“A financial September 11” - Lessons of the banking crisis – Part Two

The bourgeois economists are incapable of understanding crises, which are an inescapable result of capitalism. They look for subjective factors such as “confidence”, even “human nature”. In reality what we are witnessing are the real workings of the capitalist system in a period of decline.

Greenspan "explains"

The bourgeois economists are incapable of understanding crises, which are an inescapable result of capitalism. It is quite amusing to read the comments of Alan Greenspan, the guru of modern bourgeois economics.

However, Greenspan is right about one thing at least. He says that the sub-prime lending crisis in the USA was "an accident waiting to happen" and that is correct.  Hegel explains that necessity expresses itself through accident: "if it wasn't the sub-prime, it would have been something else. Sub-prime in the US was the weak link in our system. If we had gotten past that and we hadn't broken the overall fever it would have been something different, but it would have happened one way or the other".

So what caused the crisis according to Greenspan?

"At the core of it, he says, is the fact that in recent years banks have been selling on packages of debt to investors all over the world. ‘[Sub-prime] wouldn't have been an economic problem at all if we didn't securitise this stuff and sneak it out of the country,' he says. Meanwhile, the pricing of the complex and opaque collateralised debt obligations which contain so much of this debt has ‘turned out not to be all that successful'."

For the bourgeois crises (and economics in general) are always explained in subjective terms. In the same way as all consumers are assumed to possess a universal knowledge of commodities, so all crises are caused either by the mistaken decisions of governments or central banks, or, as in this latest version of Greenspan, human nature:

"Human nature moves from euphoria to fear," he informs us. "It is this sense of fear that modern economists are failing to take account of when they make forecasts, he adds. The old habit of boom-and-bust has not died in recent years - it has merely been dormant.

"We've been having bubbles since the South Sea Bubble in 1720, and then before that the Tulip bubble. It's one of the innate aspects of how human beings behave. You cannot end them unless you undermine, very fundamentally, the economy; and you can't defuse them because you have to wait for the fever to break.

"I don't think we forecasters have been factoring in innate human nature at the level we should and can. Innate human nature is forecastable: we repeat the same thing time and time again, [yet] we cannot learn. You can go through a period of fear and things come out alright in the end, and you do it 10 times and you'd think on the 11th time you wouldn't worry. But you worry. There's no way of altering the pattern." (Daily Telegraph, September 17, my emphasis, AW)

There are many obvious advantages in this interpretation. Human nature is permanent, and therefore capitalism and all its consequences (unemployment, crises, inequality, exploitation, etc.) must also be permanent. According to this view, like the poor in the Bible, they are "always with us". Human nature is also imponderable, mystical and something that cannot be easily understood. Therefore, by appealing to human nature, all discussion and questioning must cease. We do not have to explain crises; they just are. Consequently, it is useless to look for solutions or alternatives: "There's no way of altering the pattern."

As a matter of fact, Greenspan is half correct. Under capitalism crises are inevitable and there is no way of altering the pattern. If you accept capitalism then you must accept the laws of capitalism: that is to say, you must accept booms and slumps (now referred to in polite circles as "corrections"). The reformists and Keynesians like Will Hutton who advocate tinkering with the system to "smooth out the cycle" by state intervention, deficit financing, pump-priming and the like, may succeed in postponing a slump for a time, but only at the cost of preparing an even more serious crisis in the future. That is precisely what Darling and Brown have just done. As Roger Bootle says:

"At the very least, these developments imply the next MPC meeting will be a humdinger. Those members who thought that interest rates were already high enough should logically now be voting for a cut. But the Governor and his allies will surely want to resist that for all the reasons he outlined last week in a letter to the Treasury Committee. King warned that action to shore up the financial system could ‘encourage excessive risk-taking' and ‘sow the seeds of a future financial crisis'." (The Daily Telegraph, September 17)

Critical point?

Every economic cycle begins with a boom and ends in a slump. It is impossible, however, to be precise about the timing of the cycle.

The present financial crisis is a turning point. In the opinion of Roger Bootle "this is the financial markets' 9/11." It may or may not signify that the critical point has been reached when the world economy begins a slide into recession. That is a possibility. But the laws governing the conduct of the money markets are not the same as those that govern the capitalist cycle. A stock market crisis may be the spark that ignites a general crisis, as happened in 1929. But if the underlying process is still on an upwards curve such a crisis can serve to squeeze out fictitious capital from the system, preparing the way for a further period (longer or shorter) of economic growth, as in 1987.

The general opinion of the bourgeois economists is that central bankers and governments can manipulate the economy so that slumps can be avoided. Most of them agree that a repetition of the crash of 1929 and the Great Depression is impossible. They assume that because for the last twenty or so years there have only been two recessions and both of them were relatively mild, that they have finally managed to find a magic recipe for avoiding slumps as in the past. This is an entirely erroneous assumption.

The recent crisis in Britain showed precisely that all the instruments for solving a crisis and avoiding panic are useless. In the moment of truth people were gripped by a herd instinct. They moved en masse like a herd of wildebeest frightened into a stampeded by the mere scent of a lion. Many commentators have spoken scornfully about this "irrational" conduct. If it was irrational, then it is the same irrationality that is the heart and soul of the capitalist market economy. 

The government and the Bank of England were powerless either to prevent a major banking crisis or to calm the nerves of depositors and investors. In the end they only succeeded in preventing a total collapse by giving a promise of unlimited funds to the bankers, paid for out of the taxpayers' pockets. This has temporarily halted the downward slide, but only at the cost of preparing the way for even steeper falls in the future.

Is the crisis over?

Is the crisis in Britain over? Not at all. Only the unprecedented intervention by the Government temporarily "solved" the Northern Rock crisis by publicly guaranteeing all the bank's deposits. The intervention by the Chancellor, Alistair Darling was forced by the spectacle of mass queuing outside Northern Rock branches and billions wiped off banks' shares.

The government could not afford to allow Northern Rock to go under and possibly set off a chain reaction that would cause the collapse of one bank after another. It therefore announced it would after all fund Northern Rock. This temporarily calmed the situation, but none of the underlying problems have gone away. On the contrary, by injecting even more (public) money into a diseased system, they will ultimately make the problems far worse than they were before the crisis over Northern Rock broke.

In an interview with Edmund Conway, Economics Editor of the Daily Telegraph (17/9/07), Alan Greenspan warns of a UK house prices drop. He predicts that Britain's housing market is heading for a "painful correction" and warns of "difficulties" ahead for UK home owners, as rising interest rates bring house price growth to a shuddering halt. The 81-year-old economist, an adviser to Gordon Brown, said that recent increases in house prices - particularly those in London and the South East - were unsustainable:

"Can [the boom] last? No. You're already beginning to see the mortgage rates are moving; a lot of the two-year fixes are beginning to unwind, and the teaser rates are going," he adds, referring to mortgages where rates jump after an introductory period in which low rates are used as bait to attract people. "It's going to turn, it's got to turn," he says.

Mr Greenspan also warns that Britain is more vulnerable to the effects of the credit crunch than the US: "Britain is more exposed than we are - in the sense that you have a good deal more adjustable-rate mortgages," he says, referring to the standard variable rate loans that many households have chosen over fixed-rate deals.

In the same interview he also warned that:

 "Inflation will pick up dramatically over the coming years, as much as doubling from its recent lows and that interest rates may have to hit double figures in the coming years to avoid inflation."

The crisis has not been avoided. It is only just beginning. From now on, after years of low inflation and low interests and easy credit, we will see a tightening of credit and rising interest rates. This will have a number of effects. On the one hand, dearer and scarcer credit will reduce demand by cutting into the purchasing power of the consumers, both in Europe and the USA. On the other hand, together with the inevitable rise in inflation (oil prices recently hit a new high), it will negatively affect the profits of the capitalists, which will lead to a slowing of production, or even a recession.

To begin with, a fall in the profits of the banks must lead to job cuts in the financial sector, which must affect property prices. This will lead to a further contraction of demand, unemployment and bankruptcies in the construction industry. This in turn will affect demand for steel, cement, bricks and other commodities, leading to a further downturn in industry.

The collapse of house prices must provoke a slump in the construction industry. Already in the USA two million homes have been repossessed. So millions of poor Americans find themselves homeless, while millions of others are struggling to pay the mortgages on homes that are no longer worth as much as they paid for them. One writer recently predicted the emergence of a sub-class of mortgage slaves in the USA.

Let us leave aside the social effects of all this. From a strictly economic point of view it is extremely serious because the construction boom was the main motor-force of the US economy in recent years. Therefore, in this case, it is not hard to see that a slump in the housing sector must have an effect on the real economy in the not too distant future.

US - the key to world economy

All the ingredients are present for a downward slide, particularly in the all-important US economy. The bursting of the technology bubble in 2000 led to a recession, but it was a relatively mild affair. But there is no guarantee that the next one will be the same. In economics the past is no guide to the future. The present crisis in the money markets has raised the prospect of a recession in the wider economy. The dollar, despite everything, remains the world's "reserve currency". A steep fall in its value could destabilize the global economy.

The US economy remains the decisive factor in the world economy. But the strategists of capital are increasingly concerned about the state of its health. On August 14 an article appeared in the Financial Times with the title Learn from the fall of Rome, US warned. This title tells us a lot about the current psychology of the strategists of Capital. Jeremy Grant in Washington wrote:

"The US government is on a 'burning platform' of unsustainable policies and practices with fiscal deficits, chronic healthcare under funding, immigration and overseas military commitments threatening a crisis if action is not taken soon, the country's top government inspector has warned.

"David Walker, comptroller general of the US, issued the unusually downbeat assessment of his country's future in a report that lays out what he called ‘chilling long-term simulations'.

"These include ‘dramatic' tax rises, slashed government services and the large-scale dumping by foreign governments of holdings of US debt.

"Drawing parallels with the end of the Roman empire, Mr Walker warned there were ‘striking similarities' between America's current situation and the factors that brought down Rome, including ‘declining moral values and political civility at home, an over-confident and over-extended military in foreign lands and fiscal irresponsibility by the central government'.

" ‘Sound familiar?' Mr Walker said. ‘In my view, it's time to learn from history and take steps to ensure the American Republic is the first to stand the test of time.' The fiscal imbalance, he wrote, meant the US was ‘on a path toward an explosion of debt'."

There was great uncertainty on Wall Street as the big four US investment banks released their third-quarter results, which gave the clearest insight to date of the full damage from the sub-prime rout and the summer credit crunch. US banks have seen their combined share prices fall 22% during the quarter amid concerns about their exposure to the sub-prime market. Lehman Brothers, Bear Stearns, Morgan Stanley and Goldman Sachs all wrote off hundreds of millions of dollars. Merrill Lynch warned in a regulatory filing that it had made "fair value adjustments" in the face of potential losses and admitted to "significant risk" from further exposure.

The US Federal Reserve's board met for the first time since the summer crisis to consider a cut in interest rates. A quarter-point trim to 5% was seen as the most likely outcome, but in the end there was a half percentage point cut. The reason for this move was pressure from US business on the bank to ease monetary policy dramatically in order to prevent "contagion" - that is to say, to prevent the crisis in the sub-prime sector from spreading to the rest of the financing world and tipping the USA into a full-blown recession.

Paul McCully, of bond fund Pimco, told the Daily Telegraph (17/9/07) that the Federal Reserve might have to cut rates even further during the next three months. "It needs to ease and will ease substantially, not to bail out Wall Street but to make certain that weaker economic growth does not morph into a recession." It is these fears that lie behind the present nervousness in money markets.

Inflation is increasing, a fact not adequately reflected in government statistics. In 2000, when Bush took office, gold was $273 per ounce, oil was $22 per barrel and the euro was worth $0.87 per dollar. Currently, gold is over $700 per ounce, oil is over $80 per barrel, and the euro is nearly $1.40 per dollar. Some economists are talking about oil at $125 per barrel by next spring. The recent cut in interest rates will pour fuel on the flames.

The boom in the USA has been a consumer boom, fed by credit. As Marx explains, credit is a way of expanding the market beyond its natural confines. But this has its limits and these have now been reached. If the capitalists cannot find markets for their commodities, no surplus value will be realised and a crisis of overproduction will ensue.

The American worker is now producing on average thirty percent more now than ten years ago, yet wages have stagnated for the last six years. Rising prices signify a cut in real wages. The same is true for pensioners and others on a fixed income. Even without a recession the American people will see an erosion of their standard of living. Many poor Americans are already struggling just to make ends meet. Now millions will be threatened with the loss of their jobs and homes. This will provoke an upsurge in strikes and class conflict such as the USA has not seen since the 1930s.

The rate cut is at best a temporary palliative. It will not revive the housing market. That carnival is over. The banks, having burnt their fingers, are tightening lending standards and the housing inventory is larger than any time since records began. The resulting fall in house prices will affect consumer spending, bringing about a contraction of demand. The real effect of the interest cut will be an increase in inflation.

The inflation in the stock market was already staggering before this. The market capitalization of all US stocks grew from $5.3 trillion at the end of 1994 to $17.7 trillion at the end of 1999 to $35 trillion at the end of 2006, generating a geometric increase in price earnings ratios and so on. This was not the result of an expansion of productive activity but because of a massive increase in fictitious capital: more dollars chasing the same number of securities.

"What goes up must come down". This applies not only to the law of gravity but also to the stock market. The dizzying rise of share prices and house prices is preparing the way for an equally steep fall in the future. There will be repossessions, losses, bankruptcies and defaults, despite the actions of the Fed.

Global impact

The investment banks are hoping that a cut in the Fed's fund rate will send the stock market soaring again. But a cut in the interest rate does not solve the fundamental problems. It does not eliminate insolvency among homeowners, mortgage lenders, hedge funds and banks. Far from solving the problem, it will ultimately make it worse.

The US market is already awash with liquidity as the result of the antics of Alan Greenspan, which produced the present housing bubble - the biggest speculative boom in history. By reducing the cost of borrowing, the Fed is only creating a further extension of credit and indebtedness at all levels. It will prolong and exacerbate the housing and the credit bubbles. As one market-analyst said: "A cut in the Fed Fund rate is simply heroin for credit junkies."

From a capitalist point of view this is the height of irresponsibility. It is

better to let bankrupt companies (including banks) close than to cut interest rates and encourage "irrational exuberance" that will eventually undermine the dollar and the entire financial system in the USA. Sooner or later this bubble will burst and the consequences will be even more painful. If the US authorities are not willing to take action, the markets will take it for them.

As we have seen, the bourgeois always seeks to explain economic phenomena in terms of "confidence", as if this were entirely subjective. It is not. The "confidence" of investors is based on very real material considerations. As long as the US economy was going forward, even though the fundamentals were unsound, the bourgeois of other countries were prepared to invest in it. They paid no attention to the colossal levels of debt and the huge deficits, including a current account deficit of around $800 billion a year. The US needs to raise at least $70 billion every month just to cover this deficit.

America has changed from being the biggest world creditor to the biggest debtor, with net external liabilities of $3,000bn. The savings rate has fallen below zero for the first time since the Great Depression of the 1930s. At present China and other Asian countries hold huge stocks of dollars and US bonds. It is not in their interest to provoke an economic collapse in the USA, and the Americans are banking on this. But there are limits to all things. Sooner or later the unsound nature of the US economy will provoke an international run on the dollar. Lower interest rates will not bring money back into the markets, but they will further undermine the dollar.

By lowering interest rates the Federal Reserve is entering onto very dangerous ground. The US economy is defying the laws of gravity. It is so unsound that it is unthinkable that the present situation should last for long. Eventually foreigners will worry that the dollars and bonds they are holding will not be worth the paper they are written on. And why should they want to lend money at low rates in a currency that is declining in value when they can take these same funds and lend them at high rates in a currency that is gaining in value?

The rest of the world will not be willing forever to finance the United States' tendency to consume far more than it produces. There are already signs of this. Paradoxically, it seems that the first ones to panic are the Saudis, the main allies of Washington in the Arab World, who have huge investments in the USA. Saudi Arabia has refused to cut interest rates in step with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg. This move risks setting off a stampede out of the dollar across the Middle East.

For its part, the Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation. Henry Paulson, the US Treasury Secretary, said any such sanctions would undermine American authority and "could trigger a global cycle of protectionist legislation". This indicates the real dangers that now face the USA and the whole world economy. What really turned the slump of 1929 into the Great Depression that lasted ten years till the outbreak of the Second World War was the protectionism, trade wars and competitive devaluations that undermined world trade.

Greenspan predicts that the dollar is likely to fall in the coming years as the massive US deficit unwinds. "There will have to be a correction, and ultimately one of the things that will create it is the currency," he says. And by "correction" he means a slump.

Jim Rogers, the commodity king and former partner of George Soros, said the Federal Reserve was playing with fire by cutting rates so aggressively at a time when the dollar was already under pressure. The risk is that a flight from US bonds could push up the long-term yields that form the base price of credit for most mortgages, driving the property market into even deeper crisis.

"If Ben Bernanke starts running those printing presses even faster than he's already doing, we are going to have a serious recession. The dollar's going to collapse, the bond market's going to collapse. There's going to be a lot of problems," he said.

At a certain stage a large number of foreign investors will lose confidence in the US economy. Then we will see the same kind of scenes we saw recently in Britain replicated on a global stage. There will be a run on the dollar just as there was a run on Northern Rock, and for the same reasons. If foreign investors fear they will not get their money back from "USA inc.", they will be queuing up to withdraw their funds. When that happened in Britain, the Bank of England intervened to support the bank by underwriting its deposits. But who will do this for the USA economy? The Bank of England is the "lender of last resort" in Britain. But the USA is the "lender of last resort" for the entire world.

In the recent period it has become fashionable to claim that a crisis in the USA will not affect the rest of the world. I have already dealt with this in my speech on world perspectives, The International Situation and Perspectives, published on Marxist.com. It contradicts all the arguments of the bourgeois economists on globalisation, which precisely means that the world economy is more integrated than at any other time in history. Major events in any large economy must affect other economies. This applies above all to the USA.

This global interdependence was clearly revealed by the latest crisis, which began in the USA and rapidly spread to Europe and Britain. Now the banking crisis in Britain is affecting the rest of the world, as depositors, investors and savers absorb the lessons of the run on the fifth largest bank in Britain that almost provoked a general collapse. Mike Whitney put this very well when he wrote:  

"The same Force Five economic-hurricane that just touched ground in Great Britain is headed for America and gaining strength on the way.

"A more powerful tsunami is about to descend on the United States where many of the banks have been engaged in the same practices and are using the same business model as Northern Rock. Investors are no longer buying CDOs, MBSs, or anything else related to real estate. No one wants them, whether they're sub-prime or not. That means that US banks will soon undergo the same type of economic gale that is battering the UK right now. The only difference is that the US economy is already listing from the downturn in housing and an increasingly jittery stock market.

"That's why Treasury Secretary Henry Paulson rushed off to England yesterday to see if he could figure out a way to keep the contagion from spreading."

The crisis of 1997-8 began in Asia, and then spread to Turkey, Poland, Russia, Brazil and Argentina, where it produced the collapse of December 2001. This provoked a virtual uprising on the streets of Buenos Aires and the collapse of the De la Rua government. Similar dramatic events are being prepared. Sudden changes can occur in any country in the world. This is an expression of the underlying instability of capitalism on a world scale. Not accidentally does Greenspan entitle his recent autobiography The Age of Turbulence.

London, 24/9/07

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