit crises, Internet banking pioneer NetBank goes bankrupt and the Swiss bank UBS announces that it lost US$690 million in the third quarter.
October 10: Hope Now Alliance is created by the US Government and private industry to help some sub-prime borrowers.
October 15–17: A consortium of U.S. banks backed by the U.S. government announces a "super fund" of $100 billion to purchase mortgage-backed securities whose mark-to-market value plummeted in the subprime collapse. Both Fed chairman Ben Bernanke and Treasury Secretary Hank Paulson express alarm about the dangers posed by the bursting housing bubble.
November 1: Federal Reserve injects $41B into the money supply for banks to borrow at a low rate.
2008
January 2–21: January 2008 stock market downturn.
January 24: The National Association of Realtors (NAR) announces that 2007 had the largest drop in existing home sales in 25 years.
March 1–June 18: 406 people arrested for mortgage fraud in an FBI sting across the U.S., including buyers, sellers and others across the wide-ranging mortgage industry.
March 10: Dow Jones Industrial Average at the lowest level since October 2006, falling more than 20% from its peak just five months earlier.
March 14- 16: Bear Stearns gets Fed funding as shares plummet and then gets acquired for $2 a share by JPMorgan Chase in a fire sale avoiding bankruptcy. The deal is backed by Federal Reserve providing up to $30B to cover possible Bear Stearn losses.
May 6: UBS AG Swiss bank announces plans to cut 5,500 jobs by the middle of 2009
June 19: Ex-Bear Stearns fund managers arrested by the FBI for their allegedly fraudulent role in the subprime mortgage collapse. The managers purportedly misrepresented the fiscal health of their funds to investors publicly while privately withdrawing their own money.
July 11: Failure of Indymac Bank, the fourth largest bank failure in United States history
July 30: President Bush signs into law the Housing and Economic Recovery Act of 2008 which authorizes the Federal Housing Administration to guarantee up to $300 billion in new 30-year fixed rate mortgages for subprime borrowers under certain conditions.
September 7: Federal takeover of Fannie Mae and Freddie Mac which at that point owned or guaranteed about half of the U.S.'s $12 trillion mortgage market, effectively nationalizing them. This causes panic because almost every home mortgage lender and Wall Street bank relied on them to facilitate the mortgage market and investors worldwide owned $5.2 trillion of debt securities backed by them.
September 14: Merrill Lynch sold to Bank of America amidst fears of a liquidity crisis and Lehman Brothers collapse[138]
September 17: The Fed acquires 80 percent of AIG in exchange for lending it $85 billion. As NYU economics professor Nouriel Roubini (aka “Dr. Doom”) puts it, “The U.S. government is now the largest insurance company in the world.”
September 19: Paulson financial rescue plan unveiled after a volatile week in stock and debt markets.
September 23: Federal Bureau of Investigation reported to be looking into the possibility of fraud by mortgage financing companies Fannie Mae and Freddie Mac, Lehman Brothers, and insurer American International Group, bringing to 26 the number of corporate lenders under investigation.
September 25: Washington Mutual seized by the Federal Deposit Insurance Corporation, and its banking assets sold to JP MorganChase for $1.9bn.
September 29: Emergency Economic Stabilization Act defeated 228-205 in the United States House of Representatives; Federal Deposit Insurance Corporation announces that Citigroup Inc. would acquire banking operations of Wachovia.
September 30: US Treasury changes tax law to allow a bank acquiring another write off all of the acquired bank's losses for tax purposes.
October 1: The U.S. Senate passes HR1424, their version of the $700 billion bailout bill.
October 3: President George W. Bush signs it into law the Emergency Economic Stabilization Act creating a $700 billion Troubled Assets Relief Program to purchase failing bank assets. The Act also eases accounting rules.
October 6-10: Worst week for the stock market in 75 years. The Dow Jones lost 22.1 percent, its worst week on record, down 40.3 percent since reaching a record high of 14,164.53 October 9, 2007. The Standard & Poor's 500 index lost 18.2 percent, its worst week since 1933, down 42.5 percent in since its own high October 9, 2007.[152]
October 6: Fed promises to provide $900 billion in short-term cash loans to banks.[153]
October 7: Fed makes emergency move to lend around $1.3 trillion directly to companies outside the financial sector.
October 7: The Internal Revenue Service (IRS) relaxes rules on US corporations repatriating money held oversees in an attempt to inject liquidity into the US financial market. The new ruling allows the companies to receive loans from their foreign subsidiaries for longer periods and more times a year without triggering the 35% corporate income tax.
October 8: Central banks in USA (Fed), England, China, Canada, Sweden, Switzerland and the European Central Bank cut rates in a coordinated effort to aid world economy. Fed also reduces its emergency lending rate to banks.
October 11: The Dow Jones Industrial Average caps its worst week ever with its highest volatility day ever recorded in its 112 year history. Over the last eight trading days, the DJIA has dropped 22% amid worries of worsening credit crisis and global recession. Paper losses now on US stocks now total $8.4 trillion from the market highs last year.
October 11: Central bankers and finance ministers from the Group of Seven meet in Washington but cannot agree on any concrete plan.
October 14: The US announces the injection of $250 billion of public money out of the $700 billion available from the EESA into the US banking system. The rescue package includes the US government taking an equity position in banks that choose to participate in the program in exchange for certain restrictions such as executive compensation. Nine banks agree to participate in the program and will receive half of the total funds: 1) Bank of America, 2) JPMorgan Chase, 3) Wells Fargo, 4) Citigroup, 5) Merrill Lynch, 6) Goldman Sachs, 7) Morgan Stanley, 8) Bank of New York Mellon and 9) State Street.
October 21: The US Federal Reserve announces it will spend $540 billion to purchase short-term debt from money market mutual funds.
November 12: Treasury Secretary Paulson abandons plan to buy toxic assets under the $700 billion Troubled Asset Relief Program (TARP) and says the remaining $410 billion in the fund would be better spent on recapitalizing financial companies.
November 15: The group of 20 meets in Washington DC.
November 24: The US government agrees to rescue Citigroup after an attack by investors caused the stock price to plummet 60% over the last week.
November 25: The US Federal Reserve pledges $800 billion more to help revive the financial system. $600 billion will be used to buy mortgage bonds issued or guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae, and the Federal Home Loan Banks.
ON December 6 1994, Orange County, a prosperous district in California, declared bankruptcy after suffering losses of around $1.6 billion from a wrong-way bet on interest rates in one of its principal investment pools. Robert Citron, the hitherto widely respected Orange County treasurer who controlled the $7.5 billion pool, had invested the pools funds in a leveraged portfolio of mainly interest-linked securities at great risk. This was the largest financial failure of a local government in US history.
This involves financial institutions providing credit to borrowers deemed "subprime" i.e., those who have a heightened perceived risk of default, such as those who have a history of loan delinquency or default, those with paltry incomes or a recorded bankruptcy, or those with limited debt experience. Subprime lending encompasses a variety of credit types, including mortgages, auto loans, and credit cards.
Foreclosure is the legal proceeding in which a mortgagee, or other lienholder, usually a lender, obtains a court ordered termination of a mortgagor's equitable right of redemption. Usually a lender obtains a security interest from a borrower who mortgages or pledges an asset like a house to secure the loan.
Securitization is the process of creating a more or less standard investment instrument by pooling assets to back the instrument. Financial institutions take an illiquid asset, or group of assets, and through financial engineering, transforming them into a security.
A typical example of securitization is a mortgage-backed security (MBS). Till recently, some subprime originators (mortgage companies or brokers) used to promote residential loans with features that could trap low income borrowers into loans with increasing payment (of interest and part of principal) terms that eventually exceed borrower’s capability to make the payments. Most of these loans were originated for the purpose of reselling them to other financial institutions.
Derivatives are instruments or securities that are derived from another security, commodity, market index, or another derivative. In other words, a derivative is an instrument whose value is based on that of another asset. The base is referred to as the benchmark. Derivatives are also called "Contingent Claims" because they are dependent on variables which influence the valuation process. The more common derivatives include those traded in Foreign Exchange (FOREX) or Currency Forward Markets, Financial Futures Markets, Commodities Futures Markets and so on. They can be related to one another in numerous ways. For example, in currencies, there is a cash or spot forex market, a bank forward market, a currency futures market, options on actual or cash currencies, options on currency futures, swaps on currencies, instruments on stocks or shares (ADRs), options on swaps (swaptions) and so on.
Derivatives are used for risk management, investing, and speculative purposes. Important institutional users include banks, brokers, dealers and mutual funds. Broadly there are two distinct groups of derivative contracts.
Over-the-counter (OTC) derivatives are contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. Products such as swaps (including credit default swaps), forward rate agreements, and exotic options are almost always traded in this way. The OTC market is the largest market for derivatives, and is unregulated. Exchange-traded derivatives (ETD) are products that are traded via specialized derivatives exchanges or other exchanges. A derivatives exchange acts as an intermediary to all related transactions, and takes initial margin from both sides of the contract to act as a guarantee. Being routed through an exchange, they come under regulation by the board of that exchange and thus indirectly by the government of the country.
There are many types of derivatives, some of which are described below.
CDOs are a type of asset-backed security constructed from a portfolio of fixed-income assets. In other words, a CDO is a security backed by a pool of bonds, loans and other assets. Since 1987, CDOs have become an important funding vehicle.
They represent different types of debt and credit risk, referred to as 'tranches' or 'slices' such as senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated). Each slice has a different maturity and risk associated with it. The higher the risk, the more the CDO pays. The various types include Collateralized loan obligations (CLOs) -- CDOs backed primarily by leveraged bank loans; Collateralized bond obligations (CBOs) -- CDOs backed primarily by leveraged fixed income securities; Collateralized synthetic obligations (CSOs) -- CDOs backed primarily by credit derivatives and so on.
The issuer of the CDO, typically an investment bank, earns a commission at the time of issue and earns management fees during the life of the CDO. The ability to earn substantial fees from originating and securitizing loans, coupled with the absence of any residual liability, skews the incentives of originators in favour of loan volume rather than loan quality. This is a structural flaw in the debt-securitization market that was directly responsible for both the credit bubble of the mid-2000s as well as the credit crisis, and the concomitant banking crisis of 2008.
A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a standardized quantity of a specified commodity of standardized quality (which, in many cases, may be such non-traditional "commodities" as foreign currencies, commercial or government paper [e.g., bonds], or "baskets" of corporate equity ["stock indices"] or other financial instruments) at a certain date in the future, at a price (the futures price) determined on the particular exchange at the time of the contract. The future date is called the delivery date or final settlement date. The official price of the futures contract at the end of a day's trading session on the exchange is called the settlement price for that day of business on the exchange.
Both parties of a "futures contract" must fulfill the contract on the settlement date, whereas an option (see below) grants the buyer the right, but not the obligation, to exercise the contract. The seller delivers the underlying asset to the buyer, or, if it is a cash-settled futures contract, then cash is transferred from the futures trader who sustained a loss to the one who made a profit.
A futures contract is a standardized contract written by a clearing house that operates an exchange, while a forward contract is a non-standardized contract written by the parties themselves.
These are contracts that give the owner the right, but not the obligation, to buy (in the case of a call option) or sell (in the case of a put option) an asset. The price at which the sale takes place is known as the strike price, and is specified at the time the parties enter into the option. The option contract also specifies a maturity date. In the case of a European option, the owner has the right to require the sale to take place on (but not before) the maturity date; in the case of an American option, the owner can require the sale to take place at any time up to the maturity date. If the owner of the contract exercises this right, the counterparty must carry out the transaction.
These are contacts that offer protection to borrowers who borrow long term with an interest rate that resets periodically, as well as to borrowers who borrow for a short term at a fixed rate and plan to roll the loan each time it matures.
By purchasing a cap, a borrower can limit or “cap” his maximum interest cost regardless of how high the rate on his loan or bond gets. When the loan or bond rate exceeds the cap limit (usually referred to as the “strike” level) the borrower pays the higher interest rate but the seller of the cap compensates him for the exact amount of interest paid in excess of the strike price. The cost of the cap varies based on its term and the strike level chosen by the borrower.
Similar to a cap, a collar allows a floating-rate issuer/borrower to limit his maximum interest cost regardless of the rate on his bond or loan. However, to reduce the cost of the protection, the collar includes an interest rate floor that limits his maximum interest cost regardless of how low the bond or loan rate becomes. Therefore, a collar has two strike levels, an upper (cap) strike and a lower (floor) strike. For example, an issuer and seller may agree on a 3% floor and 5% cap. This hedge effectively guarantees the issuer/borrower interest cost will always be in a “collar” between 3% and 5% in this example. If the interest rate for an interest period is 6%, the seller will pay to the issuer the difference between 5% and 6% or 1%. If the interest rate drops to 2%, the issuer must pay the seller the difference between the 3% floor and actual 2% rate or 1%.
These are insurance contracts that purport to protect bondholders against the possibility of default. While purchasing bonds, an investor can also buy CDS issued by some financial institution like large commercial banks, investment banks or insurance companies to protect himself against the risk of default on the part of the firm that issued the bonds. The premium that the investor pays for the CDS, calculated at say two per cent of the amount insured, is called the "rate" or "spread”. If the firm that issued the bonds defaults, the financial institution which issued the CDS will pay the investor the amount insured (principal) plus interest on that amount.
CDS rates remain low when the market thinks the probability of default of firms issuing bonds are low and go up when the opposite belief prevails in the market. Thus they serve as a good barometer of faith in the financial markets.
A strategy designed to reduce investment risk using call options, put options, futures contracts etc.
An investment vehicle that somewhat resembles a mutual fund, but with a number of important differences. Hedge funds employ a number of different strategies that are not usually found in mutual funds. For example, there are two fees for managers: fixed and variable. The fixed fee is a percentage of assets under management. The variable or performance fee is a percentage of the profit of the fund. Another important difference is that the minimum required investment is usually quite large and, as a result, minimizes the participation of retail investors.
According to US law if the fund is "off-shore", it can only sell to non-US investors and does not have to adhere to any SEC (Securities Exchange Commission) regulations. The term "hedge", however, is often misleading. The traditional hedge fund is actually hedged. For example, a fund employing a long-short strategy would try to select the best securities for purchase and the worst for short sale. The combination of longs and shorts provides a natural hedge to market-wide shocks. However, much more common are funds that are not actually hedged and engage in high-risk speculative activities. There are funds that are either long-biased or short-biased. There are also funds of funds which invest in a portfolio of hedge funds.
IN many ways the current crisis constitutes the second -- and higher -- stage of the one that appeared with the "dot-com bubble burst". And it is not without reason that it is being compared to the GD of 1930s. To better understand the present, let us therefore take a short and a rather long look back.
Also known as "I.T. / New Economy bubble", the "dot-com bubble" was a speculative bubble covering roughly 1995–2000, during which stock markets in Western nations saw their value increase rapidly thanks to growth in the new Internet sector and related fields. The period was marked by the founding of a group of new Internet-based companies commonly referred to as dot-coms. They relied on harnessing network effects by operating at a sustained net loss to build market share or “mind share”. These companies expected that they could build enough brand awareness to charge profitable rates for their services later. The motto "get big fast" reflected this strategy. During the loss period the companies relied on venture capital and especially initial public offerings of stock to pay their expenses. The novelty of these stocks, combined with the difficulty of valuing the companies, sent many stocks to dizzying heights and made the initial controllers of the company wildly rich on paper.
Historically, the dot-com boom can be seen as similar to a number of other technology-inspired booms of the past including railroads in the 1840s, automobiles and radio in the 1920s, transistor electronics in the 1950s, and home computers and biotechnology in the early 1980s.
As evident from these experiences, a bubble occurs when speculators note the rapid increase in value and decide to buy in anticipation of further rises, rather than because the shares are undervalued. Many companies thus become grossly overvalued. When the bubble "bursts," the share prices fall dramatically, and many companies go out of business.
This was what happened this time too. Several communication companies, burdened with unredeemable debts from their expansion projects, sold their assets for cash or filed for bankruptcy. WorldCom, the largest of these, was found to have used illegal accounting practices to overstate its profits by billions of dollars. The company's stock crashed when these irregularities were revealed, and within days it filed the largest (till then) corporate bankruptcy in U.S. history. Other examples include NorthPoint Communications, Global Crossing etc.
Altogether the dot-com bubble crash wiped out $5 trillion in market value of “new technology” companies from March 2000 to October 2002. Most of the new high-speed optical fiber infrastructure remained unutilised, and came to be known as dark fiber.
Several companies and their executives were accused or convicted of fraud for misusing shareholders' money, and the U.S. Securities and Exchange Commission fined top investment firms like Citigroup and Merrill Lynch millions of dollars for misleading investors. Various supporting industries, such as advertising and shipping, scaled back their operations as demand for their services fell. A few large dot-com companies, such as Amazon.com and eBay, survived the turmoil and are now doing reasonably well. So did a number of small players who were able to weather the financial markets storm.
After the dot-com bubble burst, instead of channeling finance capital back into production through institutional reform, US authorities paved the way for another bubble by reducing interest rates. Regarding people with investable funds, Yale economist Robert Shiller wrote in 2005, “Once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed. Where else could plungers apply their newly acquired trading talents? The materialistic display of the big house also has become a salve to bruised egos of disappointed stock investors.” (Cited by M. Obstfeld in “Models of currency crises with self-fulfilling features”; European Economic Review 40 (1996), pp. 1037-47.)
World War I was followed by a sharp postwar recession and during the 1920s millions of Americans began to purchase stocks for the first time. Stock prices rose steadily. Investors eventually realized that a large imbalance existed between stock prices and the real assets available to back them up, including profits, and decided to sell. On October 29, 1929, great numbers of people tried to sell their stocks all at once. Prices tumbled so drastically on the NYSE and other exchanges that the event became known as the crash of 1929.
This precipitated the Great Depression (GD).The economy raced downhill. Unemployment, which affected 3 percent of the labor force in 1929, reached 25 percent in 1933. People with jobs had to accept pay cuts. Demand for durable goods—housing, cars, appliances—and luxuries declined, and production faltered. By 1932 the gross national product had been cut by almost one-third. By 1933 over 5,000 banks had failed, and more than 85,000 businesses had gone under.
In cities, the destitute slept in shanties that sprang up in parks or on the outskirts of town, wrapped up in “Hoover blankets” (newspapers) and displaying “Hoover flags” (empty pockets). In African American communities, unemployment was disproportionately severe. In Chicago in 1931, 43.5 percent of black men and 58.5 percent of black women were out of work, compared with 29.7 percent of white men and 19.1 percent of white women. The depression quickly spread throughout the world. For example, nearly 40 percent of the German workforce was unemployed by 1932, bringing grist to Hitler’s mills.
The proximate cause of the GD, as Irving Fisher argued, lay in loose credit and over-indebtedness, which fueled speculation and asset bubbles that inevitably crashed. In 1929 margin requirements in stock markets were only 10%. In other words, brokerage firms would loan $9 for every $1 an investor had deposited. When the market fell, brokers called in these loans, which could not be paid back. Banks began to fail as debtors defaulted on debt and depositors attempted to withdraw their deposits en masse, triggering multiple bank runs. Government guarantees and Federal Reserve banking regulations to prevent such panics were ineffective or not used. Bank failures led to the loss of billions of dollars in assets. Outstanding debts became heavier, because prices and incomes fell by 20–50% but the debts remained at the same dollar amount. After the panic of 1929, and during the first 10 months of 1930, 744 US banks failed. By 1933, depositors had lost $140 billion in deposits. In all, 9,000 banks failed in the US during the 1930s.
Bank failures snowballed as desperate bankers called in loans but many borrowers defaulted. With future profits looking poor, capital investment and construction slowed or completely ceased. In the face of bad loans and worsening future prospects, the surviving banks became even more conservative in their lending. Banks built up their capital reserves and made fewer loans, which intensified deflationary pressures.
The liquidation of debt could not keep up with the fall of prices which it caused. The mass effect of the stampede to liquidate increased the value of each dollar owed, relative to the value of declining asset holdings. The very effort of individuals to lessen their burden of debt effectively increased it. Paradoxically, the more the debtors paid, the more they owed. This self-aggravating process turned the recession into a great depression. Fisher called this phenomenon debt-deflation, the specter of which is again looming large on the horizon today, according to many an economist based in US.
A good many similarities between the GD and the current crisis are quite evident. Both started in the financial sector and gradually spread to the real sector as credit dried up. During both crises many financial institutions either defaulted or had to be bailed out. In both cases the crisis started with the bursting of a bubble. And of course, both crises started in the US and subsequently spread to other countries.
The differences also are no less notable. Responses of both fiscal and monetary policies today are much swifter and vigorous. The GD was characterized by beggar thy neighbor policies. In mid 1930 the US Congress passed the Smoot-Hawley Tariff Act that raised tariffs on over 20,000 imported goods to record levels. Other countries retaliated by also imposing restrictions on imports and engaged in competitive devaluations of their respective currencies. This led to a serious contraction of international trade. This time major trading partners have so far largely avoided the temptation to tread this path, keeping in mind the adverse consequences of such actions during the 1930s. Some economists believe that thanks to these differences, the current crisis will not assume such alarming proportions as the GD did.
On the other hand, there are a number of differences that adds to the difficulties of tackling the present crisis. More important among these are the extreme complexity and lack of transparency of financial operations, the enhanced interpenetration of financial markets across the world, the excessive preponderance of the financial sector vis-a-vis manufacture, agriculture, manufacturing and commodities trade.
Elected President in 1932, Franklin Delano Roosevelt instituted a program termed the New Deal, which included several measures aimed at rebuilding the economy. By the start of Roosevelt’s second term in 1937, some progress had been made against the depression; the gross output of goods and services reached their 1929 level. Unemployment was still high, and per capita income was less than in 1929. The economy plunged again in the so-called Roosevelt recession of 1937, caused by reduced government spending and the new social security taxes. To battle the recession and to stimulate the economy, Roosevelt initiated a spending program which served to tone up demand to some extent.
The New Deal never ended the Great Depression, which continued until the United States’ entry into World War II revived the economy. As late as 1940, 15 percent of the labor force was unemployed. Nor did the New Deal redistribute wealth or challenge capitalism. But in the short run, the New Deal averted disaster and alleviated misery, and its long-term effects were profound in rebuilding the socio-economic infrastructure.
From memoirs of Marriner S. Eccles
The author served as Chairman of the Federal Reserve under Franklin D. Roosevelt from November 1934 to February 1948. Here he details what he believed caused the Depression.
“As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth -- not of existing wealth, but of wealth as it is currently produced -- to provide men with buying power equal to the amount of goods and services offered by the nation's economic machinery. [Emphasis in original.]
Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.
That is what happened to us in the twenties. We sustained high levels of employment in that period with the aid of an exceptional expansion of debt outside of the banking system. This debt was provided by the large growth of business savings as well as savings by individuals, particularly in the upper-income groups where taxes were relatively low….The stimulation to spend by debt-creation of this sort was short-lived and could not be counted on to sustain high levels of employment for long periods of time. Had there been a better distribution of the current income from the national product -- in other words, had there been less savings by business and the higher-income groups and more income in the lower groups -- we should have had far greater stability in our economy. Had the six billion dollars, for instance, that were loaned by corporations and wealthy individuals for stock-market speculation been distributed to the public as lower prices or higher wages and with less profits to the corporations and the well-to-do, it would have prevented or greatly moderated the economic collapse that began at the end of 1929.
The time came when there were no more poker chips to be loaned on credit. Debtors thereupon were forced to curtail their consumption in an effort to create a margin that could be applied to the reduction of outstanding debts. This naturally reduced the demand for goods of all kinds and brought on what seemed to be overproduction, but was in reality underconsumption when judged in terms of the real world instead of the money world. This, in turn, brought about a fall in prices and employment.
Unemployment further decreased the consumption of goods, which further increased unemployment, thus closing the circle in a continuing decline of prices.
This then, was my reading of what brought on the depression.” [from Beckoning Frontiers (New York, Alfred A. Knopf, 1951)]
Crises are endemic to capitalism, but each particular crisis has its distinctive features and implications. The present one has its roots in the economic slump of 1970s. To counter stagnation in the 'real' or productive economy, big capital, particularly in the US relied on financialisation, generating one growth bubble after another. But bubbles inevitably burst, bringing the fundamental economic problems back to the surface. New and bigger bubbles lead to still greater financial crises and worsening conditions of production, in what has now become a vicious cycle.
The book in your hand shows exactly how this happened in the present case and adds a backgrounder on the dot-com bubble burst a few years ago and the Great Depression of 1930s. To help you arrive at your own judgement, a chronology of major economic events during the last two years and a glossary of relevant technical terms have been appended. You can also read how the Federal Reserve chairman under President Roosevelt -- the real architect of the New Deal -- analysed the causes of the Great Depression and what George Soros has to say on the recent "financial meltdown". And of course, the whole discussion is constructed on Marx's essential observations on capitalist crisis. If you really wish to go deep into the causes and consequences of the unfolding crisis, this is your book.
