Unprecedented! That was the mantra of the broadcasters, pundits and newspapers throughout September, as the credit crisis took a dark turn. Credit markets (mortgages, loans for cars and goods, company bonds and overdrafts) just dried up. Banks stopped lending even to each other. Liquidity disappeared like water into the Sahara desert. Interest rates rocketed despite the best efforts of the central banks to provide unlimited credit at almost any price. The capitalist financial machine seized up. Banks started to go bust and even countries went bankrupt (Iceland). Nothing has ever been seen like it – for the first time in the hyperbole of the news media, it really was unprecedented.
The difference between what banks were charging each other for loans and what they could borrow from the Bank of England, the Federal Reserve Bank of the US or the European Central bank reached unheard of levels.
This spread fear and loathing through the capitalist financial system. Stock markets rocketed up and then fell like a rollercoaster with every piece of news. The volatility index of the US stock market hit unprecedented levels.
Governments of every political hue were thrown into a frenzy of activity. First, the right-wing American Republican government announced that it was nationalising the biggest mortgage lenders (already semi-government agencies); then it proposed a massive bailout package of $700bn to buy up all the rotten ‘toxic’ mortgages and bonds that the banks held and were now worthless after the collapse of the US housing market.
But it didn’t work. The crunch grew ever tighter. Finally, the British government bit the bullet that all had been avoiding. Gordon Brown and Alastair Darling, after months of dithering and denial, decided to part nationalise the British banks with taxpayers money. The Europeans quickly followed suit and even the Americans decided to adopt a similar approach. They all had to admit that capitalism could not be saved without state intervention.
As the last few weeks have passed, credit markets have started to ease a little and stock markets have stopped plummeting and even recovered somewhat. It appears that the end of capitalism has been averted – at least for now. And all thanks to state interference – the enemy of ‘free markets’.
“A British bank is run with precision! A British home demands nothing less! Tradition, discipline and rules must be the tools; without them – disorder, chaos! Moral disintegration! In short, we have a ghastly mess. Mr Banks in Mary Poppins
Take a moment. How did all this come about? How did this seemingly ‘fundamentally healthy’ all-powerful financial system become a ‘ghastly mess’? How did a seemingly strong and ever more ‘prosperous’ and ‘endogenously growing’ (to use Gordon Brown’s phrase), capitalist economy just collapse like a toboggan over a precipice?
To my mind, it was a combination of what Marx called the most important law of motion of the capitalist system and the new forms of anarchic excess in capitalist expansion. Take the first component. Marx explained that the most important driver of capitalist growth is profitability. Without profits, there will be no investment, no jobs and no incomes. Capitalists will not allow production without because they own and control the means of production. But capitalist expansion does not proceed in a straightforward and orderly progression. Instead it jumps forward and slumps back in an anarchic, unequal and wasteful manner, creating and then destroying jobs, incomes and lives.
Indeed, profitability moves in cycles. Marx’s law of the tendency of the rate of profit to fall explains that, as capitalism expands, there is a downward pressure exerted on the profit ‘earned’ from the capital (money, plant, equipment and labour) invested by capitalists. For some time profitability can rise, but eventually the rate of profit begins to fall, laying down the conditions for a crisis – namely a strike of capital, what Marxists call a ‘slump’ and what capitalist economists call a ‘recession’.
In the major capitalist economies, the last up phase in the profit cycle peaked in 1997. It had lasted about 16 years from the 1982 trough. From then on, profitability began to decline. After the dot.com hi-tech stock market bubble burst in 2000, it dropped sharply, causing a recession in 2001. It then recovered from mid-2002 to reach a peak (but a peak below that of 1997) in 2006. After that, profitability began to slide again. And in the latter part of 2007, the total mass of profits, not just the rate of profit, fell. A capitalist crisis was brewing.
The movement of profits is the main law of motion under capitalism, but it is not the only one. There are other cycles driving capitalist production up and down. One is the building and construction cycle: again lasting about 16-18 years in its up and down phases. The housing cycle started at its bottom in 1991 and rose at an ever increasing pace in the main capitalist economies, almost without a break to reach a peak in house prices and sales in 2007. But then the bubble burst, as the sheer height of house prices finally outstripped the ability of purchasers to buy, even with higher incomes or ever bigger and cheaper mortgages.
Capitalism moves in a succession of booms and slumps – that is normal. But each boom and each slump has different characteristics from another; and what triggers the bust can be very different. In 1974-75, it was rocketing oil prices. In 1980-2, it was a housing bust. In 1991-2, it was the collapse of the Soviet bloc and another housing downturn. In 2001, it was the collapse of the hi-tech mania.
But this time, in 2008, it was a humungous credit crunch. The 1991-2 recession was in a period where profitability was in its upward phase. In 2001, profitability was in its downward phase, but the housing boom was still strong. So in both cases, the recession was mild or short-lived. In 1974-5 and 1980-2, profitability and housing were both going down, so the recessions were vicious and long-lasting. The global recession of 2008-10 looks like those.
This cycle of boom and slump had its own peculiar characteristic. The boom was driven by housing, sure, but in particular by the expansion of new forms of credit. When profitability starts falling, as it did after 1997, capitalists look for ways to maintain profit growth. There are many: colonial expansion, an arms race or an outright war; or nearly always an expansion of credit: or what Marx called fictitious capital.
He said fictitious because it was not a real expansion of values created by labour power, but the apparent expansion of value through rising stock prices, rising levels of debt and rising house prices. Investment of profits made went more and more into unproductive areas that produced apparent quick bucks.
So capitalists invested not in new equipment and plant, or new techniques so much, but more into real estate or into the stock market or into buying what appeared to be very profitable bonds. In this way, profits rose, at least for a while.
In 1980, just 5% of US capitalist profits came from the financial sector (namely from bank loans, buying bonds and stocks). By 2007, it provided 41% of all US profits! Money was being made more and more from investing in money! You know that does not make sense and you would be right. To make money from money cannot last because eventually profit must be generated from the production of real values.
This was a giant Ponzi scheme, named after the man who invented the idea of paying investors big returns by attracting new investors in a pyramid of money with no actual business involved. Eventually, the pyramid topples over under its own weight.
And so it was this time. The Ponzi pyramid this time was built by investing in the great housing boom through buying a share of the mortgages lent by the banks at increasingly attractive terms to increasingly risky borrowers who could only afford to service them as long as house prices kept rising at exponential rates. Investors like a small Norwegian council or the British Cat Protection League would be persuaded to buy a bond that paid very high rates. This bond was backed by a myriad of various mortgages in far-off America batched together and sold on. The bond was rated triple A by ratings agencies to give it a high standing so that investors could feel confident that their taxpayers’ or cat lovers’ money was safe.
On this basis, the banks cut and diced up the mortgages to make yet more bonds and sell them onto other investors – thus the risk was spread far and wide. The further it spread, the more the banks could issue more. On top of this, they began to sell insurance on these bonds to make more money. As they were triple A rated, it was no problem.
But it was. The housing market toppled. Prices began to fall and mortgages began to look sick, especially the so-called sub-prime ones sold to people with little income to pay them. They began to default and lose their homes. And the banks were left with ‘toxic’ assets. The credit pyramid crumbled. And this particular credit collapse is unprecedented.
However, government action, taxpayers money and huge government borrowing has come along to save the fat cats in Wall Street and the City of London from pulling us all down into the abyss. Of course, that does not mean that a recession has been avoided.
At the very best, a Great Depression as experienced in the 1930s has been averted (although then it may be too early to say). But the boom and slump of capitalism has returned. Only fools and knaves argued that it had the cycle of capitalism had gone forever.
Of course, there were and still are plenty of fools and knaves. Take Mr George Mudie, a Labour MP on the esteemed UK parliamentary Treasury committee (supposedly composed of people who know about the economy and finance). Just last April, the honourable Mr Mudie pronounced: “I do not see how anyone can table a motion that suggests we are nearing a recession and that we are in all sorts of economic gloom… I cannot see how anyone can come to the House and say there will be a recession.” Mr Mudie’s words were repeated and echoed by PM Gordon Brown, Chancellor Darling, America’s Treasury secretary, Hank Paulson and many others of the ‘great and good’ (or is that fools and knaves?) – until recently.
Suddenly, Alastair Chancellor Darling reversed course and said the UK faced the worst crisis in 60 years, just before he announced (reluctantly) the nationalisation (temporarily) of the banks!
“Mr Darling used to boast to Wendy that her mother not only loved him, but respected him. He was one of those deep ones who know about stocks and shares. Of course no one really knows, but he seemed quite to know and he often said stocks were up and stocks were down in a way that would have made any woman respect him”. JM Barrie from Peter and Wendy.
All the great and good now scream for regulation and control of the excesses that brought capitalism to its knees. But they sang a different song just months ago, demanding yet more ‘deregulation’ and ‘free markets’. Indeed, the Financial Services Authority, supposedly the guardian of the public interest against reckless and fraudulent behaviour by the banks and financial institutions, has had to apologise in public for its failure to notice anything wrong!
But don’t worry, Gordon Brown is now appointing people to clean up the City of London. Who? Well step forward Lord Adair Turner, former head of the bosses union, the CBI and vice chairman of the bust American investment bank, Merrill Lynch. And with him will be Sir James Crosby, the former head of HBOS, the failed UK mortgage lender. And then there is Sir John Grieve, the former deputy head of the Bank of England and responsible for financial supervision. Talk about poachers becoming gamekeepers!
Now there is much talk of ending the lavish salaries and bonuses of the financial fat cats. But don’t hold your breath. In 2008, bonuses in the City of London will hit a record £16bn, more than triple that of 2001. At the same time, employers announced that they would try and defer pay rises for their workers to ‘control costs’. In the US, Wall Street bonuses will reach $70bn this year even though stock prices of the banks have plummeted and the government is to plough $700bn into the banks to save them from their follies.
And remember just 1% of American households own 25% of all America’s wealth in homes, stocks and businesses, while half of Americans have lost as much as $2trn in the last 15 months from the value of their pension funds invested in the stock market. Both Americans and Britons about to retire will take a huge cut in their retirement incomes. So much for control of the fat cats.
And when we move from the UK to the world, we can see who is going to pay for this slump. According to a UN report, upwards of 20m people globally are set to lose their jobs next year as a result of the coming recession, taking global unemployment to 210m in 2009, the first time it has topped 200m – unprecedented!
Nothing can stop the oncoming recession. The IMF now expects global growth next year to be just 3%, which means rising unemployment in the majority of so-called ’emerging economies’ like China, India, Brazil, Argentine, Turkey and eastern Europe. In the advanced capitalist economies, British, American and European national output is already falling along with Japan. There is going to be ‘negative growth’ next year and into 2010.
In the face of disaster, many capitalist apologists are ditching their cherished beliefs in free markets, deregulation and balanced budgets and turning back to the ideas of John Maynard Keynes, the British aristocrat and economist of the inter-war years. He argued that there was nothing wrong with the capitalist system of production. It was the financial sector that was the problem. It suffered periodic credit crunches and slipped into what he called a liquidity trap where banks would not lend to businesses or workers.
That sounds familiar. Keynes’ solution, along with lower interest rates and government-backed liquidity was state spending and government projects to provide income and jobs. It seems that Chancellor Darling plans something similar; and all round the world governments are raising borrowing and running up deficits to ‘unprecedented’ levels.
But it won’t work. At the heart of the crisis is the lack of profitability. Profits have been falling quarter by quarter and are set to fall further until enough fictitious and real capital is destroyed in value to create a bottom in profitability.
A slump is needed to cleanse the capitalism system of ‘excess capital’, expressed in ‘overproduction’. There will be no bottom until mid-2009 at the earliest, probably later. Then there will be a gradual and weak recovery. But profits will not return to levels of 1997 or even 2006. We are still in the downphase of the profitability law of motion of capitalism. Eventually, another slump will occur, probably about 2014-15, which will be deep again, if socialist governments do not come to power by then.
This article first appeared on Socialist Appeal.
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This post was written by Michael Roberts