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Credit crunch threatens global downturn
THE GLOBAL CAPITALIST economy has been hit by a
major credit crunch. The collapse of the sub-prime mortgage business in
the US, brought home by the collapse of two hedge funds managed by Bear
Stearns investment bank, provoked panic on money markets. The effects
have already spread much wider than the housing finance sector. As a
result, there is a paralysis of inter-bank lending and a seizing up of
big sections of the wholesale money market.
This crisis is potentially much more serious than
the Asian currency crisis of 1997 and its aftermath, the collapse of the
Russian rouble and the bankruptcy of the hedge fund, Long Term Capital
Management. At that time, the US and other advanced capitalist countries
were in a relatively strong position and intervened to stabilise the
world economy. The present liquidity crisis originates in the US, the
product of a partial deflation of the housing bubble and other debt
bubbles which developed after 2001. The global financial system is under
threat.
Massive intervention by the US Federal Reserve, the
European Central Bank and, belatedly, the Bank of England, as well as
other central banks, may have averted a meltdown for the time being. But
the frenzied financial speculation of the last few years has produced
multiple bubbles which still pose a danger to the system. Moreover,
there are already signs that the liquidity crisis, brought on by the
slump in the US housing market, is in turn spilling over into the real
economy. Capitalist commentators who in July dismissed the sub-prime
crisis as a mere hiccup which would have a limited effect on the real
economy are now gloomily contemplating a recession in the US and
globally, with the possibility of an even more serious downturn in the
world economy.
This is a turning point for the world capitalist
economy. To avert the possibility of a serious downturn after the
collapse of the dotcom bubble in 2001 and the potential impact of the
9/11 attacks, the Federal Reserve, followed by other central banks,
slashed interest rates to near zero levels and opened the floodgates of
global liquidity. This fuelled a series of bubbles – in housing, shares,
commodities, currencies, debt trading, etc – that sustained world growth
for several years. But underlying these bubbles is an unprecedented
accumulation of debt, especially in the US, Britain, and other countries
following the Anglo-US model. It is now becoming a dead weight on
consumers, sections of business and governments. The sub-prime debt
mountain has been the first to collapse, but others will undoubtedly
follow.
The measures taken after 2001 only served to
postpone a deeper crisis, as the current credit crunch shows. Moreover,
the unprecedented imbalances between deficit countries, like the US and
Britain which finance their consumption through debt, financed from
abroad, and the surplus countries, like China, Japan and other
South-East Asian countries, that have accumulated huge foreign currency
reserves on the basis of their trade surplus, have grown even more
extreme.
What expedient can capitalist leaders use now to
avert a downturn in the world economy? Initially, as in 1997-98 and
2001, they have intervened to bail out floundering investment banks and
cut interest rates. But given the enormous burden of debt already
weighing on workers/consumers and sections of the capitalists
themselves, it is by no means certain that more liquidity will do the
trick. In the 1990s, for instance, Japanese capitalism suffered a decade
of stagnation, with near zero growth, despite increasing state
expenditure and pumping liquidity into the economy.
Liquidity crisis
FINANCIAL GLOBALISATION has rebounded on the system.
Capitalist leaders boasted that the near total integration of financial
markets across the globe would provide lenders and borrowers everywhere
with instant access to a completely liquid money market. Moreover, new
types of financial securities, sophisticated derivatives, would spread
the risk of borrowing so widely as to almost eliminate risk entirely.
While economies were growing and bubbles inflating, it appeared that,
through derivatives trading, any losses were widely diffused among
speculators, apparently reducing risk to very low levels. Not even the
most astute speculators or financial analysts could predict what would
happen in the event of recession. The unanswerable question was: who
would ultimately bear the risks arising from widespread defaults or
bankruptcies? The veteran investor, Warren Buffet, warned that
derivatives would prove to be ‘weapons of mass destruction’.
This fantasy of financial alchemy transforming high
risk gambling into low risk money-making has now been shattered. Banks
and other moneylenders knew that the sub-prime sector was risky. They
pushed mortgages onto borrowers with insufficient incomes to repay huge
loans on over-priced houses. Many loans, often for 80% or even 100% of
the property price, were for 125 year terms. Borrowers were enticed with
absurdly low interest rates (sometimes only 1%) – but which (read the
small print) would shoot up to a high level after a year or even a
month. Moneylenders and their agents made huge profits and fees.
The lenders, whether banks or specialised mortgage
lenders, convinced themselves that they were eliminating the risk from
this obviously risky business by selling off the mortgages through the
money market, especially in the form of CDOs – collateralised debt
obligations. Housing debt, in the form of bonds and other securities,
was chopped and rebundled into packages containing securities of varying
grades of risk, from investment grade to dodgy. The theory was that this
diversification and diffusion of risky debt would reduce or even
eliminate risk. The illusion developed that the CDOs were somehow less
risky than the underlying debts.
As the US housing bubble peaked, however, and
defaults began to escalate, especially among sub-prime borrowers, huge
losses began to bankrupt major sub-prime lenders, as well as inflicting
massive losses on hedge funds that had speculated in CDOs and other debt
securities. The collapse of several big sub-prime lenders in the US made
it impossible to trade CDOs and other derivatives linked to high risk
mortgages.
Moreover, it soon became clear that the banks (both
the big high street retail banks and investment banks) are, despite the
derivatives market, still the lenders of last resort. Mortgage lenders
still depend on banks to provide finance for their business, initially
using bank funds to provide mortgages which are later sold on the money
market. Hedge funds, too, rely on bank loans to finance their day-to-day
trading in currency and money markets. Moreover, the banks themselves
had, alongside their banking business, moved into the mortgage market
through their own special investment vehicles – ‘off-balance sheet’
activity that has not been subject to government or central bank
regulation.
In July and August, a number of US, British and
European banks were hit by massive sub-prime losses, through both their
borrower-clients and their own investment vehicles. They also fear
further big losses, which cannot be calculated in advance. The banks
therefore suspended most of their lending activities, fearing that
prospective borrowers might be exposed to sub-prime losses.
Suddenly, moreover, banks would no longer lend to
one another, even on an ‘overnight’ (24-hours) basis, the inter-bank
lending that normally lubricates the financial system. The whole finance
system was threatened with complete paralysis and could have melted down
without the intervention of the central banks (especially the Federal
Reserve and the European Central Bank).
The market in mortgage-linked securities is unlikely
to revive in its previous form. Ironically, a big slice of lending has
now returned to the banks, which had previously tried to offload it on
to the open money market. In effect, there has been a forced return to
‘intermediated’ lending through the banks, reversing the recent trend
towards ‘securitisation’, the parcelling of all kinds of assets into
tradable investments (securities).
Globalisation, moreover, now ensures that any
financial shock is immediately transmitted around global markets. This
was shown by the crisis of the British mortgage lender, Northern Rock
(see page seven). Its exposure to sub-prime loans was relatively low
compared to some of the British banks. However, its chosen ‘business
model’ was to finance 70% of its lending through securitising its loans
on the open money market. When the market seized up in August, Northern
Rock could no longer finance its business, and was forced to go to the
Bank of England for credit.
That move triggered a classic run on the bank, with
thousands of depositors queuing to withdraw their money – or using the
internet to transfer their cash. Only a pledge from the government and
the Bank of England prevented a draining away of Northern Rock’s
capital, with a complete collapse. This could have resulted in runs on
other banks using a similar ‘business model’. It became a political
necessity for the Brown government to act to prevent a devastating loss
of confidence, not only in the banks but in the government itself.
A US recession?
WILL THE CREDIT-market crisis spill over into the
real economy in the US and globally? Even if the liquidity crisis is
contained, as it may be for a time, the US economy is now likely to go
into a recession. In fact, the ongoing slump in the US housing market
has already indicated growing problems in the wider economy. Despite the
capitalists’ hopes for ‘decoupling’ – the continued growth of Europe,
Japan, China and other regions through the development of their regional
and domestic markets, and reduced dependence on the US – a US recession
will most likely bring a global slowdown or worse.
The US housing bubble was a key factor in US growth
since 2001. The ready availability of cheap mortgages fuelled a
phenomenal house-buying spree. House prices on average (adjusting for
inflation) were pushed up 70% more than consumer prices, and even more
in some metropolitan ‘hotspots’. Many homeowners, including new buyers,
used part of their mortgages to convert some of the increased value of
their homes into additional purchasing power (in many cases trying to
compensate for the real decline in household incomes over the last
period). It is estimated that the bubble has created $8 trillion in
housing bubble wealth. Now, the collapse of the bubble could cut annual
consumer expenditure by between $160 and $540 billion.
The crisis in the risky, sub-prime sector is only
the beginnings of a disastrous housing crisis, especially for lower
income families who are being squeezed by higher interest rates, reduced
incomes, and increasingly by rising unemployment. As housing prices
generally fall, the crisis will spread to the ‘prime’ sector as well.
Alan Greenspan, former head of the Federal Reserve,
has compared the situation to the savings and loans crisis of the 1980s.
The rescue then cost the Federal government, ultimately the taxpayer,
between $150-250 billion.
Until around the end of July, financiers and
commentators were claiming that the decline in house prices would have
only a minimal effect on the wider economy. US GDP growth for the second
quarter of this year was 3.4%, significantly higher than the 0.6% of the
first quarter. At the same time, however, consumer spending fell from
3.7% to 1.3% between the first and the second quarters, indicating the
growing effects of the housing slump. Then, the August employment
figures (issued in early September) showed an overall fall of 4,000, and
this was accompanied by a downward revision of the June and July
figures. The monthly average for new jobs created was only around
32,000, compared with 390,000 in the first quarter, a clear sign of a
slowdown. This provoked a sharp dip in share prices in the US and
elsewhere, aggravating already volatile stock markets.
Now there are widespread fears among capitalist
leaders that there can be quite a severe recession. Consumer spending,
which accounts for 70% of the US economy, will undoubtedly be severely
squeezed as a result of the housing crisis. Moreover, serious breakdowns
of other sectors of the financial markets cannot be ruled out, which
means there can be further financial shocks which would impact on the
real economy.
Decoupling?
BUT SPECULATORS ARE very optimistic. They are now
placing their hopes for a continued growth of the world economy on
‘decoupling’. True, in the last few years, there has been an increase of
intra-regional trade within Europe, Asia and other regions. The world
economy, however, still revolves around the US-China axis. Japan and a
number of European economies, for instance, have increased their exports
to China and South-East Asia faster than to the US. This mainly reflects
the increased supply of capital goods, production equipment, to China
and other South-East Asian producers. But China and its neighbours are
importing capital equipment in order to increase their output of
manufactured goods – which they mainly sell to the US. A decline in US
demand would work its way back through the Chinese economy, which would
undoubtedly slow down, to China’s European and Japanese suppliers of
production goods.
Many commentators argue that China and Japan could
increase their domestic consumption, thereby sustaining growth. But
western leaders have been calling on Japan for decades to stimulate
domestic growth, but Japan, with its huge trade surplus, still depends
decisively on exports. In China, the poverty level wages paid to most
workers, and gross inequalities of wealth, strictly limit domestic
purchasing power. This is a structural phenomenon which results from
China’s economic relationship with the US and Europe, and will not be
rapidly changed.
For these reasons, a recession in the US will lead
to a slowdown in the rest of the world, and a more serious downturn in
the US could lead to a worldwide recession, with minimal growth or even
an absolute decline for a period.
Another factor is the role of the US dollar. This
was previously significantly overvalued, as a result of capital flowing
into the US. This was partly private capital in search of high profits,
but also funds channelled by the governments of the surplus countries,
particularly China, Japan and major oil producers, in order to sustain
the US market which they rely on. The recent fall of the dollar, which
has now been accelerated by the Federal Reserve’s interest rate cut, is
likely to have a negative effect on world growth. US exports may
increase as a weaker dollar will make US goods cheaper on world markets.
But the rise of those exports will be limited by the slowing of major
importers, particularly Europe and Japan.
As capital shifts from a slowing, debt-ridden US
economy to Europe and Japan, the euro and yen will be pushed up in
value, as we can already see. This will make eurozone and Japanese
exports more expensive, cutting across the already weak growth of these
major economies. At a certain point, moreover, there could be a massive
flight of capital from the dollar, with a collapse in its value. Past
experience shows that such a collapse would be likely to provoke a
convulsion in the world financial system.
A weak dollar, reflecting a flight of capital from
the US, will make it impossible for US capitalism to finance its annual
trade deficits and accumulated capital debt on the scale of the last
15-20 years. That will mean a painful adjustment – a sharp cutback in
consumption and living standards generally.
The US ruling class will undoubtedly attempt to
offload the crisis onto its own working class, while pursuing aggressive
trade and economic policies internationally in an effort to protect its
national interests. It will also attempt to use its strategic power to
safeguard its economic interests, enormously sharpening inter-capitalist
rivalry and tensions internationally.
A turning point
THERE ARE, MOREOVER, several other international
factors which point towards increased difficulties for world capitalism,
despite its record global growth during the last five years. The price
of oil, for instance, has recently risen above $80 a barrel, which
through higher fuel costs will cut consumption in all the major
economies. In the event of a slowdown, the price of oil will undoubtedly
fall again. But in the meanwhile it could help trigger a recession.
World food prices have also risen sharply in the recent period, partly
because of adverse weather and also because of increased demand for
crops used for biofuels.
It is never possible to predict the exact course of
the capitalist economy. There are too many factors involved, too many
unknowns. Nevertheless, it is clear from recent events that the global
economy has entered a new period of crisis. The debt-driven, multiple
bubble economy of the last six years has begun to deflate. It is clear
that the flood of liquidity, encouraged by the Federal Reserve and other
central banks, only postponed the crisis that was developing at the time
of the Asian currency crisis in 1997 and the collapse of the so-called
dotcom boom in 2001. All the underlying contradictions remain, and the
huge volume of global debt will increasingly become a dead weight on the
global economy.
The expansion of credit – or the accumulation of
debt – prolonged the post-2001 recovery cycle, even amazing the most
optimistic capitalists. There has been record global economic growth of
around 5% a year for five years. However, this has not led to
generalised prosperity, even in the fastest growing economies. On the
contrary, inequalities have grown, especially in countries like the US
and China, and the huge imbalances between the deficit and surplus
countries has become even greater. It is completely unsustainable and
will at some point be corrected, quite likely provoking convulsions
throughout world capitalism.
The big corporations have raked in record profits in
recent years. But their capital expenditure, investment in new means of
production, has fallen to historically low levels. Instead of investing,
they have handed back money to their wealthy shareholders. This
situation reflects the limitation of the market: the growth of consumer
spending has been limited by the very inequality and poverty-level wages
that have produced the record profits. Moreover, it is the lack of
investment in production that has led to the grotesque expansion of the
finance sector, with frenzied speculative activity – which mainly
redistributes wealth within the circles of the super-rich.
Speculation, however, has clearly reached
unsustainable levels. The collapse of the sub-prime mortgage market in
the US, which still threatens the viability of many hedge funds and
investment banks, is only the beginning. Institutions which have
speculated in other fields, such as commodities, currencies, takeovers,
public utilities, etc, may also face crises in the coming months.
Recently, there has been a huge growth of debt
default derivatives, a means of lenders insuring themselves against
borrowers defaulting on their loans. But what will happen when the scale
of defaults escalates? As with any kind of insurance, a huge surge in
claims can bankrupt the insurers, in this case, the institutions
financing and trading the debt default derivatives market.
By pouring in massive liquidity, in effect, cheap,
more or less unlimited credit for the big speculators, the central banks
and major governments may avert a meltdown. But they will not be able to
prevent a prolongation of the liquidity crisis, as more and more
speculative institutions face losses or even collapse. The financial
sector undoubtedly has the potential to produce further spasms which
could have a devastating effect on the real economy. For instance, given
the extent of financial globalisation, financial crises in the US or
Europe can undermine apparently robust growth in Asia and other regions.
Whether or not a more serious crisis develops in the
financial sector of the global economy, there will be a slowdown in the
world economy. The only questions are how severe and how long?
Every economic crisis is also a political crisis for
capitalism. As shown by the Northern Rock episode in Britain, the
failure of banks and other financial institutions shakes public
confidence, not only in financial institutions but also in the
governments responsible for their regulation. In the next few years, the
unfolding of economic crises will shatter the idea that capitalism is a
‘successful’ system, the only way of organising the economy and society.
This was recognised by Greenspan in his recently
published memoirs, The Age of Turbulence. According to the Financial
Times (17 September), "He endorses the view that stagnation in average
worker incomes in the US poses a threat to the political sustainability
of deregulated markets". He also asks: "Why, for all capitalism’s
material success, have we not been able to rediscover the 19th century
optimism that free markets and free societies will bring a broader
measure of human progress".
When stagnation gives way to real cuts in workers’
living standards, there will undoubtedly be mass movements against the
brutal effects of ‘deregulated markets’, in reality unfettered,
ultra-free market capitalism. As in other regions of the world recently,
there will be tremendous struggles against the effects of globalisation
and neo-liberal policies. The capitalist system will be called into
question, shaken to its roots, and there will be an intensified search
among the advanced layers of workers for an alternative which, in our
view, means a socialist planned economy and workers’ democracy.
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