Monday, December 29, 2008
Thursday, December 11, 2008
Behind the debate over remaking U.S. financial policy will be a debate over who’s to blame. It’s crucial to get the history right, writes a Nobel-laureate economist, identifying five key mistakes—under Reagan, Clinton, and Bush II—and one national delusion.
by Joseph E. Stiglitz
There will come a moment when the most urgent threats posed by the credit crisis have eased and the larger task before us will be to chart a direction for the economic steps ahead. This will be a dangerous moment. Behind the debates over future policy is a debate over history-a debate over the causes of our current situation. The battle for the past will determine the battle for the present. So it's crucial to get the history straight.
What were the critical decisions that led to the crisis? Mistakes were made at every fork in the road-we had what engineers call a "system failure," when not a single decision but a cascade of decisions produce a tragic result. Let's look at five key moments.
No. 1: Firing the Chairman
In 1987 the Reagan administration decided to remove Paul Volcker as chairman of the Federal Reserve Board and appoint Alan Greenspan in his place. Volcker had done what central bankers are supposed to do. On his watch, inflation had been brought down from more than 11 percent to under 4 percent. In the world of central banking, that should have earned him a grade of A+++ and assured his re-appointment. But Volcker also understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing, and he found him in a devotee of the objectivist philosopher and free-market zealot Ayn Rand.
Greenspan played a double role. The Fed controls the money spigot, and in the early years of this decade, he turned it on full force. But the Fed is also a regulator. If you appoint an anti-regulator as your enforcer, you know what kind of enforcement you'll get. A flood of liquidity combined with the failed levees of regulation proved disastrous.
Greenspan presided over not one but two financial bubbles. After the high-tech bubble popped, in 2000-2001, he helped inflate the housing bubble. The first responsibility of a central bank should be to maintain the stability of the financial system. If banks lend on the basis of artificially high asset prices, the result can be a meltdown-as we are seeing now, and as Greenspan should have known. He had many of the tools he needed to cope with the situation. To deal with the high-tech bubble, he could have increased margin requirements (the amount of cash people need to put down to buy stock). To deflate the housing bubble, he could have curbed predatory lending to low-income households and prohibited other insidious practices (the no-documentation- or "liar"-loans, the interest-only loans, and so on). This would have gone a long way toward protecting us. If he didn't have the tools, he could have gone to Congress and asked for them.
Of course, the current problems with our financial system are not solely the result of bad lending. The banks have made mega-bets with one another through complicated instruments such as derivatives, credit-default swaps, and so forth. With these, one party pays another if certain events happen-for instance, if Bear Stearns goes bankrupt, or if the dollar soars. These instruments were originally created to help manage risk-but they can also be used to gamble. Thus, if you felt confident that the dollar was going to fall, you could make a big bet accordingly, and if the dollar indeed fell, your profits would soar. The problem is that, with this complicated intertwining of bets of great magnitude, no one could be sure of the financial position of anyone else-or even of one's own position. Not surprisingly, the credit markets froze.
Here too Greenspan played a role. When I was chairman of the Council of Economic Advisers, during the Clinton administration, I served on a committee of all the major federal financial regulators, a group that included Greenspan and Treasury Secretary Robert Rubin. Even then, it was clear that derivatives posed a danger. We didn't put it as memorably as Warren Buffett-who saw derivatives as "financial weapons of mass destruction" -but we took his point. And yet, for all the risk, the deregulators in charge of the financial system-at the Fed, at the Securities and Exchange Commission, and elsewhere-decided to do nothing, worried that any action might interfere with "innovation" in the financial system. But innovation, like "change," has no inherent value. It can be bad (the "liar" loans are a good example) as well as good.
No. 2: Tearing Down the Walls
The deregulation philosophy would pay unwelcome dividends for years to come. In November 1999, Congress repealed the Glass-Steagall Act-the culmination of a $300 million lobbying effort by the banking and financial-services industries, and spearheaded in Congress by Senator Phil Gramm. Glass-Steagall had long separated commercial banks (which lend money) and investment banks (which organize the sale of bonds and equities); it had been enacted in the aftermath of the Great Depression and was meant to curb the excesses of that era, including grave conflicts of interest. For instance, without separation, if a company whose shares had been issued by an investment bank, with its strong endorsement, got into trouble, wouldn't its commercial arm, if it had one, feel pressure to lend it money, perhaps unwisely? An ensuing spiral of bad judgment is not hard to foresee. I had opposed repeal of Glass-Steagall. The proponents said, in effect, Trust us: we will create Chinese walls to make sure that the problems of the past do not recur. As an economist, I certainly possessed a healthy degree of trust, trust in the power of economic incentives to bend human behavior toward self-interest- toward short-term self-interest, at any rate, rather than Tocqueville' s "self interest rightly understood."
The most important consequence of the repeal of Glass-Steagall was indirect-it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people's money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people's money-people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risktaking.
There were other important steps down the deregulatory path. One was the decision in April 2004 by the Securities and Exchange Commission, at a meeting attended by virtually no one and largely overlooked at the time, to allow big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher) so that they could buy more mortgage-backed securities, inflating the housing bubble in the process. In agreeing to this measure, the S.E.C. argued for the virtues of self-regulation: the peculiar notion that banks can effectively police themselves. Self-regulation is preposterous, as even Alan Greenspan now concedes, and as a practical matter it can't, in any case, identify systemic risks-the kinds of risks that arise when, for instance, the models used by each of the banks to manage their portfolios tell all the banks to sell some security all at once.
As we stripped back the old regulations, we did nothing to address the new challenges posed by 21st-century markets. The most important challenge was that posed by derivatives. In 1998 the head of the Commodity Futures Trading Commission, Brooksley Born, had called for such regulation-a concern that took on urgency after the Fed, in that same year, engineered the bailout of Long-Term Capital Management, a hedge fund whose trillion-dollar- plus failure threatened global financial markets. But Secretary of the Treasury Robert Rubin, his deputy, Larry Summers, and Greenspan were adamant-and successful-in their opposition. Nothing was done.
No. 3: Applying the Leeches
Then along came the Bush tax cuts, enacted first on June 7, 2001, with a follow-on installment two years later. The president and his advisers seemed to believe that tax cuts, especially for upper-income Americans and corporations, were a cure-all for any economic disease-the modern-day equivalent of leeches. The tax cuts played a pivotal role in shaping the background conditions of the current crisis. Because they did very little to stimulate the economy, real stimulation was left to the Fed, which took up the task with unprecedented low-interest rates and liquidity. The war in Iraq made matters worse, because it led to soaring oil prices. With America so dependent on oil imports, we had to spend several hundred billion more to purchase oil-money that otherwise would have been spent on American goods. Normally this would have led to an economic slowdown, as it had in the 1970s. But the Fed met the challenge in the most myopic way imaginable. The flood of liquidity made money readily available in mortgage markets, even to those who would normally not be able to borrow. And, yes, this succeeded in forestalling an economic downturn; America's household saving rate plummeted to zero. But it should have been clear that we were living on borrowed money and borrowed time.
The cut in the tax rate on capital gains contributed to the crisis in another way. It was a decision that turned on values: those who speculated (read: gambled) and won were taxed more lightly than wage earners who simply worked hard. But more than that, the decision encouraged leveraging, because interest was tax-deductible. If, for instance, you borrowed a million to buy a home or took a $100,000 home-equity loan to buy stock, the interest would be fully deductible every year. Any capital gains you made were taxed lightly-and at some possibly remote day in the future. The Bush administration was providing an open invitation to excessive borrowing and lending-not that American consumers needed any more encouragement.
No. 4: Faking the Numbers
Meanwhile, on July 30, 2002, in the wake of a series of major scandals-notably the collapse of WorldCom and Enron-Congress passed the Sarbanes-Oxley Act. The scandals had involved every major American accounting firm, most of our banks, and some of our premier companies, and made it clear that we had serious problems with our accounting system. Accounting is a sleep-inducing topic for most people, but if you can't have faith in a company's numbers, then you can't have faith in anything about a company at all. Unfortunately, in the negotiations over what became Sarbanes-Oxley a decision was made not to deal with what many, including the respected former head of the S.E.C. Arthur Levitt, believed to be a fundamental underlying problem: stock options. Stock options have been defended as providing healthy incentives toward good management, but in fact they are "incentive pay" in name only. If a company does well, the C.E.O. gets great rewards in the form of stock options; if a company does poorly, the compensation is almost as substantial but is bestowed in other ways. This is bad enough. But a collateral problem with stock options is that they provide incentives for bad accounting: top management has every incentive to provide distorted information in order to pump up share prices.
The incentive structure of the rating agencies also proved perverse. Agencies such as Moody's and Standard & Poor's are paid by the very people they are supposed to grade. As a result, they've had every reason to give companies high ratings, in a financial version of what college professors know as grade inflation. The rating agencies, like the investment banks that were paying them, believed in financial alchemy-that F-rated toxic mortgages could be converted into products that were safe enough to be held by commercial banks and pension funds. We had seen this same failure of the rating agencies during the East Asia crisis of the 1990s: high ratings facilitated a rush of money into the region, and then a sudden reversal in the ratings brought devastation. But the financial overseers paid no attention.
No. 5: Letting It Bleed
The final turning point came with the passage of a bailout package on October 3, 2008-that is, with the administration' s response to the crisis itself. We will be feeling the consequences for years to come. Both the administration and the Fed had long been driven by wishful thinking, hoping that the bad news was just a blip, and that a return to growth was just around the corner. As America's banks faced collapse, the administration veered from one course of action to another. Some institutions (Bear Stearns, A.I.G., Fannie Mae, Freddie Mac) were bailed out. Lehman Brothers was not. Some shareholders got something back. Others did not.
The original proposal by Treasury Secretary Henry Paulson, a three-page document that would have provided $700 billion for the secretary to spend at his sole discretion, without oversight or judicial review, was an act of extraordinary arrogance. He sold the program as necessary to restore confidence. But it didn't address the underlying reasons for the loss of confidence. The banks had made too many bad loans. There were big holes in their balance sheets. No one knew what was truth and what was fiction. The bailout package was like a massive transfusion to a patient suffering from internal bleeding-and nothing was being done about the source of the problem, namely all those foreclosures. Valuable time was wasted as Paulson pushed his own plan, "cash for trash," buying up the bad assets and putting the risk onto American taxpayers. When he finally abandoned it, providing banks with money they needed, he did it in a way that not only cheated America's taxpayers but failed to ensure that the banks would use the money to re-start lending. He even allowed the banks to pour out money to their shareholders as taxpayers were pouring money into the banks.
The other problem not addressed involved the looming weaknesses in the economy. The economy had been sustained by excessive borrowing. That game was up. As consumption contracted, exports kept the economy going, but with the dollar strengthening and Europe and the rest of the world declining, it was hard to see how that could continue. Meanwhile, states faced massive drop-offs in revenues-they would have to cut back on expenditures. Without quick action by government, the economy faced a downturn. And even if banks had lent wisely-which they hadn't-the downturn was sure to mean an increase in bad debts, further weakening the struggling financial sector.
The administration talked about confidence building, but what it delivered was actually a confidence trick. If the administration had really wanted to restore confidence in the financial system, it would have begun by addressing the underlying problems-the flawed incentive structures and the inadequate regulatory system.
Was there any single decision which, had it been reversed, would have changed the course of history? Every decision-including decisions not to do something, as many of our bad economic decisions have been-is a consequence of prior decisions, an interlinked web stretching from the distant past into the future. You'll hear some on the right point to certain actions by the government itself-such as the Community Reinvestment Act, which requires banks to make mortgage money available in low-income neighborhoods. (Defaults on C.R.A. lending were actually much lower than on other lending.) There has been much finger-pointing at Fannie Mae and Freddie Mac, the two huge mortgage lenders, which were originally government-owned. But in fact they came late to the subprime game, and their problem was similar to that of the private sector: their C.E.O.'s had the same perverse incentive to indulge in gambling.
The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, "I have found a flaw." Congressman Henry Waxman pushed him, responding, "In other words, you found that your view of the world, your ideology, was not right; it was not working." "Absolutely, precisely," Greenspan said. The embrace by America-and much of the rest of the world-of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.
© 2008 Vanity Fair
Joseph E. Stiglitz is University Professor at Columbia University. Among many books, he is the other of Globalization and Its Discontents. He received the Nobel Prize in Economics in 2001 for research on the economics of information. Most recently, he is the co-author, with Linda Bilmes, of The Three Trillion Dollar War: The True Costs of the Iraq Conflict.
Today at 5:25am
Manila Standard Today
Tuesday, December 9, 2008
It was columnist Lito Banayo who first raised the question of why the chartered Philippine Air Lines Flight 001, carrying President Gloria Arroyo and her party to the Asia-Pacific Economic Cooperation Summit in Lima, Peru last Nov. 21 was diverted in mid-flight, six hours after leaving Manila. It was made to detour to Osaka , Japan .
The First Gentleman, Mike Arroyo, was said to have suffered “severe stomach pains and vomiting” and, although there were doctors on board, it was decided to unload him in Osaka so that he could receive emergency medical treatment in a hospital.
PGMA is said to have waited for his physicians to arrive in Osaka from Manila (in a San Miguel Corporation HS-125 executive jet) before proceeding to Lima .
Banayo quotes an unnamed “friend” who asked: “Was it a case of the presidential party being alerted by phone that someone among them was going to be picked up by authorities upon landing at Los Angeles airport for money laundering activities?
“Remember that in the wake of Lehman Brothers, Merrill Lynch, AIG and so many other Wall Street corpses, the federal anti-money laundering task force may have found the smoking gun documents about the financial capers of someone in the presidential plane.
“That would have been a terrible embarrassment, because no one else in the party aboard PAL Flight PR 001 was important enough to merit a reason to retreat and fly back except the President or her husband….”
Frank Wenceslao, president of an organization called Philippine Anti-Corruption Movement USA, has a different take:
“GMA, husband and their children are reportedly barred to enter the US by virtue of the United Nations Convention against Corruption (UNCAC) and the Bush administration’s ‘No Safe Haven’ policy to deny kleptocrats to enjoy the fruits of corruption.
“The Family’s last visit when the policy was specially lifted was when Ambassador Kristie Kenney thought that the MOA on Ancestral Domain would push through and the US could negotiate a bases agreement with the Bangsa Moro.
“GMA’s US visit [last October] was only allowed for a head-of-state attending UN-related conferences or meetings.
“It is out of protocol [that] Mrs. Arroyo is allowed to come to the US , but not her husband. There is a report that Atty. Arroyo’s emergency landing in Japan happened when the presidential party learned [that] his request for [a] US visa wasn’t granted, and he really needed [one] for a stopover in Los Angeles.
“Mike Arroyo might suffer what happened to Joc Joc Bolante and be detained…”
I do not know which version, if any, is accurate: Was Mr. Arroyo about to be arrested in LAX for money laundering, or was his request for a US visa denied and he was going to detained, like Joc Joc Bolante before him, for having an expired US visa? I tend to doubt that Mr. Arroyo would leave for LAX without a valid US visa.
But both columnist Banayo and crusader Wenceslao did not mention a significant fact: namely, that six hours out of Manila, in a non-stop 12-hour flight eastward towards LAX, PAL Flight 001 would have been within a triangle described by Wake Island, Midway Island and Hawaii, the first two US territories, the third a state in the American Union..
In case of a medical emergency situation—and I have no doubt that Mr. Arroyo needed emergency help—the most logical place to make a stop would have been Honolulu, about an hour and a half away from where the plane was when the decision was made to rush him to a hospital.
Turning back to Osaka suggests that the party deliberately avoided US territory—for either of the reasons suggested by Banayo and Wenceslao, or for some other reason unknown to us. Stopping at Honolulu also would not have delayed PGMA’s trip to Lima as much as the stopover in Osaka did.
Interior Secretary Ronaldo Puno was quoted as saying that “Six more hours to reach LAX. There was no way we could wait that long. I think the precautions taken were warranted. It is very hard to take risks with anyone’s life.” What risks would there have been in landing in Honolulu , aside from the two given by Banayo and Wenceslao?
Why the presidential party seems to have deliberately avoided US territory should be the subject of a Senate investigation, not to determine if Mr. Arroyo really suffered from diarrhea, but to salvage what is left of our national self-respect.
Is it really true that Mr. Arroyo was about to be arrested by the FBI in LAX for money laundering activities? We have a right to know.
Is it really true that President Arroyo has been black-listed by US authorities and may set foot on US soil only....
Saturday, December 6, 2008
Lee Sustar analyzes the roots of the worst economic crisis since the Great Depression--and shows why Marxism offers the best way of understanding what went wrong.
THERE ARE plenty of people who should be held accountable for turning an ordinary recession that began a year ago into a global catastrophe.
Topping the list is former Federal Reserve Chair Alan Greenspan, who fed the bubble by keeping interest rates at rock-bottom levels, urging home buyers to take on adjustable-rate home loans and refusing to use the Fed's powers to oversee a mortgage industry rife with fraud.
Then there are the former Treasury Secretaries from the Clinton administration, Robert Rubin and Larry Summers, who teamed up with Greenspan to block regulation of so-called derivatives--complex financial instruments based on underlying assets like mortgages.
Backing them up was former Sen. Phil Gramm, the Texas Republican who, as chair of the Senate Banking Committee, pushed through legislation repealing the Depression-era Glass-Steagall Act that restricted commercial banks from entering the high-stakes financial activities of investment banks.
Former President Bill Clinton, who signed Gramm's bill into law, bears responsibility as well.
This Clinton-era deregulation opened the way for operators like former Countrywide Financial CEO Angelo Mozilo, whose company pushed sub-prime loans on people who qualified for better deals.
Countrywide paid mortgage brokers a higher commission on high-interest sub-prime mortgages, since those mortgages were more profitable to sell to Wall Street investment banks--like the now-bankrupt Lehman Brothers, where CEO Dick Fuld pushed the company into the obscure but highly profitable market for collateralized debt obligations (CDOs), which packaged together large numbers of prime and sub-prime loans as investments for Wall Street's biggest players.
And there's Robert Rubin--again. This time, as chair of Citigroup's executive committee, Rubin egged on executives as they plunged the bank ever deeper into the market for CDOs. "According to current and former colleagues, [Rubin] believed that Citigroup was falling behind rivals like Morgan Stanley and Goldman Sachs, and he pushed to bulk up the bank's high-growth fixed-income [bond] trading, including the CDO business," the New York Times reported.
Those assets turned toxic with the housing bust and resulting credit squeeze. Now, Citigroup is the latest financial institution to be bailed out by the Bush administration, with a rescue package that will put $45 billion of government money into Citigroup--and put taxpayers on the hook to insure $306 billion in bad assets.
But back at the start of the decade, with the table set by Clinton's economic policies, Wall Street could gorge itself on an ever-expanding financial menu, as the new Bush administration looked on approvingly.
Even when the financial crisis first broke out in the summer of 2007, Bush and Treasury Secretary Henry Paulson insisted that the problem would be "contained" in the sub-prime mortgage market. It was only after the failure of the investment bank Bear Stearns in March 2008 that Paulson and Federal Reserve Chair Ben Bernanke lurched into action with an array of new lending programs and multibillion-dollar bailouts of Fannie Mae, Freddie Mac, AIG and, now, Citigroup.
According to Bloomberg news service, taxpayers are on the hook (so far) for an astonishing $7.7 trillion--a figure equivalent to more than half the total U.S. economic output, or gross domestic product, for 2007.
But despite this immense sum, the crisis has gotten worse--not least because free-market ideologues like Bush and Paulson delayed taking decisive action before carrying out its series of confused and contradictory "rescues."
So yes, the people who presided over this crisis should be held accountable. But the global scale of the crisis points to a far more fundamental problem--the crisis-prone nature of capitalism itself.
With even the most pro-capitalist analysts and commentators panicked about the prospect of a repeat of the Great Depression, it's important for those on the left to revisit the work of capitalism's first great scientific critic and revolutionary opponent--Karl Marx.
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TO UNDERSTAND the dynamics of today's crisis, it's helpful to look briefly at what Marx's identified as contradictions at the core of the capitalist system.
Marx stressed that a key distinguishing feature of capitalism is its reliance on wage labor. Unlike previous societies, in which most production was carried out by slaves, peasants or small crafts producers, capitalist production relies on workers who have nothing but their labor power to sell to the boss.
Of course, independent producers and small farmers still exist. But the system as a whole is dominated by big capitalists, who own the factories, offices and other "means of production," to use Marx's term. Where the output of pre-capitalist societies was primarily geared to creating "use values"--items that met an immediate human need--capitalists produce for sale on the market, or for "exchange value."
Under capitalism, competing employers command the labor power of workers, who are "free" to work--or starve.
What gives capitalism its dynamism is that workers' labor adds value to the commodities they produce, by transforming raw materials into something that can be sold on the market. The value of a given commodity, Marx argued, is determined by the amount of labor time necessary to produce it. And in this process, Marx said, "surplus value" is created.
What is surplus value? Capitalists can pay workers wages that are sufficient (in boom times, anyway) to cover the costs of food, housing, raising children, etc., and still have a surplus left over when commodities are sold. Essentially, workers are paid for only part of their workday. This is true whether the boss appears to the workers as a "good" or "bad" one.
These basic relationships give capitalism both its dynamism and its propensity to crisis, Marx argued.
In order to compete with one another, rival capitalists are compelled to maximize the productivity of labor--that is, to get more commodities produced from the same expenditure on labor power. They can try to do so by forcing workers to work harder and longer--but the physical limits of (if not resistance by) workers and the length of the day restrict how far this can go.
Real breakthroughs in productivity can only come through the use of labor-saving technology that allows workers to produce the same commodity in less time. Thus, Marx described capitalism as constantly revolutionizing the means of production. Capitalists who invest in technological innovations win out over rivals who are unwilling or unable to do so.
For capitalists, Marx wrote, the motto is, "Accumulate, accumulate! That is Moses and the prophets!...Therefore, save, save, i.e, reconvert the greatest possible portion of surplus value, or surplus product into capital! Accumulation for accumulation's sake, production for production's sake..."
This drive to technological change is the reason why industrial capitalism could start to transform the world in a few decades.
However, the rapid accumulation of capital created a boom-bust cycle. Investment would pour into industries that seemed to be the most profitable. As capitalist enterprises grew larger, they increasingly relied on credit to carry out the years-long investments needed to develop, say, a new steel mill. Since all these investments take place without any overall coordination, there's an inevitable disconnection between production and demand--and when the gap reaches a certain point, the boom turns into a bust.
In Volume III of Capital, Marx described the perverse nature of capitalist crisis this way:
The contradiction of the capitalist mode of production...lies precisely in its tendency towards an absolute development of the productive forces, which continually come into conflict with the specific conditions of production in which capital moves, and alone can move. There are not too many necessities of life produced, in proportion to the existing population. Quite the reverse. Too little is produced to decently and humanely satisfy the wants of the great mass.
This "crisis of overproduction" is the defining feature of a capitalist crisis, according to Marx. Factories are shuttered even as workers look for work. People go hungry while food sits unsold in warehouses or rots in the fields. Homes stand empty although millions lack an affordable place to live.
In 1880, Marx's collaborator Frederick Engels described capitalism's periodic crises in words that could have been written last week:
Commerce is at a standstill, the markets are glutted, products accumulate, as multitudinous as they are unsaleable, hard cash disappears, credit vanishes, factories are closed, the mass of the workers are in want of the means of subsistence, because they have produced too much of the means of subsistence; bankruptcy follows upon bankruptcy, execution upon execution.
The stagnation lasts for years; productive forces and products are wasted and destroyed wholesale, until the accumulated mass of commodities finally filter off, more or less depreciated in value, until production and exchange gradually begin to move again.
Little by little, the pace quickens. It becomes a trot. The industrial trot breaks into a canter, the canter in turn grows into the headlong gallop of a perfect steeplechase of industry, commercial credit and speculation, which finally, after breakneck leaps, ends where it began--in the ditch of a crisis. And so over and over again.
Beyond this destructive boom-slump cycle, capitalism had an even more fundamental tendency toward crisis, Marx argued.
Because capitalists are under constant pressure to invest in ever-greater amounts of machinery, there is a long-term tendency for the rate of profit to fall. The reason: because labor is the source of the surplus value that capitalists keep as profit, a rising proportion of machinery to workers creates a downward pressure on the rate of profit over the long run.
That, however, didn't mean that Marx expected capitalism to collapse of its own accord as profit rates dried up. He identified several countervailing influences--and pointed out that capitalist crises actually clear the way for a revival of growth by bankrupting unproductive capitalists and devaluing capital in general.
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BY THE early 20th century, capital had become concentrated in ever-larger business entities and centralized into fewer ones. These monopolized companies, the forerunners of modern corporations, were increasingly intertwined in their home nation-states.
Military and economic competition between rival countries gave rise to a new, imperialist stage of capitalism and the slaughter of the First World War. Rather than rival capitalists trying to put one another out of business and take over their markets, competing imperial states sought to destroy the economic capacity of their rivals.
The war didn't overcome the underlying economic problems of the world system, however. The boom of the 1920s gave way to capitalism's biggest slump ever--the Great Depression of the 1930s.
The Great Depression confirmed Marxist crisis theory in all its essentials. It was only overcome through another imperialist slaughter--the Second World War. So as the war drew to a close, the allied powers led by the U.S. created a new, American-dominated world economic order (excluding the Eastern bloc controlled by the USSR).
Unlike the prewar era, financial services and capital flows were strictly regulated. But capitalism nevertheless boomed as never before, and the depression was seen as an aberration, the result of poor political leadership. Capitalism, according to its apologists, had overcome its contradictions.
The reality was different. As the late British Marxist writer Mike Kidron explained, the Cold War had given rise to a permanent arms economy that gave the system a constant stimulus. But because these enormously expensive nuclear weapons were never used, arms spending acted as a kind of safety valve for the system: It drained capital away from investment in new machinery that would have increased the tendency of the rate of profit to fall.
By the mid-1970s, however, the picture had changed. Profit rates had fallen sharply across the advanced industrial countries as a revitalized Germany and Japan, the losers in the Second World War, were able to compete with the U.S. Efforts to stimulate the economy led to a combination of inflation and slow growth, known as "stagflation." Marx's theory of the tendency of the rate of profit to fall was validated once more.
The capitalist solution to this crisis was to go back to market fundamentals. Economists like Milton Friedman, for decades seen as a right-wing crank, were suddenly promoted as sages for preaching deregulation of business, privatization of government services and "flexible" labor policies.
Politicians like Ronald Reagan in the U.S. and Margaret Thatcher in Britain turned Friedman's ideas into policies by smashing unions, slashing government spending and turning finance capital loose. The Clinton administration shaved off some of the rough edges of these policies, but basically consolidated what is now known as "neoliberalism."
For U.S. capitalists, neoliberalism was a spectacular success. The deep recession in 1982 gave rise to a boom, and following the relatively mild (for capitalists) recession of 1991, U.S. GDP increased by 49 percent until the slump of 2001. Total non-agricultural employment grew by 22.5 percent in the same period. By the late 1990s, U.S. profit rates approached those of the late 1960s at the peak of the long boom.
Bill Clinton hailed this as the "miracle economy," and once again, capitalist ideologues proclaimed that capitalism had finally cured itself of the tendency to crisis.
The dot-com stock market bust of 2000 and the recession of 2001 threatened to undo that success. The number of corporate bankruptcies soared--with Enron and WorldCom among the highest-profile casualties. In response, Federal Reserve Chair Greenspan cut interest rates to effectively zero to stimulate the economy, repeating measures he had taken in the late 1990s when the East Asian financial crisis threatened to sweep the world.
For business, Greenspan's rock-bottom interest rates allowed them to clean up their balance sheets and begin investing again--but not in the U.S. Even as the economic expansion began in 2002, job growth remained miserable and wages flat--or worse. According to the Economic Policy Institute, real income for the median family fell by 1.1 percent between 2000 and 2006--and wages remained flat during the 2002-2007 expansion.
For the wealthy, however, the 2000s saw continued dramatic increases in income. Between 1989 and 2006, the wealthiest 10 percent got more than 90 percent of all income growth. The richest 1 percent saw their income increase 203.7 percent, while the wealthiest 0.1 percent saw an increase of 425 percent.
By contrast, if workers wanted to maintain, let alone improve, their standard of living, they had to take on debt. Personal debt increased by 159.1 percent since 1997, from about $5.5 trillion to $14.4 trillion. In that same period, the ratio of debt to disposable income increased from 93.4 percent to 139 percent.
By 2006, the average debt owed by every U.S. adult was about $52,000, compared to average yearly pay of less than $31,000 for non-supervisory production workers. Buying a house that would supposedly keep increasing in value seemed like a way out of this dilemma--and the likes of Angelo Mozilo and Robert Rubin engineered the financial system to take full advantage of working people.
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WITH CONSUMER demand sustained by debt, the U.S. economy was able to maintain its role as the importer of last resort into the 2000s.
For China, the prospect of an endlessly expanding U.S. market was the basis for crash investment programs to build steel mills, airports, roads and factories of all sorts. China's industrial revolution, in turn, spurred demand for oil and other raw materials, particularly from Latin America. Japanese and German companies profited by selling machine tools and other goods to rapidly expanding Chinese capitalism. By early 2007, the world economy was growing at its fastest rate in 30 years.
Fueling this expansion was a vast extension of credit from both the $10 trillion traditional banking system and an unregulated shadow banking system of equal size.
But as the U.S. Federal Reserve Bank began to raise interest rates and the economy slowed, the dominoes of debt began to fall. What began in the U.S. sub-prime mortgage market became a global financial credit crunch, as capitalists were forced to reckon with the fact that assets of all types were overvalued.
Here, too, Marx's analysis of capitalism is validated. Credit, he argued, may postpone a capitalist crisis, but it cannot overcome the contradictions created by capitalism's drive toward production for its own sake. "The means--unconditional development of the productive forces of society--come continually into conflict with the limited purpose, the self-expansion of the existing capital," he wrote.
Thus, at some point, a crisis of "overproduction" is inevitable, as capitalists can no longer realize their profits through the sale of goods on the market. At that point, financial instruments of various sorts are depreciated, as are elements of fixed capital.
Next, Marx wrote, "[t]he chain of payment obligations due at specific dates is broken in a hundred places. The confusion is augmented by the attendant collapse of the credit system, which develops simultaneously with capital, and leads to violent and acute crises, to sudden and forcible depreciations, to the actual stagnation and disruption of the process of reproduction, and thus to a real falling off in reproduction."
Such periodic crises have not always been catastrophic for the capitalist system. Today, however, a prolonged slump seems inescapable--both because the U.S. can no longer drive the world economy through debt-financed consumption, and because the world financial system is staggering under the weight of bad debt.
The risk of such a long and deep recession has forced policymakers in the U.S. and Europe to toss free-market orthodoxy aside to try to find a way out. But as Marx showed, capitalism will inevitably generate crises until it is replaced with a socialist alternative.