The end of neo-liberal economics: Great Crash of 2008 and the demise of the Regan-Thatcherism
The ‘global-state’ (G7 and some G20 governments, central banks, and the IMF and IBRD multilateral agencies) intervened in the international banking system during the October 11-12, 2008 weekend, financially on an unparallel scale, and politically with resolute, coordinated, authority. One is left wondering what is left of global finance capital that is distinctively capitalist anymore. The implications of intervention on such a scale are momentous for international banking and finance. If the intrusion goes much further, British, French, German and other governments will become the primary owners of banks in a watershed reversal of Regan-Thatcher neo-liberalism after 30 years. For the ilk of Francisco Fukuyama, this is the end of his-story.
One more thing, US global financial hegemony is over, forever, that is for sure; an economic-multipolar globe based on a new sharing of global power-positions is taking shape. For years I have been insisting that Globalisation-II (my copyright!) is different from the early decades of globalisation. The present financial crisis will complete the transition. The economic strength of the BRIC (Brazil, Russia, India, China) nations in manufacturing, energy and certain technologies, will be complemented by financial clout. Consider dollar reserves; China $1.9 trillion, the Petro Middle East $1.3 trillion, Russia $500 billion, then add Japan, South Korea, Taiwan, Hong Kong and Singapore; well over $5 trillion in total. How will these countries use their financial power? They will become global centres of finance capital, acquiring banks and finance houses, while American and European finance capital slips. Economic power will be underpinned by financial expertise and deep pockets.
The scale of intervention
There is a sea change in how political business is done in Washington, London, Paris and Berlin; a paradigm shift whose significance is sinking in slowly. Ideologically, it is borne out by the news that the banks were given no choice; it did not matter whether they wanted government support or not, the heads of the relevant banks were called in and told, whether they like it or not, the Treasury was going to inject liquidity, that is part nationalise them.
US Treasury Secretary Hank Paulson, announcing the decision on Monday (13) said that this was “not what we like to do but what we have to do”. He went on to add that the government was buying shares in banks because the “alternative was totally unacceptable”. A frank admission that free-market capitalism had terminated in a catastrophic meltdown of the world’s greatest banking system and it was being part nationalised; make no mistake about the stark and explicit reality.
Nationalisation in the UK is voluntary, but its extent is stunning. Britain’s second largest (Royal Bank of Scotland – RBS) and sixth largest (HBOS) banks are now under a controlling government stake – in the case of RBS 60%. A third of all bank branch outlets in the country will be state controlled. Market capitalisation of RBS was $76 billion in February this year, but it has fallen since and a $35 billion investment in 5% preference shares is buying the government 60% ownership. The numbers for HBOS are still not known and Lloyds, the UK’s fifth largest bank, is also being part nationalised, but again numbers are not known. Several smaller banks will also be affected – Northern Rock and Bradford & Bingley have already been 100% nationalised. It is evident that the government is determined to do what it takes to make the banks liquid, and one need have no doubt that it will take nationalisation as far as necessary, and even all the way.
Ben Bernanke, the US Fed Chairman said on the 13th, “our strategy will evolve with the crisis; we will not stand down till we achieve our objective”. The US has so far thrown only $250 billion of the $700 that Congress approved in early October, towards bank nationalisation (the Americans need a euphuism for nationalisation, so they call it “injecting liquidity”). However, a larger proportion is likely to be thrown into the nationalisation programme eventually.
It is difficult to estimate what share of bank ownership will end up in government hands – Washington is not even willing to name the nine banks earmarked for immediate medication but eight are known (Bank of America, CitiGroup, Wells Fargo, JP Morgan Chase, Goldman Sacks, Morgan Stanley, Merrill Lynch, Bank of New York Mellon, and State Street – phew, reads like a roll call of the Himalayan heights of banking!) Let me put the ownership size estimation in perspective. The market capitalisation of Wachovia was $76 billion in February 2008, but when it went belly-up in September its banking operations were acquired by CitiGroup for $2.16 billion; Wachovia shares which were trading at $38 in January sank to $10 before the debacle, and were 97 cent junk on acquisition day.
The market capitalisation of Bank of America and CitiGroup were $200 billion and $140 billion, respectively, in February, but because of enormous market volatility there is no certainty of how much they will be valued at today, except to say the numbers will be much lower. The government’s intention is to buy 10% preference shares to the tune of $25 billion in each; the share of ownership accruing to government will depend on valuation on the purchase date. JP Morgan Chase and Wells Faro will see injections of $20 billion each and Goldman Sachs and Morgan Stanley $10 billion, BoNY-Mellon and State Street get much smaller amounts. Half of the earmarked $250 billion will go into these nine big banks; the remainder will be made available for thousands of smaller banks and thrift societies that proliferate across the US. It is hard to imagine that Uncle Sam wishes to be a stake holder in these midgets; some other arrangement will be worked out.
There is a possibility that developments may spiral further out of control. For example, it is estimated that RBS shares continued to dive even after partial nationalisation and market capitalisation at close on Black Friday (10 October) was down to $21 billion. The British government’s share values are said to have declined by $1 billion and it will face criticism if its investments continues to depreciate. Hence there will be temptation to nationalise the bank altogether and take it off the stock market. The same could happen in other European countries. Are we on the road to omni nationalisation as in 1948? Is it going to be a full 180 degree reversal, a wholesale trouncing of Regan-Thatcher liberalism? Time and crisis will tell.
It is not possible within the confines of this article to mention all developments in Europe, the Far East and Australia-NZ. Let me only mention that the rest of Europe is pouring $1.8 trillion into bank recapitalisations, mainly Germany $680 billion and France $490 billion; the Australian government has turned to full blown populism; and the Chinese government, at last, is paying lip service to growing China’s domestic market.
Paradoxically, this process is not being led by socialists and social-democrats at all. Gordon Brown hangs out at the extreme rightwing margin of social democracy and Nicolas Sarkosy came to power on a centre-right, anti-socialist, platform. To confound matters most is George Bush, though tensions were stark at the October 13th press conferences. Paulson and Bernanke spoke in the language quoted above, but Bush was at pains to emphasise “these measures are not intended to take over the free market”. Tension must be mounting within the ruling cabals in Washington and elsewhere and could become more acute after November 4th.
The secret to unlocking these paradoxes is to grasp that the contradictions of capitalism are driving its political captains to constrain and sometimes negate their very own system. It would, however, be wrong to read too much into these incipient developments, apart from taking some intellectual delight. A regular e-mail friend, Swaminathan Palendra, put it like this: “That is very interesting, Kumar. So, in other words, capitalism is trying to re-adjust to save itself and in that process may give birth to some unforeseen global changes ( which will most probably be positive ), but not necessarily change the basic structure of capitalism”. Rather well put and to the point I thought.
The preceding crisis and spread to the real economy
The antecedent events are not unknown but a brief review is necessary. However to keep it brief I will use a compressed point form presentation.
a) The crash was appalling, the worst since the Great Depression (GD) of 1929-33. Banks whose names are household words, giant Financial institutions and mammoth Mortgage companies (collectively, BFMs) are failing in droves. Stock markets, worldwide, were in turmoil. The almighty Dow was down 39% in an year; European stock markets were in tumult; Nikkei, Hong Kong, Singapore, South Korean, Australian and New Zealand indices were at their lowest in years, in some cases decades; the Russian stock exchange closed down for days at a time; the Indian rupee is at a record low. The combined nominal asset valuation wiped out on global stock markets since the start of the crisis in mid-2007 was about $15 trillion. That is, $15 trillion of global capital asset values just vaporised! (This paragraph is updated to Friday 10 October).
b) American and EU government reactions were similar. In the worst cases BFMs go bust (Lehman Brothers) or are nationalised (Fannie and Freddie in USA, Northern Rock and Bradford & Bingley in the UK). In other cases central banks extend easy loans to ease liquidity (examples are too many to name). In still other cases banks are forced to restructure – sell themselves to another bank (Wachovia, Washington Mutual), or change from Investment Banks to ordinary Commercial Banks (Goldman Sachs, Morgan Stanley), or concede a government purchase of shareholding. The most ‘pro-capitalist’ option is when the government takes over bank’s bad debts. This last approach I will call PP.
c) PP is Paulson’s Package, the recent $900 billion US scheme. The US Treasury will buy bad debts and mortgages from banks at a reduced price after valuation. Once these ‘toxics’ are removed from balance sheets, banks can breathe more freely, trust each other, and make inter-bank loans; this is called re-liquefying banks. It is hoped that thereafter the financial system will return to normality. The government also hopes ‘toxics’ will recover value and can one day be sold at a profit. This is the theory; nothing happened in the first two weeks.
d) On 8-9 October all the developed economies cut interest rates by between 0.5% and 1%. Nevertheless, finance capital and the ‘analysts’ woke up next morning panting like vultures feeding on a decaying carcass. “Not enough, not enough, cut interest rates more and more; pump more, pump more of the workers, widows and taxpayers savings into the BFMs; save rotting capitalism” and Stock markets continued their rout. G7 finance ministers (leaving out Russia) met in crisis in Washington on October 11, desperate for a coordinated response to avert a depression. IMF Head, Dominique Strauss-Kahn, told a G20 meeting “the financial system is on the brink of a global meltdown”.
e) At first it appeared that the crisis was mainly in the financial sector, not yet spreading to the real economy, the productive sector: manufacturing, agriculture, and real services – not financial or war related services. Hence, output and employment were holding their heads above water, initially. However the signs of spreading to the real economy emerged. US consumer demand began declining steeply; Japan’s machinery output fell for the last three months; in September it was down 14.5% compared to last year. America’s emblems, General Motors and Ford, started wobbling. US unemployment rose to over 6% and looked like 10% was on the horizon. Prices of cereals, commodities, oil, metals started falling steeply on fears of a deepening recession and declining demand. There is even talk of global deflation. Crisis has percolated into the real economy and a recession in the real economy is already upon the West. Erosion in export oriented sectors in the rest of the world has commenced.
Prospects for decoupled-depression
I have in recent months been saying that Asia and Latin America can avoid a deep recession (they cannot avoid dislocation and fall in growth rates, stock-markets have already been hammered) if they take correct policy decisions. This option still remains open because the economy – employment and output – is steady; banks remain solvent; and growth, though lower, remains strong. But the problem is that though Latin America has taken some necessary policy decisions, Asia, including China, so far, has not. What are the policy decisions? Countries like China and India need to place emphasis on domestic consumption not exports (creating internal demand and wealth), regional economic cooperation, and regional banking and financial restructuring.
One thing is certain, US global financial hegemony is over, forever; that is for sure. An economic-multipolar globe based on a new sharing of global power-positions is emerging. For years I have been insisting that Globalisation-II (my copyright!) is different from the previous phase, Globalisation-I. This financial crisis will complete the transition. The economic strength of the BRIC (Brazil, Russia, India, China) nations in manufacturing, energy and certain technologies, will be complemented by financial clout. Consider dollar reserves; China $1.8 trillion, the Petro Middle East $1.3 trillion, Russia $500 billion, then add Japan, South Korea, Taiwan, Hong Kong and Singapore; over $5 trillion in total is my estimate. How will these countries use their financial power? They will become global centres of finance capital, acquiring banks and finance houses, while American and European finance capital slips. Economic power will be underpinned by financial power.
Two factors are decisive; the impact of the turmoil itself, and the internal class struggle – Latin America shows the importance of the internal class struggle and political leadership. Trotsky’s remark that the principal crisis in the world is the crisis in the leadership of the working class remains true today; but amend “working class” to read “less privileged and middle classes” to reflect current social and economic reality in both developed and developing countries.
‘Analysts’ (apologists for capitalism) in Bloomberg, Financial Times, the Economist, Wall Street Journal and such magazines, websites and TV channels, say the crumble will worsen. Their chorus: “It’s going to get worse before it gets better”. For sure, it is not possible to predict how deep the crisis in the real economy will go; there is an old saying that you can never predict a recession or how deep it will be, you can only look back and analyse it. The half truth here is that psychological factors are at work, in addition to economic trends and data.
There are two fundamentally different approaches to understanding the global rout of the capitalist financial system; the bourgeois-apologetic (BA, though it could just as well be named BS) and the Marxist. Within the BA school, which dominates Western media, academia and websites, there are many variants, such as those who blame market greed, those who blame former Fed Chairman Alan Greenspan, or Bush tax policies, or bad regulatory practices. But all BAs have one thing is common: “There is nothing inherent and endemic in the capitalist system that leads to catastrophes; it’s just that somebody did something wrong”, that is their swansong. It’s not methane that is depleting the ozone layer; it’s the fault of some bilious cow that farted!
The apologists and Marxists both agree on empirical antecedents of the systemic collapse. A huge amount of unjustified credit has been created; unjustified because it should have been clear that a vast number of recipients of credit would not be able to meet their repayment obligations. This refers not only to sup-prime house mortgages (poor quality borrowers) and credit-card consumers (even people without incomes), but even big financial fund managers, speculative investors and businesses. Secondly it is also agreed that banks and finance companies wanted to share the risk. To spread risk around they created many innovative financial devices, collectively called derivatives, and sold them throughout the financial system. This is similar to insurance companies reinsuring a multitude of risky deals with all other such companies.
The thorny problem is that derivatives were packaged together and sold in parcels to other banks and financial companies, who repackaged them again with still other risk contracts and resold in more bits and pieces, here and there and everywhere. The result is that nobody knows how much bad credit is lurking, where it is hidden, or who will crash next. Peter S Goodman (New York Times, 8 October) says that the derivatives market has grown to $531 trillion which is much too large to believe but even half of this would be colossal. The reason why banks are refusing to ease up liquidity and lend to each other is that no one knows which bank will go down next.
Another way in which fictitious capital was bloated-up were asset bubbles; that is, the value of stock market holdings and houses kept rising during the last 10 years in an utterly irrational manner. The underlying company was making no improvements or expansion, the houses and neighbourhoods were not being refurbished, but values rose and rose and rose; a bubble, a fake, and it had to burst. Bill Lussinhide in his personal website estimates that, at peak, the valuation of shares in the US stock market was an “atmospheric and unprecedented 185% of total GDP”; its historical average value should only be 58% of GDP.
The immediate psychological cause of the crash was panic; banks realised that their debts would not be serviced, lenders saw that debtors were empty vessels, mortgage providers went broke when house owners defaulted as sub-primes ended their ‘easy period’, asset values on stock markets plunged and collateral of all forms (shares, houses and pieces of paper on which derivative contracts were written) turned into rubbish. A huge crisis of confidence set in and so was born the Great Crash of 2008. These are the agreed facts, the empirical antecedents, agreed by BAs and Marxists alike.
Schools of apologists
There are many sub-schools but two basic versions of BA prevail – the free marketers and the regulators, overlapping neo-liberals (Austrian School economists) and pinkish Democrats (theory-less empiricists). The former say the mistake was interfering with the natural boom and recession cycle; they say monetary and fiscal intervention stalling the 2001 recession only bottled things up and made the later explosion worse. They are like my grandmother: “Don’t take those bloody antibiotics, let the body go through its natural processes and cure itself, in the end it will be stronger”. Greenspan’s low interest rates, Bush’s tax refunds to middle classes to stimulate spending, fiscal revenues (big government) and big spending (except defence), are their culprits.
The pinks point to failures of disclosure, inadequate regulatory frameworks, lax oversight and 15 years of low interest rates stimulating excess credit. Failure to enact legislation to monitor hundreds of derivatives was courting disaster. Legions of pink academics have been warning that derivatives had become an alphabet soup of products whose tentacles had spread dangerously.
Warren Buffett observed, five years ago, that derivatives were “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal” and financial wizard George Soros said he refused to touch them “because we don’t really understand how they work.”
The Congressionally unchallenged “Oracle” Greenspan refused to regulate derivatives; he rebuffed even minimalist proposals, he trusted the market to spread, smoothen and regulate risk. “What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so,” he told the Senate in 2003 (many of these quotes are from the NY Times article). He believed that derivatives spread risk and allowed financial services to take more complex risks on a grander scale than they might otherwise have done. He told Congress that “there is nothing involved in federal regulation per se which makes it superior to market regulation”. But today market infatuated liberals get laryngitis when asked to explain the egg in the face of unregulated free-markets.
Every economics textbook has a chapter or two on conformist Business Cycle theory. There is some natural overlap since the roots of conventional wisdom lie in Marx’s thesis of periodic crisis built into the capitalist system. What is distinctive about the textbook versions is that it lacks historical sweep. The scope is limited to discussions of whether monetary or fiscal policy blunders reinforced a plunge, recounting of leading and lagging indicators, or a historiography of past recessions. Bourgeois economics is short on theory and lacks an analysis of longer, secular movements and accumulations of fundamentals that lead to systemic shocks. What conventional economics is good at, especially after Keynes, is policy prescriptions on how to delay or mitigate a recession, or climb out of a depression – a one of experience.
Marx developed a rather more far-reaching compendium of ideas. As capital expands through a boom, profits rise. Then a natural process linked to capitals expansion, market competition, the challenge of sustaining higher productivity, established wage levels and constraints in labour availability relative to capital’s growth, combine to diminish the rate of profit. This is endemic, inherent and natural to capitalism. Clever methods were devised to maintain unsustainable profits – financial engineering, working on endless credit expansion. New profits came not from production, not from the real economy, but from thin air. Gigantic bubbles of puffed up credit (fictitious capital) allowed fake money to make money out of fake money. This con worked for more than a decade, but then the fundamentals won and the hoax collapsed. Both schools of apologists say that if Bush did this, or if Greenspan did that, or if financial regulations were thus restructured, all would have been well. Rubbish!
“The notion that Greenspan could have generated a totally different outcome is naÃ¯ve,” says Robert Hall a Stanford economist. If credit explosion and derivatives driven financial engineering were stalled, the fall in the rate of profit would have arrived sooner. The intrinsic business cycle of capitalism will have its say like a river flowing to the sea, you can dam it and divert it, but you cannot stop it. Let’s give the final say to old Greenspan himself; in his new book he says: “Governments and central banks could not have altered the course of the boom” – QED.
Below, four one-year stock market charts at close on 15 October, 2008