In depth – World Economy

Who’s to blame?

The current economic crisis has fuelled waves of anger around the world. Prime targets are the top bankers and stock market dealers who epitomise the rampant, ultra-free market policies of the last 20 years. Backed by their political accomplices, they gorged themselves while workers’ conditions worsened, and finance capital drove down living standards in the neo-colonial countries. LYNN WALSH argues that behind the obscene greed lie more fundamental reasons for today’s global turmoil.

The finger of blame points to greedy bankers and financiers. They are seen as responsible for the financial meltdown that has triggered a world-wide slump. A wave of fury swept the US when 80 directors of the American International Group paid themselves $165 million in bonuses after being bailed out by taxpayers to the tune of £173 billion.

“Do the leaders of Wall Street want to set off an anti-capitalist political tidal wave across the United States that will sweep them away forever? It’s certainly starting to look that way”. (Martin Sieff,, 16 March)
In Britain, there was popular outrage when Sir Fred Goodwin, ‘Fred the Shred’, the boss of Royal Bank of Scotland who presided over its ruination, walked away with a pension fund of £17 million – giving him a pension of £700,000 a year – effectively financed by taxpayers.

There is growing recognition, however, that the bankers and speculators are the figureheads of a rotten system. The Financial Times referred to the US people’s “widespread and deeply felt anger at financial capitalism and capitalism… the new and dominant fact in the country’s political life”. (Chrystia Freeland, 27 March) But it is politically convenient for political leaders and even big-business bosses to blame the ‘greedy’ and ‘irresponsible’ financiers. Even in the serious financial press, debate about the causes of the present crisis, which is rooted in a profound, long-term crisis of the system, is mostly very superficial.

Writing in the New York Times, for instance, columnist David Brooks claims there are “two general narratives… gaining prominence… the greed narrative and the stupidity narrative”. (Greed and Stupidity, 3 April) How can there be any doubt that the predatory profit-drive of investment bankers, hedge funds, and ultra-rich investors accelerated the process of financial boom and bust? True, they were the agents of deeper processes. But they became fabulously wealthy while inequality deepened.

Yet Brooks dismisses the greed narrative in favour of the stupidly narrative: “Overconfident bankers didn’t know what they were doing”. They did not understand the complex financial instruments they were using. They relied too much on mathematical models. “We got into [the crisis]”, Brooks concludes, “because arrogant traders around the world were playing a high-stakes game they didn’t understand”.

There is an element of truth in this, of course. The complex financial instruments, derivatives, asset-backed securities, etc, that were supposed to spread risk – and even abolish risk – actually disastrously generalised risk. But again, this was a symptom of a diseased economy, not a primary cause. Brooks’ narrative is almost laughable in its simplicity. However, the columnist refers to a more serious analysis, one that has provoked debate in serious capitalist journals.

Submerging market economies

‘THE QUIET COUP’ by Simon Johnson, chief economist to the IMF in 2007-08, lays bare (as the magazine’s introductory caption puts it) the alarming and “unpleasant truth” that “the finance industry has effectively captured [the US] government”. (The Atlantic Monthly, May 2009, As an IMF official, Johnson was involved in many crises in ‘emerging markets’, semi-developed economies like the South-East Asian countries in 1997, Russia in 1998, and so on. Every crisis is different, but he sees a common thread:

“Typically, these countries are in a desperate economic situation for one simple reason – the powerful elites within them overreached in good times and took too many risks”. (This is somewhat one-sided, given the uneven, contradictory development of the neo-colonial developing countries.) “Emerging-market governments and their private-sector allies commonly form a tight-knit… oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon – correctly, in most cases – that their political connections will allow them to push onto the government any substantial problems that arise”.

But the oligarchs “get carried away: they waste money and build massive business empires on a mountain of debt”. With the onset of crisis, there is a downward spiral of corporate bankruptcies and collapsing banks. “Yesterday’s ‘public-private partnerships’ are relabelled ‘crony capitalism’.” Governments find various ways of bailing out their big business friends. “Meanwhile, needing to squeeze someone, most emerging-market governments look first to ordinary working folk – at least until the riots grow too large”.

Johnson finds a strong resemblance to the US crisis: “In its depth and suddenness, the US economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the US financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people”.

Without using the precise, appropriate term, Johnson points to the role of US finance capital, which has become the dominant faction of the US capitalist class. “But there’s a deeper and more disturbing similarity [with development in neo-colonial countries]: elite business interests – financiers, in the case of the US – played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them”.

Mesmerised by Wall Street

BLAME HAS BEEN targeted at an array of people and policies. Greedy bankers and irresponsible government officials (who lowered interest rates and loosened the money supply). Financiers proposed financial instruments they did not understand. Regulators turned a blind eye to shady practices. The twin deficits – the Federal government and the US trade deficit – allowed consumer spending and the housing bubble to grow on the basis of ever mounting debt. China supplied cheap goods and provided market-supporting credit. All these developments benefited the finance sector, and all attempts to limit potentially risky activities were brushed aside.

From the early 1980s, the finance sector boomed, becoming increasingly powerful. The monetary policy of Paul Volcker, chair of the Federal Reserve, which supported high interest rates and reduced inflation, favoured money lenders and those trading financial assets. Republican president, Ronald Reagan, opened up a period of deregulation, which was continued under Bill Clinton (Democrat) and George W Bush (Republican). There was an unprecedented boom of money trading outside the previous framework of the commercial banks through securitisation, with the proliferation of a host of exotic derivatives.

The growth of pension funds and individual saving plans also expanded the profit-making opportunities of investment banks, hedge funds, and so on. The accelerated globalisation of financial markets enormously extended the scope of speculative activity, channelling fabulous profits into the coffers of money traders (including the special trading units of commercial banks).

“Not surprisingly, Wall Street ran with these opportunities. From 1973 to 1985, the financial sector never earned more than 16% of domestic corporate profits. In 1986, that figure reached 19%. In the 1990s, it oscillated between 21% and 30%, higher than it had ever been in the post-war period. This decade, it reached 41%. Pay rose just as dramatically. From 1948 to 1982, average compensation pay in the financial sector ranged between 99% and 108% of the average for all domestic private industries. From 1983, it shot upward, reaching 181% in 2007”.

Finance capitalists concentrated massive wealth into their hands in recent years and, as a result, have exerted enormous political power. Johnson points to the ‘cultural capital’ acquired by the finance sector, ‘a belief system’: “Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country”. In other words, ultra-free market ideology was a powerful force in shaping conditions favourable to finance capital: “Faith in free financial markets grew into conventional wisdom – trumpeted on the editorial pages of The Wall Street Journal and on the floor of Congress”.

Wall Street firms were among the top contributors to political campaigns, Republican and Democrat. Leaders rotated between Wall Street and Washington, people like James Rubin (Clinton’s Treasury Secretary), Alan Greenspan (from Wall Street to the Fed and back again), and now Tim Geithner, Barack Obama’s Treasury Secretary. Politicians, journalists and academics (says Johnson) were “mesmerized by Wall Street, always and utterly convinced that whatever the banks said was true”.

Systemic flaw

BUT IT HAS all come to an end. The beginning of the unwinding of the subprime housing bubble in 2007 triggered a world-wide seizure of the banking system. The ensuing credit squeeze produced an economic downturn. This in turn has aggravated the financial crisis. The illusion of limitless, risk-free profits has been totally shattered. The recovery, when it comes, is likely to be long-drawn-out and painful, particularly for workers who, as always, will bear the main burden of the crisis.

According to Brooks, Johnson’s analysis is just another ‘greed narrative’. Investment bankers, pursuing bigger and bigger profits, became increasingly powerful, “the US economy got finance heavy and finance mad, and finally collapsed”. This just shows how shallow this columnist is. Johnson’s The Quiet Coup accurately describes a structural change in US capitalism – which also developed in Britain and other economies following the ‘Anglo-Saxon model’ – with the emergence of finance capital as the dominant section of the capitalist class.

Yet Johnson’s analysis also has its limitations. Nowhere does he explain the underlying reasons for the rise of the financial oligarchy. This means that, ultimately, he fails to analyse the causes of the current financial-economic crisis, which he simply blames on the rise of the oligarchy. Like any other structural change in capitalism, it is ultimately rooted in the underlying relations of production, in the inner processes of the capitalist economy.

The swing to financial investment and speculation over the last three-and-a-half decades arises from a crisis of over-accumulation of capital. During the post-war upswing (1950-73), capitalism enjoyed very favourable conditions, especially in the advanced capitalist countries. Historically high levels of investment and productivity growth supported both relatively high wage levels (sustaining consumer demand) and a rise in profitability (encouraging new investment). The growth of state expenditure also supported investment and demand for goods and services. This period is now referred to as the ‘golden age’ of capitalism.

The favourable relationships of that period, however, were undermined by the inner contradictions of capitalism. In particular, new investment in the means of production (plant, machinery, etc) no longer produced the level of profits required by the capitalists. “Between 1968 and 1973 the profit rate for the ACCs [advanced capitalist countries] as a whole fell in the business and manufacturing sectors by one fifth”. (Andrew Glyn: Capitalism since 1945 [1991], p182) In the US, for instance, the profit rate for manufacturing fell from the previous peak of 36.4% to 22% in 1973. Significantly, the end of the upswing, marked by the 1973 oil price shock, was marked by an explosion of speculation, especially in commodities and commercial property. In their search for higher profits, the capitalists turned more and more towards financial investment, which became increasingly speculative. The Thatcher-Reagan ‘revolution’ – deregulation, privatisation, tax changes for the super-rich, and an offensive on workers’ rights – was carried through under pressure of the underlying economic change and, of course, enormously widened the scope for speculative capital.

The growth of investible funds (from corporate profits, pension funds, investment banks, etc) continuously grew, but far outstripped the opportunities for profitable investment in new productive capacity. In capitalist terms, there was an ‘over-supply’ of capital. Not that millions of people did not need essential goods and services, but there was insufficient money-backed demand because of the limited income of the working class. Overcapacity developed in most major industries, so why should capitalists invest in new means of production?

For the major capitalist economies, the growth rate of fixed capital stock (a measure of capital accumulation) in the 1990s and 2000s has been only half that of the 1960s. In the US, the growth fell from 4% per annum in the 1920s to 3% in the 1990s and 2% in the 2000s: “capital stock growth started from an exceptionally low point in the early 1990s. The most positive conclusion from [the data] would be that the investment boom of the later 1990s halted the seemingly inexorable downward trend in the growth rate of the capital stock which had begun in the late 1960s. Moreover, when the boom came to an end in 2000, capital stock growth plummeted more steeply than ever before”. (Andrew Glyn: Capitalism Unleashed [2006], pp86, 134)

Surprisingly, perhaps, this analysis was confirmed in 2007 by a Morgan Stanley economist, whose role is to advise investors in the financial sector. Rejecting the ‘conventional wisdom’ that the flood of cheap credit was merely the result of “the central banks’ irresponsibly easy monetary policy”, Stephen Jen wrote: “I believe that the more important source of global liquidity is the (curiously) low capex/capital stock in the world”. (Capex is short for capital expenditure.) In spite of low interest rates and an abundance of credit, “there has been a curious reluctance on the part of the corporate sector in the world to invest in physical assets, ie capex has been surprisingly low…” Jen’s explanation emphasises the “intense uncertainty regarding the outlook of the global economy [which] may have forced companies to restrain their capex plans… multinational corporations may have attached a certain risk to expanding capacity in emerging markets, due to uncertainties regarding both political and economic policies”. (Low Investment is the Main Source of Global Liquidity, Morgan Stanley Global Economic Forum, 23 February 2007)

Credit plays an essential part in the process of capitalist production, as Karl Marx showed. But, in the last 30 years, finance capital became increasingly parasitic. As Johnson’s figures show, finance swallowed an ever increasing share of total profits. The pressure of the finance sector for short-term profit also raised the profitability of many manufacturing and service industries, mostly through downsizing and intensifying the exploitation of workers. But the biggest profits for finance came from churning the huge volumes of cash flowing around the global economy.

Some originated, as we have seen, in the ‘surplus’ profits of big corporations which had no incentive to reinvest in new productive capacity. But the biggest profits have come from trading financial assets using ultra-cheap credit borrowed from economies with big surpluses, like Japan, China and the oil-producers. Much of the super-profits have come, not from the production of new wealth, but from the redistribution of savings and profits from small and medium savers, and investors to the super-rich, elite financiers who run the big hedge funds, investment banks and private equity firms.

An ongoing crisis

THESE, IN JOHNSON’S language, constitute the financial oligarchy. Its leaders were seen, until the collapse, as ‘masters of the universe’. But, in reality, they are the alchemists of capitalist impasse, conjuring up capital gains from speculative trading. The domination of finance capital arises from the inability of capitalism in this period to develop the productive forces in a broad-based way. There has been a surge of investment in some sectors, where there is new technology, and in some countries like China (where growth is still very uneven). But, on a world scale, the accumulation of capital, which should be the dynamic motor of capitalist growth, has collided with the barrier of private ownership, which demands profitable returns as the condition of new investment.

Johnson argues that all toxic assets should be written off at their true market value (a lot lower than their current valuation). Banks with insufficient capital should be nationalised, broken up, and eventually sold back to private owners. But he clearly does not believe that this is what will happen. The US government has effectively partially nationalised several big banks and financial institutions, but it has not taken control. Like the Bush administration, the Obama government is attempting to muddle through with a series of bank-by-bank deals, handing out state subsidies that are too complex for the public to understand. “Throughout the crisis”, writes Johnson, “the government has taken extreme care not to upset the interests of the financial institutions, or to question the basic outlines of the system that got us here”.

There are now two scenarios, says Johnson. With government bailouts, the US and other major capitalist economies may muddle through. Alternatively, there could be a deepening world financial and economic crisis. It would be wrong (he says) to rely on the consoling idea that ‘it can’t be as bad as the great depression’ of the 1930s: “What we face now could, in fact, be worse than the Great Depression – because the world is now so much more interconnected and because the banking sector is now so big. We face a synchronised downturn in almost all countries, a weakening of confidence among individuals and firms, and major problems for government finances”. Whatever scenario plays out, the capitalist ruling class will do all it can to offload the effects of this deep economic crisis onto the backs of the world’s working class and poor.

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