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International Socialism, March 1998


Rob Hoveman

Financial Crises and the Real Economy


From International Socialism 2:78, March 1998.
Copyright © International Socialism.
Copied with thanks from the International Socialism Archive.
Marked up by Einde O’Callaghan for ETOL.


The Asian ‘Tiger’ economies (South Korea, Taiwan, Hong Kong and Singapore) and the ‘Tiger cubs’ (Indonesia, Malaysia, Thailand and the Philippines) are in acute crisis. Some are facing a 1930s style collapse of their financial systems and severe economic contraction.

These were the showcases of contemporary capitalism. They boasted phenomenal rates of economic growth over a number of years. For example, South Korea, the biggest of the Tigers, had an average annual growth rate of 8 percent from 1960 through to 1997, making it temporarily the eleventh largest economy in the world and giving it membership of the prestigious Organisation of Economic Cooperation and Development, the OECD.

The Tigers provided a model of economic growth for less developed countries on the basis of export led growth, assisted in many instances by substantial state direction and protection for the domestic economy. Tony Blair visited Singapore, and Peter Mandelson, sponsored by Barclays Bank, visited South Korea before the 1997 election. They both singled out for praise their economic performance and remained utterly silent on the Singaporean and South Korean governments’ record of repression, particularly against trade unionists and socialists.

Now the Tigers are in turmoil and the International Monetary Fund (IMF) has been forced to intervene to support loans totalling more than $100 billion in order to try and stave off a collapse that would threaten a worldwide financial and economic crisis. The speed with which the crisis has broken and spread and the depths to which it has so far gone have taken the world’s political, business and financial leaders by surprise. Despite the clear signs of financial distress, signalled by the devaluation of most East Asian currencies, Alan Greenspan, chairman of the US Central Bank, the Federal Reserve Board, Michel Camdessus, director general of the IMF, and others were still talking optimistically of this being a short term crisis at the end of September 1997. The crisis, they claimed, would presage timely economic and financial reform, upon which the Tigers would resume their upward path, albeit at a more leisurely and sustainable rate of growth as befits the more mature economies. By January 1998 the mood had changed radically and Greenspan, the arch-fighter against inflation, was warning instead of the dangers of worldwide deflation.

For millions of workers across East Asia the impact of the crisis was already having a profound effect, with layoffs, wage cuts, higher prices for basic foodstuffs and the forced expulsion of large numbers of migrant workers.

To understand why the Tigers have been transformed from miracle economies to basket cases in a matter of months we have to go back to Marx and the theory of capitalist development and crisis that he bequeathed us. [1]

Capital and exploitation

Capitalism is a class system based upon two fundamental divisions: firstly between the ruling class or bourgeoisie on the one hand and the working class or proletariat on the other, and secondly between members of the ruling class as they compete against one another for markets and profit. The ruling class own and/or control the means of production, distribution and exchange whilst the working class have to sell their ability to work (their labour power) to whichever capitalist, if any, can profitably employ them.

Surplus value (put crudely, profit) is then extracted from workers by paying them less in wages than the value they create in the process of production. That is why exploitation lies at the heart of the capitalist system.

The bosses, however, constantly face the threat of competition from other bosses, forcing any boss, if he or she is to remain successful and to avoid takeover or bankruptcy, to try to increase the length and intensity of the working day and to try to minimise the wage paid to the worker. There are limits, however, to how far this process can go, limits set by the physical health of the workers, by their expectations and above all their collective resistance. Limits are also set by the supply of suitable labour. Shortages of labour put the bosses into competition with one another to attract and retain labour, which can mean rises in wages rather than cuts.

The bosses also therefore compete by trying to raise productivity and expand their markets through investment in more and more sophisticated technology. If they can cut the cost of producing certain goods and make those goods more attractive, they will be able to grab a bigger share of the pool of surplus value and therefore a bigger slice of the profit.

Productive capital

Productive capital, which equates broadly to the real economy, refers to the investment of surplus value in the production of commodities for sale, in order to increase the capitalist’s surplus value. The capitalist will spend his profits or money borrowed from the banks or raised in the stock markets (M) on buying materials, machines and employing workers (C) to produce goods (P) of higher value than the cost of the original materials, machines and labour. These new goods (C1) are then sold for more than the cost of the labour and the machines (themselves produced by past or ‘dead’ labour) which produced those goods. This provides the bosses with an increase on their original investment (M1). This is the industrial or productive circuit of capital identified by Marx in the formula M–C–P–C1–M1.

The increase in value that accrues to the capitalist is derived from the exploitation of the working class employed in the production process. Providing the goods are sold, this surplus value then accrues to the capitalist class as a whole and is divided into profits, interest, dividends and rent.


In a barter economy goods are exchanged by the immediate producers directly for other goods that they need or desire. Such exchange will normally be dictated by the relative amounts of labour that were expended in the production of those goods. In a capitalist economy, however, the exchange of goods takes place through the medium of money. Capitalism is a system of generalised commodity production. Goods are not produced for immediate exchange with other goods. They are produced in the hope that there is a market for those goods, a market mediated by money – the universal equivalent which measures the relative value of goods, acts as the means of exchange and also as a store of value. Money therefore represents a claim on the total social production in a society. And labour itself becomes a commodity under capitalism, with the working class having to sell its ability to work to the bosses in return for a wage, a wage that will then be used to purchase shelter, clothing and food.

Money obscures the key role of labour in the production of goods. Capitalists are able to portray themselves as the wealth creators because they accumulate money over time through the exploitation of the working class and use the social power that this money represents to determine what will be invested, who will be employed and at what rate, etc. That wealth represents a social dependency of the working class on the decisions of the tiny minority of bosses. Laughably, bourgeois apologists have claimed the profit that the capitalist class reaps is a reward for their abstention from consumption, a claim that a momentary glimpse at the lifestyles of the rich will immediately refute. The fact is that nothing can be produced without workers working, as any strike demonstrates.

Money also obscures the role of labour in the determination of the relative values of different commodities. The value of commodities is ultimately determined by the amount of labour time that is required on average in the production of those commodities. It is this ‘socially necessary labour time’ that determines the relative value of goods and ultimately underpins the value of money itself.

However, money also allows a limited freedom in the determination of relative prices. A picture penned in an hour by Picasso may be ‘worth’ more than a house that involved hundreds and even thousands of hours of labour, because those with large amounts of money may choose to bid up the price of Picasso’s works. The general level of prices may rise if the government chooses to print money in excess of the growth of the economy – a phenomenon known as inflation – and relative prices will be distorted by changes in supply and demand. If demand exceeds supply, prices will go up, and if supply exceeds demand, prices will come down.

Far from Marx having ignored the question of supply and demand which has preoccupied bourgeois economists and politicians, he was well aware of their influence on relative prices and indeed on the dynamics of the capitalist economy. Without goods having a use value which gives rise to their purchase by money holders, surplus value cannot be realised through the sale of those goods.

However, the socially necessary labour time involved in the production of goods ultimately provides the only objective measure of value and acts as a gravitational centre around which prices will move. Even more importantly it is the amount of surplus value, as determined by exploitation in the production process, relative to the amount of investment capitalists are required to make through competition which ultimately underpins the rate of profit in the capitalist economy. And it is the rate of profit which ultimately determines the health of the system.

Financial capital

Some capitalists may not have an immediate outlet for their profits. Other capitalists may have ideas for productive investment but not the capital. The emergence of a banking system and a stock exchange can help to match one to the other. This is the financial circuit of capital.

The financial system means that capitalists do not have to depend on the capital they are able to accumulate directly through the sale of goods produced by the companies they own. They can raise money through stock exchanges, where they sell stocks and shares giving stock and shareholders part ownership of the company and more importantly a share of the future profits in the form of a dividend. They may borrow money from the banks in exchange for a commitment to repay the loan together with interest. Or they may borrow money directly from the financial markets by issuing bonds, carrying a similar commitment to repay with interest as applies to bank loans. Governments and government supported institutions have become major issuers of bonds over the last 25 years as they have sought to cover sizeable amounts of their spending through borrowing rather than through taxing the rich. The market in US government bonds is now the largest financial market in the world. The financial system helps to expand the productive forces under capitalism by recycling surplus funds to companies and, indeed, countries where there are more profitable outlets for investment.

To induce capitalists and others to put their money in the banks, the banks have to offer the depositor interest on their deposits, hence providing the possibility of profit without direct investment in production (M-M1). To obtain the money to pay their depositors the interest on their deposits, the banks must charge a higher rate of interest on their loans and ensure the interest on their loans is repaid. Again this process helps to obscure the underlying nature of the system by apparently allowing the accumulation of wealth without any direct involvement in the production and sale of real goods.

Whilst a banking system is vital for increasing the expansion of capitalism and for sustaining the complex transactions that occur in a sophisticated capitalist economy, it is also a source of vulnerability. Banks typically borrow short, meaning depositors can withdraw their deposits very quickly, and lend long, meaning banks cannot recoup much of their lending in the short term. Banks may be vulnerable therefore to panic withdrawals or changes in sentiment amongst those on whom they depend for deposits and to changes in market conditions which turn some of their loans bad. In the 1930s many US banks were forced to close their doors to those trying to withdraw their deposits because they were afraid they were about to lose their savings as a result of the collapse of the bank. This fear was fuelled by the bankruptcy of indebted companies and other bank failures. But panic withdrawals then threatened to bring about the very collapse the depositors feared.

To reassure depositors and prevent financial panics, the US government and governments elsewhere in the world have sought to reassure depositors since the 1930s that their deposits in commercial and investment banks were guaranteed by the government, either explicitly through legally guaranteed deposit insurance or through an implicit understanding that the government would not allow depositors to lose their money for fear of ‘panic contagion’. [2]

Some bourgeois commentators have begun to talk of the ‘public/private’ nature of the banking system in the aftermath of the Asian crisis. They claim banks have repeatedly and recklessly lent in recent years precipitating financial crises – for example, the Latin American debt crisis in the early 1980s, the US Savings and Loans debacle, the property lending crises of the late 1980s in the UK and US, the Scandinavian banking crisis of the early 1990s, and the Japanese bubble.

They have done so because they know they will always be bailed out if their risky lending goes bad. Such commentators demand greater regulation and transparency in the banking system and more penalties on banks which make risky loans, even allowing them to go bankrupt. [3] But this ignores the competitive pressures which have led banks to demand and get deregulation, which encourages them to make risky loans and it ignores the threat of financial collapse which obliges states to limit the degree to which banks can be allowed to go bankrupt.

States therefore retain an absolutely vital role in providing the necessary support to the financial system to prevent its collapse and with it the collapse of the real economy. However, ‘panic’ does not explain why banks in general should run into difficulties which then spread panic. The health of the financial circuit of capital ultimately depends on the creation of surplus value through the production of goods for sale. Financial capital merely distributes and redistributes the surplus value created in the process of production. That is why on a world scale financial capital ultimately depends on the health of the productive sector and it is the crisis of profitability in the productive sector that government guarantees to depositors cannot overcome.


Nowadays stock exchanges have a much less significant role in raising capital for new investment. Instead they primarily constitute a market for speculation in the values of already existing stocks and shares. If interest rates are low but profits (and therefore dividends) are high or rising, there will be a relative financial gain for speculators who switch their funds out of interest bearing bank deposits and into shares. A rising ‘bull’ stock market can therefore reflect rising profits in the productive, real economy. However, the history of stock markets shows that markets have always risen far further in a bull market than rising profitability can justify in the long term. Speculators will bet on stocks and shares in part because they expect those shares to rise and by pouring more money into a limited supply of shares their expectations of a rising market becomes self fulfilling. Sooner or later, however, as conditions and sentiments change, the market will experience a ‘correction’ or a crash. Such a crash can be precipitated by a sudden significant rise in interest rates, making bank deposits more attractive, or a downturn in profits and therefore likely dividend payments, or shocks elsewhere in the system which simply induce a change from an expectation of rising share values to one of falling share values or any combination of these.

Even if City traders are aware that rising financial markets cannot defy the force of gravity forever, they are obliged to keep speculating on continuing rises until the last possible moment. If, for example, a trader bales out some months before a decline actually sets in he will in the short term be left with results far inferior to those who have stayed in. Therefore it is competition for profit which drives up speculative excess just as it is competition for profit which leads to overproduction in the productive sector. The speculator simply hopes there will be a ‘bigger fool’ who will take his speculative assets off his hands as the market turns from bull to bear and begins to fall.

Stocks and shares constitute a relatively small area of financial speculation today. Just about anything, from tulips to pork belly futures, can become a focus of speculation in capitalism. In terms of value traded the biggest area of speculation today is in the currency markets. A 1993 survey by the Bank of International Settlements reported that on an average day in the rather placid month of April 1992 some $880 billion in currencies changed hands, up from $620 billion in 1989, an increase of only 42 percent – insignificant compared to the doubling between 1986 and 1989. To put that $880 billion in perspective, it means that the currency markets turned over an amount equal to annual US GDP (the value of total production in the US in one year) in about two weeks, and equal to world production in about two months. [4]

Volumes today are much higher even than this. In March 1995 turnover involving US dollars hit $1.29 trillion up from $700 billion in 1989. Only a tiny fraction of these currency deals are directly related to international trade. Whilst speculators in currencies respond to changes in the real economy, they can also, like speculators in the stock market, profoundly exaggerate the trends. And, as we will see, the movement of the values of currencies relative to one another can have a profound and highly destabilising effect on the real economy.

Economic crisis

When the economy is booming and profits are high many bosses will invest to expand production. Any boss who fails to do this will find themselves outdone by those who do take advantage of the economic conditions. However, the surge of unplanned investment will cause costs to rise as shortages of raw materials, machines and workers occur. On the other hand, the prices of the extra commodities that result from the investment will fall as supply to the market begins to exceed demand. With costs rising and prices falling, profits are inevitably squeezed. Profit squeezes send some companies into bankruptcy, cutting investment spending and throwing workers onto the dole, thereby cutting their spending power. An overproduction profit squeeze therefore leads to cuts in spending which further squeezes profits and makes the crisis worse.

This is the boom to bust cycle in which capitalism is plunged into crisis and recession time and again as a result of ‘overproduction’. Overproduction is a phenomenon unique to capitalist society. In previous class societies economic crises took the form of a lack of production to meet the needs of the mass of the population. In capitalism crises take the form of a surfeit of goods. Such a surfeit occurs not because of the saturation of the needs of the mass of the population but because the bosses can no longer sell the excess goods at a profit. [5]

Financial crisis

The impact of a profit squeeze in the productive sector will lead to a deterioration in the financial circuit of capital which in turn makes the overall crisis worse. Lending takes place, when lending decisions are not determined by corruption and nepotism, on the calculation that the borrower will be able to pay back the interest on the loan and within a certain time period pay back the loan itself. Lending contributes to the ultimate crisis of overproduction by increasing access to the reserves of capital that might ultimately be invested. When the expected profits, against which the banks’ loans were made, fail to materialise, companies fail to make their repayments and the loans go ‘bad’. In the worst circumstances the loans may be called in and the company, unable to repay its debts, rendered bankrupt, the company’s workers sacked and the company’s assets seized and sold off at ‘fire sale’ prices to recoup some of the lender’s money. This widens and deepens the crisis just as the financial system originally broadened and prolonged the boom.

Banks, which constitute some of the major lending institutions, take deposits which they owe to their depositors. These are the bank’s ‘liabilities’. They then lend money to borrowers. These loans are known as the bank’s ‘assets’. To provide some security for depositors and some discipline over bank lending, international standards have been established for the ratio that must exist between a bank’s capital (the sum of money that is theoretically owned by the bank, raised from its shareholders and the profits it makes on its transactions) and the bank’s assets (its lending). When loans go bad, banks eventually have to write the loans off. Writing loans off is in effect a charge against the bank’s capital. This reduces the value of the bank’s capital. The smaller this sum of capital is, the less the bank can lend. So an increasing level of bad debts reduces bank lending provoking a ‘credit crunch’. [6] This further compounds the crisis by cutting credit and reducing spending in the economy. Banks may also begin to call in their loans as they fear borrowers are getting into difficulties. This will have a further depressive effect on the economy. And the banks themselves may get into difficulties as they find themselves unable to repay loans from other banks and as other banks demand higher interest on their loans or refuse to make further loans to loss-making banks altogether.

Speculation and crisis

Problems brought on by overproduction in the productive sector can be made worse by speculative excess. Rapid rises in asset values (the value of existing shares, property, commodities, etc.) as a result of speculation can help to induce overproduction. If property rises dramatically in value, property developers will be encouraged to build more property. In the late 1980s in London there was a big increase in the supply of office space. Unplanned and in pursuit of mega-profits, supply swiftly outstripped demand until it was calculated that it would take 25 years for all of the empty office blocks to be filled. As a result of this excess, and with rises in interest rates making borrowing more expensive as the government sought to rein back the excesses of the Lawson Boom, the commercial property bubble burst.

As speculators turn from buying to selling, asset values begin to fall and the banks begin to worry that the collateral that supported their loans is no longer sufficiently valuable. The banks begin to call in their loans before values fall much further but calling in the loans and cutting credit lines then further depress asset values in a vicious downward spiral.

It is important to understand that speculative excess is built into the financial circuit of capital and that the financial circuit of capital is an inevitable aspect of capitalism as a whole. Moreover, although it is important to understand the distinction between the financial and productive circuits of capital, productive capitalists engage in speculation and speculators may invest in production. The attempt by left reformists to isolate the City as the primary cause of, for example, British economic problems poses a false dichotomy. The bosses as a whole are driven by the pursuit of profit wherever they can derive it from and it is the anarchy of competition in the pursuit of profit which afflicts the working class. But we should also note that speculative excess and a subsequent speculative crash need not necessarily be followed by a downturn in the real economy or adversely affect the real economy as a whole.

The 1987 crash

In 1987 a rapid rise in the major world stock markets was reversed when there was a sudden change in speculative sentiment. This resulted from perceived differences between the US and West German governments over what action to take over the enormous twin deficits on the US government budget and its international trade. Western governments feared that ‘Black Monday’, 19 October 1987, when major stock markets fell by 25 percent, presaged a downturn in the real economy. They feared that the markets were right in their belief that the failure of Western governments to hit on a package to resolve the so called structural imbalances of the US economy and its relationship to its major trading partners would lead sooner or later to economic downturn.

The 1987 crash was indicative of underlying problems in the continued expansion of the real economy in the 1980s, problems demonstrated by the significant, if brief, downturn of the world economy in 1985. However, in response to the crash governments cut taxes and reduced interest rates on central bank lending to commercial banks in order to stimulate spending, investment and speculative confidence. The reaction of Western governments helped to prolong the expansion of the real economy for two more years but encouraged further speculative excesses in property and shares.

The role of the state

The 1987 worldwide stock market crash illustrates three things. Firstly, dramatic financial events like big falls in the stock market do not necessarily precipitate an immediate downturn in the real economy. They are indicative of endemic instabilities in the capitalist system but there is no unqualified and direct connection between ‘corrections’ to speculative excesses and major changes in the circumstances of the real economy.

Secondly, governments retain a vital role in the well being of the financial sector and have the power to intervene to seek to prop up and try to rectify problems that emerge in this sector. They do so in three ways: firstly by providing deposit insurance to guard against depositor panics and by bailing out major or strategically vital banks with loans; secondly by seeking to follow the ‘Keynesian’ path of lowering interest rates, cutting taxes or increasing government spending to stimulate the economy; and thirdly, even if they do not pursue the Keynesian prescription the generally much higher levels of government spending prevailing throughout the post-war period up to today will help to limit the effects of the decline in demand that a financial crunch might precipitate – this is the so called ‘automatic stabiliser’.

Thirdly, the knowledge of both the financial markets and of governments about the state of and trends in their national economy or, even more so, in the international economy is highly imperfect. This means that financial markets can be prone to wild fluctuations from day to day based on changing sentiments in the face of titbits of information and the herd instinct. And it means government action intended to address fundamental problems can instead make them worse.

Currency crisis

We live in a world of many currencies, not one international currency. States have retained their own currencies in order for the individual state to have some control over its own monetary policy – essentially the interest rate on short term borrowing – and as a symbol of national sovereignty. For about 25 years after the Second World War the relative values of the currencies of the major Western trading nations, their exchange rates, were fixed by the Bretton Woods Agreement. This fixed the values of currencies against the anchor of the dollar, which in turn was fixed to a gold standard. This was a period of relative stability for currency values as international trade grew at a faster rate than the overall growth of Western economies.

However, the fixed exchange rate system broke down at the beginning of the 1970s. The US had been running increasingly large deficits on its balance of payments, an excess of imports over its exports, as a result of the growing competitiveness of West Germany and Japan, and rising US spending on the Vietnam War. Such a balance of payments deficit would normally be rectified by either the state depressing its economy in order to depress imports and boost the focus on exports, or by devaluing the currency which makes imports more expensive and exports cheaper. The US government did not dare to depress its own economy and could not devalue the dollar which was the linchpin of the fixed exchange rate system.

In the end, those holding dollar reserves outside the US lost confidence in the claim that the dollar was as ‘good as gold’ and tried to cash in their dollars for gold. This forced the US to abandon the gold link, devalue the dollar and eventually abandon support for the Bretton Woods arrangements altogether. The relative decline of the US and the decline of US arms spending was also the major factor behind the end of the post-war long boom. [7]

In 1973 currencies began to float freely against one another. Along with the growing instability of the real economy, which suffered the first major post-war recession in 1974, large fluctuations in exchange rates began to compound the problems. A large and rapid fall in the value of a currency can raise the price of imports dramatically, injecting inflation into the economy. On the other hand, a rapid rise in the currency can see exports priced out of their markets and imports flood in, damaging domestic producers twice over.

The instability in exchange rates was exacerbated by the explosion of speculative capital crossing the international foreign exchanges to make large and quick profits. In the face of this instability governments have three means by which they can seek to influence the exchange rate.

Firstly, they can seek to impose physical controls over the sale and purchase of their currency on the foreign exchanges – exchange controls. However, the currency markets and the IMF increasingly demanded the end of exchange controls so that they would have the freedom to bale out of a currency if they saw economic trouble ahead.

Secondly, particularly with the breakdown of exchange controls, the government can seek to defend a chosen value by buying its own currency with its foreign reserves (accumulations of other currencies held by its central bank). This can be enough to see off the speculators. However, if speculators are determined enough, the price of running down the reserves may prove too high for the government. The central bank will suffer severe losses if the currency is ultimately devalued despite the intervention or it might even face the prospect of running out of reserves altogether, which would entail that the central bank would be unable to provide the foreign exchange to repay foreign debts.

Thirdly, governments can try to iron out fluctuations through raising or lowering interest rates to lure or repel speculative capital. But this will have destabilising consequences for the domestic economy, artificially boosting the economy if they lower interest rates and therefore reduce the cost of borrowing, or depressing the economy if they raise interest rates.

Governments found that they could not live with floating exchange rates and yet they ran into difficulties whenever they tried to re-establish a fixed regime. The vexed question of the exchange rate remained a running sore within the Tory government throughout its 18 years of office.

The Asian Tigers and the Tiger cubs sought to stabilise their exchange rate situation by tying the value of their currencies to the US dollar. Initially this worked well for them as their export sector saw productivity and therefore competitiveness rise more quickly than other exporters and the industries of the economies to which they were primarily exporting.

However, their competitiveness began to be eroded as the dollar rose in value, particularly against the Japanese yen and the Chinese yuan (since renamed the renminbi), which was devalued in 1994 to boost Chinese exports. As cumulative economic problems of overinvestment, declining profitability and declining productivity, growing balance of payments deficits and mounting domestic bad debts began to increase, speculators began to sell East Asian currencies, ultimately forcing the devaluation of all but the Hong Kong dollar. The familiar problems of rising import prices resulting from devaluation, however, almost paled into insignificance compared to the effect devaluation had on the ability of Tiger companies and banks to service their enormous international loans. By simple arithmetic, the halving of the dollar value of a currency doubles the amount that a Tiger company or bank must earn in its own currency to repay the debt. It was in the first instance this loan crisis that was the most visible manifestation of the East Asian economic crisis.

The crisis in East Asia

Overinvestment and overproduction: Although the loans crisis was the most dramatic manifestation of the crisis, the underlying principal factor which brought about the debacle was a classic crisis of overinvestment in the productive economy. Gavyn Davies of Goldman Sachs estimated that the East Asian economies experienced an unprecedented investment rate equivalent of up to 40 percent of their annual production, a rate of investment unprecedented in history. Investment had an annual average growth rate of over 20 percent throughout the 1990s, rising about three times as fast as growth in annual output. [8] The effect of this overinvestment was rising overcapacity across East Asia. Thus The China Analyst, a prestigious monthly economic review, estimated in June 1997 that capacity use was running at 70 percent in South Korea and 72 percent in Taiwan while China was running at below 60 percent, suffering in particular from its highly inefficient state sector. [9]

This overinvestment was a classic product of the anarchy of the market and had nothing specifically to do with the favoured targets of the neo-liberal ‘new critics’ of the Tigers who sought to blame government regulation and direction of investment and an ‘immature’ financial system which lacked ‘transparency’. Much was made in the West of the inefficient use of the high levels of investment, as a result of state direction and ‘crony capitalism’. [10] But this ignored firstly that these same economies experienced their very high levels of growth, and earned the universal plaudits of the West, with exactly the same regimes of export oriented state capitalism in place (with the exceptions of Hong Kong and Singapore). The crisis was not essentially a product of state direction, except in the sense that the political and economic structure sustained high levels of investment which were bound to cause a fall in profit rates sooner or later as high levels of investment have always done in the past – just as Marx predicted they would almost 150 years ago.

Overinvestment had a number of consequences which explain more clearly why the crisis has occurred. Firstly, it expanded the supply of, for example, electrical goods, a key motor of economic growth, in excess of the demand for those goods in the key export markets of Europe and the US. East Asia was hit hard, for example, by the collapse in the price of semi-conductors. Secondly, it sucked in manufacturing imports at a faster rate than the growth of exports producing increasingly unsustainable deficits on the balance of payments. Thirdly, there were increasing shortages of skilled and unskilled labour and growing working class expectations and confidence and, particularly in South Korea, trade union organisation and militancy which combined to raise labour costs. Fourthly, the plentiful supply of loans in the Tigers inevitably spilled over into speculative investment in shares and property just as it did in the US, Britain and Japan in the 1980s. For example, the Hong Kong based investment house Peregrine Investments, which collapsed in January 1998, lent $280 million, a quarter of its capital base, to Steady Safe, an Indonesian taxi, bus and ferry firm with close links to the Suharto family, whose assets in January 1998 were estimated by some to be just $4.4 million! Once interest rates rose, the speculative bubble was inevitably punctured, bringing in its wake bankruptcy, bad debt and the exposure of corrupt and illegal practices.

The extraordinary levels of growth witnessed in the East Asian economies would not have been possible without very substantial levels of foreign lending. Western financial institutions clamoured for the freedom to use surplus funds in the West to lend to countries with relatively low levels of surplus funds in return for much higher profits than could be earned in the West. Tiger companies were able to borrow from Western banks at lower levels of interest than domestically, where there was a relative shortage of surplus funds given the investment boom. And with the Tiger currencies pegged to the dollar, there was apparently no risk of falls in the value of the currencies which would make servicing these debts much more expensive. With the prospect of high returns the West was only too willing to lend. The Bank of International Settlements, which monitors the world financial system, reported in June 1997 that ‘total net flows to Latin America and Asia in 1996 alone exceeded total flows for the entire 1980s’. Much of this lending was short term, a factor which was to be crucial in the crisis that broke in July 1997. [11]

Devaluation: In the face of worsening economic indicators across the region, the primary focus amongst speculators, foreign lenders and domestic borrowers settled on the Thai economy. Currency speculators who buy currencies which they expect to rise and sell currencies which they expect to fall finally forced the devaluation of the baht on 2 July 1997, after the scale of Thailand’s financial crisis was finally made known to the newly appointed central bank director. He concluded it was pointless trying to defend the baht further.

Once the baht had gone, attention turned to other currencies. Now the speculators were joined by domestic borrowers of foreign loans. The latter feared the inevitability of devaluation and a potentially massive increase in the domestic cost of servicing their dollar loans and therefore rushed to convert their holdings of the domestic currency into dollars, pounds, etc.

The sheer weight of this money and the underlying predicament of the Tiger economies meant that it was just a matter of time before other currencies were forced to float with the inevitably dramatic fall in value. The most significant of these devaluations in terms of the size of the economy was the collapse of the South Korean won.

The effect of currency devaluations in certain circumstances should be to stimulate exports and reduce imports. The forced devaluation of the pound in 1992 did have the effect of stimulating exports and is an important factor in the limited recovery of the British economy since then. Exports from the Tigers to the US became anything from 20 to 70 percent cheaper as a result of the devaluations. Imports, on the other hand, became 20 to 70 percent dearer. However, the circumstances of these devaluations were quite different from those of Britain in 1992.

Firstly, unless there was an enormous increase in demand for exports from the Tigers the dollar earnings from exports would still fall rather than rise. There was no reason to suppose that there was a huge untapped demand in the US for the excess capacity of the Tigers, whilst Europe remained largely trapped in slow growth and the Japanese economy was teetering on the brink of a serious recession, if it was not already in one.

Secondly, rising import prices injected inflationary pressure into the economy and would slow down the economy as it became more expensive and therefore difficult to purchase imports vital for economic production. Moreover, as the prices of imports dramatically rose and foreign loans dried up there was every possibility that companies would be unable to purchase imports vital to keeping production for export going.

Thirdly, to try to make their currencies more attractive to speculators and limit the dramatic slide in the currencies, Tiger central banks were forced to raise interest rates dramatically. This made borrowing much less attractive domestically and diverted economic resources to servicing existing debts. Even worse, it was likely to push even more industrial companies into bankruptcy, producing defaults on loans, further cuts in investment, cutting the spending of workers thrown into unemployment and slowing down the economy even further.

Fourthly, higher interest rates were likely to burst the speculative bubble in property provoking bankruptcies across the property sector and defaults on loans. The scale of this speculative excess in turn threatened to produce dramatic falls in bank lending and even banking bankruptcies. By November 1997, for example, 16 bankrupt banks had been shut down by the Indonesian government and there had been a panic run on the Bank of Central Asia as rumours of the death of its owner spread.

Fifthly, and most importantly, the devaluation threatened defaults on many of the loans to the Tigers and reduced very significantly the willingness of foreign lenders to lend and the willingness and ability of domestic borrowers to borrow. Yet the levels of growth in the last 20 years were sustained only on a flow of foreign lending.

Foreign debt: The Latin American debt crisis in the early 1980s was a crisis of Western lending to Latin American governments. The Tiger debt crisis was a crisis of Western and Japanese lending to private banks and companies – it was a crisis first and foremost of the private sector. It was estimated that there were well over $400 billion worth of foreign loans outstanding in the private sector in the most vulnerable Tigers and Tiger cubs – over $200 billion in South Korea, including unreported offshore borrowing by subsidiaries of the chaebols (big South Korean conglomerates), $120 billion in Indonesia and another $120 billion between the Philippines, Thailand and Malaysia. Of these loans a very sizeable proportion were extremely short term and due for repayment some time in 1998 – for example, South Korea was due to repay $92 billion, Indonesia more than $59 billion. With the devaluation of their domestic currencies making it much more expensive to repay these debts, the IMF rushed to support emergency loans to the distressed economies. The IMF was concerned to avoid major defaults on the loans which could have precipitated a worldwide financial crisis, as Western and Japanese banks were forced to acknowledge enormous losses, and to stave off economic and political collapse in strategically important countries like South Korea and Indonesia.

However, IMF loans come with very significant strings attached. The IMF is governed first and foremost by the desire to guarantee that indebted economies are able to service and pay back their loans. Their prescription for this is for the government to cut back dramatically on its own spending and to rein back domestic spending generally so that resources are diverted to exports and even more to paying off foreign debts, including the IMF loans themselves. These policies, already inflicted on the working class and peasantry in many countries across Africa and Latin America, inevitably slow down economic growth further and increase mass poverty.

In addition, the IMF urged the closure of insolvent banks, hurting the Tiger governments’ supporters, to try to restore confidence in the remaining financial institutions and to open up their financial markets so that Western multinationals could come in and cherry-pick some of the major Tiger companies. Not surprisingly this provoked resistance amongst some members of the Tiger ruling classes and popular opposition from below. The stick that the IMF wielded was that without the IMF loans and its seal of approval the Tigers would be cut off from the international financial markets altogether with even more disastrous consequences for their economies.

In fact the major credit rating agencies downgraded the creditworthiness of the most distressed Tigers, despite the latter reluctantly agreeing to the terms of the IMF loans, to such a level that some Western investment funds became forbidden by their rules to make further loans to these economies. There was little evidence by January 1998 that the IMF intervention had done much, if anything, to restore the confidence of the Western financial markets. This was hardly surprising given the still emerging scale of their indebtedness and their developing economic crisis.

Bourgeois economists were and are radically divided as to what surgery was necessary and what would be most effective. Some supported the general IMF prescription. Others argued that the economic conditions of the Tigers were radically different from those countries subjected to the IMF’s ‘Structural Adjustment Programmes’, the problem being not excessive government spending and debt but excessive private sector debt, ‘misdirected’ private sector investment and a loss of competitiveness as a result of the dollar peg. [12] Many argued for reform of the financial sector, erroneously believing overinvestment in production and speculative investment to be a product of the structure of the financial system rather than endemic to the capitalist system. But they were divided about what to do about the weakened banks and the massive bad loans they now carry.

Some argued for a process of recapitalisation and state guaranteed loans for the imperilled financial sector in East Asia whilst others prefer a ‘big bang’ solution, with weak banks being allowed to go to the wall, companies unable to service their loans pushed into bankruptcy, and allowing over-inflated asset values to plunge. In practice, Tiger governments are being forced to vacillate between the two policies, allowing some institutions to collapse whilst trying to prop others up to prevent a spiral of decline.

No one knows just how bad the crisis will ultimately be for the Tigers and the Tiger cubs and the crisis has affected different countries differently. Indonesia suffered the biggest falls in its currency, reflecting the scale of its foreign loans and the weakness of its economic and financial position. The closure of 16 banks at the behest of the IMF in October 1997, far from improving confidence in the Indonesian financial system, prompted a run on other banks with the withdrawal of $2 billion worth of rupiah. In a new IMF agreement concluded in January 1998, President Suharto agreed a wide ranging set of reforms ending the monopoly of a number of large companies owned by members of his family and his political cronies, the ending of subsidies to some sectors of the economy, the cutting of demand to ensure that there would be no economic growth in Indonesia in 1998 and the disbanding of the state organisation which in effect controlled the price and distribution of several staple foods. Indonesia also faced the probable expulsion and repatriation of many Indonesian migrant workers from other East Asian countries and particularly Malaysia. Despite the agreement with the IMF, the prospect of widespread private sector default on many of its foreign loans remained high, along with backsliding by the government as the terms of the deal began to jeopardise the vested interests of sections of the ruling class. Such backsliding and default in turn threatened to trigger further financial crisis. Indonesia is the fourth most populous nation in the world with 200 million inhabitants and controls shipping lanes which are strategically important for the West. Fifty eight percent of the population are under 25. It needs a minimum of 5 percent growth to absorb the extra 2.6 million new workers who come onto the labour market each year. Suharto, a ruthless dictator who came to power over the bodies of 500,000 people, mostly Chinese Communists slaughtered after the coup in 1965, is already threatened by division within the rulin class. The most important threat though, and the threat which above all had the US government turn over its operations room in the White House to the East Asian economic crisis, came from the threat of revolt from an enormous and angry working class.

South Korea is by far the largest of the East Asian economies, formally ranked the eleventh largest economy in the world (since downgraded to twentieth as a result of its devaluation, reflecting the superficiality of these rankings) and a member of the prestigious OECD. The government has vacillated between propping up bankrupt banks and companies and letting them go to the wall. In January 1997 Hanbo Steel collapsed under $6 billion debts. In March Sammi Steel, Korea’s biggest speciality steelmaker, was allowed to fail. In July the largest liquor group, Jinro, and the third largest car maker, Kia, went bust. However, after severe criticism over Kia’s failure within the Korean ruling class the government did a U-turn and announced in October 1997 that Kia was to be nationalised. In December 1997 the government announced it would take over two of its weakest banks, Korea First and SeoulBank, and had persuaded Daewoo, one of the biggest chaebols, to take over the debt laden Ssangyong Motor and forced Ssangyong creditor banks to share much of the financial burden. [13] Government support for ailing chaebols further rattled Korea’s creditors and the IMF insisted that any IMF backed loan agreement had to involve the closure of insolvent companies and banks, the break up of protective aspects of the chaebols, the opening of Korea’s financial markets, giving Western multinationals the chance of cherry-picking profitable companies at fire sale prices, and the passing of laws making it easier to sack workers. Conservative estimates suggested that unemployment could rapidly rise from 2.5 percent to 6 percent. There was every possibility of severe recession and of defaults on private sector foreign loans estimated by some to be more than $200 billion.

Hong Kong, on the other hand, withstood the pressure to devalue the Hong Kong dollar, although at the cost of much higher domestic interest rates. This helped to precipitate a fall of 50 percent in the value of its stock exchange and of 20 percent in the property market. Whether it would be able to hold on was another question, especially if the Chinese government had a change of heart and further devalued the yuan.

As a result of the devaluation of the yuan in 1994, China had experienced a 20 percent increase in its exports in 1997. It had a surplus on its balance of payments of $40.3 billion and foreign exchange reserves of $120 billion. This was a position of strength from which to withstand the hurricane that had blown through the Asian financial markets. However, 40 percent of its exports went to the Asian economies including Japan. In addition China’s labour cost competitiveness, though still superior to many of the Tigers’ despite the devaluations, had nonetheless been eroded. With the domestic economy stagnant following the tightening of credit in an anti-inflation drive, exports had been the motor of Chinese growth. That growth was bound to fall in 1998 and millions of Chinese workers faced the sack as the government planned to restructure the ailing state industrial sector. The chances of a competitive devaluation later in 1998 remained high despite the protests of China’s economic tsar, Zhu Rongji. Such a devaluation was likely to undermine the Hong Kong dollar and bring further instability to Asia.


The Asian economic crisis was the product of the tendency towards repeated crises in the capitalist economy identified and explained by Marx in his greatest work, Capital. The crisis was likely to have depressive effects in the rest of the world. Other ‘emerging economies’ like Brazil and Russia were likely to be hit by increased competition and a general loss of confidence in the financial markets. Japan, already suffering from seven years of domestic stagnation and facing a severe recession was likely to see its problems compounded as its exports to East Asia plummeted and its banks were hit by defaults on East Asian loans. East Asia had taken well over 30 percent of its exports, 40 percent if China is included. Its banks were the most exposed of the developed countries with some $250 billion of East Asian loans outstanding, and were least able to cope with defaults as a result of the accumulated bad debts generated domestically. Both Europe and the United States were likely to see intensified competition from Tiger exports as a result of the dramatic devaluations.

Whilst government action can ameliorate the financial and economic crisis and limit the possibilities of a dramatic 1930s style collapse, there is no easy solution for the ruling class. None of this means that a global depression is inevitable. But the world economy is probably closer to one than for many years. There is, however, one thing on which the bosses will be united – that it is the working class and the poor whom the bosses will try to make pay the heaviest price for the crisis into which the bosses’ system has plunged.


1. Marx focuses on the process of capitalist exploitation in Capital, volume 1, on the circuits of capital in volume 2 and on the theory of crisis in volume 3. For the clearest expositions of the basic elements of Marx’s economic theory, see P. Green, Introduction to Marxist Economics, SWP Educational Pamphlet no. 4 (London 1986); A. Callinicos, The Revolutionary Ideas of Karl Marx (London 1997), ch. 6; and C. Harman, Economics of the Madhouse (London 1997), passim.

2. In the 1980s US building societies, the Savings and Loans institutions (S&Ls), incurred massive amounts of bad debt and many were technically unable to pay back their depositors. The federal government was obliged to underwrite deposits up to $100,000 for collapsed S&Ls under legislation originally introduced in the 1930s. The total bill for the US taxpayer was estimated to run to more than $500 billion. See L.J. White, The S&L Debacle (New York 1991) for a thorough, if by no means Marxist, account of this episode of greed, incompetence and government complicity.

3. See M. Wolf for an example of such thinking in Why Banks are Dangerous, Financial Times, 6 January 1998.

4. D. Henwood, Wall Street (London and New York 1997), p. 45.

5. Marx’s theory of economic crisis is rather more complicated and sophisticated than this brief outline. His multi-faceted theory, far superior to anything bourgeois economics has managed over the last 150 years, is to be found through the three volumes of Capital. For a useful but needlessly condescending account of his theory (condescending both to Marx and to those who have worked on economic theory within the real Marxist tradition since) see S. Clarke, Marx’s Theory of Economic Crisis (London 1994). Clarke ultimately fails to see that a fully coherent theory can be extracted from Capital and that there is a reason to emphasise the relative importance in analysing crises of Marx’s law of the tendency of the rate of profit to fall and its countervailing tendencies. This law, outlined in Capital, volume 3 (London 1981), Part Three, refers to longer term trends within capitalism. The boom/bust cycle occurs even when the general trend of world profitability is relatively high. But when the general conditions for profitability deteriorate, as has been the case since the beginning of the 1970s, the boom/bust cycle becomes much more pronounced and particular countries can suffer prolonged periods of stagnation and worse. Since 1970 there have been three severe world recessions, in 1974–1975, in 1979–1981 and in 1990. Since 1990 the Japanese economy, the most successful capitalist economy in the post-war period, and since the early 1990s the major European economies of France and Germany have all been in severe difficulties. We may well now be on the verge of another world recession. For a clear outline of Marx’s theory of the tendency of the rate of profit to fall and the countervailing tendencies, see A. Callinicos, The Revolutionary Ideas of Karl Marx (London 1997), ch. 6. For the application of the theory to contemporary capitalism, see the writings of Chris Harman in Economics of the Madhouse (London 1997), Where is Capitalism Going?, International Socialism 58 and 60, and Explaining the Crisis (London, 1983).

6. In Japan banks are allowed to count as part of their capital base 45 percent of the unrealised profits on their shareholdings. In the late 1980s the stock market began to rise rapidly. This boosted the capital base of the banking sector. As their capital base increased banks were able to increase their lending. Some of this lending was ploughed back into the stock market thus further boosting the banks’ capital base, thereby allowing yet further lending. Bank lending was also ploughed into property speculation and into expanding real production. This process could not continue indefinitely despite the assumption of almost all bourgeois commentators that it could. With rising interest rates at the end of the 1980s and the emergence of overproduction in the productive sector the bubble burst. As stock markets fell so did the capital base of the banks. The banks were forced to cut back on lending, puncturing the property bubble and saddling the banks with enormous bad debts. In January 1998 the Nikkei Dow index of share values on the Tokyo stock exchange was languishing below 15,000, the cut off point at which Japanese banks would have to start showing losses on their shareholdings. This raised the fear that what had been a virtuous spiral for credit creation in the late 1980s would turn into a vicious deflationary spiral just as the Japanese economy was heading for recession anyway.

7. For much more on the role of arms spending in sustaining the long boom, see M Kidron, The Permanent Arms Economy, IS reprint number 2 (London 1989). For a comprehensive analysis of the long boom and the period of instability that has followed it since the early 1970s, see C. Harman, Explaining the Crisis (London 1983).

8. Gavyn Davies quoted in the Sunday Times, 11 January 1998.

9. The China Analyst, quoted in the Financial Times, 20 June 1997.

10. A term coined in the West to describe the fact that loans and other economic advantages are granted on the basis of family or political connections with state institutions rather than ‘impartial’ market assessment.

11. BIS quote from the Jakarta Post, 18 November 1997.

12. For example Jeffrey Sachs, who had acted as adviser to the Polish government, was particularly scathing about the IMF, and even the World Bank’s chief economist, Joseph Stiglitz, weighed in with criticisms.

13. As reported in the Financial Times, 15 January 1998, in the aptly entitled article The Country that Invested its Way into Trouble.

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