by Michael Roberts

Economic growth in the major capitalist economies has slowed sharply.  The recovery from the Great Recession of 2008-9 that began in mid-2009 appears to be faltering.  In previous posts (Double dips, deficits and debt, 24 August 2011; US heading into recession again?, 15 August 2011), I have argued that a double-dip recession was unlikely.  By double-dip, most economists mean that, after a recession or slump, the subsequent recovery lasts less than a few quarters before the economy slips back into recession.  And by recession, economists mean a contraction in the level of national output in an economy for at least two quarters.

Well, a double-dip recession is a pretty rare event, happening  only once since the second world war – in 1980-2.  And I continue to hold that the economic data in the major economies do not suggest a contraction in output in the major economies, but merely a slowdown to very low economic growth rate of about 1-2% a year.

However, in many ways, what’s the difference between recession and slow growth for those out of work, those facing a freeze on their wages and for those seeing a slashing of public services and social benefits including pension entitlements?  For example, in the UK,  the median average household will have seen its net income fall by 3.5% in real terms in the financial year 2010-11 – the largest annual drop since 1981.  That will make it one of the worse decades for living standards since World War II.

The economic recovery in the capitalist economies since mid-2009 has not changed anything much for the majority of their populations.  Only the income of the richest and the profits of large capitalist corporations have recovered.   Also, although there has been a recovery in national output of the major economies since 2009, the absolute level of output is still below the last peak in 2008.  This is the slowest economic recovery for capitalism since the Great Depression of the 1930s.  Indeed, in that sense, we are in another depression rather than just a slump or recession as capitalism experienced in the 1970s, 1980s or 1990s.

This table from the HSBC bank has the key numbers.

As HSBC put it: “Back in 2008, the consensus forecast among independent economists was that the US economy would now be nearly 8% larger.  In the case of the UK, they were expecting cumulative growth of more than 6%. By historical standards, those were pretty downbeat forecasts.  Now they look positively utopian. National income is now lower than it was in 2008 in every single one of the countries listed – and much, much lower than expected.  Among the largest advanced economies, only Japan’s recovery has been more disappointing than Britain’s.  The UK economy is now 10% smaller than it was expected to be at this stage in the recovery – and the forecasts for 2011 and 2012 are now busily being downgraded.”

The employment situation in the US and the UK is correspondingly awful.  In the  UK, unemployment has jumped by 80,000 over the past three months and employment is up by just 24,000 over the past year.  The post-recession jobs rebound has ground to a halt.  Private sector employment peaked at 23.542m during the first quarter of 2008.  Private jobs reached a trough in the final quarter of 2009, when private sector employment fell to 22.515m, down 1.027m from the boom-time peak.  It would have been worse if  public spending, including in construction, had not propped up private sector employment with state-funded jobs (hundreds of thousands of “private” jobs are dependent on government contracts).  British companies started to add to their staffing levels at the start of 2010. Private sector employment has grown during each of the past six quarters, with a net 617,000 jobs added, taking the total back to 23.132m.

But the strong growth of previous quarters is now running out of steam. One reason for this is the loss of state-supported jobs; but the main factor is British companies, despite enjoying sharp increases in profits since 2009 are not willing to invest or employ more staff.  And now there is an acceleration of public sector job losses as the fiscal austerity measures of the coalition government begin to take effect.  Public sector employment reached its peak as a share of total jobs in late 2009, hitting 21.9% on the official measure; state payrolls reached 6.327m at the end of 2009. They then started to fall and dropped to 6.037m in the second quarter, 20.7% of the total.  So far, total state sector jobs are down by 290,000, through a combination of non-replacement and redundancies.   And in the last three months total public sector job losses (111,000) swamped private sector growth in jobs for the first time (41,000).

We are in a recovery that feels like a depression for two big reasons.  First, the recovery in profitability for the capitalist sector is still not enough to convince companies to invest and employ more.  And second, as economic growth slows down, the UK government is applying measures to cut public investment by 40%, reduce state employment and wages and raise taxes.  In the US, Congress is discussing how much to cut back, not spend more.  These austerity policies don’t help get the economy going.

Mainstream economics is divided about what to do.  As I have argued in this blog before (The Great Recession and the recovery: who is right?, 1 August 2011), the Keynesian answer is to spend more money with more borrowing until economic growth is assured.  This policy has been applied by the Obama administration up until now and they want to continue it to some extent.  But it has not succeeded in reviving employment and consumer demand.  The Keynesians say that this is because the stimulus and borrowing has been too small.  More needs to be done.   The Austerians say that the economic crisis was the result of excessive private credit in a bubble that eventually burst.  The last thing we need to do now is to add to the level of debt by more public sector borrowing.  This merely drives up the cost of borrowing and thus stops investment to grow the economy.

In the US, this debate has taken a particularly crude turn with the attempt of the likely Republican nominee for the next year’s presidential election, Texas Gov. Rick Perry claiming that the Keynesian policies of the Obama administration and the monetarist policies of Fed Reserve chairman Ben Bernanke are ‘treasonous’  and will destroy the fabric of the capitalist economy.  The level of public debt is out of control.  We need balanced government budgets, no borrowing and an end to the Ponzi-scheme of social security.  Let people “make their own choices” for pensions, health and benefits.

Perry likes to claim these policies of balanced budgets and low public spending have been operating in Texas and, as a result, the Lone Star state has better growth and lower unemployment than the nation as a whole.  It’s true that Texas has gained more than a million jobs since the end of 2000, while the U.S. has lost almost 1.5 million, according data from the Bureau of Labor Statistics.  So has Perry proved his point?  Well, for a start, of those one million jobs, about 300,000 were in government (hardly an example of free market enterprise).  So the man who hates big government has presided over a huge increase in state employment.  Indeed, employment in the Texas state’s public sector has jumped 19% since 2000, compared with a 9% rise in the private sector. Looking at the number of net new jobs, the biggest increases were in private education and health, up 408,000 jobs, or 40%, and then government.

Employment in productive capitalist sectors like manufacturing and information actually fell.  The fastest-growing employment sector in Texas during Perry’s tenure has been in mining, which includes the booming oil and gas industry, up 63% in past decade, or 94,000 jobs.   This is a special advantage that Texas has over other US states.  But most of the new jobs in Texas are low-wage and without benefits.  According to federal data, the Texas state is tied with Mississippi for the largest percentage of hourly workers who make minimum wage or less, at 9.5%.

The main reason for the relatively fast growth in jobs in Texas is not Governor Perry’s policies but simply that the population has exploded.  Over the past decade, Texas has added more people than any other state and now accounts for 8.1% of the U.S. population, up from about 7.4% in 2000.   Indeed, given the growth of the population, Texas should have created MORE jobs than it has now.  Keynesian economist Paul Krugman singled out that one important statistic that debunks Pery’s arguments.  Relative to population, activity in work in Texas in declining faster than national employment to total population is.  As Krugman explained: “According to the figures we have for 2011, 44.7% of the total US population has a job, compared to 43.5% of the Texas population.  And Perry’s record is pretty bad, here: he inherited a ratio of more than 47% in Texas from George W Bush, and has presided over a steady decline ever since — including every year of the Bush presidency, bar 2005.”

You can argue about the facts in Texas, but the bottom line is that the Keynesians and Austerians are both right and wrong.  The Keynesians are right (and the Austerians are wrong in opposing it) in their view that curtailing the public sector when the private sector is on an investment strike will only make matters worse.  The Austerians are right (and the Keynesians are wrong in opposing it) in the view that, without reducing the level of debt (what Marx called fictitious capital) in the economy, capitalists cannot or won’t invest.  The level of debt inherited from the credit boom of the previous 15 years has eaten into the profitability of capital accumulation in tangible or physical productive assets.  This fictitious capital must be cleansed from the system before capital accumulation can resume sufficiently to get sustain faster growth.  Ironically, that implies that another deep recession is necessary.

In that sense, we are in another Great Depression.   After all, in the Great Depression of the 1930s and the Long Depression of the 1870s and 1880s, there was no double-dip recession, but instead we started with a huge slump (1873-8 or 1930-32), then a recovery (1878-82 or 1932-7) that did not restore the peak of output achieved before.  Then the recovery was followed by another deep recession (1882-4 and 1937-8).  In the case of the Long Depression, a sustained boom did not begin until the early 1990s.  After the recession of 1937-8, recovery was led by the arms race into world war through to 1946.

We can see a distinct depressionary period for capitalism, as the figures for economic growth in the 19th century show.

Growth rates of industrial production (1850s–1913)

	1850s–1873	1873–1890	1890–1913
Germany	4.3	2.9	4.1
United Kingdom	3.0	1.7	2.0
United States	6.2	4.7	5.3
France	1.7	1.3	2.5
Italy		0.9	3.0
Sweden		3.1	3.5

In my book, The Great Recession, I have defined these depressionary periods within the idea of Marxist profit cycles lasting 32-36 years from trough to trough and in the longer prices of production cycle (lasting 54-72 years), named after the Soviet economist Kondratiev.  We can divide the Kondratiev cycle into four sections or seasons.  We start with the Spring season, when profitability is in an upwards phase and so are prices of production.  This spring season is a period of significant economic recovery for capitalism, where economic recessions or slumps are small, infrequent and short-lived.

Next is the Summer season when prices keep rising but profitability falls.  In this summer season, capitalism suffer more slumps of an increasingly deeper nature.  The Autumn season follows with prices of production having peaked and beginning to fall.  There is disinflation, but profitability rises.  In this autumn season, recessions are few and short-lived but the pressure is on wages as prices are hardly rising.  Finally, in the Winter season, we enter a period of depression in prices and falling profitability.  This is a really bad period for capitalism.

In the Kondratiev cycle, there was a winter season in the British capitalist economy from 1871-92, which coincided with falling profitability (see chapter 13 in my book), not dissimilar to the fall in profitability in the US economy since 1997.  The next winter season in the Kondratiev cycle was from 1929-46 and now we are in another winter season that began about 1997-00 and should last until 2016 or so.  In this context, the Great Recession of 2008-9 is part of the general depressionary winter season for capitalism that we are still in.

http://thenextrecession.wordpress.com

 By Michael Roberts 

The great guru of the financial collapse, economist Nouriel Roubini, who is famously acclaimed as having forecast the crisis of 2008-9 (see my paper, The causes of the Great Recession), has now pronounced that Karl Marx was ‘partly right’ after all about capitalism (http://www.economonitor.com/nouriel/2011/08/15/is-capitalism-doomed/).

Roubini put it this way.  “Karl Marx, it seems, was partly right in arguing that globalization, financial intermediation run amok, and redistribution of income and wealth from labor to capital could lead capitalism to self-destruct (though his view that socialism would be better has proven wrong).

I don’t think Marx would have agreed that this was his theory of capitalist crisis at all.  It seems closer to the view of many followers of Keynes or those who have adopted a theory based on the crisis of  ‘neo-liberalism’ (see my post, Gerard Dumenil and crisis of neoliberalism, 3 March 2011).  Marx did not think capitalism was subject to slumps and financial collapses because income and wealth was distributed “from labour to capital”.  Income and wealth inequality are clearly products of a production system based on capital, where the owners of the means of production can often dictate the distribution of wealth and income through control of  taxation, the printing of money and above all the ownership of the means of production in an economy.  But inequality existed before capitalism in other modes of society and there have been periods of sustained economic growth under capitalism that were achieved not because inequalities were reduced.   Inequalities rose from the early 1980s to now in the major economies because capitalist production began to suffer increased problems, forcing the capitalist elite to squeeze the majority more.  The core of capitalist production is that it is production for profit.  If profitability can be sustained, capitalism will grow (albeit unequally and unevenly).   Capitalism goes into crisis because it cannot sustain profit rates for the owners of capital.  When profitability in the major capitalist economies  reached a low in the late 1970s, the strategists of capital adopted policies designed to raise profitability that led to greater inequalities.  It was not inequality that led to the crises of the 1970s, but vice versa.

And is Roubini really saying that if there was a shift in the share of national income from ‘capital to labour’ that the crisis would have been avoided?  If so, he is suggesting that the answer to a crisis in a system of production for profit is to lower profits!  For more on this issue, see the excellent paper by Guglielmo Carchedi, Behind and beyond the crisis (http://gesd.free.fr/carchedib.pdf) and of course, various chapters in my book, The Great Recession (http://gesd.free.fr/mrob2009.pdf).

When profitability falls to the point that the mass of profits for companies are in jeopardy, then investment stops, employment falls and spending contracts.  Roubini tells us that the crisis has happened because “Firms are cutting jobs because there is not enough final demand. But cutting jobs reduces labor income, increases inequality and reduces final demand”.    It’s a vicious circle.  Yes, but the firms did not start cutting jobs in the beginning because there was ‘not enough final demand’; they did so because profitability fell so much that it threatened the solvency of the weakest companies, which started making losses.  They stopped production and investment and the loss of their demand for other companies’ products intensified the reduction in profitability for the rest.   Thus overall final demand (starting with investment demand) began to plummet.   The data for the US and UK economic recessions clearly show that it was a collapse in investment, not a drop in consumption that triggered the slump.  So it was that part of ‘final demand’ that was subject to profitability.

This is the nature of the process of the slump.  Final demand falls because profits fall, driving down profits further.  During the slump, businesses slash back on costs , laying off labour and closing down plant.  The stronger companies buy out the weak at cheap prices, laying the basis for higher profitability for those that survive.  Eventually profitability picks up, even at lower level of demand and production, and then investment begins to recover.  The Great Recession did not end because governments came to the rescue, although government spending may have helped ameliorate the impact of the recession – at the expense of increasing the burden of debt on the capitalist economy that makes it more difficult to recover.  The GR came to an end because profitability started to rise and enabled companies to build up cash and begin reinvesting (see my post, Profit and investment in an economic recovery, 29 December 2010).  The current recovery, however, is one of the weakest seen since the second world war, because households and small businesses are still weighed down with debt from the credit boom before 2007 and now must pay higher taxes with stagnant wages, while governments are overloaded with debt that they are trying to reduce.  So consumer spending growth remains weak.

Roubini tells us that Marx’s alternative of socialism has proved to be wrong.  Roubini does not say why, but probably we would get the usual mantra that the failure of the Soviet Union shows this.  But what does Roubini offer as the way out?

He says that “to enable market-oriented economies to operate as they should and can, we need to return to the right balance between markets and provision of public goods. That means moving away from both the Anglo-Saxon model of laissez-faire and voodoo economics and the continental European model of deficit-driven welfare states. Both are broken.”     He is right that both ‘models’ are broken, although how we can say Anglo-Saxon model avoids government deficits, when we have 8-10% of GDP deficits in the US and the UK; or that the European model avoids deregulation and privatisation, when these were just as prevalent there before the crisis. Be that as it may, Roubini’s prescription that we must get market-oriented economies to operate as they should and can, is utopian as it defies the experience of history.  Presumably ‘market-oriented’ economies should operate to provide sustained economic growth, reasonable equality in incomes and wealth, good pensions, healthcare, education and other social needs.  Since when have ‘market-oriented’ economies ever done that even in the developed capitalist economies, let alone across the globe?

Roubini argues that market economies will work better if “the right balance” is found between markets and the public sector.  But he does not make it very clear what he means by this.  He wants more investment on infrastructure and that is certainly badly needed.  Remember the report of the American Society of Civil Engineers on the state of the US national infrastructure (see the details in my post, Criminality – pure and simple, 10 August 2011).   But is this infrastructure spending to be done by capitalist companies for a profit or by state-owned operations as a public service.  If the latter, how is it to be paid for?

Roubini says we need more “progressive taxation”.  But is this because it is fairer or is it the way to find funds for the state to invest?  Maybe it is both.  And as billionaire investor, Warren Buffett has pointed out in a revealing NYT article this week (http://www.nytimes.com/2011/08/15/opinion/stop-coddling-the-super-rich.html), America’s super-rich continue to pay way less tax as a share of their income and wealth than the average American.   But does Roubini really believe that taxing the rich more will be enough to provide the funds for national investment and, more important, the control of investment so that it can be directed towards the needs of the whole country and not just towards ‘profitable investment’.   Roubini does not recognise the contradiction there between profit and social need.

Even his ‘short-term’ solutions are contradictory.  He says that market economy needs “more short-term fiscal stimulus with medium- and long-term fiscal discipline”.    So stimulate now and then make everybody pay back the handouts to business through taxation later.   He wants “a reduction of the debt burden for insolvent households and other distressed economic agents”, but does not tell us how that can be done if these agents cannot repay it themselves.  Somebody has to pay if households and other agents cannot – will it be the lenders (the banks) or the taxpayers (government)?  Would we have to bail out the banks again, still leaving them privately-owned or not?  Apparently, we would because they would need to be ‘regulated’.

And anyway, how are we to avoid another big slump or financial crisis, something Roubini recognises is inherent in the “self-destructive nature of capitalism”?  Apparently, all we need is  “stricter supervision and regulation of a financial system run amok; breaking up too-big-to-fail banks and oligopolistic trusts.”    So send in the regulators who so dismally failed last time to spot the financial bubble and warn about the crash.  But this time also ‘break up oligopolistic trusts”.  So do not abolish the market economy, but break it up into smaller bits.  Not only is this the height of unrealism but also flies in the face of very trend of capitalism towards the concentration of capital.  To break up modern capitalist entities poses the question of their survival as profitable enterprises.

Roubini ends his piece with this profound observation:  “Over time, advanced economies will need to invest in human capital, skills and social safety nets to increase productivity and enable workers to compete, be flexible and thrive in a globalized economy. The alternative is – like in the 1930s – unending stagnation, depression, currency and trade wars, capital controls, financial crisis, sovereign insolvencies, and massive social and political instability.”

Yes, but how can this better world be achieved while it is dominated by a market-oriented system that only invests in human capital and skills if it is profitable?    Is not that where Marx was right?  The dismal alternative that Roubini poses is the most likely result if the capitalist system of production remains in place.

August 16, 2011

http://thenextrecession.wordpress.com

By Michael Roberts, from Labour Briefing  http://www.labourbriefing.org.uk

The UK economy is struggling to recover from the worst economic recession since WWII – the “Great Recession”. The crisis began with a global credit crunch in mid-2007. “History will record this moment as the beginning of a new golden age for the City of London” said Gordon Brown in January 2007. A huge collapse in financial institutions around the world followed, from Bear Stearns and Lehmans in the US to Northern Rock and regional banks in Germany. The ensuing economic slump saw global output fall in absolute terms for the first time since the 1930s. As the former Chancellor of the Exchequer Alastair Darling in the previous Labour Government said, it was the biggest economic crisis in over 60 years.

How did we get into this mess? It is very clear. Even the most rabid Thatcherite cannot deny it. The crisis cannot be blamed on public sector workers, and it cannot be blamed on workers in the private sector either. Nobody was asking for “too much money”, nobody was “holding the country to ransom” – at least, not teachers, health workers, technical and administrative workers in offices, or engineers in factories or assistants in supermarkets, or building workers on construction sites, or rail, airline and bus staff.

This crisis began in the financial sector and specifically in the US housing market. A huge credit bubble had driven house prices to unprecedented heights, up to ten times the average household income in the US. A similar property bubble expanded in the UK, Ireland, Spain, Australia and many other countries.

The ensuing financial collapse was widespread and deep because the banks and other mortgage lenders lent money to many households who could not afford to keep up their payments as soon as the loss leader interest rate and zero deposit terms, used to entice them in, lapsed. These sub-prime borrowers began to default in 2007.

Worse, the US banks had developed a new wheeze that they claimed spread the risk. They batched up all their mortgages into mortgage-backed assets that they accumulated into special financial vehicles with high rates of return. They sold these onto banks and financial institutions across the world. However, once the sub-prime mortgagees began to default, the party was over. Investors found that the returns on their assets collapsed and the banks started to lose billions. They stopped lending to each other and the credit crunch began. They then stopped lending to businesses and households, and the recession began.

Banks began going bankrupt everywhere. The governments of the major economies made a decision to bail out the banks to avoid a financial collapse that would engender an economic slump similar to the Great Depression of the 1930s. They pumped trillions into the banks either by printing the money or by borrowing it. Where did they borrow it from? From the very banks that they were bailing out – it was a perfect circle of capital!

The end result was that the financial system was saved, but the legacy was a huge transfer and accumulation of debt by governments. Before the crisis, public sector debt stood at about 60% of GDP in the major economies. Now it stands at over 100% of annual output. Annual budget deficits have risen from about 3% of GDP to 10% in many cases, and the main reason was the bailout of the financial system.

The greatest economists of the world did not forecast this crisis; they have struggled to explain it; and they have no remedies to avoid it in future. “We don’t know what causes recessions. We’ve never known. Economics is not very good at explaining swings in economic activity. If I could have predicted the crisis, I would have. I’d love to know more what causes business cycles.” said Eugene Fama, Nobel prize winner in Economics.

When the bankers were hauled before committees of inquiry in the US Congress or the UK Parliament, after briefly apologising, they said that it was a chance in a billion, an event that could not possibly have been forecast – a tsunami. When the officials of the central bankers and finance civil servants tried to explain it, they said it was a lack of proper regulation of the banks which engaged in “excessive risk-taking”.

The crisis can be explained, but deregulation is not a sufficient explanation. The crisis began in the financial sector – but then most crises do, because that is where most of the money is. It is not an explanation of what caused the crisis.

The key to understanding that lies in the nature of the capitalist mode of production. Under capitalism, production is for profit. Profit is the life blood of capitalism – and also its Achilles heel. Since the 1960s, there has been a long term decline in the profitability of capitalist production in the major economies. The mass of profits have risen, but the cost of new plant, equipment and employing labour has, on average, risen more. Although there have been periods of rising profitability, on the whole profitability has slipped back.

That has meant that the major economies have grown more slowly each decade since the 1960s, with the slowest rate in the last decade. Investment growth has slowed too. As a result, the banks have looked elsewhere to maximise their returns for their shareholders, speculating in all sorts of financial instruments and laying the basis for the eventual financial disaster. Now the very politicians and economists who failed to see the crisis coming want us to return those banks that the taxpayers now own to the private sector, bringing down government debt and giving the private sector back the reins of the economy. “Government does not ‘grow’ the economy, only the private sector can. So it must make room for the private sector,” Trevor Williams, economist at state-owned Lloyds Bank, said on CNBC TV last October.

Why should the banks go back to the private sector? Why can’t we make banking a public service in the same way that the NHS is or the railways ought to be? As a public service, banks could return to their traditional role as lenders to small businesses and households and also take on the role of the funders of major state projects in housing, infrastructure and the environment. They would no longer pay grotesque salaries, bonuses and pensions to the fat cats at the top or speculate in financial markets. Such an approach would threaten the profit motive of the private sector, but if we continue with business as usual, the cycle of boom and slump will be renewed.

Michael Roberts is an economist working in the City of London and author of The Great Recession, published by Lulu, 2009.

• “In the 1990s, the banks, they all came to us and said, ‘Look, we don’t want to be regulated, we want to be free of regulation’...All the complaints I was getting from people was, ‘Look you’re regulating them too much’. And actually the truth is that globally and nationally we should have been regulating them more. So I’ve learnt from that. So you don’t listen to the industry when they say, ‘This is good for us’. You’ve got to talk about the whole public interest.”

Gordon Brown, ITV interview, April 2010

• “A vast range of regulations on the financial services industry should either be abolished or watered down, including money-laundering restrictions affecting banks and building societies. There no need to continue to regulate mortgage provision, as it is the lender, not the client, who takes the risk.”

David Cameron backing a report by John Redwood outlining plans to cut £14 billion in red tape and regulation for UK businesses in August 2007.

• “Today our system of light touch and risk-based regulation is regularly cited – alongside the City’s internationalism and the skills of those who work here – as one of our chief attractions. It has provided us with a huge competitive advantage and is regarded as the best in the world… The Government’s interest in this area is specific and clear: to safeguard the light touch and proportionate regulatory regime that has made London a magnet for international business… We must ensure that all new regulations are implemented in a sensitive and light touch manner.”

Ed Balls, City minister, September 2006

• “Those people who think that the global market can be run without regulation, or with self regulation, or with light touch regulation have been entirely routed; have been entirely disproved.”

Ed Balls, September 2008

 THE ANSWER ()

Children have a terrifically simple way of exploring the limits of adult knowledge. They do so by asking a question, then responding to each new piece of data with “but, why?”. The almost inevitable ending to this line of questioning is either “because I said so” or “I don’t know, that’s just how it is”.

I seem to have a elicited a similar response when, on Friday, I posted the blog “To Whom Do We Owe This Money, Exactly?” Since then, that post has been read by 20,000 people on the blog (and many thousands more via a circulating viral email). I have received many hundreds of responses whether by direct comment, email, Facebook or Twitter. The blog has been re-tweeted 1,000 times and shared on Facebook 1,200 times – before being flagged as abusive! The responses almost universally accept that the research is accurate.

The answer is: we owe this money, primarily, to the financial sector we went into debt to bail out.

Broadly speaking, the reactions break down into four major categories:

1. Other children like me, saying “I too have wondered. Thank you for asking!”
2. People who seem to understand the issues better than me, sharing my outrage at the cyclical madness of the system, but at a loss as to where we go next.
3. People presenting themselves as experts, expressing surprise at my anger, because the situation is precisely as it should be.
4. A minority of folks calling me “disingenuous”, “sensationalist” or “some kabuki-obsessed drag-queen”.

All of the above answers equip me better, intellectually, and I thank them.

In many ways, the third group of responses (which claims this is all completely normal) is the most disturbing. Assigning a sophisticated term like “Quantitative Easing” or explaining that this is how “Fractional Reserve Banking” works, does not detract from the absurdity of the circle. If this business model did not have government support, it would be called a “Pyramid Scheme” and outlawed.

A consistent response has been this tale (and variants thereof) – big thanks to my good friend Melina:

It is a slow day in a damp little Irish town. The rain is beating down and the streets are deserted. Times are tough, everybody is in debt, and everybody lives on credit. On this particular day a rich German tourist is driving through the town.

He stops at the local hotel and lays a €100 note on the desk, telling the hotel owner he wants to inspect the rooms upstairs in order to pick one to spend the night. The owner gives him some keys and, as soon as the visitor has walked upstairs, the hotelier grabs the €100 note and runs next door to pay his debt to the butcher. The butcher takes the €100 note and runs down the street to repay his debt to the pig farmer. The pig farmer takes the €100 note and heads off to pay his bill at the supplier of feed and fuel. The guy at the Farmers’ Co-op takes the €100 note and runs to pay his drinks bill at the pub. The publican slips the money along to the local prostitute drinking at the bar, who has also been facing hard times and has had to offer him “services” on credit.

The hooker then rushes to the hotel and pays off her room bill to the hotel owner with the €100 note. The hotel proprietor then places the €100 note back on the counter so the rich traveller will not suspect anything. At that moment the traveller comes down the stairs, picks up the €100 note, states that the rooms are not satisfactory, pockets the money, and leaves town. No one produced anything. No one earned anything. However, the whole town is now out of debt and looking to the future with a lot more optimism.

This story is a superb way of describing the matter in a simple way, but contains two fundamental misconceptions. First, it assumes interest free debt. The reality is that the hotelier, butcher, farmer, publican and prostitute only managed to pay a small part of their debt, most of their repayment being interest. Second, it assumes no intermediaries – what if each transaction were handled by the Town’s Banker who skims €10 each time for his services?

My own, perhaps dramatic, but more accurate way of describing the situation involves a necessary transfer of blood between patients using a colony of leeches. The transfer of blood does happen, but there is considerable pain involved and the leeches feed from each transaction, fatten and multiply. This is what is affectionately known as growth. When the colony of leeches reaches critical mass (too big to fail) and there is not enough blood to feed them, some patients have to be sacrificed. This is what is affectionately known as a bail-out.

Yesterday, Sir John Vickers published the Interim Report of the Independent Commission on Banking. John used to be my boss at the OFT. I know him well and am very fond of him. He is a kind, compassionate man and a brilliant economist. The one aspect of him that bothered me then, is the same that still does. He tends to shoot for the middle; goes for the solution that will upset everyone as little as possible. The Interim Report is an expression of all his attributes, but also of that flaw. It seems to me to be suggesting the addition of a rather pretty lace trim to a tapestry that has been rotting for a century and fell apart spectacularly in 2008; suggesting that the taxpayer should pay, again, to invest in a system of slightly more efficient leeches.

I remember my first lesson in physics, as a kid. I was explained the difference between an axiom (something that is self-evident as truth) and a theory (something which required proof). Economics has become axiomatic; a religion. It has become the science of “because I said so” or “I don’t know, that’s just how it is”. It has done so in the face of incontrovertible evidence to the contrary. Creationist in its resistance to the truth. In my time at the OFT, I was part of a team that used free market theory and its many exceptions to explain the hundreds, thousands of cases referred to us; all of them cases of entities acting in a way that was contrary to free market theory.

Here is my counter-suggestion on Banks:

We have an absolutely unique opportunity in the UK right now. RBS is almost fully publicly owned. And yet, it is always talked of in terms of building up the value of our stock-holding then selling (so we can settle our debt to the Banks, including RBS). Why? How about running RBS as the publicly owned institution it is? An institution which does not have greed at its core, provides loans in the areas the government wants to stimulate at reasonable terms and ethical banking services to ordinary people. Then we would have an alternative. We could move our savings and accounts to this institution which is actually run for our benefit, with no hidden agenda. We, as customers, could punish the rest of the financial institutions in the UK until they mend their ways.

Don’t bother telling me why “we can’t”; that this is “very complicated”, “unworkable” or “unrealistic”. My answer is likely to be: “but, why?” We have flags planted on the surface of the moon and a particle accelerator under Geneva crashing hadrons into each other, that say “we can”.

There is a classic economist joke. It goes -

Q: How many economists does it take to change a light bulb?

A: None. If the light bulb needs changing, market forces will do it.

We have given this idea a real go, for more than a century. We are still sitting in a dark room. Maybe all we need is One Good Electrician.

http://sturdyblog.wordpress.com

 You couldn't make it up

 This is from a right wing economics blog but still a riveting and explosive read.

Second of a three part story on the part Goldman Sachs played in creating the European financial crisis.  The first part of the story is posted earlier in the blog.

In short, Goldman converted ten billion dollars of Greek debt that had been purchased with U.S. dollars and Japanese yen into debt that could be repaid in Euros. However, in creating this “currency swap”, they used a fictitious value for the Euros which lowered the reported amount of Greek debt by billions.

The structure enabled Greece to owe billions to Goldman in a currency deal without having to report it to the European Union as a loan, which is clearly what it was. Turns out using the Alice in Wonderland value for the Euro wasn’t illegal, just deceptive as hell.

Having cut the deal, Goldman’s covert loan needed to be paid. Greed never sleeps. And since the faux currency swap was not officially a loan, Goldman had to have some way to get repaid other than “loan payments”. To wit, the pirates of pinstripe go on a Hellenic treasure hunt and wind up commandeering the rights to a few of the country’s income-producing crown jewels — airport fees, the national lottery and toll road income.

Pericles, where are you?

Securing the rights to the tax revenues, they wrap the repayment into an interest rate swap. (Don’t go to sleep on me now, I’ll explain).

Greece had previously issued some bonds and had to pay the bond holders a fixed rate of interest of 4%. So, as their part of the swap, Goldman agreed to pay Greece a fixed rate of 4%. In return, the government of Greece agreed to pay Goldman a floating rate.

The exact amount Greece had to pay Goldman is not known. However, what is reported is that Goldman received a rate in excess of LIBOR (the rate set in the UK that banks charge each other for short term loans) + 6.6%.

The rate was floating, not fixed, but note that even if LIBOR was zero – 0% – (which it wasn’t) Goldman would be paying Greece 4% but would be receiving 6.6%. The absolute worst they could get, then, was an annual profit of 2.6% on a deal for $10 billion in bonds ($260,000,000).

But that’s not really enough to push those year-ending Goldman bonus babies to the Hamptons. Oh no, not by a long shot, because Goldman also picked up a fee to arrange this charade of about $300,000,000.

In summary, Goldman arranges what appears to be a currency swap for Greece, which is really a loan that doesn’t have to be reported to the EU as such.

In so doing, Greece pushes its existing debt back to the future, is accepted into the European Union, gets yet another loan, and still has access to the debt needle.

Goldman gets a fee of $300,000,000 for setting the deal up and ongoing revenue from an interest rate swap estimated at $260,000,000 a year from government owned assets.

Yeah, Baby!

Of course, the story doesn’t end there. But then you knew that, didn’t you?

ENTER THE NATIONAL BANK OF GREECE

In 2005, Goldman apparently, and we say, “apparently” as all of these figures are a matter of news reports, not official Goldman records, having received their eye-watering fee and having recouped about a billion dollars from the interest rate swap (which is what they were reportedly out-of-pocket on the deal), sold the balance of the deal to the National Bank of Greece.

At this point, Goldman is out of it; Greece has joined the European Union and it now owes the balance of the off-balance-sheet loan of about $9 billion to their homies at the National Bank of Greece.

All is well…well, that is until 2008 and the eruption of the Global Financial Crisis.

THE HELLENIC SWAP

As the planet’s financial system started to go into the DTs, the European Central Bank did what all central banks do at such times, they went to print mode. They structured a program designed to pour billions of Euros into the European banking system.

The National Bank of Greece wanted some of that cheap coin. They could borrow it from the European Central Bank (ECB) and lend it out at handsomely higher rates. Yum, yum. But to get it, they had to pledge some collateral to the ECB, collateral they didn’t have.

What they did have was the income stream from the government tax revenues that they had purchased from Goldman three years earlier. There was just one problem, the European Central Bank would not lend to them on that deal. They needed to pledge some bonds.

It’s midnight in Athens. From the roof of the headquarters office of the National Bank of Greece we see a gigantic spot light beaming an enormous image of a dollar sign into the Mediterranean sky, a la the Bat Signal.

The next morning, the Humvee is back with Julia, baldy and their Blackberries. Goldman goes into closed-door session with representatives of the National Bank of Greece and the Treasury officials of the Hellenic Republic. At this point, the Greek government owes the National Bank of Greece about seven billion dollars.

Goldman channels Houdini yet again. They create and execute what has come to be called “The Hellenic Swap.” And if you want to see some sleight of hand on the stage of international finance, watch this, because this kind of fiscal alchemy is going on 24/7 around the planet with governments large and small.

In December, 2008, Goldman arranges an interest rate swap between the Greek government and the National Bank of Greece (The Hellenic Swap).

THE HELLENIC SWAP

Under the terms of this arrangement, the Greek Government (the Hellenic Republic) is to receive fixed-interest payments from the National Bank of Greece of 4.5 % on $6.96 billion dollars.

In return, Greece agrees to pay the National Bank of Greece an interest rate of LIBOR + 6.6% on that amount of money. LIBOR was .8% at the time, making the Greece’s interest rate 7.4%. This rate could fluctuate but could never go below 6.6%.

As can be seen, the National Bank of Greece makes a profit of 2.9% on this swap (about $201,000,000 a year). Nice.

Except the National Bank of Greece doesn’t keep the swap. Not exactly.

Shortly after setting up the interest rate swap between the government and the bank, Goldman sets up an entity in London called Titlos, PLC. The name isn’t important, but what they do is. Titlos is what is called a “Special Purpose Vehicle (SPV).” That means it is a legal entity that was set up for the sole purpose of conducting a financial transaction.

Titlos issues $6.96 billion worth of notes on which interest is payable.

Titlos then trades the notes to the National Bank of Greece in exchange for their rights to the Hellenic Swap. It so happens that the notes issued by Titlos are the same amount as the balance of the loan that Greece owed the bank ($6.96 billion).

Greece now owes Titlos the $6.96 billion and is paying the Goldman created shell the 7.4% interest while receiving a fixed rate of 4.5%.

Titlos receives money, takes an administrative fee and the 4.5% that it must pay Greece, and pays the balance to the National Bank of Greece which services the interest due on the notes.

And Shazam! The National Bank of Greece now has bonds that it can pledge to the European Central Bank so they can borrow some of that cheap money and lend it dear. In essence, Goldman has become a Central Bank creating money out of thin air.

We love you, Goldman.

(Two years later, when the country is on the verge of financial collapse, Goldman issues a statement downgrading the National Bank of Greece saying, “Greece faces both a liquidity and, potentially, a solvency problem. While we believe that, individually, Greek banks tend to be well-run, the problems they face are outside their operational control.”)

Isn’t that sweet?

Part III to follow shortyl

 I have followed the political debate about the austerity programme of cuts relatively closely over the last few months. I have been witness to countless television and radio debates in which the importance of our credit rating status, so that we may borrow money on better terms, is repeated with military-drummer-like regularity; in which any possible criticism of the assault currently under-way on public services is met with lachrymose alacrity by three words “our national debt”.

Equally, I have been amazed by the rarity of the question “to whom do we owe this money?” It is a fairly esoteric subject, but an important one nevertheless – don’t you think?

Let’s take Cameron, Osborne and Clegg’s (sounds like a posh accounting firm, does it not?) puerile analogy of “households in dire trouble” and “maxed out credit cards”. In that situation the first thing I would do would be to sit down and list the entities to whom I owe money; a list of creditors. Only such a list could give me an overview of which are the high interest loans I can pay straight away, whether any restructuring were possible, who would be happy to wait a bit. Is there such a list? If there is, I haven’t seen it. I could not find it on the websites of the OBR, Bank of England, IMF, ONS, or the rather elusive Office of Debt Management (“ODM”).

I will take an analytical leap. It’s a short leap, so bear with me. Governments are very good at hanging bells on figures that help their cause. It is my assumption, and I think it is a fair one, that when things are difficult to find, it is because they are rather inconvenient.

So, I continue to endlessly trawl through information trying to find an answer, but with no success. Instead, I find titbits of aggregated data which only give rise to more questions.

A list of countries by external debt, compiled from the CIA’s World Factbook, makes fascinating reading. I find the figure at the top of the list jaw-dropping. It is a total figure for “the World”. According to this total, the “World” is in external debt to the tune of just under 60 trillion US dollars. Or 95% of the entire world’s GDP. Go back and read that again. How can this be? Is there an alien entity lending US dollars that I know nothing about? Or is the world in debt to private individuals, so isolated and untaxable that they do not count as part of the GDP of any country? Is the fact that, looking down the list, the lowest figures (or unlisted figures) are all totalitarian regimes or tax havens, important?

Next, I found this excellent analysis of US debt, by Mike Hewitt (an economist that until a few years ago was a high-ranking official with NATO). He found that, looking at US external debt, the biggest single creditor by a clear country mile was Japan. Japan itself has one of the largest external debts as a percentage of GDP. One of its main creditors is (you guessed it) the US. An analysis of US debt from 2001 to 2006, shows that the group most in debt (about double the next contender) was “Private Households”. Next were “Federal Government”, “Non-Farm, Non-Corporate Business”, then “Non-Financial Corporate Business”. Banks or Financial Businesses do not even appear on the top ten of debtors. The top four creditors (groups of entities to whom the US owes this money) were “Foreigners”, “Commercial Banks”, “Insurance Companies” and “Federal Reserve”. The same financial sector that the US went further in debt to rescue two years later. Perhaps we are not all in it together.

Next, the BBC piece “Who owns the UK’s debt” by Anthony Reuben. Reuben explains: “In the case of the country as a whole, the way it borrows money is by issuing gilts, which are IOUs, promising to repay an amount of money on a particular date and a specified interest rate until then.” These gilts are issued and auctioned by the ODM. So tracing who buys them, should reveal who owns our debt. Here you are:

So, the majority are owned by financial institutions. And more particularly, there is a huge spike in the purchase of gilts by Banks around the time when the country was putting itself in more debt by the single, highest amount in living memory. In order to underwrite the Banks’ liabilities and bail-out and stabilise the sector. So, the UK was borrowing money, in the name of ordinary taxpayers, FROM THE BANKS in order to stabilise THE BANKS.

But surely, surely- surely – not the actual Banks that we were bailing out…

Lloyds Banking Group’s Report and Accounts for 2010, state that the company has been buying government gilts increasingly, to cover its pension and benefit obligations. Their “Liquidity and Funding Risk” statement from the same year states clearly that “Primary liquidity assets are FSA eligible liquid assets including UK Gilts, US Treasuries, Euro AAA government debt and unencumbered cash balances held at central banks.”

The RBS Report and Accounts for 2010 states that their figures include “an £18.0 billion increase in the gilt liquidity portfolio.” On page 291 of the same document they confirm that this includes UK gilts.

By this point of my research, my hands were shaking with rage. Somebody must be kicking up a huge fuss in the House of Commons over this, I told myself. A search for the word “gilts” through the Hansard’s House of Commons Debates reveals only two mentions. Only one of them is related to the question “to whom to we owe this money?” and that is only on domestic vs foreign ownership.

So, I invite the tax lawyers, the economists, the MPs, the journalists that read this to answer my question; to give me a simple, lucid explanation of why I have this all wrong. I plead with them to reassure me that this is not how it appears; that we do not borrow money from and pay interest to the same people that were the cause of the collapse; that ordinary people like me are not trapped in a perpetual game of Monopoly where someone else always wins the “prize at the beauty contest” and the only card we pick up is a “library fine”; where we never pass “Go”, but always land on “Super-Tax”.

And if they cannot answer my question, then why the hell are they not asking it?

 http://sturdyblog.wordpress.com

 March 3, 2011 By Michael Roberts

 By Mick Brooks

 The Great Depression: then and now

 The 1920s were good years for the world economy. They were years of boom. Boom and speculation go together like strawberries and cream, and there was speculation aplenty as well. In such a period of ‘irrational exuberance’ the illusion spreads that the good times will go on for ever. Sound familiar? On the eve of the great 1929 stock exchange collapse, a journalist asked a speculator how so much money was being made on the market. This was the reply: "One investor buys General Motors at $100" (he meant a GM share) "sells to another at $150, who sells it to a third at $200. Everyone makes money". This seems pure magic, but for a while it can work. In a 'bull market' as in 1925-29 nearly all share prices go up and up. Over those years US industrial shares trebled in price!  We all know what happened next.

Another feature of the 1920s boom was the massive global imbalances. Briefly Anglo-French imperialism had emerged militarily victorious from the First World War, but economically wounded and forced to borrow from the USA to cover their war debts. The only real victor was the USA, which had showed itself to be the mightiest economic and military power in the world. American bankers, as creditors to the British and French, demanded their pound of flesh.  These governments in turn decided the only way to pay the USA was by squeezing defeated German capitalism, demanding war reparations from the stricken German economy.

Reparations flowed out from Germany, and then flowed straight out of Britain and France to the USA. So the upshot was that the poor subsidised the rich.

The Great Depression of 1929-33 produced male unemployment at one time of more than 30% in Germany whose economy was totally dependent on the health of the world economy. But if Germany could not pay reparations, how could Britain and France pay their debts to the USA? So the Depression destroyed this mad flow of money, and with it the delicate balance of the global economy. The collapse of world trade (falling from a factor of 10 in 1929 to 3 in 1933) in turn further impacted on the major national economies. But as ever it was the small and poor nations that fared the worst. This remains the case today – as we shall see.

Bubbles

There are startling similarities between the boom of the 1920s and its inevitable sequel in bust from 1929 to 1933 and the present decade. As we all know the boom in the advanced capitalist countries was fuelled by a housing price bubble – a situation where prices go up because people are buying and people are buying because prices are going up. Huge amounts of fictitious capital, pure paper wealth, were created. For instance the annual output of the world in the year 2007 at the end of the boom was about $64trn. At the same time the amount of financial assets in the world was $196trn. And the amount of total trades in that year was $1,168trn – seventeen times as much as was produced. This was literally a paper merry-go-round.

These pieces of paper were ‘valued’ at what they were likely to deliver in the future. As anyone who knows that what goes up must come down would realise, these expectations of ever-expanding wealth were impossible to achieve since this wealth ultimately had to be generated in the real capitalist profit-making economy. So the unstable boom eventually came to an end with a sickening crunch.

That much of the capital built up over the boom was fictitious is shown by one stark fact. The total value of quoted shares on the global stock exchanges was $63trn in October 2007. A year later in November 2008 it was $31trn. More than half the value of the world’s bourses had gone up in smoke! Though we have seen a ‘bull’ market in shares since March 2009 on most exchanges, this fact illustrates the phantom nature of this wealth. The same applied to the price of houses. In the early years of this millennium they were seen as not bricks and mortar but appreciating assets. Not any more. All kinds of other paper assets, created by financial ‘innovation’ during the boom, were also on the slide.

Financial Crisis

This in turn hit the banks and credit institutions. Their lending was based on holding assets which turned out not to be assets at all. This was catastrophic, particularly since the financial institutions, in order to fill their boots in time of boom, had ‘leveraged’ themselves by thirty times or more. This technical expression means that they had lent thirty times more money than they actually had. Rather than holding the loans on their books the official banks bundled them up and passed them on as fantastically complex financial assets.

But these assets were by no means ‘out of sight, out of mind.’ They passed into the hands of the secondary banking sector. The central institutions of this shadowy nether world of finance are the hedge funds. Hedge funds are melting away. Those that handled more than $1bn (small change to them!) fell by 40% last year. They are disappearing because they are losing money on the recondite financial institutions they bought from the main banks. And their losses mean the official banking sector has to take a heavy hit. Lehman Brothers went under in 2008 because they were more exposed to the dodgy dealings and had more links to the secondary banking sector than the other major players

Inter-bank lending, the essential oil of the world’s monetary system, ground to a halt. No bank would lend to any other because they didn’t know what their own assets were worth, if anything, and they realised that all the other banks were in the same position.

Martin Wolf sums up the present imbalances in the world economy (Financial Times 08.03.09):

“How did the world arrive here? A big part of the answer is that the era of liberalisation contained seeds of its own downfall: this was also a period of massive growth in the scale and profitability of the financial sector, of frenetic financial innovation, of growing global macroeconomic imbalances, of huge household borrowing and of bubbles in asset prices.

“In the US, core of the global market economy and centre of the current storm, the aggregate debt of the financial sector jumped from 22 per cent of gross domestic product in 1981 to 117 per cent by the third quarter of 2008. In the UK, with its heavy reliance on financial activity, gross debt of the financial sector reached almost 250 per cent of GDP…

“These huge flows of capital, on top of the traditional surpluses of a number of high-income countries and the burgeoning surpluses of oil exporters, largely ended up in a small number of high-income countries and particularly in the US. At the peak, America absorbed about 70 per cent of the rest of the world’s surplus savings.

“Meanwhile, inside the US the ratio of household debt to GDP rose from 66 per cent in 1997 to 100 per cent a decade later. Even bigger jumps in household indebtedness occurred in the UK. These surges in household debt were supported, in turn, by highly elastic and innovative financial systems and, in the US, by government programmes.

“Throughout, the financial sector innovated ceaselessly. Warren Buffett, the legendary investor, described derivatives as ‘financial weapons of mass destruction’. He was proved at least partly right. In the 2000s, the ‘shadow banking system’ emerged and traditional banking was largely replaced by the originate-and-distribute model of securitisation via constructions such as collateralised debt obligations. This model blew up in 2007.”

Eastern economies ‘emerging’ – into ruin

How has the world recession impacted on the poor nations? We shall examine the fate of the former Stalinist countries in particular. These Eastern European economies saw an unprecedented economic collapse with the downfall of the Stalinist regimes after 1989. Russia, for instance, saw the biggest fall in production since the invasion of the Mongols, who left pyramids of skulls in their wake. In the early years of the present millennium these countries reached rock bottom and began to bounce back. They re-emerged as hapless client states of the major capitalist powers.

Most of the East and Central European economies have been growing at around 5% a year since the past boom gathered speed in the early years of the century. As a result many of their political leaders have developed a cargo boat cult of capitalism and tried to pass it on to the population. They have seen their future as ‘emerging’ capitalist economies. They have copied the worst excesses of the advanced capitalist economies. And the present world recession has brought them to their knees.

Accepting that their fate lies with capitalism, these economies have relied on trade with the West. Their ‘comparative advantage’ lies in wage differentials with the North American and Western European economies of the order of 7:1. Canny capitalists in Western Europe located more and more production processes in the East, hollowing out manufacture in the West as a result.

Basic manufacturing processes are being transferred to the East. The Ukraine, for instance is a massive exporter of iron and steel to Western Europe. You might have thought that the Eastern countries would enjoy an export surplus with the West. The opposite has been the case. They were on a treadmill – running fast and going nowhere. East and Central European countries have run deficits of the order of 5-10% of GDP with the West. Latvia managed 23% at one time and Bulgaria 27%. This means these countries were spending about £5 for every £4 they were earning. This can not go on! These current account deficits were only covered by capital inflows from the imperialist heartlands. Capital inflows were as much as 5-8% of GDP and funded about 70% of East and Central Europe’s deficit.

So corresponding to the outflow of basic industrial production from the East has been vast capital inflows. In effect the Eastern countries have been borrowing the money from the West – to buy the West’s products! Suddenly, just when the money is needed most, the tap has been turned off. Capital inflows have collapsed. According to the Financial Times (28.01.09) “The Institute for International Finance predicts that net private sector capital flows to emerging markets will be no more than $165bn this year, less than half the $466bn inflow in 2008 and just one fifth of the amount sent in the peak year of 2007.” In the case of the Central and East European six nations inflows will fall from $161.9bn in 2008 to $59.5bn this year.

Dependent growth

Now comes the collapse of this dependent growth. To take just one statistic – Russian industrial production fell by 20% in the month of January 2009 alone. These are figures only matched by the economic wipe-out of 1929-33.

In the meantime nations such as the USA and Britain have been in effect living at the expense of the rest of the world, running trade deficits with other nations and borrowing from them in order to maintain consumption levels. For instance the American trade deficit with China is closely matched by the inflow of Chinese money into the USA. So China is lending America the money to buy its exports – but China is a much poorer country than the USA. This daisy chain of payments is remarkably similar to the pattern of monetary flows of the 1920s. The destruction of these capital movements in the Depression did much to make the slump deeper by drying up world trade.  Could this happen again? Sure it could.

In recent years the deficits in the household sector, government sector, financial sector and with the rest of the world run by countries such as Britain and the USA have spiralled as the world boom became more and more obviously based on speculation. Similar deficits and speculation is mirrored in the Eastern countries. There has been a housing bubble in the Baltic countries. Banks, learning from the West, have invented exotic financial instruments and floated such deals as mortgages denominated in yen, since Japanese interest rates were low. In Hungary they preferred mortgages in Swiss francs

All this was fine as long as the exchange rate remained stable. But instability in capitalism means instability in exchange rates. This instability in turn is a product of the unevenness that is an inevitable feature of capitalist development. These imbalances are ultimately unsustainable. Their ‘resolution’ is having catastrophic consequences for the people of the region

Imbalances

All this is a repetition on a larger scale of the imbalances of the interwar period. So the Chinese have been kind enough to lend the Americans the money to keep on buying Chinese goods in the form of acquitting US government securities. Clearly this can’t go on for ever! But the situation is likely to persist until the Chinese government foresees a wholesale depreciation of the dollar. Yet, as long as the American economy runs these huge deficits, the counterpart is bound to be a net outflow of dollars to buy foreign goods. And if speculators perceive that the USA is living at the expense of the rest of the world by printing dollars, a flight from the US currency is inevitable.

Once again imbalances become causes of contention in a crisis. The flashpoint of national conflicts, as capitalist nations try to unload the effects of the crisis on to other nations as well as their own working class, is bound to be the exchange rate.

The ECE countries are small economies. That means that they are dependent on the fate of the major imperialist powers. The same is true of their currencies. After all, who in Britain but a pub quiz nerd has heard of the Ukrainian Hyrvania? Usually these nations have fixed their currencies against the dollar or the euro. The transmission mechanism of crisis from one country to another works through trade and monetary flows. These currencies naturally are a flash point of the stresses and imbalances that are tested to the limit in the recession.

These fixed rates of exchange can be washed away by a giant wave of global money, with catastrophic effects on the economy. While their exports are cheaper as a result of the depreciation, each good sold abroad earns less foreign currency and their debts become more and more expensive to service in the national money. And those exotic mortgages denominated in Japanese yen and Swiss francs don’t look such a bright idea when the local money tanks against the major trading currencies of the world.

Financiers are essentially gamblers. They would bet on two flies climbing up a wall. And they also bet on the prospects of countries going bust. These bets are called sovereign credit default swaps. From this point of view Ukraine looks like a derby winner. Their CDS rate is 3,700 base points (these are in effect the odds on a default) compared with 1,000 for Latvia and 560 for Hungary, two other high risk economies. The money men (and women) are gambling that a whole nation is unable to pay its bills. And they complacently await a sovereign default – a whole country going under - so they can collect their winnings.

Iceland has already in effect defaulted as a nation. Last October it was discovered that the wizards of high finance had produced a situation that Icelandic banks owed six times as much as the people of Iceland produce in a year. In Western countries when the banks turned up their toes, finance ministers rushed to save them on the grounds that they were ‘too big to fail.’ But the Icelandic banks were ‘too big to save’! Naturally the people of Iceland are to pay for the crimes and stupidities of their bankers.

The knock-on effects of the crisis have already hit Hungary, Lithuania and Latvia. Other countries in the region are also in the firing line. Governments are going down like ninepins. There is no end in sight to the economic and political turmoil. In Iceland the left has been swept to power by a ‘pots and pans’ revolution, but they have been given the job of pulling the chestnuts out of the fire for capitalism and making the cuts demanded by the International Monetary Fund.

IMF

The IMF is the financial sheriff. It stabilises capitalist economies at the expense of the common people. For instance Estonia’s deficit with the West has fallen to 15% of GDP. In order to cut their coat according to their cloth, GDP must fall by 15%. That is the IMF’s remedy.

Like the spectre at the feast the IMF always turns up when things look bleak, and helps make them worse. What do they propose? They demand that countries at their mercy cut government spending. Latvia has pledged to cut $913m (5% of GDP), a huge sum for a country of only 2 million people. One country after another is now lined up outside the head’s office for chastisement.

Readers will notice that countries under the cosh of recession such as Britain and the USA allow government deficits to balloon. They are reluctant to cut government spending as they know it will make the recession worse. Yet that is exactly what the IMF is insisting upon. The IMF is deliberately making unemployment, and the plight of the poor, worse. What sort of medicine is that? It represents the interests of the capitalist class in the dominant imperialist countries.

The Observer (26.04.09) reports from the economists blowing the whistle on the IMF. “An analysis of the new wave of loans, by Mark Weisbrot and colleagues from the Washington-based Centre for Economic Policy Research (CEPR), finds that every one contains pro-cyclical policies.” (i.e. it makes the slump worse) “While the IMF has led the argument for large-scale fiscal stimulus in the rich world to kick-start economic growth, at the same time, the CEPR argues it is still forcing the countries that come to it for emergency loans to cut back on spending and reduce budget deficits.

For example, Pakistan had to promise to cut its deficit from 7.4% of GDP last year to 4.2% this year. ‘While this might be a desirable goal, it is questionable whether this reduction should all be done this year, when the economy is suffering from a number of external shocks that are reducing private demand,’ Weisbrot and his co-authors say…” But who cares about the Pakistani poor? Not the IMF.

“Duncan Green, head of research at Oxfam, says that whatever the message from HQ in Washington, IMF staff on the ground can't help handing out tough medicine: ‘It's in their DNA.’”

At the G20 in the beginning of April the big capitalist nations pledged with great fanfare to increase the IMF’s funding to ‘help out’ the poor nations who are at the sharp edge of the crisis. Amid silent recrimination the rich nations have been unable to agree as to who is to stump up the cash. It is a measure of the depth of the crisis that the IMF, and the rich countries it represents, has lost control of the situation.

Political Repercussions

All in all things look bad for the ‘emerging economies.’ This is already having predictable political repercussions. According to Jason Burke (Observer 18.01.09): “Eastern Europe is heading for a violent "spring of discontent", according to experts in the region who fear that the global economic downturn is generating a dangerous popular backlash on the streets.

Hit increasingly hard by the financial crisis, countries such as Bulgaria, Rumania and the Baltic states face deep political destabilisation and social strife, as well as an increase in racial tension…

“According to the most recent estimates, the economies of some eastern European countries, after posting double-digit growth for nearly a decade, will contract by up to 5% this year, with inflation peaking at more than 13%. Many fear Romania, which joined the European Union with Bulgaria in 2007, may be the next to suffer major breakdowns in public order.

‘In a few months there will be people in the streets, that much is certain,’ said Luca Niculescu, a media executive in Bucharest. ‘Every day we hear about another factory shutting or moving overseas. There is a new government that has not shown itself too effective. We have got used to very high growth rates. It's an explosive cocktail…’

“Marius Oprea, security adviser to the last Romanian government, said the economic crisis would mean ‘serious problems for the middle class.’” (and not just them!) “He added: ‘There will be a fall in tax revenue which will lead to major problems for state budgets. The numbers of state employees will also be cut right back and their salaries will be worth less and less…’”

Dr Jonathan Eyal, a regional specialist at the Royal United Services Institute thinktank in London, said eastern European countries were ill-equipped to deal with the impact of the global downturn and risked ‘social meltdown’.

‘These are often fragile economies ... with brittle political structures, political parties that are not very well formed and weak institutions. They are ill-prepared for what has hit them," Eyal said. "Last year it was the core western European countries which were shaky; now it is the weaker periphery that are getting the full blast of the crisis.’”

 May 2009

 December 18, 2010 by Michael Roberts http://www.thenextrecession.wordpress.com