Colombo, Economy, Politics and Governance

A Spectre Haunting Global Capitalism

Alan Greenspan, former chairman of the US Federal Reserve, has described the current financial crises as “probably a once-in-a-century event”. Does he mean very long Kondratiff cycle? In a recent speech, French President Nicolas Sarkozy declared that “laissez-faire is finished, the all powerful market that always knows best is finished”. The crisis began at the financial end of the system, but appeared to be extending gradually to the real segment of the economy. The US motor industry has already come up begging for a bail-out plan. Last few months have witnessed that big companies that everyone though too big to fall have either submitted for bankruptcy, or been bailed out by the US government or been statized. This list includes AIG, Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers and Merrill Lynch, Washington Mutual. City Bank that is also in crisis decided few weeks ago to sack 53,000 employees in its US operation alone. Dominique Strauss-Kahn expressed the gravity and magnitude of the crisis in the following words: “[W]ith much of the losses yet to be realized, and with financial crisis now acute, it has become clear that nothing sort of a systemic solution -comprehensive in tackling the immediate fallout and comprehensive in addressing the root causes- will permit the broader economy, in the US and globally, to function with any semblance of normality” (Financial Times, September 22, 2008). How did capitalist firms respond? The Wall Street and City of London went to their respective governmnets with a begging bawl to get a bigger share of taxpayers’ money for the survival of the system. The USA, most countries in Western Europe, Japan and South Korea have all funded private banks and financial institutions either through recapitalization or statization. The US decided to pump $ 700 billion to save the ailing financial sector while the United Kingdom proposed £ 89 billion bail-out plan. Some economists believe that the economy needs around 2- 3 trillion dollars for it to come out of the mess. Other countries took varying measures ranging from guaranteeing bank deposits and cracking down on short-selling. Big investment banks such as Goldman Sachs and Morgan Stanley forced themselves to transform into bank holding companies. Right wing radical fundamentalists like George W Bush, Henry Paulson and Ben Bernanke accepted the defeat and declared that market lacks a self-correcting mechanism, the truth that was revealed by John Maynard Keynes. In 1933, Keynes wrote: “We have reached a critical point. We can see clearly the gulf to which our present path is leading”. The world is once again going through such a time that is “accompanied by the utter discredit of orthodox leadership in finance and government”. The spectre, Marx and Engles talked about 160 years ago, has begun to haunt once again. The spectre is the idea that capitalism is basically flawed and modern society can do better by creating post-capitalist system that works on different principles.

How did it happen? Prior to answering this question, let me delineate the main lessons that we can draw from the events unfolded in the last 3- 4 months. Of course, the roots of the current crisis stretch back much further. Four major lessons cam be drawn:

  1. Capitalist system is inherently crisis-driven and it in-build self-correcting mechanisms include periodical economic crisis that makes the life of the all, especially, low-income earners miserable. This feature of capitalism makes the state intervention imperative;
  2. The current crisis has also revealed that the large sector of the modern society in developed capitalist world is not governed by the principles of transparency, accountability and democracy. Liberal theory may say this segment is outside the public sphere and belong to the private sphere so that no needs to apply such principles.
  3. Neo-liberal economics is basically flawed, failed understand the systemic dynamic of capitalism and cannot diagnose the ills of the current system;
  4. Humankind should develop and alternative system that ensure freedom, justice, and development and be eco-friendly and humane (definitely not the system that existed in the former Soviet bloc countries).

Nonetheless, these lessons do not imply that an alternative post-capitalist system would evolve out of the current impasse. Human kind may make next leap when the principles of such a system is developed and when human agency is prepared to take the necessary steps towards the reconstruction.   

Enigma of Financial Crisis

We are living in a world that is dominated by financial capital. The countries that dominate the world economy, the USA and UK, are not real producers, but dealers of finance, credit and stocks. Hence they wanted international economy to be arranged and rearranged according to the needs of financial capital. The IMF, and the World Bank are the agents of financial capital and neo-liberal economists are its spokespersons. In the last two decades, the real income of the US average workers have declined significantly and the firms were able to maintain low real wages by introducing multiple systems like outsourcing, automation and increasing women in the labour force. This has created the potential for what Marx called typical ‘realization crisis’. It was postponed by creating a system of massive debt. Consumer lending was expanded and the financial markets were more and more deregulated. Competition between banks and financial institutions also contributed since the financial companies were forced to cut rates in order to attract more borrowers in order to keep afloat in the face of cut-throat competition. An average US household now spend more of their disposable income to pay off debts (14 per cent) than to buy food (13 per cent).

The financial market in developed capitalist countries were able do so as they managed to obtain massive savings of emerging economies that adopted more careful policies after 1990 financial crisis that hit many emerging markets. The creditworthiness of securities issued by the big financial giants was inaccurately rated by competing rating companies like Fitch, Moody’s and Standard and Poor. After internet boom in the 1990s, many were to float the stock for such companies. But they did not have business plans but these actions bid up stock prices until it reached unrealistic levels. Responding to stock market crash in the early 2000, Federal Reserve reduced interest rates thus reducing the cost of loans. This is how sub-prime lending (NINJA loans) especially in real estate sector became so prominent. By 2006, the most popular mortgage option entailed paying less than the amount due in each month by adding the balance to the principal. According to Business Week, in the early 2000s American household mortgage amounted to $ 3 trillion. US private sector borrowed from rest of the world $ 3 trillion. Bubble economy was formed and maintained through deregulated market environment without transparency, accountability or democratic decision making. Prof Ulrich who visited Sri Lanka a couple weeks ago abhorred the practices of these giant financial institutions and high salaries of their CEOs. European Banks accumulated these toxic assets of the US companies. Bear Stearns‘s short term debts were 33 times of its capital. SEC examiners detected the danger of these practices but the political appointees at the top disregarded these warnings. To maintain high profit rates of big financial companies and to avoid classical realization crisis, the US capitalism resort the creation of what Marx called ‘fictitious capital’ in place of real capital. Because of the dominance of the New York and London financial markets in the globalized system, the US and to a limited extent the UK was able to subordinate real capital to the needs and interests of fictitious capital.  

What actually happened was the bubble that was created in the last ten years or so burst up. That is the only solution the deregulated markets could offer through the operation of ‘invisible hand’. Since the systemic outcome of this market modality is economically unbearable and politically unjustifiable, the only solution left for the system is the intervention by the government with massive bail-out plan. However, the outcome of the crisis for lower income earning people may be disastrous. The IMF has already said that the global GDP growth would be less than 2 percent this year and next year. This slow growth would increases unemployment worldwide.

  • Sinthaamani

    The article highlights the complex financial world we are living in. Financial instruments, and transactions have become complex that even the most astute econmists are unable to forsee the trends until the effect become irreversibly disasstrous.

    Perhaps this is why economists often talk in abstract terms. Greenspan dismissed the bad fall out of the 2000+ stock market crash pointing to the unusual rise as "irrational exuberance," and dismissed the housing bubble as "speculative price imbalances," and said "a national severe price distortion seems most unlikely."

    But, in the U.S. one can see that rush to seek short term profits has trumped over building strong economic fundamentals. High borrowing ends up as consumer spending, mainly on foreign goods, and less on investment. Housing bubble was mainly due to unregulated lending by large financial firms, trading sliced and diced morgage-backed securites, disguised as complex financial instruments. Absent a technology/medical advance that can propel U.S.'s world leadership, U.S. economic dominance will be on an inexorable downward trend.

  • Robert Freeman

    Hi,
    Does "realization crisis" or "fictitious capital" translate into financial markets creating artificial surplus value? Surplus value being that which a person creates over what is required for food, clothing, shelter and reproduction.
    It may sound simplistic but it is a point at which I can proceed from.