Capitalism fails again (1999)

Book Review from January 1999 issue of the Socialist Standard

Tigers in Trouble. Ed. Jomo K.S. Zed Books. £14.95.

The current crisis in Asia is usually said to have begun with the forced devaluation of Thailand’s currency, the baht, in July 1997. It then spread to the other countries of the region, in particular Indonesia, Malaysia and South Korea which also had to devalue their currencies as outside banks and financial institutions stampeded to withdraw their money.

It would, however, be a mistake to see this as just a financial crisis. As most of the contributors to this book make clear, the financial crisis was a reflection of the situation that had arisen in the real economy where, spurred on by rising export sales which they expected to continue, private capitalist firms had expanded productive capacity beyond what could profitably be sold on world markets. As various different contributors put it:

  “In Japan the post-Plaza recovery [i.e. after 1985] was based on a very strong investment boom, but only to result in excess capacity subsequently. Again, the current difficulties in East Asia are traced back to excessive investment in the region since the beginning of the decade” (p. 42). 

  “Alternatively, it may be termed an over-investment crisis which, in a way similar to Japan, has caused massive over-investment and over-capacity which will produce downward pressure on the prices of traded goods and thus deteriorate the terms of trade of these countries” (p. 57). 

  “Insofar as it is possible to isolate the original sin in this particular Asian drama it must lie in the deceleration of export growth experienced by the entire region from about the middle of 1995” (p. 66). 

  “[In Korea] Lack of investment co-ordination led to overcapacity, which resulted in falling export prices, falling profitability due to low capacity utilisation, and the accumulation of non-performing loans in a number of leading industries, including semi-conductors, automobiles, petrochemicals and shipbuilding” (p. 228).

This became a financial and currency crisis because much of the investment in productive capacity that proved to be excessive in relation to markets had been financed by loans from local banks which in turn had borrowed the money from financial institutions in the industrialised world (US, Europe, Japan) where interest rates were.

Contrary to what some claim, banks do not make profits by “creating credit” by the stroke of a pen but are, as this crisis has again confirmed, intermediaries who make profits—or not—out of the difference between the rate at which they lend out money and the rate they pay those they themselves borrow the money from.

When exports began to slow down some of these loans became “non-performing”, i.e. the interest on them was not being paid. Which meant that the local banks were not going to be able to pay interest to those they had borrowed from. When these international lenders got wind off this they decided to get out. This put pressure on the dollar exchange rate of the local currencies which eventually collapsed, so making the situation of local banks worse as they had in effect borrowed in dollars which now became more expensive. This “credit crunch” meant that they were unable to lend so much to local businesses, even those which were still profitable, so obliging them too to cut back on production and lay off workers.

The slump in production which always follows over-investment and overproduction set in, with countries which had enjoyed in the decade 1985-1995 sustained annual growth rates of over 7 percent returning negative figures and seeing unemployment more than double.

In time—after the excess capacity in relation to the market has been destroyed (capitalism’s solution to the problem of poverty amidst potential plenty)—growth will resume but two contributors (Chandrasekhar and Ghosh) doubt that this will be at the same rate as previously. These countries’ growth has been based on “export-oriented industrialisation”, but “the fundamental problem of insufficient world markets for very rapidly increasing exports still remains” (p. 82). Another, Kregel, is even more pessimistic. He thinks this situation could lead to a rise in protectionism which “is precisely the scenario which was the prelude to the global crisis of the 1930s” (p. 66). We shall see.

Adam Buick

Cooking the Books: Brown re-invents the wheel (2011)

A Cooking the Books column from the April 2011 issue of the Socialist Standard

Gordon Brown has written a book. Not gossip about what went on between him and Tony Blair but about the Crash of 2008 and what he thinks should be done to avoid another one. Called, Beyond the Crash, the subtitle of the first part could well have been “How I saved the world from financial meltdown.”

He writes that by 26-27 September “the choice was clear: either we had to step in and accept all the associated risks, or simply leave the free-market system to collapse”:

“We were facing a situation that risked becoming worse than 1929. No one trusted anyone in the banking system, and people were predicting not a recession but a depression. People were panicking, asking which would be the next bank to collapse. The financial system was looking over an abyss.”

Brown puffs himself for discovering that the way to end a financial panic in which banks and other financial institutions are afraid to lend to each other is for the government to make more money available. As if governments hadn’t done this in the past, even in Marx’s day.

In Volume III of Capital, Marx quoted extensively from the parliamentary reports into the financial panics which occurred in 1847 and 1857. This from the Report on the Commercial Distress, 1847-8:

“[T]he bankers and others finding that they would not rely with the same degree of confidence that they had previously done upon turning their bills and other money securities into bank-notes, for the purpose of meeting their engagements, still further curtailed their facilities, and in many cases refused them altogether; they locked up their bank-notes, in many instances to meet their own engagements; they were afraid of parting with them… The alarm and confusion were increased daily; and unless Lord John Russell…had issued the letter to the Bank…universal bankruptcy would have been the issue.”

Lord John Russell was the Prime Minister and his letter to the Bank of England suspended the Bank Charter Act of 1844. Engels explained in a footnote what this meant:

“The suspension of the Bank Act of 1844 permits the Bank to issue any quantity of bank-notes regardless of the gold reserve backing in its possession; thus, to create an arbitrary quantity of fictitious paper money-capital, and to use it for the purpose of making loans to banks, exchange brokers, and through them to commerce.”

Marx wrote of “a point where either the entire industrial world must go to pieces, or else the Bank Act”, and went on:

“Both on October 25, 1847, and on November 12, 1857, the crisis reached such a point; the government then lifted the restriction for the Bank in issuing notes by suspending the Act of 1844, and this sufficed in both cases to overcome the crisis.”

So Brown did nothing extraordinary. He merely did what the capitalist class expect their government to do when there’s a financial panic that threatens to seize up commerce and production – make more money available to the banks. As in similar circumstances in the past, this stopped the immediate financial panic. But it didn’t stop the coming slump, as GNP fell from that quarter on and is nowhere near its pre-crisis level even today.

Lord John Russell was more modest. He didn’t write a book about how in 1847 he had saved the world from universal bankruptcy.

Cooking the Books: Was the crisis just a mistake? (2011)

From the March 2011 issue of the Socialist Standard

The Financial Crisis Inquiry Commission set up by the US government reported at the end of January. They concluded that the crisis of 2007 and 2008 was the result of “human action and inaction, not of Mother Nature or computer models gone haywire”, but “of human mistakes, misjudgments, and misdeeds” and so avoidable (http://www.fcic.gov).

Obviously, the crisis was the outcome, even if unintended, of decisions by humans to behave in particular ways, but that’s not at issue. We need to know why the economic decision-makers involved took the decisions they did. What was the context of their decisions? What were the constraints acting on them?

The driving force of capitalism is the pursuit of profits by competing enterprises. As the Commission put it, “in our economy, we expect businesses and individuals to pursue profits…” If there is a chance to make a profit from some activity then the businesses in that field will go for it. If the profits are high enough then other businesses will enter the field to share in the bonanza.

This is what happened in the US. From 1997 until 2006 there was a boom in house building and buying. Big profits were to be made from lending money either directly to housebuyers or to businesses that did so. Easily able to borrow funds at relatively low rates of interest, the Wall Street investment banks decided to get in on the act, and in a big way,

“The large investment banks and bank holding companies,” the Commission reported, “focused their activities increasingly on risky trading activities that produced hefty profits.” The prospect of making “hefty profits” out of lending money to build and buy houses led them to borrow more and more money to take part in the chase after them:

“In the years leading up to the crisis, too many financial institutions, as well as too many households, borrowed to the hilt, leaving them vulnerable to financial distress or ruin if the value of their investments declined even modestly. For example, as of 2007, the five major investment banks – Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley – were operating with extraordinarily thin capital. By one measure, their leverage ratios were as high as 40 to 1, meaning for every $40 in assets, there was only $1 in capital to cover losses.”

Note the matter-of-fact acceptance here that banks cannot create money out of thin air but are dependent on themselves borrowing the money they lend.

The Commission criticised the investment banks and other financial institutions for taking such risks but could those involved in making these decisions have decided otherwise? Could they have decided to forgo the chance of making the ‘hefty profits’ that were there to be taken? No, because if one of them decided not to pursue these profits, the others would have enthusiastically taken their place. It wasn’t a mistake on their part. Given the competitive, profit-seeking nature of capitalism they had to take the decisions they did. In that sense the financial crisis was not avoidable.

It was outside the remit of the Commission to examine the housing boom whose collapse in 2006 triggered the financial crisis. They merely recorded that “when housing prices fell and mortgage borrowers defaulted, the lights began to dim on Wall Street”. If they had gone further into the housing boom and why it ended, they would have discovered that it was a classic case of the pursuit of profits leading to overproduction (too many houses being built in relation to what people could afford to buy) and perhaps revised their view that “the profound events of 2007 and 2008” were not “an accentuated dip in the financial and business cycles we have come to expect in a free market economic system.”

Cooking the Books: Financial alchemy (2010)

The Cooking the Books column from the January 2010 issue of the Socialist Standard

When the Bank of England introduced "quantitative easing" last year is was popularly described as the government having recourse to the printing press. This was not meant to be taken literally – the Bank of England did not arrange for more notes to be printed – as it was done electronically. Nor, as Charles Bean, a deputy governor of the Bank of England explained in a speech to the London Society of Chartered Accountants on 13 October (see here), was it the same process that leads to more currency (notes and coins) getting into circulation (through banks being put in a position to have to convert some of their reserves with the Bank of England into cash).

Bean described it as "a programme of large scale asset purchases financed by the issuance of extra reserves". A new fund called the Asset Purchase Facility was set up to which the Bank of England has so far lent £200 billion. This did not come out of the Bank's existing assets but was literally created out of nothing:

"Technically what happens is the following. The Asset Purchase Facility buys assets funded by a loan from the Bank. In turn, the Bank funds that loan through additional reserve creation. If that sounds like financial alchemy, consider how the money flows through the system. When the Asset Purchase Facility buys a gilt from a pension fund, say, it can be thought of as paying with a cheque drawn on the Bank of England. The pension fund will then bank the cheque with its own commercial bank, so the latter now has a claim on the Bank of England – that is what reserves are. In reality, these payments are not made by cheque, but rather are carried out electronically. But the principle is the same, though one key difference is that we pay the Bank Rate to the commercial bank on its claim on us, as well as charging the Bank Rate on the loan we make to the Asset Purchase Facility."

So, what is involved is a circulating IOU from the Bank which can be used to buy financial assets and which, from an accounting point of view, takes the form of a notional increase in the reserves which the commercial banks keep with the Bank of England, except that it is the Bank not the commercial banks that has increased these reserves.

Will this cause inflation? After all, what the Asset Purchase Facility spends does represent an increase in purchasing power. However, the immediate aim is not to cause a rise in the general price level but a rise only in the price of government bonds and stocks and shares:

"If the Asset Purchase Facility buys gilts from pension funds or asset managers, they will then have to look for another home for their money. As it is not very rewarding just to hold it on deposit, they are likely to look to put their money into other assets, including equities and corporate bonds. Thus not only does the price of gilts rise as a consequence of the Asset Purchase Facility's initial purchases, but also the prices of a whole spectrum of other assets".

This limited aim seems to have been achieved as prices of bonds and shares on the stock exchange have risen, helping to repair some black holes on financial company balance sheets. But there is supposed to be a wider aim: to "boost spending and activity" as Bean put it. Which hasn't been achieved. Bean, in fact, honestly admitted that if and when economic activity revives there will be no way of telling whether or not this was due to quantitative easing "for the simple reason that we can never know with precision what would have happened in its absence".

The intention is that, as the real economy recovers, the process will be reversed. The Asset Purchase Facility will sell the bonds it purchased and repay its loan from the Bank of England. The Bank will then liquidate the corresponding commercial banks' reserves with it. If this happens there will be no general inflationary effect as the extra purchasing power pumped into financial markets will be taken out again. But this could be years away. In the meantime the extra purchasing power will continue to go towards financing a stock exchange revival, even perhaps a speculative bubble – while the real economy goes its own way, recovering in due course for real economic reasons not through financial alchemy.