[DEBATE] : (Fwd) Bello on structural roots of financial crisis

[Patrick Bond]

Capitalism in an apocalyptic mood
Walden Bello
Focus on the Global South, 20 February 2008

The current global financial crisis is symptomatic of a capitalist 
growth model driven by financial speculation that is disconnected from 
the stagnant real economy, argues Walden Bello.


An apocalyptic mood has seized the highest levels of global capital as 
the global financial system continues to implode. This implosion is but 
the latest financial crisis to wrack global capitalism. Financial crises 
are inevitable since capitalist growth has increasingly been driven by 
speculative bubbles such as the housing bubble in the United States. The 
increasingly uncontrolled financial gyrations stem from the increasing 
divergence between an expansive financial economy and a stagnant real 
economy. This "disconnect" stems from the persistent stagnationist 
trends in the real economy owing to overproduction or overcapacity. The 
search for profitability is capitalism's driving force, and 
increasingly, significant profits can only be obtained from financial 
speculation rather than investment in industry. This is, however, a 
volatile and unstable process since the divergence between momentary 
financial indicators like stock and real estate prices and real values 
can proceed only up to a point before reality bites back and enforces a 
"correction." The bursting of the US housing bubble is one such 
correction, and it is leading not only to a recession in the US but to a 
global downturn owing to the unprecedented level of integration fostered 
by corporate-led globalization. It will not be easy to restore dynamism 
by fostering another speculative bubble, for instance, by resorting to 
"military Keynesianism."



"We have to pay for the sins of the past."
- Klaus Schwab, key organizer of the Davos elite jamboree



(San Francisco, Feb. 17, 2008). Skyrocketing oil prices, a falling 
dollar, and collapsing financial markets are the key ingredients in an 
economic brew that could end up in more than just an ordinary recession. 
The falling dollar and rising oil prices have been rattling the global 
economy for sometime, but it is the dramatic implosion of financial 
markets that is driving the financial elite to panic.

Capitalist Apocalypse?

And panic there is. Even as it characterized Federal Reserve Board 
Chairman Ben Bernanke's deep cuts amounting to a 1.25 points off the 
prime rate in late January as a sign of panic, the Economist admitted 
that "there is no doubt that this is a frightening moment." The losses 
stemming from bad securities tied up with defaulted mortgage loans by 
"subprime" borrowers are now estimated to be in the range of about $400 
billion, but, as the Financial Times warned, "the big question is what 
else is out there" at a time that the global financial system "is wide 
open to a catastrophic failure." What is "out there" is suggested by the 
fact that it has only been in the last few weeks that a series of Swiss, 
Japanese, and Korean banks have owned up to billions of subprime-related 
losses. The globalization of finance was, from the beginning, the 
cutting edge of the globalization process, and it was always an illusion 
to think that the subprime crisis could be confined to US financial 
institutions, as some analysts had thought.

Some key movers and shakers sounded less panicky than resigned to some 
sort of apocalypse. At the global elite's annual weeklong party at Davos 
in late January, George Soros sounded positively necrological, declaring 
to one and all that the world was witnessing "the end of an era." World 
Economic Forum host Klaus Schwab spoke of capitalism getting its just 
desserts, saying, "We have to pay for the sins of the past." "It's not 
that the pendulum is now swinging back to Marxist socialism," he told 
the press, "but people are asking themselves, ‘What are the boundaries 
of the capitalist system?' They think the market may not always be the 
best mechanism for providing solutions."

Ruined Reputations and Policy Failures

While some appear to have lost their nerve, others have seen the 
financial collapse diminish their stature.

As chairman of President's Bush's Council of Economic Advisers in 2005, 
Ben Bernanke attributed the rise in US housing prices to "strong 
economic fundamentals" instead of speculative activity, so is it any 
wonder, ask critics, why, as Fed Chairman, he failed to anticipate the 
housing market's collapse stemming from the subprime mortgage crisis? 
His predecessor, Alan Greenspan, however, has suffered a bigger hit, 
moving from iconic status to villain of the piece in the eyes of some. 
They blame the bubble on his aggressively cutting the prime rate to get 
the US out of recession in 2003 and restraining it at low levels for 
over a year. Others say he ignored warnings about aggressive and 
unscrupulous mortgage originators enticing "subprime" borrowers with 
mortgage deals they could never afford.

The scrutiny of Greenspan's record and the failure of Bernanke's rate 
cuts so far to reignite bank lending has raised serious doubts about the 
effectiveness of monetary policy in warding off a recession that is now 
seen as all but inevitable. Nor will fiscal policy or putting money into 
the hands of consumers do the trick, according to some weighty voices. 
The $156 billion stimulus package recently approved by the White House 
and Congress consists largely of tax rebates, and most of these, 
according to New York Times columnist Paul Krugman, will go to those who 
don't really need it. The tendency will thus be to save rather than 
spend the rebates in a period of uncertainty, defeating their purpose of 
stimulating the economy. The specter that now haunts the US economy is 
Japan's experience of virtually zero growth per annum and deflation in 
the nineties and early part of this decade despite one stimulus package 
after another after Tokyo's great housing bubble deflated in the late 
1980's.

The Inevitable Bubble

Even as the finger-pointing is in progress, many analysts remind us that 
if anything, the housing crisis should have been expected all along. The 
only question was when it would break. As progressive economist Dean 
Baker of the Center for Economic Policy Research noted in an analysis 
several years ago, "Like the stock bubble, the housing bubble will 
burst. Eventually, it must. When it does, the economy will be thrown 
into a severe recession, and tens of millions of homeowners, who never 
imagined that house prices could fall, likely will face serious hardship."

The subprime mortgage crisis was not a case of supply outrunning real 
demand. The "demand" was largely fabricated by speculative mania on the 
part of developers and financiers that wanted to make great profits from 
their access to foreign money that flooded the US in the last decade. 
Big ticket mortgages were aggressively sold to millions who could not 
normally afford them by offering low "teaser" interest rates that would 
later be readjusted to jack up payments from the new homeowners. These 
assets were then "securitized"with other assets into complex derivative 
products called "collateralized debt obligations" (CDO's) by the 
mortgage originators working with different layers of middlemen who 
understated risk so as to offload them as quickly as possible to other 
banks and institutional investors. The shooting up of interest rates 
triggered a wave of defaults and many of the big name banks and 
investors-- including Merrill Lynch, Citigroup, and Wells Fargo--found 
themselves with billions of dollars worth of bad assets that had been 
given the green light by their risk assessment systems.

The Failure of Self Regulation

The housing bubble is but the latest of some 100 financial crises that 
have swiftly followed one another ever since Depression-era capital 
controls began being lifted at the onset of the neoliberal era in the 
early 1980's. The calls now coming from some quarters for curbs on 
speculative capital have an air of déjà vu to many observers. After the 
Asian Financial Crisis of 1997, in particular, there was a strong clamor 
for capital controls, for a "new global financial architecture." The 
more radical of these called for currency transactions taxes such as the 
famed Tobin Tax that would slow down capital movements or for the 
creation of some kind of global financial authority that would, among 
other things, regulate relations between northern creditors and indebted 
developing countries.

Global finance capital, however, resisted any return to state 
regulation. Nothing came of the proposals for Tobin taxes. Even a 
relatively weak "sovereign debt restructuring mechanism" akin to the US 
Chapter Eleven to provide some maneuvering room to developing countries 
undergoing debt repayment problems was killed by the banks despite its 
being proposed by Ann Krueger, the conservative American deputy managing 
director of the IMF. Instead, finance capital promoted what came to be 
known as the Basel II process, described by political economist Robert 
Wade as steps toward global economic standardization that "maximize 
[global financial firms'] freedom of geographical and sectoral maneuver 
while setting collective constraints on their competitive strategies." 
The emphasis was on private sector self surveillance and self policing 
aiming at greater transparency of financial operations and new standards 
for capital. Despite the fact that it was Northern finance capital that 
triggered the Asian crisis, the Basel process focused on making 
developing country financial institutions and processes transparent and 
standardized along the lines of what Wade calls the "Anglo-American" 
financial model.

While there were calls for regulation of the proliferation of many of 
the new, sophisticated financial instruments such as derivatives being 
placed on the market by developed country financial institutions, these 
got nowhere. Assessment and regulation of derivatives were to be left to 
market players who had access to sophisticated quantitative "risk 
assessment" models that were being developed.

Focused on disciplining developing countries, the Basel II process 
accomplished so little in the way of self regulation of global financial 
from the North that even Wall Streeter Robert Rubin, formerly Secretary 
of the Treasury under President Clinton, warned in 2003 that "future 
financial crises are almost surely inevitable and could be even more 
severe."

As for risk assessment of derivatives such as the "collaterized debt 
obligations" (CDOs) and "structured investment vehicles" (SIVs)-the 
cutting edge of what the Financial Times has described as "the vastly 
increased complexity of hyperfinance"--the process collapsed almost 
completely, with the most sophisticated quantitative risk models left in 
the dust as risk was priced according to one rule by the sellers of 
securities: Underestimate the real risk and pass it on to the suckers 
down the line. In the end, it was difficult to distinguish what was 
fraudulent, what was poor judgment, what was plain foolish, and what was 
out of anybody's control. As one report on the conclusions of a recent 
meeting of the Group of Seven's Financial Stability Forum put it:

[T]here is plenty of blame to go around for the financial chaos: The US 
subprime mortgage market was marked by poor underwriting standards and 
‘some fraudulent practices.' Investors didn't carry out sufficient due 
diligence when they bought mortgage-backed securities. Banks and other 
firms managed their financial risks poorly and failed to disclose to the 
public the dangers on and off their balance sheets. Credit-rating 
companies did an inadequate job of evaluating the risk of complex 
securities. And the financial institutions compensated their employees 
in ways that encouraged excessive risk-taking and insufficient regard to 
long-term risks.

The Specter of Overproduction

It is not surprising that the G 7 report sounded very much like the 
post-mortems of the Asian financial crisis and the dot.com bubble. One 
chieftain of a financial corporation chief writing in the Financial 
Times captured the basic problem running through these speculative 
manias, perhaps unwittingly, when he claimed that "there has been an 
increasing disconnection between the real and financial economies in the 
past few years. The real economy has grown...but nothing like that of 
the financial economy, which grew even more rapidly-until it imploded." 
What his statement does not tell us is that the disconnect between the 
real and the financial is not accidental, that the financial economy 
expanded precisely to make up for the stagnation of the real economy.

This growing gap between the financial and the real cannot be 
comprehensively understood without referring to the crisis of 
overaccumulation that overtook the center economies in the late 
seventies and 1980's, a phenomenon that is also referred to as 
overproduction or overcapacity.

The golden period of postwar growth globally that skirted major crises 
for nearly 25 years was due to the massive creation of effective demand 
via rising wages for labor in the North, the reconstruction of Europe 
and Japan, and the import-substituting industrialization in Latin 
America and other parts of the South. This was done principally via 
state intervention in the economy. This dynamic period came to a close 
in the mid-seventies, with stagnation setting in, owing to global 
productive capacity outrunning global demand, which was constrained by 
continuing deep inequalities in income distribution. According to the 
calculations of Angus Maddison, the premier expert on historical 
statistical trends, the annual rate of growth of global gross domestic 
product (GDP) fell from 4.9 per cent in what is now regarded as the 
golden age of the post-World War II Bretton Woods system, 1950-73, to 3 
per cent in 1973-89, a drop of 39 per cent. These figures reflected the 
wrenching combination of stagnation and inflation in the North, the 
crisis of import substitution industrialization in the South, and 
erosion of profit margins all around.

In the eighties and nineties, global capital blazed three escape routes 
from the specter of stagnation. One was neoliberal restructuring, which 
included redistribution of income towards the top via tax cuts for the 
rich, deregulation, and an assault on organized labor. Neoliberalism 
took the form of Thatcherism and Reaganism in the developed North and 
World Bank and International Monetary Fund (IMF)-imposed structural 
adjustment in the global South.

Another was corporate-driven globalization or "extensive accumulation," 
which opened up markets in the developing world and moved capital from 
high-wage to low-wage areas. As Rosa Luxemburg long ago pointed out in 
her classic The Accumulation of Capital, capital needs to constantly 
integrate precapitalist societies to the capitalist system to shore up 
the fall in the rate of profit. In the last two decades, the most 
spectacular case of incorporating a precapitalist society into the 
global capitalist system was China, which became both the world's second 
biggest exporter and the primary destination of foreign investment. This 
was, however, a double edged sword for capitalism, as we shall later see.

A third was the process we are mainly concerned with here: "intensive 
accumulation or "financialization," that is, the channeling of 
investment towards financial speculation, where much greater returns 
were to be derived than in industry, where profits were largely 
stagnant. Finance capital forced the elimination of capital controls, 
the result being the rapid globalization of speculative capital to take 
advantage of differentials in interest and foreign exchange rates in 
different capital markets. These volatile movements, the result of 
capital's liberation from the fetters of the post-war Bretton Woods 
financial system, was one source of instability. Another was the 
proliferation of novel sophisticated speculative instruments like 
derivatives that escaped monitoring and regulation. Instability derived 
ultimately from the fact that speculative finance boiled down to an 
effort to squeeze more "value" out of already created value instead of 
creating new value since the latter option was precluded by the problem 
of overproduction in the real economy.

The disconnect between the real economy and the virtual economy of 
finance was evident in dot.com bubble of the 1990's. With profits in the 
real economy stagnating, the smart money flocked to the financial 
sector. The workings of this virtual economy were exemplified by the 
rapid rise in the stock values of Internet firms which, like Amazon.com, 
still had to turn a profit. The dot.com phenomenon probably extended the 
boom of the 1990's by about two years. "Never before in US history," 
Robert Brenner wrote, "had the stock market played such a direct, and 
decisive, role in financing non-financial corporations, thereby powering 
the growth of capital expenditures and in this way the real economy. 
Never before had a US economic expansion become so dependent upon the 
stock market's ascent." But the divergence between momentary financial 
indicators like stock prices and real values could only proceed to a 
point before reality bit back and enforced a "correction." And the 
correction came savagely in the dot.com collapse of 2002, in the form of 
the wiping out of $7 trillion in investor wealth.

A long recession was avoided, but it was only by encouraging another 
bubble, the housing bubble, and here, as noted earlier, Greenspan played 
a key role by cutting the prime rate to a 45-year low of 1 per cent in 
June 2003, holding it there for a year, then raising it only gradually, 
in quarter-percentage-increments. As Dean Baker put it, "an 
unprecedented run-up in the stock market propelled the US economy in the 
late nineties and now an unprecedented run-up in house prices is 
propelling the current recovery."

The result was that real estate prices rose by 50 per cent in real 
terms, with the run-ups, according to Baker, being close to 80 per cent 
in the key bubble areas of the West Coast, the East Coast, North of 
Washington, DC, and Florida. How big was the bubble created? It is 
estimated by Baker that the run-up in house prices "created more than $5 
trillion in real estate wealth compared to a scenario where prices 
follow their normal trend growth path. The wealth effect from house 
prices is conventionally estimated at five cents to the dollar, which 
means that annual consumption is approximately $250 billion (2 per cent 
of gross domestic product [GDP]) higher than it would be in the absence 
of the housing bubble."

The China Factor

The housing bubble fueled US growth, which was exceptional given the 
stagnation that has gripped most of the global economy in the last few 
years. During this period, the global economy has been marked by 
underinvestment and persistent tendencies toward stagnation in most key 
economic regions apart from the US, China, India, and a few other 
places. Weak growth has marked most other regions, notably Japan, which 
was locked until very recently into a one per cent GDP growth rate, and 
Europe, which grew annually by 1.45 per cent in the last few years.

With stagnation in most other areas, the US has pulled in some 70 per 
cent of all global capital flows. A great deal of this has come from 
China. Indeed, what marks this current bubble period is the role of 
China as a source not only of goods for the US market but also capital 
for speculation. The relationship between the US and Chinese economies 
is what I have characterized elsewhere as "chain-gang economics": On the 
one hand, China's economic growth has increasingly depended on the 
ability of American consumers to continue their debt financed spending 
spree to absorb much of the output of China's production. On the other 
hand, this relationship in depends on a massive financial reality: the 
dependence of US consumption on China's lending the US Treasury and 
private sector dollars from the reserves it accumulated from its yawning 
trade surplus with the US-some one trillion so far, according to some 
estimates. Indeed, a great deal of the tremendous sums China-and other 
Asian countries--lent to American institutions went to finance middle 
class spending on housing and other goods and services, prolonging the 
US's fragile economic growth but only by raising consumer indebtedness 
to dangerous, record heights.

The China-US coupling has had massive consequences for the global 
economy. One has to do with the addition of massive new productive 
capacity by American and other foreign investors moving to China. This 
has aggravated the persistent problem of overcapacity and 
overproduction. One indicator of persistent stagnation in the real 
economy is the aggregate annual global growth rate, which averaged 1.4 
per cent in the 1980's and 1.1 per cent in the 1990's, compared to 3.5 
per cent in the 1960's and 2.4 per cent in the 1970's. Moving to China 
to take advantage of low wages may shore up profit rates in the short 
term but, as it adds to overcapacity in a world where a rise in global 
purchasing power is limited owing to growing inequalities, it erodes 
profits in the long term. And indeed, the profit rate of the largest 500 
US transnational corporations, which fell drastically from +4.9 per cent 
in the 1954-59, to +2.04 in 1960-69, to -5.30 in 1989-89, -2.64 in 
1990-92, and -1.92 in 2000-2002. Behind these figures, notes Philip 
O'Hara, was the specter of overproduction: "Oversupply of commodities 
and inadequate demand are the principal corporate anomalies inhibiting 
performance in the global economy."

The succession of speculative manias in the US have had the function of 
absorbing investment that did not find profitable returns in the real 
economy and thus not only artificially propping up the US economy but 
also "holding up the world economy," as one IMF document put it. Thus, 
with the bursting of the housing bubble and the seizing up of credit in 
almost the whole financial sector, the threat of a global downturn is 
very real.

Decoupling or Chain-Gang Economics?

In this regard, talk about a process of "decoupling" of regional 
economies, especially the Asian economic region, from the United States 
has been without substance. True, most of the other economies in East 
and Southeast Asia have been pulled along by the Chinese locomotive. In 
the case of Japan, for instance, a decade-long stagnation was broken in 
2003 by the country's first sustained recovery, fueled by exports to 
slake China's thirst for capital and technology-intensive goods; exports 
shot up by a record 44 per cent, or $60 billion. Indeed, China became 
the main destination for Asia's exports, accounting for 31 per cent 
while Japan's share dropped from 20 to 10 per cent. As one account 
pointed out, "In country-by-country profiles, China is now the 
overwhelming driver of export growth in Taiwan and the Philippines, and 
the majority buyer of products from Japan, South Korea, Malaysia, and 
Australia."

However, as research by Jayati Ghosh and C.P. Chandrasekhar has 
underlined, China is indeed importing intermediate goods and parts from 
these countries but only to put them together mainly for export as 
finished goods to the US and Europe, not for its domestic market. Thus, 
"if demand for Chinese exports from the US and the EU slow down, as will 
be likely with a US recession, this will not only affect Chinese 
manufacturing production, but also Chinese demand for imports from these 
Asian developing countries." Perhaps the more accurate image is that of 
a chain gang linking not only China and the United States but a host of 
other satellite economies whose fates are all tied up with the now 
deflating balloon of debt-financed middle class spending in the US.

New Bubbles to the Rescue?

One must not, however, overestimate the resiliency of capitalism. Many 
are now asking: After the collapse of the dot.com boom and the housing 
boom, is there a third line of defense against stagnation owing to 
overcapacity? One theory is that military spending could be a way that 
the government might pull the US out of the jaws of recession. And, 
indeed, the military economy did play a role in bringing the US out of 
the 2002 recession, with defense spending in 2003 accounting for 14 per 
cent of GDP growth while representing only four per cent of the GDP of 
the US. According to estimates cited by Chalmers Johnson, 
defense-related expenditures will exceed $1 trillion for the first time 
in history in 2008.

Stimulus could also come from the related "disaster capitalism complex" 
so well studied by Naomi Klein--that "full fledged new economy in home 
land security, privatized war and disaster reconstruction tasked with 
nothing less than building and running a privatized security state both 
at home and abroad." Klein says that, in fact, "the economic stimulus of 
this sweeping initiative proved enough to pick up the slack where 
globalization and the dot.com booms had left off. Just as the Internet 
had launched the dot.-com bubble, 9/11 launched the disaster capitalism 
bubble." This subsidiary bubble to the real estate bubble appears to 
have been relatively unharmed so far by the collapse of the latter.

It is not easy to track the sums circulating in the disaster capitalism 
complex, but one indication is that InVision, a General Electric 
affiliate, producing high tech bomb detection devises used in airports 
and other public spaces received an astounding $15 billion in Homeland 
Security contracts between 2001 and 2006.

Whether or not "military Keynesianism" and the disaster capitalism 
complex can in fact play the role played by financial bubbles is open to 
question. For to feed them, at least during the Republican 
administrations, has meant reducing social expenditures, resulting in 
their positive employment effects being overwhelmed fairly quickly by 
reductions in effective demand. A study Dean Baker cited by Johnson 
found that after an initial demand stimulus, by about the sixth year, 
the effect of increased military spending turns negative. After 10 years 
of increased defense spending, there would be 464,000 fewer jobs than in 
a scenario of lower defense spending.

But even more important as a limit to military Keynesianism and disaster 
capitalism is that the military engagements to which they are bound to 
lead are likely to create quagmires such as Iraq and Afghanistan that 
could trigger a backlash both abroad and at home. This would eventually 
erode the legitimacy of these enterprises, reduce their access to tax 
dollars, and erode their viability as sources of economic expansion in a 
contracting economy.

Yes, global capitalism may be resilient, but it looks like its options 
are increasingly limited. The forces making for the long term stagnation 
of the global capitalist economy are now too heavy to be easily shaken 
off by the economic equivalent of mouth-to-mouth resuscitation.


*Dr. Walden Bello is president of the Freedom from Debt Coalition and 
senior analyst at Focus on the Global South.