Friday, 1 February 2008
by Dick Nichols from Green Left Weekly 20 September 2008 “Will my superannuation [pension] fund be next?” “Are my savings safe?” As working people in the developed economies watch the assets of one financial institution after another vaporise into nothingness, tens of millions are asking these dreadful questions. Yesterday’s AAA assets are now junk and yesterday’s “risk-free” investments are losing money. No-one, not even the world’s central bankers, who are spending sleepless nights arranging rescue bailouts and emergency injections of trillions of dollars into a financial system frozen with fear and distrust, can answer them with 100% certainty. Last fortnight’s actions by US Treasury secretary Henry Paulsen tell us why: on September 12 he refused to bail out Wall Street investment bank Lehmann Brothers, preferring to let firms that had dealt extensively in financial assets based on worthless subprime mortgages go to the wall or be taken over by others. But on September 17, faced with the collapse of the American International Group, Paulsen and Federal Reserve chairperson Ben Bernanke decided that the risks of letting the world’s largest insurance company sink were too great. AIG was too large — and too enmeshed in global financial markets — to fail. So, in the free-market, Republican-run US, the state is becoming the owner-operator of a collapsing finance system, with the losses funded by the taxpayer. Paulsen, Bernanke and their counterparts in Europe, Japan and Australia too will increasingly face this sort of choice: do they let the next stricken financial monster die or put it on government life support? And how do they decide, when no one knows where the rest of the toxic financial waste is buried, where interbank lending has nearly dried up and where, according to economic historian Harold James, “it is impossible to know what solvency means”? Fictitious capital To understand how the system has arrived at its worst crisis since 1929, it is necessary to consider some basic features of capitalism and how these have operated over the past 30 years. Confronted with the decision as to where to invest its money, any business has to make a basic choice: invest in production or in financial assets (shares, bonds, etc). The decision will be influenced by the expected rate of return on each and its riskiness. The more that individual firms invest in new production, the greater the overall (economy-wide) rate of investment will be, and — on condition that production gets sold profitably — the greater the mass of new value and new profit added. However, when firms invest in purely financial assets they are deciding to invest in claims on new value and profit, which in itself adds nothing to the mass of value added. Conventional economics blurs this distinction, but for socialists Karl Marx and Frederick Engels it was central to understanding the boom-bust cycle of capitalism. They called these claims on future profit fictitious capital. For example, share certificates are simply “marketable claims to a share in future surplus value production” and the share market is “a market for fictitious capital”. Setting up a market for any type of fictitious capital is the equivalent of setting up a casino — a place where people can speculate in these claims on future profit. During boom times, as the expectation of profit growth drives financial markets higher, the total nominal value of fictitious capital in circulation always grows more rapidly than the actual mass of profits. The less this gambling is regulated, the more manic it becomes. However, a point is always reached where more is produced than can be sold profitably. The mass of profits then shrinks and the prices of the claims on profit shrink even more. Over the past 30 years, bursting financial bubbles have become more frequent as we have experienced the biggest ever festival of fictitious capital. In 1980, world financial assets (bank deposits, government and private securities, and shareholdings) amounted to 119% of global production; by 2007 that ratio had risen to 356%. This state of affairs was the result of the wave of financial deregulation that began in the early 1980s under British PM Margaret Thatcher and US president Ronald Reagan, and then spread out across most of the world. With every act of deregulation, new financial markets and instruments — new casinos — became possible. They opened up opportunities to speculate on the future movement of any financial market, to increase borrowing on the basis of expected rises in asset values, and to bundle various forms of fictititious capital into increasingly complex packages. The economic justification for financial deregulation was that, provided essential standards were maintained, deregulation made it easier to mobilise the world’s savings for investment and consumption, resulting in greater growth than would otherwise have been the case. Deregulation also changed the traditional role of big financial firms like Lehman Brothers from intermediaries acting on behalf of major players, like pension funds and insurance companies, to investment bankers acting on their own behalf. They were joined by commercial and savings banks after the 1999 repeal of the Glass-Seagall Act (passed in 1933 to stop such banks from gambling away people’s savings!). As deregulation gathered pace, it also created a world where the greatest profit went to those who traded the most financial instruments, pressuring everyone to play the same game. Traders, money managers and financial advisers flogged as much financial product as they could manage, ignoring its dubious quality. A long period of rapid growth, low inflation and low interest rates — created by the Federal Reserve Bank to counter the 2001 dot.com crash — boosted complacency and willingness to take risks. From bursting bubble to recession? But beneath this orgy of fictitious capital, the wellsprings of real profit began to dry up as mortgage defaults began to rise. Another reality expressed by Marx was coming into play: “The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses as opposed to the drive of capitalist production to develop the productive forces as though only the absolute consuming power of society constituted their limit.” Credit, especially home mortgages, had extended “the restricted consumption of the masses” for a while, but increasingly the credit couldn’t be repaid, undermining the value of all financial instruments based on it. Just before the bubble burst, the credit default swap market (insuring against credit default) swelled to a notional value of $6.2 trillion before imploding. And worse is yet to come. Before the system can begin to recover, asset prices will have to fall massively, producing a further chain of bankruptcies, bailouts and restructurings as the survivors pick over the corpses of the bankrupt. Tens of thousands of people will lose their jobs. The potentially bankrupt finance sector will have to be recapitalised, mainly at taxpayer expense. More seriously still, as consumers are forced to wind back their debt levels, the credit-fed consumption levels of the US will fall, slowing the main motor of the world economy in the 2000s as the economy enters a long repayment period. More alarming scenarios cannot be discarded: At present there are more than 100 banks on the watch list of the Federal Deposit Insurance Commission, the body that insures the bank deposits of the mass of working people in the US. Will the US Treasury be forced to bail out this agency if the poison spreads into the savings bank sector, as in the Great Depression? How much will protecting ordinary people’s savings and recapitalising the finance sector cost the taxpayer? To fund bailouts to date the Federal Reserve Bank has had to run down its own holdings of US treasury notes by more than $300 billion. This dwarfs the $124 billion spent on rescuing the savings and loan industry in the 1980s. Former IMF chief economist Kenneth Rogoff says, “It is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to 10 times more than it has already, that is, an amount closer to $1000 to $2000 billion” (one to two times Australia’s annual output). In the end, working people will pay massively for this crisis, either because they will lose part of their savings or because taxes will have to increase and/or social spending decrease to fund the gargantuan rescue package. In the midst of the wreckage some hard-nosed neoliberal economists still dare to argue that the forces of “creative destruction” should be allowed to play themselves out as quickly as possible. They point to the consequences of rewarding bad financial behaviour, and to the stagnation that ongoing financial bailout produced in Japan’s economy after the 1980s property bubble exploded. For these proponents of shock therapy, working people will just have to grit their teeth and bear the factory closures, unemployment, house dispossessions and descent into poverty that’s involved. However, it’s a pretty good sign of the depth of the present crisis that a pillar of financial orthodoxy like the Financial Times is allowing discussion of a third option: nationalisation of the finance sector. FT columnist Willem Buiter from the London School of Economics wrote on September 17: “Is the reality of the modern, transactions-oriented model of financial capitalism indeed that large private firms make enormous private profits when the going is good and get bailed out and taken into temporary public ownership when the going gets bad, with the taxpayer taking the risk and the losses? If so, then why not keep these activities in permanent public ownership?” Why not, indeed. Dick Nichols is the national coordinator of the Australian Socialist Alliance.