Marx’s theory–explaining the credit crisis

Neoliberalism has dominated economic and social policy for the best part of three decades. This ideology claims that the economy and society can be effectively run through the market and “small government”.

However the subprime crisis afflicting the US, and threatening to push the world economy into recession, demonstrates that it cannot solve or explain the problems of the capitalist economy. Guided by this theory, most economists are at a loss to explain the volatility in global financial markets that followed the crisis in the US housing market, and the return of high inflation alongside slowing growth.

The central problem is that neoliberalism-based on neoclassical economic theory developed in the 1870s-does not acknowledge the tendency within the system towards crisis. The current crisis has thrown its validity into question, with markets unable to prevent crisis and governments stepping in with desperate attempts to stabilise the system.

In the mainstream media there is constant commentary on the chances of a recession and disagreement over the need for government intervention. “For three decades we have moved towards market-driven financial systems,” complained the British Financial Times’ Martin Wolf, a leading neoliberal, following the US Federal Reserve’s $US30 billion bailout of Bear Stearns, one of the five largest investment banks on Wall Street:

“By its decision to rescue Bear Stearns, the Federal Reserve, the institution responsible for monetary policy in the US, chief protagonist of free-market capitalism, declared this era over.”

Like Wolf, many economists have complained that such moves only create “moral hazard” by encouraging banks to lend imprudently in the belief that government will always bail them out.

They warn that this represents a return to 1970s-style Keynesian policies, when governments across the world tried, unsuccessfully, to prolong the postwar boom. Others, like Fed Chairman Ben Bernanke, argue that failure to intervene would have guaranteed a deep recession.

Behind all the confusion, neither side of this debate really grasps the dynamic that has led to the crisis. While it is occasionally possible for government intervention to prevent crisis in the short-term, there are more fundamental contradictions at the heart of the system that not even Keynesian policies are capable of addressing.

Marxist economic theory provides a means to understand these contradictions because it sees crisis as an inevitable outcome of the capitalist economy, irrespective of levels of state intervention. It alone explains how the crisis in credit and financial markets is linked to a more fundamental contradiction at the core of the system.

Explaining the crisis

Marx saw the cycle of booms and slumps-what establishment economists call “the business cycle”-as intrinsic to the system. Since the postwar boom ended, there have been five such downturns in the system (1974-5, 1980-2, 1989-91, 2000-1 and, potentially, today’s financial crisis) interspersed with periods of boom.

A boom occurs when firms invest where they think profits can be made. In the rush to out-compete each other, they expand output as rapidly as possible. As firms invest for profit they provide a market for other firms, who can sell capital goods to them, such as machinery, or consumer goods to the workers they employ.

The whole economy booms as more goods are produced and unemployment falls. However, this boom cannot last because of ingrained problems with the accumulation process.

Marx explained that the accumulation of capital created a tendency for the rate of profit to fall. On one hand, Marx saw the exploitation of human labour as the source of profit. People work above what it costs to hire them in wages, creating surplus value, which is realized as profit when the final commodity is sold.

On the other hand, firms are driven to constantly invest in more efficient technology and industry because of the need to compete. To achieve this, each firm invests a higher proportion of profit into physical capital, such as machinery. But the rate of this investment far exceeds the rate of investment in labour.

Although short-term profits might be gained for individual capitalists, in the long-term innovation becomes the norm and wipes out any individual advantage. Firms have to invest more and more just to get the same return on their investment as before. In other words, the rate of profit across the entire system begins to fall.

Marx acknowledged that there were “countervailing tendencies” to this trend. For example, firms would respond to lower returns by increasing the rate of labour exploitation. This meant lengthening the working day, making wage-earners work harder or simply cutting wages.

Capitalists could also raise profit margins after downturns by buying the capital of bankrupt firms at rock-bottom prices-what Marx called ‘the concentration and centralisation of capital’. Other Marxists, such as Lenin and Rosa Luxemburg, showed how the global expansion of major capitalist powers (i.e. imperialism) could also counter-act the falling domestic rate of profit.

Finally, the system could prolong booms by literally producing for waste, preventing falling returns from spreading across the system. For example, over half of all investment in the US economy in the late 1920s was ploughed into luxury consumption and advertising.

An even bigger boom was created by massive investment in military hardware by the US and its allies during the Cold War. None of these measures, however, could stave off crisis indefinitely.

Evidence from the past 40 years supports this basic argument. A number of Marxist economists-such as Robert Brenner, Fred Moseley, Anwar Shaikh and Simon Mohun in the US and GGérard Duménil and Dominique Lévy in France—have shown that the world rate of profit fell sharply from the late 1960s to the early 1980s, and then recovered until today, but by only half the rate of increase experienced during the 1950s and 60s.

Explanations for this rise vary. For example, US firms have increased the exploitation of workers. Working hours have risen, jobs have been casualised and average real wages have not risen since the 1970s.

Also, following the 1989-90 recession US firms, helped by the state, swallowed up competitors and ‘rationalised’ production. Military spending has also been on the rise. According to the American Marxist Harry Magdoff, US official military expenditures for 2001-05 averaged 42 percent of “gross non-residential private investment”, providing a huge boost to US industry.

Finally, the growth of industrial production in East Asia (and recently in China) has contributed to this recovery.

But, even when taken together, these policies have been unable to return the system to the stability that characterized the postwar boom, or to prevent it periodically slipping into crisis.

In the last decade in particular, the failure to rescue the rate of profit has led to renewed bursts of wasteful speculation. These have presented a short-term image of dynamic expansion but, in reality, have only led to bigger headaches for neoliberals. The subprime crisis in the US is just the latest example of their blind faith in the market.

What happens next?

The collapse of the US subprime mortgage market is central to the current crisis. In brief, mortgage brokers believed fast money could be made by lending to people unable to afford repayments. Banks and wholesale lenders then bought this debt, repackaging loans as mortgage-backed securities, collaterised-debt-obligations and other complex financial instruments. These structured products yielded high rates of return and were on-sold to pension-funds, hedge-funds and even government institutions.

Many economists believed that this was efficient. Repackaging debt was a way of ‘spreading risk’ across the economy, they argued. If a few loans went bad, the whole system could bear the load, preventing large numbers of firms from going bust.

In reality, it has only made it more difficult to predict trends in the economy—no-one really knows how widespread these debt-instruments are—and has spread crisis more quickly between different sections of capital.

This confusion has led to considerable panic. For example, in April the British government announced a $US100 million “special liquidity scheme” to help troubled banks. This follows its ₤50 billion nationalization of investment bank Northern Rock in February.

Amidst the confusion, the easiest solution has been to blame the banks or inadequate financial regulation. These criticisms have cast doubt on the validity of the market and led to claims about a ‘return’ to Keynesian economics.

It is true that crises can start through the disruption of the financial system, such as a sudden shortage of credit. But financial collapse is a symptom of a wider capitalist crisis, not its cause.
It cannot be understood without grasping with the failure of the system to recover the postwar rate of profit. For example, following the last US recession in 2001, the Fed attempted to kick-start the economy by cutting interest rates to the bone.

Policymakers hoped to substitute for the unwillingness of capitalists to invest by financing a surge in debt-driven consumption. This policy led to strong consumer spending and a booming housing market. Excited by prospects for easy money, capitalists across the world speculated in high-yield subprime mortgage products.

There is nothing new about such bouts of financial speculation. Similar trends emerged in the Japanese property market in the late 1980s and in US ‘high tech’ stocks in the late 1990s.
Marx described how the growth of credit was central to the growth of the whole system. During a period of boom, firms demand the cheapest-possible credit in order to finance investment and competition. More recently, it has transformed individual firms into giant financial institutions.

In these circumstances, finance can appear to disconnect from the ‘real’ economy that produces goods and services. Thus, according to Marx, credit “reproduces a new financial aristocracy, a new kind of parasite in the guise of company promoters, speculators and merely nominal directors; an entire system of swindling and cheating with respect to the promotion of companies, issue of shares and share dealing”.

It is only once the speculative bubble bursts that the true role of finance—to enable firms to accumulate capital—becomes obvious. If the gap between inflated financial prices and profits in the rest of the economy is large enough, a financial collapse can precipitate a full-blown recession.
All of a sudden profits are squeezed and credit dries up. In an attempt to recoup profits, firms will try to cut back production or raise prices. But this only harms other firms with tight margins, or cuts demand as workers lose their jobs.

A current credit crunch is the irony of ironies: When credit is needed the most, financial institutions are too frightened to lend it. As the Polish Marxist Rosa Luxemburg argued, “after having (as a factor of production) provoked overproduction, credit (as a factor of exchange) destroys, during the crisis, the very productive forces it created.”

Because they are unsure how deep the crisis of profitability is, state institutions such as the Fed are currently unwilling to let major banks collapse. But bailouts and injections of ‘liquidity’ (such as giving money to banks) can only fend-off crisis in the short-term—and, like the Fed’s reaction to the last recession, they can conceivably make things worse in the long-run.

As British Marxist Chris Harman argues, “The system rests on the unplanned interaction of thousands of multinational corporations and a score or so of major governments. It is like a traffic system without lane markings, road signs, traffic lights, speed restrictions or even a clear code that everyone has to drive on the same side of the road.

“This will make it very difficult for those who claim to oversee the system to prevent the crash in the financial sector generalising into something more serious in the next few months. And any success they have will be temporary, at best deferring the moment of reckoning for a couple of years”.

This does not automatically mean a crisis like the 1930s-Depression, or the East Asian crisis in 1997-8, is inevitable. Another possibility is what occurred in Japan 17 years ago.

In 1991, the Bank of Japan, concerned about inflation, lifted interest rates—only to ‘prick’ the property bubble and drive the whole economy into recession. No catastrophic Depression eventuated—instead Japan was driven into a decade-and-a-half of near-zero growth, stagnating industry and falling living standards. No amount of interest rate cutting has yet been able to stimulate a recovery to the heights of the 1980s.

So, while no-one can predict with any certainty what will happen next, we know for certain that working class people will be made to pay for the downturn unless we organise to defend our jobs and services.


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