I am traveling in Europe for three weeks to discuss the global financial crisis with government officials, politicians and labor leaders. What is most remarkable is how differently the financial problem is perceived over here. It¹s like being in another economic universe, not just another continent.
The U.S. media are silent about the most important topic policy makers are discussing here (and I suspect in Asia too): how to protect their countries from three inter-related dynamics: (1) the surplus dollars pouring into the rest of the world for yet further financial speculation and corporate takeovers; (2) the fact that central banks are obliged to recycle these dollar inflows to buy U.S. Treasury bonds to finance the federal U.S. budget deficit; and most important (but most suppressed in the U.S. media, (3) the military character of the U.S. payments deficit and the domestic federal budget deficit.
Strange as it may seem and irrational as it would be in a more logical system of world diplomacy the ³dollar glut² is what finances America¹s global military build-up. It forces foreign central banks to bear the costs of America¹s expanding military empire effective ³taxation without representation.² Keeping international reserves in ³dollars² means recycling their dollar inflows to buy U.S. Treasury bills U.S. government debt issued largely to finance the military.
To date, countries have been as powerless to defend themselves against the fact that this compulsory financing of U.S. military spending is built into the global financial system. Neoliberal economists applaud this as ³equilibrium,² as if it is part of economic nature and ³free markets² rather than bare-knuckle diplomacy wielded with increasing aggressiveness by U.S. officials. The mass media chime in, pretending that recycling the dollar glut to finance U.S. military spending is ³showing their faith in U.S. economic strength² by sending ³their² dollars here to ³invest.² It is as if a choice is involved, not financial and diplomatic compulsion to choose merely between ³Yes² (from China, reluctantly) , ³Yes, please² (from Japan and the European Union) and ³Yes, thank you² (Britain, Georgia and Australia).
It is not ³foreign faith in the U.S. economy² that leads foreigners to ³put their money here.² This is a silly anthropomorphic picture of a more sinister dynamic. The ³foreigners² in question are not buying U.S. exports, nor are they private-sector ³investors² buying U.S. stocks and bonds. The largest and most important foreign entities putting ³their money² here are central banks, and it is not ³their money² at all.They are sending back the dollars that foreign exporters and other recipients turn over to their central banks for domestic currency.
When the U.S. payments deficit pumps dollars into foreign economies, these banks are being given little option except to buy U.S. Treasury bills and bonds which the Treasury spends on financing an enormous, hostile military build-up to encircle the major dollar-recyclers China, Japan and Arab OPEC oil producers.Yet these governments are forced to recycle dollar inflows in a way that funds U.S. military policies in which they have no say in formulating, and which threaten them more and more belligerently. That is why China and Russia took the lead in forming the Shanghai Cooperation Organization (SCO) a few years ago.
Here in Europe there is a clear awareness that the U.S. payments deficit is much larger than just the trade deficit. One need merely look at Table 5 of the U.S. balance-of-payments data ompiled by the Bureau of Economic Analysis (BEA) and published by the Dept. of Commerce in its urvey of Current Business to see that the deficit does not stem merely from consumers buying more imports than the United States exports as the financial sector de-industrializes its economy. U.S. imports are now plunging as the economy shrinks and consumers are now finding themselves obliged to pay down the debts they have taken on.
Congress has told foreign investors in the largest dollar holder, China, not to buy anything except perhaps used-car dealerships and maybe more packaged mortgages and Fannie Mae stock the equivalent of Japanese investors being steered into spending $1 billion for Rockefeller Center, on which they subsequently took a 100% loss, and Saudi investment in Citigroup.
That¹s the kind of ³international equilibrium² that U.S. officials love to see. CNOOK go home² is the motto when it comes to serious attempts by foreign governments and their sovereign wealth funds (centralbank departments trying to figure out what to do with their dollar glut)tomake direct investments in American industry.
So we are left with the extent to which the U.S. payments deficit stems from military spending. The problem is not only the war in Iraq, now being extended to Afghanistan and Pakistan. It is the expensive build-up of U.S. military bases in Asian, European, post-Soviet and Third World countries. The Obama administration has promised to make the actual amount of this military spending more transparent. That presumably means publishing a revised set of balance of payments figures as well as domestic federal budget statistics.
The military overhead is much like a debt overhead, extracting revenue from the economy. In this case it is to pay the military-industrial complex, not merely Wall Street banks and other financial institutions. The domestic federal budget deficit does not stem only from ³priming the pump² to give away enormous sums to create a new financial oligarchy. It contains an enormous and rapidly growing military component.
So Europeans and Asians see U.S. companies pumping more and more dollars into their economies, not only to buy their exports in excess of providing them with goods and services in return, and not only to buy their companies and ³commanding heights² of privatized public enterprises without giving them reciprocal rights to buy important U.S. companies (remember the U.S. turn-down of China¹s attempt to buy into the U.S. oil distribution business), and not only to buy foreign stocks, bonds and real estate.
The U.S. media somehow neglect to mention that the U.S. Government is spending hundreds of billions of dollars abroad not only in the Near East for direct combat, but to build enormous military bases to encircle the rest of the world, to install radar systems, guided missile systems and other forms of military coercion, including the ³color revolutions² that have been funded and are still being funded all around the former Soviet Union. Pallets of shrink-wrapped $100 bills adding up to tens of millions of the dollars at a time have become familiar ³visuals² on some TV broadcasts, but the link is not made with U.S. military and diplomatic spending and foreign central-bank dollar holdings, which are reported simply as ³wonderful faith in the U.S. economic recovery² and presumably the ³monetary magic² being worked by Wall Street¹s Tim Geithner at Treasury and Helicopter Ben Bernanke at the Federal Reserve.
Here¹s the problem: The Coca Cola company recently tried to buy China¹s largest fruit-juice producer and distributor. China already holds nearly $2 trillion in U.S. securities way more than it needs or can use, inasmuch as the United States Government refuses to let it buy meaningful U.S. companies. If the U.S. buyout would have been permitted to go through, this would have confronted China with a dilemma: Choice #1 would be to let the sale go through and accept payment in dollars, reinvesting them in what the U.S. Treasury tells it to do U.S. Treasury bonds yielding about 1%. China would take a capital loss on these when U.S. interest rates rise or when the dollar declines as the United States alone is pursuing expansionary Keynesian policies in an attempt to enable the U.S. economy to carry its debt overhead.
Choice #2 is not to recycle the dollar inflows. This would lead the renminbi to rise against the dollar, thereby eroding China¹s export competitiveness in world markets. So China chose a third way, which brought U.S. protests. It turned the sale of its tangible company for merely ³paper²U.S. dollars which went with the ³choice² to fund further U.S. military encirclement of the S.C.O. The only people who seem not to be drawing this connection are the American mass media, and hence public. I can assure you from personal experience, it is being drawn here in Europe. (Here¹s a good diplomatic question to discuss: Which will be the first European country besides Russia to join the S.C.O.?)
Academic textbooks have nothing to say about how ³equilibrium²in foreign capital movements speculative as well as for direct investment is infinite as far as the U.S. economy is concerned. The U.S. economy can create dollars freely, now that they no longer are convertible into gold or even into purchases of U.S. companies, inasmuch as America remains the world¹s most protected economy. It alone is permitted to protect its agriculture by import quotas, having ³grandfathered² these into world trade rules half a century ago. Congress refuses to let ³sovereign wealth² funds invest in important U.S. sectors.
So we are confronted with the fact that the U.S. Treasury prefers foreign central banks to keep on funding its domestic budget deficit, which means financing the cost of America¹s war in the Near East and encirclement of foreign countries with rings of military bases. The more ³capital outflows² U.S. investors spend to buy up foreign economies the most profitable sectors, where the new U.S. owners can extract the highest monopoly rents the more funds end up in foreign central banks to support America¹s global military build-up. No textbook on political theory or international relations has suggested axioms to explain how nations act in a way so adverse to their own political, military and economic interests. Yet this is just what has been happening for the past generation.
So the ultimate question turns out to be what countries can do to counter this financial attack. A Basque labor union asked me whether I thought that controlling speculative capital movements would ensure that the financial system would act in the public interest. Or is outright nationalization necessary to better develop the real economy?
It is not simply a problem of ³regulation² or ³control of speculative capital movements.² The question is how nations can act as real nations, in their own interest rather than being roped into serving whatever U.S. diplomats decide is in America¹s interest.
Any country trying to do what the United States has done for the past 150 years is accused of being ³socialist² and this from the most anti-socialist economy in the world, except when it calls bailouts for its banks ³socialism for the rich,² a.k.a. financial oligarchy. This rhetorical inflation almost leaves no alternative but outright nationalization of credit as a basic public utility.
Of course, the word ³nationalization² has become a synonym for bailing out the largest and most reckless banks from their bad loans, and bailing out hedge funds and non-bank counterparties for losses on ³casino capitalism,² gambling on derivatives that AIG and other insurers or players on the losing side of these gambles are unable to pay. Such bailouts are not nationalization in the traditional sense of the term bringing credit creation and other basic financial functions back into the public domain. It is the opposite. It prints new government bonds to turn over along with self-regulatory power to the financial sector, blocking the citizenry from taking back these functions.
Framing the issue as a choice between democracy and oligarchy turns the question into one of who will control the government doing the regulation and ³nationalizing.² If it is done by a government whose central bank and major congressional committees dealing with finance are run by Wall Street, this will not help steer credit into productive uses. It will merely continue the Greenspan-Paulson- Geithner era of more and larger free lunches for their financial constituencies.
The financial oligarchy¹s idea of ³regulation² is to make sure that deregulators are installed in the key positions and given only a minimal skeleton staff and little funding. Despite Mr. Greenspan¹s announcement that he has come to see the light and realizes that self-regulation doesn¹t work, the Treasury is still run by a Wall Street official and the Fed is run by a lobbyist for Wall Street. To lobbyists the real concern isn¹t ideology as such it¹s naked self-interest for their clients. They may seek out well-meaning fools, especially prestigious figures from academia. But these are only front men, headed as they are by the followers of Milton Friedman at the University of Chicago. Such individuals are put in place as ³gate-keepers² of the major academic journals to keep out ideas that do not well serve the financial lobbyists.
This pretence for excluding government from meaningful regulation is that finance is so technical that only someone from the financial ³industry² is capable of regulating it. To add insult to injury, the additional counter-intuitive claim is made that a hallmark of democracy is to make the central bank ³independent² of elected government. In reality, of course, that is just the opposite of democracy. Finance is the crux of the economic system. If it is not regulated democratically in the public interest, then it is ³free² to be captured by special interests. So this becomes the oligarchic definition of ³market freedom.²
The danger is that governments will let the financial sector determine how ³regulation² will be applied. Special interests seek to make money from the economy, and the financial sector does this in an extractive way. That is its marketing plan. Finance today is acting in a way that de-industrializes economies, not builds them up. The ³plan² is austerity for labor, industry and all sectors outside of finance, as in the IMF programs imposed on hapless Third World debtor countries. The experience of Iceland, Latvia and other ³financialized² economies should be examined as object lessons, if only because they top the World Bank¹s ranking of countries in terms of the ³ease of doing business.²
The only meaningful regulation can come from outside the financial sector. Otherwise, countries will suffer what the Japanese call ³descent from heaven²: regulators are selected from the ranks of bankers and their ³useful idiots.² Upon retiring from government they return to the financial sector to receive lucrative jobs, ³speaking engagements² and kindred paybacks. Knowing this, they regulate in favor of financial special interests, not that of the public at large.
The problem of speculative capital movements goes beyond drawing up a set of specific regulations. It concerns the scope of national government power. The International Monetary Fund¹s Articles of Agreement prevent countries from restoring the ³dual exchange rate² systems that many retained down through the 1950s and even into the Œ60s. It was widespread practice for countries to have one exchange rate for goods and services (sometimes various exchange rates for different import and export categories) and another for ³capital movements.² Under American pressure, the IMF enforced the pretence that there is an ³equilibrium² rate that just happens to be the same for goods and services as it is for capital movements. Governments that did not buy into this ideology were excluded from membership in the IMF and World Bank or were overthrown.
The implication today is that the only way a nation can block capital movements is to withdraw from the IMF, the World Bank and the World Trade Organization (WTO). For the first time since the 1950s this looks like a real possibility, thanks to worldwide awareness of how the U.S. economy is glutting the global economy with surplus ³paper² dollars and U.S. intransigence at stopping its free ride. From the U.S. vantage point, this is nothing less than an attempt to curtail its international military program.
Where to draw the line between hedging and speculation? That's a key question now facing China's state-owned enterprises.
By staff reporters Wen Xiu, Li Qing, Ji Minhua and Justin Wong
(Caijing Magazine)A dark omen in the form of an official statement preceded a March 15 deadline for state-owned enterprises to report their financial derivatives positions to the watchdog State-owned Assets Supervision and Administration Commission (SASAC).
“Companies in the minority have insufficient knowledge about the leverage, complexity and risks involved in financial derivatives,” SASAC declared in February. “They opened investment positions illegally, and their risk management was uncontrolled, leading to a negative impact for state assets and security.”
SASAC based its conclusions on data gathered after it asked SOEs in September to investigate their derivatives trading, and report positions and losses. The survey found derivatives trading losses totaled between 10 billion and 20 billion yuan, although one official who participated in the survey said the losses were likely much higher. A follow-up probe of 20 SOEs in January by the National Audit Office confirmed that red ink spilled far and wide.
What’s known so far is that a host of major SOEs including China Railway Group Ltd., China Eastern Airlines, logistics giant COSCO and securities firm CITIC Pacific lost billions of yuan in derivatives.
So far, neither a single SOE nor any of their executives have been penalized for these losses. Trouble may come later. “The issue is still under investigation,” said one SASAC official.
Nevertheless, regulators so far have not been able to drawn a clear line between illegal speculation and improper hedging. Moreover, they haven’t decided whether the losses stemmed from a declining market or an irresponsible lack of risk management.
Beyond these issues and obvious frustrations over losses are questions about SOE investing behavior. Are derivatives products worthy for hedging risks, some wonder, or mere tools of speculation? Is there a clear way to determine whether hedging is in synch with a company’s needs? And are complex structured investment products beneficial, as some argue, or useless?
The losses disclosed so far are merely the tip of the iceberg. Some derivatives trading transactions have not appeared in reports by listed companies within SOE groups. The state’s chemical and steel giants, for example, have yet to report their positions.
According to a company manager who refused to be named, almost all SOEs tied to import-export business are engaged in derivatives trading. And the number of companies is far higher than the 31 formally licensed for overseas futures exchanges. As much as 1 trillion yuan in combined capital could be involved in derivatives trading.
Among those that openly reported losses is CITIC Pacific, a state-owned securities firm that bought leveraged foreign exchange forward contracts worth AU$ 9.7 billion, far exceeding what was needed to hedge its investments in Australian mining businesses.
Meanwhile, fuel-price hedging stung airlines trying to manage the risks tied to fluctuating oil prices. China Eastern and China Air, for example, acknowledged signing a large number of derivatives contracts in hopes of hedging against the ups and downs of international crude prices.
An experienced investment banker said a lot of derivatives contracts bought by SOEs were similar to those bought by their international counterparts. Japanese and American airlines, for example, use so-called the zero cost collar investment strategy to hedge risks from soaring oil prices.
When, to everyone’s surprise, oil prices fell off a cliff in August 2008, the hedging strategy led to huge losses for airlines. And Chinese airlines suffered even more than their foreign counterparts, according to a derivatives trade source.
One reason lies in the fundamental difference in hedging activities between Chinese and American airlines. China Eastern and Air China bought derivatives contracts with fatal weakness in strike prices, positions and product structures.
One derivative product that cost China Eastern and CITIC Pacific dearly is called accumulator. Airlines using this strategy expect oil prices to rise. But the strategy to buy put options and sell call options does not completely lock out upside risks. Moreover, risk positions for the airlines aggregated as oil prices dove after peaking last year.
Except for the fact that plunging oil price aggregated losses, traders found it difficult to find trading counterparts to reduce risk positions in these structured products.
In sharp contrast, America’s Southwest Airline restructured immediately its hedging contracts in the fourth quarter 2008 to eliminate risk positions, lowering hedge positions to 10 percent from 85 percent.
Also, China Eastern suffered a much larger percentage of book-value losses than its international counterparts. It reported 20 billion yuan in annual income and hedging losses as high as 6.5 billion yuan in 2008, compared with Japan Airlines, which reported operational earnings of 106 billion yuan and hedging losses of 140 million yuan for 2008.
Without a 7 billion yuan capital injection from the Chinese government, China Eastern might have filed for bankruptcy.
An SASAC source told Caijing that, in his opinion, three standards can be applied to differentiate hedging and speculation. One is whether a hedged target is what a company really needs. Another is whether the hedging direction is in line with the needs of an enterprise.
A third standard is whether the scale of the hedging matches the commodity needs of an enterprise. Normally, the hedging scale should be no more than 10 percent above the commodity needs of a company.
International investment banks have become the targets for criticism over what some consider “devilish” hedging contracts – deals that cost Chinese SOEs huge losses. At the same time, it’s worth noting that the accumulator and other risky derivative products were sold mainly on East Asian markets, but were much less popular in other parts of the world.
A former international investment bank executive said, “A Beijing-based listed company suffered huge losses for derivatives trading many years ago, which bothered me greatly. So I had a negative opinion about the derivatives sales department.”
The former banker said he later discovered that Chinese enterprises signed similar derivatives contracts with many other foreign banks. Likewise, a knowledgeable source said, of the 13 banks that signed with CITIC Pacific for Australian foreign exchange forward contracts, many were solicited by the Chinese firm.
There are many reasons why such contracts attract Chinese companies. At the time of signing for a derivatives contract, for example, a ceiling price for a call option may be below the market price, allowing investors to profit immediately through the purchase of a cap gain – an earnings channel for airlines before last year’s debacles for Air China and China Eastern. Indeed, some airlines in the past earned more through derivatives contracts than from their main businesses.
Asia-Pacific Airlines Association President Andrew Herdman said, “A principle for hedging is that the company side should not profit from speculations over market trends. The purpose of hedging for airlines is to manage the disparity between oil prices at ticket sales and takeoff times.”
Zero Cost Collar investment portfolios can lower hedging costs. But China’s hedging airlines bet only that oil prices would rise, ignoring the possibility that oil prices would fall off a cliff. Afterward, they blamed the turnaround on the market, ignoring their own gambling mentality.
And at an even deeper level, the reasons for such risky decisions are tied to structural barriers at Chinese SOEs, including the typically long chain for decision-making, gaps between trader rights and responsibilities, and a lack of mechanisms for incentives and discipline.
Meanwhile, regulators are being called to task. In February, for example, former president Chen Jiulin of China National Aviation Fuel Group returned to China after completing a jail term in Singapore for an illegal hedging conviction and told Caijing, “I want my superiors to comment on my case.”
CNAF”s US$ 550 million loss stemming from derivatives trading set a record when it was uncovered in 2004. Since then, new records have been set by other Chinese SOEs, but Chen is the only executive so far punished for derivatives errors.
China’s regulators have yet to issue clear statements about last year’s derivative losses.
An article posted on the SASAC Web site in 2006 by Deputy Chairman Li Wei entitled Management over Financial Derivatives for SOEs said: “Because of a lack of in-depth understanding and the required professional knowledge about financial derivatives, some companies hastened into derivatives trading without thinking seriously about risks. This merely resulted in huge losses and painful lessons.”
Li also said, “The goal of trading derivatives for non-financial companies is risk-hedging rather than profit-earning. CNAF and Copper State Reserves sought lucrative profits rather than hedging risks for their main businesses.”
Chinese authorities have set strict rules for regulating SOE hedging activities on commodities futures. In May 2001, China Securities Regulatory Commission (CSRC) released a measure on SOE Overseas Futures Hedging Activities to allow select SOEs, as approved by the State Council, to engage in this business. Six months later, 31 SOEs obtained CRSC permission through licenses to engage in overseas futures trading.
However, regulatory supervision through business licenses is far from sufficient. Li mentioned three areas overlooked by regulators.
For one thing, the state-assets watchdog SASAC coordinated with CSRC to review overseas futures trading for SOEs, but failed to follow through. SASAC reviewed and regulated overseas futures trading activities but excluded options, financial derivatives and over-the-counter trading from their supervision framework. In addition, overseas SOEs have not been included in the supervisory framework.
This report shows that regulators understand the challenges and risks SOEs face in managing derivatives. But, regulators themselves are unsure of their responsibilities and parameters. The China Securities Regulatory Commission last year suspended a qualification review of SOEs for engaging in overseas futures trading.
A CSRC source, “CSRC does not want to bother with the qualification review matter as this is the responsibility of state assets watchdog.”
Meanwhile, an SASAC source said, “When they asked for our opinion we did not agree, thinking CSRC should take on more responsibilities.”
What’s worse is that SASAC was unable to evaluate risk positions and give advice to SOEs on how to eliminate risk exposure. According to an industry source, after oil prices fell off a cliff in the fourth quarter 2008, some companies that sought guidance from regulators were told not to expand their trading positions.
“If we had created some positions to hedge, we could have reduced losses when oil prices first slid below the floor,” said a trader. “As opening hedging positions are not free, regulators did not approve.”
So what is the future of hedging? Many agree hedging strategies will always be needed to protect returns. Others are using the word “reasonable” to describe the best approach.
One SOE executive said, “Companies should include hedging into their annual budgets by setting reasonable hedging goals, and work out policies to be reviewed by boards of directors.”
1 yuan = 14 U.S. cents
Full Article in Chinese: http://magazine.caijing.com.cn/2009-03-15/110121002.html
The Brussels meeting is taking place ahead of April's G20 summit in London EU leaders have urged the G20 leading economies to double the money available to the International Monetary Fund to help countries in financial difficulty.
Leaders meeting in Brussels said they would provide up to 75bn euros ($102bn; £71bn) in loans in an effort to boost the IMF's capital to $500bn (£344bn).
They also doubled to 50bn euros (£47bn; $68bn) the amount of emergency funding available to help non-eurozone members.
But the bloc resisted US calls to spend even more to revive national economies.
They said they wanted first to gauge the effects of the 200bn-euro ($274bn; £188bn) stimulus package they have been implementing, and that the focus should be on reforming the global financial system.
A call to others to "avoid all form of protectionist measures" was overshadowed by an announcement that the French carmaker, Renault, would move a production line from Slovenia back to France.
France last month agreed to give Renault and Peugeot Citroen each 3bn euros ($4bn; £2.8bn) in loans if they kept French plants open.
The European Commission has demanded clarification about the plan.
If the underlying problem is the overproduction of capital, how can a lasting upturn be achieved without the destruction of capital?
I do not think it can. The fundamental contradictions of capitalism are all operating. There is no obvious way of bringing the current situation to an end. There is a huge amount of surplus capital, and this is being blamed on China and other countries. But that is absurd: the amount of surplus held by China is something like $2 trillion, which is a fraction of the surplus capital within the system as a whole.
Much of the surplus ended up in derivatives. The only solution is for surplus capital to be wiped out - and with it a section of the capitalist class. But to a certain extent excess capital is extinguished, otherwise there would not be capitalism, and this is happening now. To the extent it happens the downturn will be limited and come to an end, which is likely to occur within the next two to three years.
But can there be a return to a vibrant capitalism? The answer is no. The real question is not so much ‘Why has this happened?’, but ‘Why didn’t it happen before?’ A Marxist cannot simply argue that capitalism will come to an end when the majority are persuaded it must be overthrown. We are opposed to capitalism because it is inferior to socialism - it is inconsistent even in its own terms. It is structurally incapable of continuing to develop the forces of production to the extent that they can be developed. Capitalism’s internal contradictions make it malfunction, which is what has actually been happening.
Why was it able to do so well after the war? The answer has everything to do with the cold war and Stalinism. But once the cold war was over, it turned to finance capital, which for a time worked. Finance capital was associated with what is called neoliberalism, but that has now blown up. The cold war and Stalinism have come to an end; finance capital has come to an end. So one has to ask, what is the alternative strategy? It is very hard to see it.
What is more, they know they have no alternative strategy. Obviously there are ideological statements that can be made and piecemeal measures taken. And at the present time the working class is demoralised, so they are not in dire straits. But over the middle to long term capitalism is in considerable trouble.
Is it possible theoretically for capitalism to enter a new boom?
I cannot see it. We do not live under a system of spontaneous capitalist development. Governments have been playing a crucial role for a century now and the capitalist class wants and depends on government intervention. In fact they would prefer for the economy to expand at a fairly low rate of growth, which is what happened after 1995. They fear the possibility of inflation.
So a boom is technically possible, but very unlikely. If expansion were to be accelerated, it would lead to increased power for the working class, directly or indirectly. The capitalist class will not go there unless they are forced to. It would be better from their point of view to continue with a steady, safe capitalism than to have no capitalism at all.
Would it be reasonable to say that capitalism’s secular decline is now dominant compared to its cyclical tendencies?
It is more complicated than that. What we are actually talking about is a period from World War II until March 2000, in which the downturns were in fact quite weak. They were largely defined by governments raising interest rates and taking fiscal measures - deliberately reducing growth in order to control the working class.
Those cycles were relatively weak, even if it did not always look quite like that. What is happening now is entirely different. It is very similar to the great depression. The only reason it will not become another great depression is that governments will intervene to prevent it, which they did not do last time.
Is it possible or desirable for the US to offload the downturn onto other countries?
I am not certain about that thesis at all. It depends what one is actually saying. It is obviously true that the industrial downturn is experienced much more strongly in China than in the United States. You would expect that, because the US has exported a good deal of its industry to China - it has to a degree externalised its working class.
The effect of the downturn on countries that are not industrialising through American capital is not the same. In third world countries the effect can be far worse, but that is to a considerable degree because the standard of living is very low in the first place. Their exports are hit and their rate of exchange declines - that will be the case in South Africa, for example.
But whether this is the same as exporting the downturn is another question. After all in the US and Britain we are talking about rising levels of unemployment and a downturn of considerable severity. If it is suggested that they can somehow continue to expand and not experience a downturn compared to third world countries, that is untrue.
In the case of Britain, because of the dominance of finance capital, which reached 40% of GDP, clearly the industrial downturn, while real, is of less importance. But in Germany the downturn in industry has been very substantial. It simply cannot export its goods. Volkswagen, the biggest car producer in Europe, is about to report a loss. The automobile industry is crucial and if a major car manufacturer goes down, then the economy is in very big trouble.
Do you think the G20 will be able to come up with a united response to the crisis?
Well, the finance ministers have just met and it is reported that they could not decide on anything. That is really a commentary on where they are - they are unable to come to any agreement.
There are three aspects worth looking at in relation to the G20. The United States and United Kingdom want the world economy to expand by around 2% of GDP in monetary terms. In other words, they want to pump in that additional amount of money. But the Europeans, led by the Germans and French, are resisting this.
It is a split within the capitalist class between, if you like, the Anglo-Saxons and the continentals. America and Britain are very much finance capital powers - one finance capital power really. But the French and Germans are not in that position and are not prepared to go along with it. They do not wish to be controlled by finance capital. In a sense it is an expression of their independence.
The second aspect goes back to what we were talking about earlier. France and Germany do have a powerful working class and they are afraid if the economy expands too fast workers will start to act.
But, on the other hand, they are seeing the destruction of their industries.
Yes, that is true. But it is not that they are taking no measures - the Germans have pumped in $500 billion. It is just that they do not want to go so far, even though 2% is not that much in fact.
No doubt they will draw up a statement about agreeing to expand, but the details are likely to be fudged. They will have to have some agreement, because there would be no point in Britain and America expanding while the rest of the world does not. However, it is an expression of the comparative decline of the United States that they can no longer force everything through.
The third question relates to the IMF. It seems certain that increased funding will be agreed, but some countries will be pushing for an increased say in the IMF, which is effectively controlled by the United States. The question is how far it can be reformed.
But the main reason they will agree to extra funding is because eastern Europe is going down the plughole very fast. The IMF has already bailed out Hungary, Latvia and Ukraine. But these bailouts are insufficient and the funds held by the IMF are trivial compared to what is required.The intention is to increase it to $750 trillion, which does not look that great in terms of the US, but for smaller countries like those in eastern Europe it is significant. And they will have to be bailed out for political reasons.
Of course, the countries of eastern Europe were formerly Stalinist and they have not all made it yet to classic capitalism. Consequently under current circumstances their economies are very susceptible and living standards will go down very rapidly. Russia itself is in a precarious position, in that it is much further away from classic capitalism than the rest of eastern Europe. There is a tendency to revert to increased state control. If oil prices remain low, which looks likely, the balance of payments will continue to decline. In any case debts on a private basis are over $200 billion - Russia originally had $400 billion in reserves. It will almost certainly be in deep trouble before too long. Russia’s economy is highly dependent on the export of raw materials and its industry has been targeted for asset-stripping. The result is that it is moving towards a really critical situation.
This is what is starting to happen and there is a big danger for the capitalist class that large sections of the population will turn against the market - if not today, then tomorrow
The Financial Sector: "A House Burning Down" Ben Bernanke’s False Analogy by Prof. Michael Hudson
Global Research, March 16, 2009
On the March 15 CBS show "60 Minutes", Federal Reserve Chairman Ben Bernanke used a false analogy already popularized by President Obama in his quasi-State of the Union Speech. He likened the financial sector to a house burning down – fair enough, as it is destroying property values, leading to foreclosures, abandonments, stripping (for copper wire and anything else recoverable) and certainly a devastation of value.
The problem with this analogy was just where this building was situated, and its relationship to "other houses" (e.g., the rest of the economy). Mr. Bernanke asked what people should do if an irresponsible smoker let his bed catch fire so that the house burned down. Should the neighbor say, "it’s his fault, let the house burn"? That would threaten the whole neighborhood with fire, Mr. Bernanke explained. The implication, he spelled out, was that economic recovery required a strong banking and financial system. And this is just what he said: The economy cannot recover without yet more credit and debt. And that in turn requires trillions and trillions of dollars given by "the neighbors" to the bad irresponsible man who burned down his own house. This is where the analogy goes seriously off track.
But watching "60 Minutes," my wife said to me, "That’s just what Mr. Obama said the other night. What do they do – have a meeting and agree on what metaphor to popularize?" They seem to have an image that will lock Americans into supporting a policy even though they don’t like it and many feel like letting the financial house (A.I.G., Citibank, and Bank of America/Countrywide ) burn down.
What’s false about this analogy? For starters, banking houses are not in the same neighborhood where most people live. They’re the castle on the hill, lording it over the town below. They can burn down and leave the hilltop revert "back to nature" rather than having the whole down gaze up at a temple of money that keeps them in debt.
More to the point is the false analogy with U.S. policy. In effect, the Treasury and Fed are not "putting out a fire." They’re taking over houses that have not burned down, throwing out their homeowners and occupants, and turning the property over to the culprits who "burned down their own house." The government is not playing the role of fireman. "Putting out the fire" would be writing off the debts of the economy – the debts that are "burning it down."
To Mr. Bernanke the "solution" to the debt problem is to get the banks lending again. He’s spreading the debt-fire. The government is to lend the "threatened neighbors" enough money so that credit customers of the financial "house on the hill" can to pay it the stipulated interest charges they owe. It is not burning down at all; the neighborhood’ s money (in this case, tax money) is being burned up.
Mr. Bernanke explained to the Sunday evening audience that his policy aimed at helping the economy return to "normalcy." Fully in line with what Mr. Paulson was saying last summer, "normalcy" is defined as a new exponential growth in the volume of debt. He talked about "sustainable" recovery. But "the magic of compound interest" is not sustainable. It’s all a false metaphor.
Mr. Bernanke then left the realm of metaphor altogether to give an outright false explanation of the balance of payments and the upcoming Gang of 20 meetings in Europe. On Friday, China’s premier expressed worry over the health of the American economy, in which China had recycled nearly $2 trillion of its dollar inflows in order to prevent the yuan from rising in price against the dollar. The fear is that despite this heavy recycling of dollars by foreign central banks, the U.S. exchange rate will still weaken as the trade balance continues unabated and, just as seriously, U.S. military spending keeps on pumping dollars into the world economy as war spreads eastward from Iraq to Afghanistan and Pakistan.
The way Federal Reserve Chairman Bernanke explained the problem on CBS, America had to keep its markets attractive to "Chinese savers." The image being conjured up again and again is that there is a world "savings surplus." That is supposed to be what flooded the large U.S. banks and Wall Street with so much money that they were obliged to move it into riskier and riskier investments. "They made us do it" was the message not quite spelled out.
One would think that Mr. Bernanke knows nothing at all about the balance of payments or how the global monetary system works. Here’s what really has been happening. The U.S. economy itself pumps "savings" into foreign central banks by spending abroad on military bases. (60 Minutes showed robot fork-lift machines moving around $40-million loads of U.S. currency through the New York Federal Reserve Bank the way that similar machines have been doing in Iraq to buy off local supporters and political groups.) U.S. consumers likewise buy more than the country is exporting. When these surplus dollars are turned over to foreign banks for domestic currency, the banks turn them over to the central bank – which has a problem.
Remember when an earlier U.S. Secretary, John Connolly, said "It’s our deficit, but their problem"? He meant that the U.S. was spending funds (at that time mainly in Southeast Asia) that ended up in foreign central banks, which faced a dilemma: If they let "the market" handle these dollars, their own currency would rise. That would threaten to price their exports out of world markets, and hence would cause domestic unemployment. So foreign governments chose to recycle their dollar inflows by keeping them in dollars – mainly in U.S. Treasury bills and then, when the supply began to run out, in federal agency securities such as Fannie Mae and Freddie Mac.
So the "fire" in the international sphere was the U.S. military-spending deficit and trade deficit. This doesn’t have much to do with Chinese consumers saving too much. Central banks were doing the quasi-saving, by being stuck with surplus U.S. dollars like a hot potato. But one rarely hears public officials mention the nation’s military deficit. It is as if foreign saving comes first, then a "market-based" decision to place these in the U.S. economy, "the engine of world growth." What actually comes first is the U.S. balance-of-payments deficit, pumping surplus dollars into the economy – which foreign central banks find themselves obliged to recycle within the dollar sphere. (This is the phenomenon I discuss in Super Imperialism: The Economic Strategy of American Empire, and Global Fracture.)
As for the surplus credit that Wall Street lent out, it is created out of thin air. At least Mr. Bernanke was clear about this, when he explained that the Fed "creates deposits" for its member banks just as these banks "create deposits" for their own customers at a stroke of the computer keyboard.
The bottom line is that the American public is being fed a carefully crafted mythology (no doubt "market tested" on "response groups" to see which images fly best) to mislead the American public into misunderstanding the nature of today’s financial problem – to mislead it in such a way that today’s policies will make sense and gain voter support.
But this mythology is based on false analogies, not economic reality. It is designed to make Wall Street appear as a savior, not an arsonist – and to depict the Fed and Treasury as protecting the welfare of American citizens by shoveling billions of dollars at the banks whose gambles have caused the crisis.
While Mr. Bernanke’s "60 Minutes" interview was being broadcast, the government was releasing the counterparties on the winning side of the Wall Street casino in bets that A.I.G. lost. To deflect the widespread voter disapproval of giving $160 billion to A.I.G., the Treasury finally released the names of the "counterparties" who ended up with the funds A.I.G. paid out to winning betters. Confirming rumors that had been circulating for the past few months, Mr. Paulson’s own company, Goldman Sachs, headed the list at $13 billion! Followed by Merrill Lynch ($7 billion), Bank of America ($5 billion), Citigroup ($2,3 billion and the much-loathed junk-mortgage lender Wachovia ($1.5 billion). So as Treasury Secretary, Mr. Paulson turns out to have represented not the U.S. interest but that of his own firm and its Wall Street neighbors.
These neighbors were given U.S. Treasury bonds in "cash for trash" transactions. The rest of the economy will be paying interest on this debt for a century to come. This is what causes "debt deflation." Revenue is diverted from spending on goods and services to pay interest and taxes. So the Treasury is spreading the fire, not putting it out.
The Bank of International Settlements, which seems to be the only institution that tracks the derivatives market, has recently reported that global outstanding derivatives have reached 1.14 quadrillion dollars: $548 Trillion in listed credit derivatives plus $596 trillion in notional/OTC derivatives.
Yes, that is Quadrillion. One and 12 zeroes!
Since then, derivative trades have grown exponentially, until now they are larger than the entire global economy. The Bank for International Settlements recently reported that total derivatives trades exceeded one quadrillion dollars – that’s 1,000 trillion dollars. How is that figure even possible? The gross domestic product of all the countries in the world is only about 60 trillion dollars. The answer is that gamblers can bet as much as they want. They can bet money they don’t have, and that is where the huge increase in risk comes in.
There seem to me to be two occasions, which require two plans for the world left, and in particular for the US left. The first occasion is in the short run. The world is in a deep depression, which will only get worse for at least the next one or two years. The immediate short run is what concerns most people who are facing joblessness, seriously lowered income and in many cases homelessness. If left movements have no plan for this short run, they cannot connect in any meaningful way with most people.
The second occasion is the structural crisis of capitalism as a world system, which is facing, in my opinion, its certain demise in the next twenty to forty years. This is the middle run. And if the left has no plan for this middle run, what replaces capitalism as a world system will be something worse, probably far worse, than the terrible system in which we have been living for the past five centuries.
The two occasions require different, but combined, tactics. What is our short-run situation? The United States has elected a centrist president, whose inclinations are somewhat left of center. The left, or most of it, voted for him for two reasons. The alternative was worse, indeed far worse. So we voted for the lesser evil. The second reason is that we thought Obama's election would open up space for left social movements.
The problem the left faces is nothing new. Such situations are standard fare. Roosevelt in 1933, Attlee in 1945, Mitterrand in 1981, Mandela in 1994, Lula in 2002 were all the Obamas of their place and time. And the list could be infinitely expanded. What does the left do when these figures "disappoint," as they all must do, since they are all centrists, even if left of center?
In my view, the only sensible attitude is that taken by the large, powerful and militant Landless Workers' Movement (MST) in Brazil. The MST supported Lula in 2002, and despite all he failed to do that he had promised, they supported his re-election in 2006. They did it in full cognizance of the limitations of his government, because the alternative was clearly worse. What they also did, however, was to maintain constant pressure on the government--meeting with it, denouncing it publicly when it deserved it and organizing on the ground against its failures.
The MST would be a good model for the US left, if we had anything comparable in terms of a strong social movement. We don't, but that shouldn't stop us from trying to patch one together as best we can and do as the MST does--press Obama openly, publicly and hard--all the time, and of course cheering him on when he does the right thing. What we want from Obama is not social transformation. He neither wishes to, nor is able to, offer us that. We want from him measures that will minimize the pain and suffering of most people right now. That he can do, and that is where pressure on him may make a difference.
The middle run is quite different. And here Obama is irrelevant, as are all the other left-of-center governments. What is going on is the disintegration of capitalism as a world system, not because it can't guarantee welfare for the vast majority (it never could do that) but because it can no longer ensure that capitalists will have the endless accumulation of capital that is their raison d'être. We have arrived at a moment in which neither farsighted capitalists nor their opponents (us) are trying to preserve the system. We are both trying to establish a new system, but of course we have very different, indeed radically opposed, ideas about the nature of such a system.
Because the system has moved very far from equilibrium, it has become chaotic. We are seeing wild fluctuations in all the usual economic indicators--the prices of commodities, the relative value of currencies, the real levels of taxation, the quantity of items produced and traded. Since no one really knows, practically from day to day, where these indicators will shift, no one can sensibly plan anything.
In such a situation, no one is sure what measures will be best, whatever their politics. This practical intellectual confusion lends itself to frantic demagoguery of all kinds. The system is bifurcating, which means that in twenty to forty years there will be some new system, which will create order out of chaos. But we don't know what that system will be.
What can we do? First of all, we must be clear what the battle is about. It is the battle between the spirit of Davos (for a new system that is not capitalism but is nonetheless hierarchical, exploitative and polarizing) and the spirit of Porto Alegre (a new system that is relatively democratic and relatively egalitarian). No lesser evil here. It's one or the other.
What must the left do? Promote intellectual clarity about the fundamental choice. Then organize at a thousand levels and in a thousand ways to push things in the right direction. The primary thing to do is to encourage the decommodification of as much as we can decommodify. The second is to experiment with all kinds of new structures that make better sense in terms of global justice and ecological sanity. And the third thing we must do is to encourage sober optimism. Victory is far from certain. But it is possible.
So, to resume: work in the short run to minimize pain, and in the middle run to ensure that the new system that will emerge will be a better one and not a worse one. But do the latter without triumphalism, and knowing that the struggle will be tremendously difficult.
Mike Whitney: The financial crisis is quickly turning into a political crisis. Already governments in Iceland and Latvia have collapsed and the global slump is just beginning to accelerate. Riots and street violence have broken out in Greece, Latvia and Lithuania and worker-led protests have become commonplace throughout the EU. As unemployment skyrockets and economic activity stalls, countries are likely to experience greater social instability. How does one take deep-seated discontent and rage and shape it into a political movement for structural change?
John Bellamy Foster: The first thing to recognize is that we are suddenly in a different historical period. One of my favorite quotes comes from Gillo Pontecorvo’s 1969 film Burn! where the main character, William Walker (played by Marlon Brando), states: “Very often between one historical period and another, ten years suddenly might be enough to reveal the contradictions of an entire century.” We are living in such a period, not only because of the Great Financial Crisis and what the IMF is now calling a depression in the advanced capitalist economies, but also because of the global ecological crisis that during the last decade has accelerated out of control under business as usual, and due to the reappearance of “naked imperialism.” What made sense ten years ago is nonsense now. New dangers and new possibilities are opening up. A whole different kind of struggle is emerging.
The sudden fall of the governments in Iceland and Latvia as a result of protests against financial theft is remarkable, as are the widespread revolts in Greece and throughout the EU, with millions in the streets. The general strikes in Guadeloupe and Martinique, the French Antilles, and the support given to these movements by the French New Anti-Capitalist Party is a breakthrough. In fact much of the world is in ferment. Latin Americans are engaged in a full-scale revolt against neoliberalism, led by Venezuela’s Bolivarian Revolution, and the aspiration of a new socialism for the 21st century (as envisioned also in Bolivia, Ecuador and Cuba). The Nepalese revolution has offered new hope in Asia. Social struggles on a major scale are occurring in emerging economies such as Brazil, Mexico, and India. China itself is experiencing unrest.
The one place in the world where this world historical ferment appears to not be having telling effect at present is the United States. This can be traced to two reasons. First, the United States as the center of a world empire is a fortress of conservatism. Second, the election of the Obama administration has confused progressive forces, leading to absurd notions that the Democrats under Obama are going to create a New New Deal without renewed pressure arising from a revolt from below. Meanwhile, under Obama’s watch, and with the help of his chosen advisers, vast amounts of state funds are being infused into the financial system to benefit private capital.What is needed in the United States today, we argue in The Great Financial Crisis, is a renewal of the classic concept of political economy (with its class perspective), whereby it comes to be understood that the economy is subject to public control, and should be wrested from the domination of the ruling class. The bailing out of the system right now is going on with taxpayer funds but without the say of the public. A revolt to gain popular control of the political economy is therefore necessary.
It is possible to start with the demand for a New New Deal rooted in the best legacy of the Roosevelt administration in the 1930s, most notably the Works Progress Administration. But as Robert McChesney and I argued in “A New New Deal Under Obama” in the February 2009 issue of Monthly Review, the struggle has to move quickly beyond that to an expansion of workers’ rights along socialist principles, breaking with the logic of capital. For this to occur there has to be a great revolt from below on at least the scale of the industrial unionization movement of the 1930s that created a new political force in the country (later destroyed in the McCarthy Era). The story of this struggle is told in David Milton’s classic account, The Politics of U.S. Labor, which also points out that the rising labor movement was led by socialists and radical syndicalists.
It is important, as Istvan Meszaros explained in his Beyond Capital, that the radical politics opened up in this historical moment not be diverted into attempting to save the existing system, but be directed at transcending it. As Meszaros wrote: “To succeed in its original aim, radical politics must transfer at the height of the crisis its aspirations — in the form of effective powers of decision making at all levels and all areas, including the economy — to the social body itself from which subsequent material and political demands would emanate.”
In the United States a primary goal of any radical politics should be to cut military spending, which is the imperial iron heel holding down the entire world, while corrupting the US body politic and diverting surplus from pressing social needs.
The obvious weak link of the whole political, ideological and economic structure in command in the United States today, is that the system has clearly failed to meet peoples’ real needs. Rather than addressing these pressing needs in the crisis, the emphasis of the economic overlords is to bailout private capital at virtually any cost. Between October 2008 and January 2009 the federal government provided about $160 billion in capital and infusions and debt guarantees to the Bank of America, which had a total net worth in late January of only a small fraction of that amount. The rest had gone down the rat hole.
The robbing of public funds to bailout private capital is now on a scale probably never before seen. A politicized, organized working class capable of understanding and reacting to that theft, and choosing thereby to restructure society, to meet real social, egalitarian needs is what is now to be hoped for. The title of a recent cover story Newsweek declared: “We Are All Socialists Now.” As it turned out, Newsweek’s editors were simply referring to the increase in public spending now taking place — hardly an indication of socialism. But the fact that this is said at all in the mainstream media points to the fact that we are in a different historical moment in which radical forces have the possibility of moving forward.
MW: As the economy has become more dependent on financialization for growth, the gap between rich and poor has grown wider and wider. As you point out in your book, “In the United States the top 1 percent of wealth holders in 2001 owned more than twice as much as the bottom 80 percent of the population. If this was simply measured in terms of financial wealth, the top 1 percent owned more than four times the bottom 80 percent.” (p 130). How have working class people managed to keep their heads above water with all this wealth being shifted to the rich?
JBF: The answer is fairly obvious. If people cannot maintain their standard of living on the basis of their income, they will borrow against income and against whatever wealth they have. The result — if their incomes don’t rise, or if the value of whatever assets they have do not increase — is that they will simply get deeper and deeper in debt in an attempt simply to stand still. I became concerned about the growth of working-class household debt in 2000 and carried out a study of The Survey of Consumer Finances, which is published every three years by the federal government with a three year lag in the data. This is the only major federal government data source that we have on household debt broken down into income groups so that we can determine the debt burden of different classes. I published an article based on this research in the May 2000 issue of Monthly Review entitled “Working-Class Households and the Burden of Debt.” I then followed this up six years later with an article in the May 2006 Monthly Review on “The Household Debt Bubble,” which was to be incorporated into The Great Financial Crisis. There I wrote that “The housing bubble and the strength of consumption in the economy are connected to what might be termed the ‘household debt bubble,’ which could easily burst as a result of rising interest rates and the stagnation or decline of housing prices.” This is of course what happened, and the reason why this crisis has turned out to be so severe was the destruction over decades of the finances of working-class households, on the back of which financialization took place.
MW: Will you define “debt-deflation” and explain its potential danger to the economy? As credit continues to tighten and housing prices sink; aren’t we slipping into a reinforcing deflationary spiral? Do you think that fiscal policy will reverse this trend or is the stimulus package too small to stop real estate and equities from continuing to slide?
JBF: The term “debt-deflation” is associated particularly with the work of Irving Fisher during the Great Depression. Fisher wrote an article for the journal Econometrica in 1933 entitled “The Debt-Deflation Theory of Great Depressions.” Deflation as applied to the general economy is a drop in the general price level, something not seen in the United States since the Great Depression, and catastrophic in the economy of monopoly capital (and even more so under monopoly-finance capital). In the first place, deflation (or disinflation, i.e. the reduction of inflation to what the Federal Reserve calls “below optimal” levels) means that the profit margins of corporations are squeezed, even if the cost structure of production, and productivity remain the same. Under these circumstances price competition is reactivated with giant firms actually in a life and death struggle. This also generates pressure for heavy layoffs and wage reductions, creating all sorts of vicious cycles.
But the real fear of deflation has to do with the enormously bloated financial structure and the huge debt load of the economy. Under inflation, which is usually assumed to be built into the advanced capitalist economy, debts are paid back with smaller dollars (that is, worth less over time). In a deflationary economy, however, debt has to be paid back with bigger dollars (worth more over time). This then creates a debt-deflation spiral, enormously accelerating financial meltdown. As Fisher put it, “deflation caused by the debt reacts on the debt. Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debt cannot keep up with the fall of prices which it causes.” Stated differently, quoting from The Great Financial Crisis (p. 116), “prices fall as debtors sell assets to pay their debts, and as prices fall the remaining debts must be repaid in dollars more valuable than the ones borrowed, causing more defaults, leading to yet lower prices, and thus a deflationary spiral.” In order to check this deflationary tendency, the Federal Reserve and the Treasury have been trying to reflate the economy by printing money (euphemistically called “quantitative easing”). But they have not succeeded and deflationary forces are still very strong, causing President Obama to warn shortly after his election that “we now risk falling into a deflationary spiral that could increase our massive debt even further.”
It is also worth mentioning the effect that deflation has on investment. With capital faced with the fact that a few years down the line the price level could be lower than it is now, expected profits on investment in new productive capacity (given that this takes years to be built and has to paid for in current prices) are depressed, creating a deeper stagnation of accumulation.
The stimulus package introduced by the Obama administration is far too small to pump up demand and reflate the economy under these circumstances. It is less than $400 billion a year, forty percent of which is tax cuts, so that the increased governmental spending is minuscule compared to the size of the hole created by the drastic drop in consumption, investment, and state and local government spending. It is also dwarfed by the total federal government support programs, primarily to financial institutions, which now amount to more than $9.7 trillion in the form of cash infusions, debt guarantees, swaps of Treasuries for financial toxic waste, etc.
MW: Karl Marx seems to have anticipated the financial meltdown we are now facing. In Capital,he said, “The superficiality of political economy shows itself in the fact that it views the expansion and contraction of credit as the cause of the periodic alterations of the industrial cycle, while it is a mere symptom of them.” Marx appears to agree with your theory that the real problem is deeper — economic stagnation which forces surplus capital to look for more profitable investments. While the monetarist theories of Milton Friedman are now under withering attack, Keynes and Marx seem to have held up rather well. What does Marx mean when he talks about “political economy”?
JBF: Marx was an acute analyst of financial crises in his time and described their main features. However, he saw financial expansions as occurring at the peak of a boom, not as a secular phenomenon. Financialization in the sense of a long-term shift in the center of gravity of the economy toward finance, with financial speculation building over decades, is a completely unprecedented situation.
Marx and Engels did place great emphasis on the growth of joint-stock companies/corporations and the appearance of a market for industrial securities that began to appear near the end of the nineteenth century. It was this creation of the modern market for industrial securities that was the real beginning of the emergence of finance as a relatively independent aspect of the monopoly capitalist economy. There are essentially two pricing structures to the economy: one in the real economy related to the production of goods and services, the other in the financial realm associated with the pricing of assets (paper claims to wealth). The two are interrelated but can be disassociated from each other for periods of time. Keynes in the 1930s singled-out the dangers of an economy that was increasingly governed by the speculative pricing of financial assets. Marx was such an acute observer of capitalism, that even in his time he began to see the contradictions emerging between money (or fictitious) capital and real capital.
One thing that Marx did argue in this context is that surges in financial speculation were responses to stagnation and decline in the real economy, as capital desperately sought a way to maintain and expand its surplus. Thus he wrote that the “plethora of money capital” in such periods was due to “difficulties in employment, through a lack of spheres of investment, i.e., due to a surplus in the branches of production” and showed nothing so much as the immanent barriers to capitalist expansion (quoted in The Great Financial Crisis, p. 39).
Marx remains the strongest foundation for the critique of the capitalist economy, down to our day. But the real Keynes (not to be confused with the bastardized Keynesianism of today) is also important, since he emphasized what he called the “outstanding faults” of the capitalist economy: the tendency to high inequality and high unemployment. He also pointed to the dangers of a system geared to speculative finance.
MW: Is wage stagnation and income inequality a direct result of financialization?
JBF: I would put it the other way around. Wage stagnation and growing income and wealth inequality are components of the underlying stagnation tendency. Both have shown a tendency to worsen over time, resulting in deepening stagnation tendencies within the overall economy. Real wages in the United States peaked in 1971, when Richard Nixon was president, and by 2008 had fallen back to 1967 levels, when Lyndon Johnson was president. This is in despite of the enormous growth of productivity and expansion of wealth over the intervening decades. Hence, this is a marker of “the tendency of surplus to rise,” as Baran and Sweezy put it, or a rising rate of surplus value, in Marx’s own terms. This was accompanied by a massive growth of income and wealth at the top. As we stated in The Great Financial Crisis (p. 130), “From 1990 to 2002, for each added dollar made by those in the bottom 90 percent [of income] those in the uppermost 0.01 percent (today about 14,000 households) made an additional $18,000.” By 2007 income/wealth inequality in the United States had reached 1929 proportions, i.e., the level reached just prior to the 1929 Stock Market Crash that led to the Great Depression.
I do think you are right, though, that financialization made income and wealth inequality worse, and contributed to the stagnation of wages. We can see neoliberalism as basically the ideology of monopoly-finance capital, introduced originally as the ruling class response to stagnation, and then increasingly geared to promoting the financialization of capital, itself a structural response to stagnation.
Neoliberalism promoted incessant breaking of unions, forcing down wages, cutting state social welfare spending, deregulation, free mobility of capital, development of new financial architecture, etc. One way to understand this is the enormous need for new cash infusions to feed a financial superstructure that was voracious in its demand for new money capital, which it needed to leverage still more piling up of debt and financial speculation. Insurance companies, real estate, and mutual funds all provided infusions into this financial superstructure, as did the state. All limits were removed. Under these circumstances workers were encouraged to use their houses like piggy banks to finance consumption, credit cards were handed out to teenagers, subprime loans were pushed on those with little ability to pay. Individual retirement packages were shifted toward IRAs that were tied into the speculative financial system. This had all the signs of an addictive system. In these circumstances, too, the real economy, particularly production of goods and manufacturing, was decimated. In the introduction to The Great Financial Crisis we include a chart covering the period since 1960 showing production of goods as a percentage of GDP in a slow, long-term decline, while debt as a percentage of GDP is skyrocketing over the same period. All of this meant a massive redistribution away from working people to capital, and to those at the pinnacle of the financial pyramid.
MW: In your book The Great Financial Crisis, you are critical of Paulson’s capital injections into the banks saying that “at most they buy the necessary time in which the vast mass of questionable loans can be liquidated in an orderly fashion, restoring solvency but at a far lower rate of economic activity ? that of a serious recession or depression.” On Friday, Timothy Geithner told CNBC that “We will preserve the system that is owned and managed by the private sector.” This suggests that the Treasury Secretary might not liquidate the toxic assets at all, but try maintain the appearance that these underwater banks are solvent. What do you think will happen if Geithner refuses to nationalize the banks?
JBF: I would not interpret Geithner’s statement that way. Rather we are experiencing one of the greatest robberies in history. I have written on the question of nationalization for the “Notes from the Editors” forthcoming in the March 2009 Monthly Review. All the attempts to rescue the financial system at this time go in the direction of nationalization. The federal government is providing more and more of the capital and assuming financial responsibility for the banks. However, they are doing everything they can to keep the banks in private hands, resulting in a kind of de facto nationalization with de jure private control. Whether the federal government is forced eventually toward full nationalization (that is, assuming direct control of the banks) is a big question. But even that is unlikely to change the nature of what is going on, which is a classic case of the socialization of losses of financial institutions while leaving untouched the massive gains still in the hands of those who most profited from the whole extreme period of financial speculation.
To get an idea of what is happening one has to understand that the federal government, as I have already indicated, has committed itself thus far in this crisis $9.7 trillion in support programs primarily for financial institutions. The Federal Reserve (together with the Treasury) now has converted itself into what is called a “bad bank.” It has been swapping Treasury certificates for toxic financial waste, such as collateralized debt obligations. As a result the Federal Reserve has become the banker of last resort for toxic waste with the share of Treasuries in the Fed’s balance sheet dropping from about 90 percent to about 20 percent over the course of the crisis, with much of the rest now made up of financial toxic waste.
Obviously, full, straightforward nationalization would be more rational than this. But one has also to remember the system of power — both economic and political — that we are dealing with at present. The classic case of full bank nationalization was Italian corporatist capitalism of the 1920s and ’30s, and was carried out by the fascist regime. Without suggesting that we are headed this way now it should be clear from this that nationalization of banks itself is no panacea.
The fact that Geithner, Obama’s pick for Treasury Secretary, is overseeing the enormous robbery taking place, probably exceeding any theft in history, with the ordinary taxpayers picking up the tab, should certainly cause one to ask questions about the “progressive” nature of the new administration.
MW: Former Fed chief Alan Greenspan has dismissed criticism of his monetary policies saying that no one could have seen the humongous credit bubble developing in housing. In your book, however, you make this observation: “It was the reality of economic stagnation beginning in the 1970s . . . that led to the emergence of the ?new financialized capitalist regime’s kind of ‘paradoxical financial Keynesianism’ whereby demand in the economy was stimulated primarily ‘thanks to asset bubbles’.” (p 129) The statement suggests that the Fed knew exactly what it was doing when it slashed rates and created a speculative frenzy. Debt-fueled asset bubbles are a way of shifting wealth from one class to another while avoiding the stagnation of the underlying economy. Can this problem be fixed through regulation and better oversight or is it something that is intrinsic to capitalism itself?
JBF: Greenspan is of course trying desperately to salvage his reputation and to remove any sense that he is culpable. I would agree that the Fed knew what it was doing up to a point, and deliberately promoted an asset bubble in housing — what Stephanie Pomboy called “The Great Bubble Transfer” following the bursting of the New Economy tech bubble in 2000. The view that no one saw the dangers of course is false. It reminds me of Paul Krugman’s face-saving claim in his The Return of Depression Economics and the Crisis of 2008 that while some people thought that financial and economic problems of the 1930s might repeat themselves, these were not “sensible people.” According to Krugman, “sensible people” like himself (that is, those who expressed the consensus of those in power) knew that these things could never happen — but turned out to be wrong. It is true, as Greenspan says, no one could have foreseen precisely what really happened. And certainly there were a lot of blinders at the top. But there were lots of warnings and concerns. For example, I drafted an article (”The Great Fear”) for the April 2005 issue of Monthly Review that referred to “rising interest rates (threatening a bursting of the housing bubble supporting U.S. consumption)” as one of the key “perils of a stagnating economy.” Other close observers of the economy were saying the same thing.
The Federal Reserve Board, indeed, was internally debating in these years whether to adopt a policy of pricking the asset bubbles before they got further out of control. But Greenspan and Bernanke were both against such a dangerous operation, claiming that this could bring the whole rickety financial structure down. Since they didn’t know what to do about asset bubbles they simply sat on their hands and tried to talk the market up. The dominant view was that the Federal Reserve could stop a financial avalanche by putting a rock in the right place the moment there was a sign of trouble. So Bernanke went ahead, closed his eyes and prayed, raising interest rates to restrict inflation (an action demanded by the financial elite) and the rest is history.
At all times it was those at the commanding heights of the financial institutions that called the shots, and the Fed followed their wishes. Greenspan himself is no dummy. He wrote in Challenge Magazine in March-April 1988 of the dangers associated with housing bubbles. But as a Federal Reserve Board chairman he pursued financialization to the hilt, since there was no other option for the system. Needless to say, such financialization was associated with the growing disparities in wealth and income in the country. Debt itself is an instrument of power and those at the bottom were chained by it, while those at the top were using it to leverage rising fortunes. The total net worth of the Forbes 400 richest Americans (an increasing percentage of whom were based in finance) rose from $91.8 billion in 1982 to $1.2 trillion in 2006, while most people in the society were finding it harder and harder to make ends meet. None of this was an accident. It was all intrinsic to monopoly-finance capital
A silent $1 trillion "Run on Britain" by foreign investors was revealed yesterday in the latest statistical releases from the Bank of England.
The external liabilities of banks operating in the UK – that is monies held in the UK on behalf of foreign investors – fell by $1 trillion (£700bn) between the spring and the end of 2008, representing a huge loss of funds and of confidence in the City of London.
Some $597.5bn was lost to the banks in the last quarter of last year alone, after a modest positive inflow in the summer, but a massive $682.5bn haemorrhaged in the second quarter of 2008 – a record. About 15 per cent of the monies held by foreigners in the UK were withdrawn over the period, leaving about $6 trillion. This is by far the largest withdrawal of foreign funds from the UK in recent decades – about 10 times what might flow out during a "normal" quarter.
The revelation will fuel fears that the UK's reputation as a safe place to hold funds is being fatally comp-romised by the acute crisis in the banking system and a general trend to financial protectionism internat- ionally. This week, Lloyds became the latest bank to approach the Government for more assistance. A deal was agreed last night for the Government to insure about £260bn of assets in return for a stake of up to 75 per cent in the bank. The slide in sterling – it has shed a quarter of its value since mid-2007 – has been both cause and effect of the run on London, seemingly becoming a self-fulfilling phenomenon. The danger is that the heavy depreciation of the pound could become a rout if confidence completely evaporates.
Colin Ellis, an economist at Daiwa Securities, commented: "The outflow of overseas banks' UK holdings is not surprising – indeed foreign investors in general will still be smarting from the sharp fall in the exchange rate last year, as many UK liabilities are priced in sterling terms. That raises the question of what could possibly tempt overseas investors to return to the UK. Further heavy outflows of funds are probably a given."
The Bank of England said that there had been a large fall in deposits from the United States, Switzerland, offshore centres such as Jersey and the Cayman Islands, and from Russia.
Paranoia that the UK could follow Iceland into effective national insolvency and jibes about "Reykjavik on Thames" will find an unwelcome substantiation in these statistics – which also show that stricken British banks are having to repatriate similar sums back to Britain. This is scant consolation for the authorities, however, as it means the UK and sterling are, like some emerging markets and currencies, suffering from a flight of capital. By contrast some financial centres and currencies – notably the US dollar and the Swiss franc – are enjoying a boost as "safe havens" in a troubled world.
The sudden international trend towards financial deglobalisation and the flight of money to "home" bases has nonetheless been dramatic. The Prime Minister has already warned about this drift to "financial protectionism" – even though UK banks brought back almost $600bn in the last months of 2008, as they attempted to repair fragile balance sheets. Mr Ellis added: "These data are consistent with UK banks reducing their overseas holdings, at the same time as overseas banks scale back their presence in the UK. That is not surprising, given that governments around the world are having to prop up their banking sectors, and in turn demanding that national institutions focus on domestic markets. But it does run the risk of being financial protectionism by the back door."
Investment from the West into developing countries has fallen from the level of about $1 trillion a year seen earlier this decade to about $150bn last year. Economies in eastern Europe such as Hungary and the Baltic republics, some in Asia such as Pakistan and developed nations such as Iceland have been severely hit by the collapse in foreign investment.
Like Iceland, the UK has an unusually large banking sector in relation to her national income, with liabilities four times GDP. Should the UK taxpayer have to assume these debts it will represent, in relation to GDP, about double the national debt the nation bore at the end of the Second World War, a near unsustainable burden.
Interview on Icelandic State TV Silfur Egils, Sunday February 1, 2009.
Host : Egill Helgason Guest : Gunnar Tómasson
Egill: Economist Gunnar Tómasson has come here from Washington. He was employed for a long time by the International Monetary Fund and now works as an independent economist. Welcome Gunnar. It is a pleasure to have you come across the Atlantic to appear on the program.
You have been writing articles in the newspapers and on the internet. One thing which has attracted attention is that you have been critical of world monetary policies for a very long time, and it seems that you are one of those who saw what was coming.
But we should perhaps go over this somewhat systematically. And I begin by asking you about the collapse of the Icelandic banking system. Was it the result of domestic policies or due to external factors?
Gunnar: Well, both domestic and external factors were involved. For several years there had been excessive credit expansion within the banking system which drew an emphatic warning from the International Monetary Fund in May 2006. I remember having written an article in Morgunblaðið at the time endorsing the IMF's words of caution. The timing of the banking system's actual collapse was determined by external circumstances. That is the foreign aspect in this, but the underlying domestic conditions were in place long before things went awry abroad.
Egill: I remember that you have mentioned in your writings both leverage and currency speculation, the lack of supervision and other things in that connection.
Gunnar: The things we are now witnessing in world financial markets have in fact been ongoing and evolving ever since the fall in the early 1970s of the Bretton Woods system, which was established by the victors at the end of World War II to prevent recurrence of monetary problems associated with the Great Depression. The fall of the Bretton Woods system ushered in anarchy in the international monetary system. At the time both Paul Samuelson and Milton Friedman were columnists for Newsweek and both applauded the new world monetary order. I wrote to both of them at the time and expressed a different view. But there is no point taking on founding-fathers of so-called schools where people simply take it on faith that their gurus know what they are talking about. Paul Samuelson is the one who laid the theoretical foundation for this systemic anarchy. Milton Friedman then provided the emperor's new clothes, dressing it in the garb of neoliberalism. That is how these two leading figures in American economic thought were united in unleashing on the world community the system which now has collapsed.
Egill: That is this monetary system in which it seems that credit creation is somehow no longer in sync with the world community's real wealth creation.
Gunnar: Yes, I remember that while visiting Iceland in 1982 I was invited by someone in the know to present ideas to the Icelandic Chamber of Commerce. The key to successful economic management, I suggested, was to maintain some appropriate balance between paper wealth and real wealth, the production generated by the economy. I likened this to a ship’s superstructure, where the ship is production and the superstructure is paper – if the superstructure’s growth is excessive, there comes a point in time and circumstances which cannot be specified in advance at which the superstructure will overturn the ship. That is what is happening now and has been going on since 2007.
In this connection, I noted in an article the other day some remarkable comments by Alan Greenspan, former Chairman of the U.S. Federal Reserve Board. He said that for a period of more than 40 years he had believed himself to have solid grounds for trusting that this anarchy which succeeded the Bretton Woods system was stable – that it could be sustained thanks to automatic market forces which would restore the anarchic system to its equilibrium path in the event that its equilibrium conditions were about to be displaced. This is nonsense, it cannot be called anything else. The idea apes Newtonian ideology which is concerned with the physical universe where human decisions do not enter the picture. To equate the world’s monetary system, a man-made structure, with the laws of physics, an aspect of nature, is such nonsense that future economics students will not be able to comprehend how it could have become a basic premise of modern thought.
Egill: Does this mean that generations of students have been brought up on nonsense ideology? For this is ideology, of course.
Gunnar: Yes, nonsensical ideology. The root of the problem goes back to a point made in mid-nineteenth century by John Stuart Mill, one of the sharpest minds of all time, in an overview article on unresolved methodological aspects of economics. Mill viewed economics as a branch of logic and noted that the least error in the premises of any logical argument would infect with like error the whole superstructure built thereon. A seemingly small error is embedded in the premises of modern monetary economics. Paul Samuelson noted it very briefly in his Ph. D. thesis in 1942 and said it didn’t matter. Today, this small error is destroying the world’s monetary system.
Egill: And what is this logical error?
Gunnar: Joseph A. Schumpeter, who is one of the two greatest economists of the 20th century – the other is John Maynard Keynes – Schumpeter noted in 1935 that the source of interest and profit in the production process was unclear. That issue had never been satisfactorily resolved. Keynes had sought to clarify this in Treatise on Money in 1930. He then moved on to write his major work, General Theory published in 1936, in which he by-passed the issue because his principal concern was to argue for a new approach to getting the world economy out of the Great Depression and the point was not germane in that respect.
Paul Samuelson, the godfather of modern monetary thought, addressed the source of interest in the production process in a 1939 paper entitled ‘The rate of interest under ideal conditions’. He did not succeed in resolving the matter. Then, in his Ph. D. thesis at Harvard three years later, he said that interest and profit were the product of "something" and it didn't matter what we called it. And that is how a tiny logical error slipped into the foundations of modern economic analysis, without which what is happening now would not be happening. And thirty some years ago I realized that this was nonsense.
Egill: You have argued for a very long time that this system, the world monetary system, was fatally flawed.
Gunnar: Yes, absolutely.
But in this business there is something else which one discovers early on, namely, that if you are in a position of responsibility in the world monetary system and management, in the world’s central banks, the International Monetary Fund etc., then you must always go with the stream if you plan on continuing in that position. This has completely destroyed all professionalism in central bank management here in Iceland and elsewhere. You must go with the stream and never go against it.
I had come across this so often that I decided at the end of 1996 to document at the highest levels both in the United States and Britain that there was knowing malfeasance in the field of monetary management. In the first instance I sent a letter to Laurence Meier who was a member of the U.S. Federal Reserve Board. At the time a certain problem had surfaced in Mexico, much like the domestic aspects of Iceland's current problems. I wrote to Mr. Meier that it was fair surmise that as long as the Fed continued to use the macroeconomic models of modern monetary economics to forecast the future, it was fair surmise that it would be setting itself up for what I termed “nasty surprises”.
Egill: Is the system not salvageable?
Gunnar: It is not salvageable.
Egill: And must then a new world monetary system be created?
Gunnar: That’s where the British party, Professor Patrick Minford who was an economic advisor to Margaret Thatcher, comes into the picture. I wrote to him in January 1997 and that’s where you have the answer to your question. The last sentence of my letter to him was as follows: “This [post-Bretton Woods] system is certain to come crashing down." You cannot put it any more clearly. I just wanted to have it documented.
Egill: And there is this enormous production of …
Gunnar: … money and paper wealth. Money and paper wealth out of all proportion to the national economy's output or that of the world economy.
Egill: And now we are facing this problem in the world, having to unwind this devilish mess … and people are completely at a loss what to do.
Gunnar: The system has collapsed and it cannot be rebuilt on the foundations which were put in place with Paul Samuelson’s ideology in 1942. It is very difficult to change something like this. I have collaborated for many years with colleagues in an economics group known as Gang8. Icelanders can look it up on the internet. The group includes economists from Europe and the United States, a total of ten or so. I said to them: “There is no point debating these issues with those whose livelihood depends on them being sound. We must wait until everything goes to hell in a handbasket, if you excuse the language, and then we will give them our telephone number." It is awfully arrogant to put it like this, but that is the situation we face today. There is talk here in Iceland to call on foreign experts to give advice on how to reconstruct the economy or the monetary system. And, wouldn’t you know, they come with these same ideas. In the United States we see how George Bush responded to the unfolding US economic crisis. Barack Obama is taking the same approach. One must realize that this system cannot be salvaged.
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