From Socialist Review, February 2008.
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Every time economic crises develop they are described as aberrations in an otherwise rational and balanced system. Chris Harman looks at the roots and implications of the recent credit crunch, and explains why crises are in fact an intrinsic feature of capitalism
“Investors are no longer worried whether certain banks have enough cash. They are worried about the risk of a US or even a global recession.” So the Financial Times summed up the fear of those who live off capitalist profits on 18 January.
Mainstream economic commentators agree on one thing: the crisis that began in one section of the financial system last summer could be about to create chaos through much of the capitalist system which they support.
Former US secretary of the treasury Lawrence Summers says the US may be already sinking into a recession. Alan Greenspan, former head of the all important US Federal Reserve (the equivalent of the Bank of England), sees the chances of this happening as 50 percent. A United Nations report warns of a “clear and present danger” of the global economy slowing to near standstill this year.
Ben Bernanke, Greenspan’s successor at the Federal Reserve, tries to paint a slightly brighter picture. He expects slower growth this year but no recession. Bernanke is supposedly an expert on crises, having written academic dissertations on the role of money in the great slump of the 1930s. But last summer he failed completely to see that a crisis was about to hit the financial system. Not much faith can be put in his forecasts, or in those of other mainstream pro-capitalist economists. Their blind faith in capitalism as a money making machine for profiteers means that they nearly always believe things are going wonderfully until they suddenly go wrong.
In any case Bernanke was worried enough to cut interest rates, while George Bush is pressing Congress to agree on an emergency programme of tax cuts. They desperately hope that such measures can prevent an economic slowdown turning into a slump.
One thing is absolutely clear. The extreme optimism in the world economy which characterised most mainstream commentary just a year ago turned out to be completely wrong. Typical was April’s International Monetary Fund (IMF) World Outlook, with its forecast that “the world economy still looks well set for continued robust growth in 2007 and 2008”.
Gordon Brown, chancellor Alistair Darling and governor of the Bank of England Mervyn King were so enamoured of the wonders of the free market that they downplayed the seriousness of what was happening even after the crisis had erupted in mid-August. King resisted calls from his friends in the City to cut interest rates, while Brown and Darling believed that they only had to promise support for Northern Rock for its problems to be automatically solved. They had no notion that in the end tens of billions of taxpayers’ money would be involved. Faced with turmoil in the system, they are like people trying to navigate a ship without a map, compass or rudder.
They put their faith in orthodox “neoclassical” economics as taught in school and university as it is supposed to prove the superiority of capitalism to any possible alternative. But it has never been able to explain the system’s propensity for crisis.
The system rests on the unplanned interaction of thousands of multinational corporations and a score or so of major governments. It is like a traffic system without lane markings, road signs, traffic lights, speed restrictions or even a clear code that everyone has to drive on the same side of the road. This will make it very difficult for those who claim to oversee the system to prevent the crash in the financial sector generalising into something much more serious in the next few months. And any success they have will be temporary, at best deferring the moment of reckoning for a couple of years.
To see why, it is necessary to look at where the crisis has come from. The immediate cause, everyone now agrees, lay in the US’s subprime mortgage lending. Keen to make easy profits, financiers began lending money to people who would previously have been regarded as bad credit risks because they were poor, did not have secure jobs, or had not been able to pay off previous debts. House prices were rising and it was assumed that if they could not keep up with their mortgage payments their houses could be repossessed and sold at a handsome profit. Such lending had the effect of encouraging the very rises in the house prices it relied upon.
The financiers who lent the money did not usually do so out of their own pockets. They went to others to borrow, and these in turn would borrow elsewhere. At each stage small differences in interest rates for very large numbers of transactions involving very large sums of money meant enormous, apparently effortless, profits. Virtually all the major banks on both sides of the Atlantic joined in, setting up special entities to borrow in order to lend, packaging all sorts of different loans together into what were called “financial instruments”. For a time all seemed to go well, and those involved congratulated each other on their financial acumen and brilliant entrepreneurship. Just a year ago Northern Rock was “the toast of a glitzy City dinner where it was heaped with praise for its skills in financial innovation”. Politicians like Gordon Brown wholeheartedly agreed.
The first signs that all was not well were about 18 months ago. US economic growth slowed, causing a sharp increase in the number of mortgage holders who could not afford the interest rates on which the whole business depended and there were a growing number of repossessions. But those involved in the trade in financial instruments were more interested in continuing to make profits than in the problems of poor Americans.
Then as house prices fell the mortgage lenders discovered they could not make enough from selling off one million repossessed homes to pay back what they themselves had borrowed. The banks which had been so willing to lend them money just as suddenly found they faced losses of tens of billions of dollars. What made the situation even worse was that no one knew exactly how deep any particular bank’s problems were because the “financial instruments” were so complex. Financial institutions right across the capitalist system became afraid to lend to each other in case they found they could not get their money back. This was the “credit crunch”.
Modern capitalism depends for its day to day activity on borrowing and lending (See below: Banking and credit). Every business expects to be able to buy certain things on credit, deferring cash payment until it has sold what it has produced. A credit crunch has been compared to a heart attack. If it is not dealt with, the whole metabolism comes to a halt. That is why governments whose whole philosophy is one of not doing anything to interfere with the free market have rushed to do so, pouring billions of dollars into private hands, hoping the recipients will use the cash to start lending and borrowing again.
There are many media commentators who see the story as ending there. Usually the only lesson they draw is the need for more financial regulation. The whole debate over what has happened then degenerates into an argument about exactly how much regulation.
However, some have looked a little deeper. One of those who has been most worried about the direction of events has been Martin Wolf of the Financial Times (perhaps because he completely misjudged what was happening when the Asian crisis began in Thailand ten years ago, describing it as a mere “hiccup”). “I now fear that the combination of the fragility of the financial system with the huge rewards it generates for insiders will destroy something even more important – the political legitimacy of the market economy itself – across the globe”, he recently wrote.
Commentators like him point out that economic growth in the US since the last recession seven years ago has been to a considerable extent fuelled by growing debt, both of consumers and of the US government. Many of the goods produced by US firms could not be sold without that borrowing, and so if it dries up a slump is inevitable. It is not only US firms that are affected. If the US has been one motor of worldwide economic expansion, China has been the other. And central to its growth have been hundreds of billions of dollars a year of exports to the US.
To add to the difficulties – and to the complexities for governments and central bankers in trying to deal with them – much of the lending that has enabled US consumers to borrow to buy Chinese goods comes from China. Effectively China’s profits from selling goods to the US cross the Pacific to be used in the US to buy those goods. The US consumer, as Wolf put it, is the “buyer of last resort for the world economy”.
An important IMF-sponsored study of the world economy three years ago shows how this happens. About 10 percent of Chinese “savings” (to use the conventional term for profits) are left over after new investments have been made. Much of this excess has been poured as lending into the US economy. “Savings” from other south east Asian countries and oil producing states have followed the same path. Even US industry has been “saving” more than it invests, and lending the excess to the banks to lend to consumers.
This has had enormous implications. For a capitalist economy to function smoothly the wealth being produced throughout the system must be bought. The world’s workers and peasants cannot buy more than a portion of it, because their living standards are held down to create profits. This means the rest must be used by the capitalists, either as their personal consumption, for state expenditures they regard as essential to themselves (armies, weapons, etc.), or on investment aimed at producing future profits.
If investment falls below savings, a gap opens up between what has been produced and what is being bought. Some firms cannot sell all their output and sack workers in order to balance their books. This reduces still further what can be bought, and a slump ensues.
This has not happened over the last five years as lending to US consumers had provided extra markets and absorbed the surplus production.
The credit crunch is putting a stop to this, and house building and car sales in the US are already being hit. Even if the banks recover confidence in lending to each other, they are not quickly going to start lending again to people without very good credit ratings. That is why the prospects of a recession are so high, and why one would have an impact outside the US.
The story told by Martin Wolf and the others is not, however, complete. They cannot explain why the world economy has become so dependent on the US consumer. To answer that question it is necessary to look deeper than any version of mainstream economics – to an ailment which the world economy has been suffering from since the 1970s.
What motivates capitalists to invest is not just the absolute level of profits they make, but the “rate of profit” – the ratio of profits to investment. This stayed more or less steady through the late 1940s, the 1950s and the 1960s. That is why these years saw a rising investment and a continual boom, sometimes referred to as “the golden age of capitalism”. But from the late 1960s through to 1982 profit rates fell, until they were only about half the average level of the previous two decades (see below: Marx and the rate of profit). The deep economic recessions of the mid-1970s and the early 1980s were a result of this fall.
Mainstream economists usually blame sudden rises in the price of oil for those recessions. But those rises would have easily been absorbed by the system had profit rates not already fallen so much.
Profit rates were able to stage partial recoveries in the mid-1980s and the mid-1990s. One thing which enabled them to do so was increasing the share of total profits in total national incomes at the expense of wages. Everywhere this meant increased pressure for people to work harder and attacks on welfare services (the “social wage”). In the US it has also meant a fall in the real wage from the early 1970s until the late 1990s and a massive increase in working hours. In Europe there has not yet been the same fall in real wages, but Britain has seen a rise in working hours (particularly if you include the unpaid overtime that is the fate of many white collar workers) and the pressure is now for the major European countries to follow suit.
Alongside this, the bankruptcies of some big capitalists have allowed others to gain at their expense. Rupert Murdoch will have gained from the demise of Robert Maxwell’s media empire 15 years ago, a wave of bankruptcies in the airline industry will have helped the profits of survivors like British Airways, BAe will have benefitted from the troubles of GEC-Marconi, and so on.
But the profit rates never recovered more than about half their previous decline and the booms suddenly ran into trouble with the stock exchange crash of October 1987 and the Asian crisis of 1997. On both occasions the US Federal Reserve and the Bank of England reacted by cutting interest rates and encouraging lending. Such measures were able to extend the booms, and media commentators boasted that capitalism had entered a new era of endless growth on each occasion – until it turned out that the recessions had been deferred a couple of years, not banished forever.
The recession of 2001-2 was particularly threatening to the US economy. Giant firms like General Motors were already making losses before the 9/11 attacks, which added to the panic in the boardrooms. The US government rushed to cut taxes to the rich and to boost arms spending, while the Federal Reserve slashed interest rates so as to encourage even greater levels of borrowing than before. This dragged the economy out of recession – indeed, some mainstream economists went as far as to say the recession never happened. But it laid the ground for the problems the system faces now.
For a time firms were able to improve their profit rates by making massive cuts in their workforces, with 2.7 million manufacturing workers (about one in six) losing their jobs. Real wages, which had risen for the first time in a quarter of a century in the late 1990s, fell again. But even so calculations made by Marxist economist Robert Brenner suggest that the peak for profit rates in 2005 was only about the same as the levels on the eve of each previous crisis since the mid-1970s. In 2006 the country’s biggest firm, WalMart, announced a fall in its profits and the big US owned car companies General Motors and Ford made record losses. It is then that the slowing down of economic growth hit the ability of many poor people to keep up with the mortgage repayments.
The rise in profit rates had not been enough to raise investment to its previous level – Brenner calculates investment growth was the lowest in any economic recovery in half a century. But raising profits had cut into the capacity of workers to buy all the consumer goods being produced by the economy out of their wages. Hence the centrality of personal borrowing, which rose to the record level of 9 percent of gross domestic product. There has been no other way all the goods produced by capitalism could be sold. If borrowing collapses, there has to be a recession.
This is not just the US’s problem. Some people point to the massive rate of expansion of the Chinese economy and suggest this can rescue the rest of the system. But that expansion rests to a large extent on selling goods to the US. If the US economy goes into crisis, it will face problems as well.
The response of capitalist governments and their central banks has been to look for some desperate ploy to keep borrowing going. One way to do so is to cut interest rates so as virtually to give money to the banks to lend to people. Martin Wolf has compared this to dropping money from helicopters. Another way is to increase government borrowing. This is what Bush is proposing with his tax cuts.
But states always face a problem if they simply print banknotes in order to cut interest rates or to cover the cost of cutting taxes. Such methods can sometimes give a short term boost to a flagging economy. But they are necessarily a short term remedy, since they do not solve the fundamental problem of how to raise profits to induce investment without cutting wages in a way that cuts the market for goods. So the Japanese state cut interest rates to virtually zero through the 1990s and still did not get the economy working back at its old levels.
Governments in the US and Europe fear such measures would increase prices (on top of the existing upsurge of oil and food prices) without stopping the economic slowdown, producing the combination of stagnation and inflation known in the late 1970s as stagflation. In the US the fears are deepened by the way in which the combination of the financial crisis and low interest rates is leading to a rapid fall in the international value of the dollar. That will both increase domestic prices in the US and weaken the global economic power of the US ruling class.
It is just possible, nevertheless, that such measures will defer the crisis, as they did at the end of the 1980s and 1990s. But they will not be able to do more than that.
The British economy faces some of the same problems as the US. Borrowing has been at an even greater proportionate level here than there, with a debt to disposable income ratio of 162.9 percent compared to 137.3 percent. The house price boom has been even crazier, with average prices quadrupling in 12 years. There are already signs that house prices are beginning to fall and repossessions to rise.
More importantly, perhaps, Gordon Brown’s policy over the past 11 years has been to compensate for the continued destruction of industrial jobs by trying to make London the centre of the world’s financial system. As a result the financial crisis can have a proportionately bigger direct effect on jobs here than elsewhere. At the same time, he has less room for manoeuvre than the US government when it comes to trying to keep the economy up by substituting government spending for private borrowing. He began increasing government spending six years ago (after cutting it to the bone in the previous four years), as a way of trying to sustain electoral support and limiting the impact of the last US recession. He is now under pressure to cut spending.
His response so far has been based on his faith that the market can work wonders providing he can keep capitalists happy. Hence his offer of vast amounts of money for a “public private” solution to the Northern Rock disaster. Hence too his insistence on holding down pubic sector pay.
Such measures are not going to be sufficient to protect British capitalism if the storm brewing in the US comes to a head this year. But they are going to deepen discontent with his government. They can also open many people up to arguments about the insanity of an economic system driven forward by the drive for profit.
The financial system is often portrayed as a “weightless”, “global” system with no roots in the “real” economy and no particular national base.
But finance has long been of central importance to capitalism. At any moment some capitalists will have excess cash that they cannot invest, while others will want to expand but will not have access to the capital to do so.
Banks allow capitalists to deposit money they can’t use immediately and earn interest, or to borrow money they need for which they pay interest.
This lubricates capitalism, but if the system goes wrong it can threaten the stability of the whole system. As Karl Marx put it, “Banking and credit thus become the most potent means of driving capitalist production beyond its own limits – and one of the most effective vehicles of crisis and swindle.”
Central banks, such as the US Federal Reserve and the Bank of England, are key players in the world of finance. These central banks, which are subject to varying degrees of governmental control, are firmly rooted in a particular country, forming a pivot around which the wider financial system revolves.
Generally they will have a monopoly over the issue of legal tender and great power to influence interest rates.
The rate of profit – how many pence in profit the capitalists get for each pound they invest – is central to the dynamics of capitalism. Karl Marx argued that there was a tendency for this rate of profit to fall.
He argued that “living labour”, the labour put in by those exploited by a capitalist, was the source of profit. Living labour creates new value, and some of this value is returned to the worker in the form of wages. Profit comes from the surplus value left over.
But capitalists don’t just hire living labour. They also purchase “dead labour” – machinery, raw materials and so on. This is the product of past labour by different groups of workers. The capitalists who manufacture and sell these things might make a profit on them, but the capitalist who purchases this dead labour makes no profit on it.
Marx argued that over time competition forces capitalists to invest in more and more dead labour – so each worker sets in motion a greater mass of machinery and raw materials. But if the total amount of dead labour rises, while the living labour (the source of profit) stays the same, the capitalist will invest more but get the same profit. Hence the rate of profit will fall.
Last updated on 27 December 2009