From global credit crunch to global recession: After the thunder, comes the rain
3 December 2008
This article first appeared on fifthinternational.org
The gathering storm of the year-long credit crunch finally burst this autumn in an explosive banking crisis. Now, as the financial crisis continues to deepen, a global recession has begun. Luke Cooper asks whether Western governments and central banks have the power to stop it
Even looking back on them with a sense of perspective, the events in the autumn of 2008 remain remarkable. The world financial system faced outright collapse, central banks pumped in trillions to prop it up. Share and credit markets were infected with blind panic and banks were nationalised. The capitalist state had to step in to save capitalism from itself.
This is surely one of those traumatic moments when capitalism goes into sudden metamorphosis, when the assumptions and norms of a whole period in history are shattered and rapid change ensues. Already, the Crisis of 2008 takes its place in the history books alongside the other great crises that shaped politics and class relations for decades: the economic crisis of 1847-48, the Wall Street Crash of 1929-31, the oil shock of 1973 and the Volcker shock of 1978 which opened the deep recession of the early 1980s.
The collapse of Lehman Brothers in September was the first truly devastating event of the developing perfect storm. It drove key US investment banks and UK retail banks into the hands of the state. By November, we were in the eye of the storm; a kind of desolate calm set in as hundreds of millions of people across the world braced themselves for the coming recession.
Attention has now switched from Wall St to the High Street as the major world economies face a severe contraction in economic activity. A world recession is now underway.
The response of governments has been to take anti-cyclical measures: attempts to offset the crisis and slow the recession by injecting money back into the system, either through increased government spending or tax breaks. At the same time, they are desperate to stabilise the financial system so that the banks can resume lending, to encourage consumer spending and ensure corporations have sufficient capital to maintain their operations.
The question everyone is asking is, will it work? Will these measures be sufficient to stop a serious and prolonged world recession?
Global recession spreads
There is widespread agreement that the world's major economies are heading into the recession phase of the industrial cycle. In Britain, second quarter GDP growth was 0 per cent while the third quarter saw a sharp contraction of 0.5 per cent, a recession in all but name. Now, Chancellor of the Exchequer Alistair Darling has revised his projection for 2009 from 2.75 per cent to between minus 0.75 per cent and minus 1.25 per cent, what the BBC calls "the biggest downward revision on record".
In Germany, a 0.4 per cent contraction was followed by another 0.5 per cent contraction leaving the economy "officially" (two consecutive quarters of negative growth) in recession. The Eurozone as a whole also saw two consecutive quarters of negative growth of 0.2 per cent, while there was small comfort for France, which escaped an "official" recession, and registered third quarter GDP growth of 0.1 per cent.
In Asia, Japan fell into recession with 0.4 per cent then 0.1 per cent contraction in the second and third quarters respectively. At the same time, growth has begun falling in China, down from nearly 12 per cent to 9 per cent but projected to go below the 7 per cent level in the final quarter of this year. This has already led to widespread factory closures and workers protests. In the United States, which registered a surprise 2.3 per cent growth in the second quarter, as exporters benefited from the declining dollar, growth contracted by 0.3 per cent in the third quarter of 2008.
The spreading of recession through the world economy illustrates how important credit has been to global economic growth in the globalisation period. The retail consumption boom in Britain and the United States over the last two decades was largely funded through credit secured on soaring real estate and property prices. Now, property and real estate prices are plunging, as credit assets they are increasingly worthless so consumption is drying up.
Exporters dependent on the American market are being hit hard, too. Germany, the world's largest exporter, was clobbered by the drying up of US consumption, while the weak dollar made German exports less attractive compared to American ones. It was dragged into recession even though its domestic economy had been at the mid-point of the upward phase of its cycle. China is similar in that it, too, is heavily dependent on the American and European export markets. But this should not be over-estimated either. Declining exports only intensified the downturn already underway in China, which is principally caused by the domestic economy running up against the limits of its own feverish expansion with chronic over-capacity now existing in nearly every sector.
Credit crunch far from over
With attention now focused on the recession in the world's major economies, the fact that the financial aspect of the crisis is far from over is increasingly overlooked. It is amazing that the bailout of Citigroup by the US Treasury Department did not even make the front pages, despite this mega corporation being the world's largest bank with some 200 million customers and total assets nearly equivalent to Britain's entire economic output.
Like the world's largest insurer, AIG, before it, Citigroup has been partially nationalised, with the US government exchanging a $20 billion re-capitalisation, along with the promise to absorb losses on $306 billion in toxic credit assets, for preference shares. As the BBC's Robert Peston put it, the deal is as close as you can get to full nationalisation without the state taking 100 per cent ownership. The only comfort for shareholders is that their bits of paper are not entirely worthless, though they are worth less than 10 per cent of what they were two years ago and the US Treasury has promised that future dividend payments to shareholders will be restricted.
Citigroup shows that bailouts of more financial institutions remain on the cards. In Britain, a study by the National Institute of Economic and Social Research argued that the High Street banks need up to £110 billion in re-capitalisation to restore normal lending conditions. This figure dwarfs the £37 billion pumped directly into the banks in exchange for equity and amounts to around 8 per cent of Britain's annual GDP. Were the government to put in this amount of capital, it would amount to the full-scale nationalisation of the banking system at current share values.
Far from dismissing this suggestion out of hand as some loony-left plot, chairman of the Commons Treasury Committee, John McFall, an ally of Brown and Darling, said if the banks did not resume normal lending "the demand for full-scale nationalisation would grow". The fact the British government is even willing to countenance such a proposal illustrates how desperate governments are for the banks to resume lending to shore up consumer spending and ensure businesses have sufficient liquidity to survive the recession.
It also illustrates that their strategy, making billions available to guarantee inter-bank lending and provide cheap, short-term credit; part-nationalisation of some banks; and slashing central bank interest rates (1 per cent USA, 3 per cent Britain, 3.25 per cent Eurozone) is not working.
The banks are still not providing sufficient credit to lubricate the system. Figures from the British Banking Association showed that, in October, 21,584 new mortgages for house purchases were approved, down 52 per cent on 12 months earlier. Total mortgage lending, including re-mortgaging and equity release schemes, stood at £11.9 billion, down 39 per cent on 12 months earlier.
Total lending to consumers and non-financial businesses grew in September at the lowest rate since 1998, and much of this is driven by desperation as companies cash flow dries up. Lack of spare credit is such a threat that Richard Lambert, the Director General of the CBI, wrote to the prime minister pleading with him to get the banks lending again:
[businesses] cannot get their hands on the cash and credit they need to go about their day-to-day business, there is a real risk that we could see healthy firms going under. The next six months will be critical. If we are to stand a fighting chance of preventing this recession from becoming longer and more painful, we need to act now to get the credit markets working properly.Get the banks lending again?
This whole debate amongst business leaders and governments makes a striking change from two months ago, when the same people were condemning the banks for irresponsible lending and blaming "regulatory breakdown" for the crisis. This had led to the banks extending loans to borrowers who could not afford to pay them back. Let's remember that the Credit Crunch began with the sub-prime mortgage crisis. Poor Americans were encouraged to take out loans they could not afford on the basis that house prices would continue to increase. As the US economy began to slow and unemployment increased, the speculative boom in house prices and real estate ran its course and sub-prime borrowers began to default, sparking a domino effect that nearly brought down the global financial system. The Credit Crunch was not simply a crisis in the financial system, isolated from the "real economy", it was triggered by the slowdown in the American industrial-commercial cycle.
Governments, particularly in Britain and the United States, are still treating the crisis as something mainly internal to finance. Their aim is to get the banks lending again so they can pump more credit into the system and stimulate the real economy, as they did during the last downturn in 2001 - 2003. The whole policy is profoundly flawed. As long as the banks are commercial institutions they will not extend loans to borrowers, either businesses or individuals, who cannot pay them back (whether at sufficient interest or at all). Their balance sheets are screaming out the need to "deleverage", that is, to withdraw credit, call in loans, before extending any new ones.
Take, for example, Barclays and Deutsche Bank who both declined government offers of part-nationalisation. As The Economist (6 November) pointed out, this should not be taken as sign of rude health. Both institutions have just moved their toxic assets "off balance sheet", valuing them at the rate they bought them at rather than what they could be exchanged for now. They intend to sit on them, hoping they will mature back to their purchase prices. This was allowed for by a quiet change to international accountancy rules, RBS and Lloyds TSB followed suit, by the way, which means these financial institutions can avoid the damaging write-downs of the last year.
Whether this works is dependent not only on how serious their exposure to existing toxic credit assets is, but also whether more of their healthy assets "turn toxic" as the downturn really bites. And this is the savage beauty of this perfect storm. Firms starved of credit go bust. Administrators can "pay back those firms" loans and this triggers write-downs and further losses in the banks. Suppliers, too, are hit, as they are dependent on orders from the bankrupted firms. Workers are laid off en masse. Retail consumption collapses. More firms go bust. In short, a series of negative feedback mechanisms in the system deepen the crash.
We are already seeing this process beginning. The "big three" American car makers are facing bankruptcy and asking for a government bail out, with as many as two million jobs at stake. In Britain, Woolworths and MFI are now in administration with thirty thousand jobs on the line. No wonder the banks are reluctant to extend new lines of credit into the system as it enters the crash phase of the cycle.
The response of governments in Britain and America is, thus, completely futile. This is particularly illustrated by the vacillations of Henry Paulson and the US Treasury over how to use its $700 billion bail out fund. The original plan was to buy up all the toxic assets and hold them in a state owned "toxic bank". The decision by the Brown government to part-nationalise major high street banks forced Paulson's hand, unless he also offered part-nationalisation, US banks would be competing with British banks partially secured by taxpayers money. So Paulson did a u-turn and adopted the part-nationalisation plan instead. But, surprise, surprise, this led to the bottom falling out of the credit markets, as the banks rushed to sell their toxic assets, which they had expected the US government to buy. The result? Paulson announced another u-turn: they would buy up equity stakes and buy the toxic assets.
All attempts to get the banks lending again ultimately posit the complete nationalisation of the banking system because for-profit institutions simply will not extend risky loans in the current conditions. This is not, however, the only option being considered. Mervyn King, the governor of the Bank of England, has even called for loosening banks' capital requirements, the cash they have in the vaults relative to the credit notes they write, to encourage more lending (Financial Times, 25 November). There was not even any hint of irony in this statement, a call for more financial liberalisation. Will they ever learn? It doesn't look like it. As Martin Wolf put it, "nobody who looks at the UK economy today can seriously believe that the answer is much more debt. The era of soaring borrowing and the associated boom in finance is over." (Financial Times, 24 November).
This is what the British and American governments have yet to come to terms with, and it will not be easy. For three decades, they nurtured a bloated financial sector. The markets in London and Wall Street massively expanded their operations in an orgy of what the capitalists dare to call "wealth creation" and what Marxists call parasitism.
In official capitalist economics, banks and finance houses that advance interest-bearing capital are described as "creating wealth" because they provide funds for investment in profitable enterprises. While recognising the role of finance in coordinating and organising capitalist production and commerce, Marxists have a far better way of understanding the relation between finance and "wealth creation".
Interest-bearing capital is advanced as a precondition of capitalist production in return for making a charge on the profits of that enterprise. In return for extending what Marxists call "fictitious capital", bits of paper that underwrite investments, the financial institutions extract royalties on future productive activity. This can take the form of credit, where the royalty is returned as interest payments (debt), or stocks and bonds, which give the investor a legal claim on future profits (equity). These bits of paper are then themselves traded with changes in market prices, encouraging speculation.
Of course, this can take many forms, the point is that this activity is both indispensable for a developed capitalist system, and parasitic on production (the real economy). Crucially, the financiers are both privileged, in terms of having far greater access to detailed information about markets, and yet, at the same time, blind - ultimately they are speculating on what future profits will be from a number of profit-generating investments. The system demonstrates positively the possibility of planning an economy, and negatively the absolute contradiction between rational planning and production for profit.
So, in the last two decades, when financial profits far exceeded non-financial profits, this was a sign that finance capital was assuming that future profits would far exceed existing ones. As we have seen, this assumption was radically false. The Credit Crunch can thus be understood as a devastating realignment between the imagined worth of financialised assets and their real underlying value.
From an inflationary to a deflationary crisis
One feature of the crisis over the last 18 months has been spiralling inflation, particularly in commodity prices. Between the summer of 2007 and April 2008, world food prices shot up by around 40 per cent. World oil prices peaked at over $145 dollars per barrel in the summer of 2008, a colossal rise when you think the oil price was $10 dollars a barrel ten years earlier.
Dramatic surges in prices are a classic feature of the end of the expansionary phase of the business cycle. They are driven by the competitive struggle between capitalists to realise the maximum possible profits across the cycle. The capitalists invest heavily in machines and technology to raise productivity and increase the mass of profit. As a result, the costs of production increase and the capitalist passes this on to consumers in the form of higher prices. At the same time, demand for raw materials spurs price rises in this sector, too. In Volume 2 of Capital, Marx shows how disproportions between the sector that produces machinery and means of production and the sector that produces consumer goods mean that, in the expansionary phase of the cycle, employment rises faster than the supply of wage goods. This causes price rises, and wage rises, as the cycle pushes towards its peak. This is just one cause of inflation, the reason it arises in the upward phase of the cycle. There are other causes, too, causes that aggravate inflation in the crisis phase.
As Richard Brenner shows in "The Credit Crunch : A Marxist Analysis", this process stores up tremendous contradictions. To maximise profits, capitalists expand investment in "constant capital" (machinery, buildings and raw materials) more rapidly than in living labour (variable capital) but, in the final analysis, it is only the unpaid element of the labour of living people that generates profit. As a result, the rising proportion of constant to variable capital gives rise to a tendency of the rate of profit (the profit relative to investment) to fall. If this tendency did not exist then capitalism would simply expand indefinitely, employing ever more workers and generating ever more profits but, of course, it doesn't do that. Quite the opposite.
As profit rates fall, eventually the mass of profit goes down (that's why we see profit warnings and corporate collapses). Banks and other lenders spot this early on and withdraw loans. As too much capital is now chasing too few opportunities for profitable returns, capital must be destroyed (devalued) before a new round of expansion can begin.
It is important to understand this because, in the crisis phase, inflation appears as a form of devaluation. Of which commodity? Of money.
An increase in the amount of the money circulating in the system, through credit or by central banks printing money, will also tend to cause inflation. More money is chasing the same goods so the prices of those goods will tend to rise and the value of money will fall. Normally, this is what would have happened when governments in the US and UK used cheap credit to allow a dramatic increase in money in circulation to avoid a deep recession in 2001-03. However, as Workers Power has argued for some time, this was offset by the deflationary impact of cheap commodities based on the exploitation of cheap Asian labour. This effect has declined since early 2007, as China's capitalist development created its own inflationary pressures. But, if inflation is such a problem, why is there now a sudden panic about a "deflationary" crisis?
First of all, when we speak of a global deflationary environment created by the expansion of Asian capitalism in the globalisation era, we are talking specifically about commodity prices. At the same time as commodity prices were cheap, there was dramatic inflation in other parts of the capitalist economy: rising prices in stocks and shares, in real estate, in property, for example. There was, therefore, a certain equilibrium between inflation and deflation at different points in the system. This led to a low inflation environment in Britain and the United States, Gordon Brown, for example, was able to meet his 2 per cent inflation target as chancellor. It is this relative equilibrium that has now unwound.
The panic about deflation is because it is another means for capital to become devalued. It can mean a devaluation of capital invested in property, in raw materials, in commodities and industry. As capitalists cannot realise profits from these investments, they will tend to hoard cash and only reinvest when they are convinced the market has reached its bottom and capital will not be devalued any further. Of course, those capitalists with active investments, in consumer goods like clothing, for example, will be desperate to shift their stockpiles of goods and will slash prices to do so. At the same time, as profits from industries dry up, banks will be reluctant to extend cheap credit, indeed, they will raise commercial interest rates, which naturally further encourages the hoarding of cash in high yield savings accounts. We see once more the negative feedback mechanisms exacerbating the crash.
The British and American governments now consider this kind of deflationary recessionary environment as the bigger danger, rather than the risk of pumping too much money into the system and fuelling inflation. Certainly, deflation appears to be the big danger at the moment. The Bank of England Monetary Policy Committee predicts that the Retail Price Index measure of inflation will "go negative" next year and this is the first time the committee, set up by Brown in 1997, has predicted actual price deflation. This is a result of the sheer scale of devaluation that is happening in the global recession.
Pumping money into the system
There are good reasons for thinking the drive to re-stimulate the credit markets and get lending going again faces huge obstacles, not least from the banks themselves. But what would happen on the (perhaps hypothetical) assumption that it was successful?
In effect it would encourage further fictitious capital creation and, while it might create a speculative boost in housing and real estate for a time, it would again run up against the same problem as before: can the value anticipated by the expansion of fictitious capital be realised in the productive sector? This seems unlikely so, even if, in the short term, Brown and Obama force banks to reactivate large scale lending, any sudden credit-induced boom would be likely to be followed by another sharp crash.
Jump-starting the credit markets is only one part of the strategy now being employed by governments. There are also plans to push a major "fiscal stimulus", including state spending on construction, infrastructure and maintaining existing welfare spending levels, along with tax cuts, financed through an expansion in state borrowing. In Britain, Alistair Darling announced a £20 billion stimulus including a 2.5 per cent cut in VAT and a £3 billion pound investment in schools, road building projects and social housing. While this may seem like a lot, it is miniscule in the scheme of things, just 1 per cent of British GDP and in no way sufficient to reactivate the economy again. Even the cut in VAT is probably more to do with the government anticipating a decline in prices as demand collapses, which they want to take the credit for, rather than a genuine attempt to stimulate economic growth.
In the United States, Obama has promised a state spending stimulus package of between $500 and $700 billion, but has not yet disclosed the details. In China, the government has launched a similar stimulus plan they claim is worth some $586 billion, and the European Union proposed a €200 billion plan. While the details of the plans will naturally vary, the aim is essentially the same: to increase demand for commodities in the economy. In the case of Britain, most of the EU states and the USA, this will be financed through increasing the state spending deficit by soliciting loans from the international money markets. China, on the other hand, can dip into huge savings reserves, as well as the foreign exchange it has accumulated through its export industries and may also be a source of credit.
Whatever the sources of the money may be, and this is certainly not unimportant for power relations between states, all these stimulus packages to different degrees are Keynesian insofar as they use state action in the attempt to stimulate demand for commodities. Can it solve the crisis and stop a recession?
In a word, no - but it can delay it and change its form. The crisis is driven by an over-accumulation of capital; too much capital is chasing too few opportunities for profitable investment. To create conditions for a sustained recovery, this over-accumulated capital must be devalued and destroyed. Pumping money into the economy will partially obstruct the spontaneous destruction of that capital through, for example, businesses collapsing. In the short term, this may appear successful by increasing demand for labour and means of production, encouraging a new bout of speculation in fictitious capital and increasing consumption levels. But this cannot last for long. Pumping money into the system does nothing to devalue or destroy over-accumulated capital, but encourages deeper over-accumulation, storing up problems for the future.
In the specific circumstances of today, there are good reasons for thinking that the crisis is of such severity, that the over-accumulation of capital has got so acute, that these Keynesian tax and spend measures will not even be able to delay the crisis. George Bush used similar fiscal measures in 2001-2003 when he slashed taxes and massively increased military spending. This was what "stored up the problems for the future" that exploded this year. When we consider the enormous crisis in the credit system, it is difficult to imagine that even a stimulus to the tune of hundreds of billions of dollars will stimulate re-leveraging on the scale western economies have grown used to.
This all points to a deep and sharp recession in 2009. It also means government spending and growth targets are unlikely to be met. In Britain, by January 2010, there could be three million unemployed, an economy contracting faster and deeper than government targets and a public sector deficit running out of control.
As the crisis phase, a moment of violent transition in finance and politics, morphs into a large-scale process of capital destruction in real productive capacity, a recession sets in: workplaces will close, goods will be dumped, workers will be thrown on the dole.
The task of Marxists is, of course, not to oppose Keynesian reflationary spending schemes per se, but to demand that not a penny goes to bailing out billionaires and parasites. That vast publicly funded works schemes that generate socially useful employment are funded through steep progressive taxes on profit and unearned wealth. That the banks and finance houses are not propped up with public funds but expropriated and merged into a single state bank run to coordinate production and distribution to meet human needs in a sustainable way, rather than for obscene private profit.
Marxists will continue to point out at
every opportunity that the inflationary consequences of Keynesian policy
testify not to the impossibility of taking action to reduce the negative
effect of the crisis on working people, but to the impossibility of freeing
the mass of the people from the depredations of crisis and recession without
overcoming the limitations of the capitalist system itself. The crisis
is caused by the contradictions of capital; only by freeing ourselves from
capital can we build a higher form of civilisation free from convulsive
economic and social crises.