Why is the world economy in meltdown?

With the US economy in tatters, questions are being raised about what caused the crisis and what it will mean for people around the world. Feiyi Zhang looks at the economic turmoil and what it reveals about the health of capitalism as a whole

AS THE US economy lurches from one crisis and bailout to the next, many are predicting recessions will sweep across the globe.

Conservative French President Nicolas Sarkozy was the latest in a long line of neo-liberals denouncing their previous orthodoxy saying, “Laissez-faire is finished. The all-powerful market that always knows best is finished.”

Whilst the ideology that made the market king may not be dead just yet, things are certainly not looking good for the global economy.

Wall Street has been on a roller coaster ride, complete with spikes and plunges. Congress has struggled to respond, as Henry Paulson, the Treasury Secretary, failed to get his corporate handout scheme rubber-stamped on the first attempt (see page 5).

This latest disaster on Wall Street is part of a much broader picture of crisis affecting the world economy.

For starters, the European Commission predicts that Britain, Germany and France will all plunge into recession this year. Ireland and New Zealand are already in recession.

Similarly the US is probably already in recession. Stagnating or negative growth and rising unemployment affects Japan and other European countries.

Some commentators have gone so far as to predict a depression (a sustained period of negative growth and rising unemployment) for the US—with all the consequences that would have for the world economy.

The US subprime mortgage crisis, which began to hit US markets in 2007, is credited with sparking the current crisis. Although there is agreement that the subprime crisis is an immediate cause of the current meltdown, behind this crisis there are fundamental problems of profit generation in the capitalist economy.

The problem is more than the product of a few greedy traders or one or two bad financial products—the Wall Street crash has once again revealed that crisis is endemic to the system.

The subprime crisis

Still, it is important to start where we are now—with the subprime crisis and its shockwaves.

Subprime mortgages were just one part of the phenomenal growth of financial speculation in the search for profits across the globe over the last two or three decades.

The dot com boom and bust of the 1990s saw large flows of investment into technology stocks in the US, investments that did not end up being profitable. The bubble collapsed from 2000-2002 and the US’s central bank, the Federal Reserve, responded by slashing interest rates.

This cheap credit fuelled a new bubble in housing. There was an explosion in personal debt. The housing sector grew rapidly until brokers, having sold to nearly everyone who could afford a mortgage, needed to find a way to sell to those who previously could not afford one.

The word “subprime” refers to the category of mortgages that were taken out by the poorest in American society. These mortgages were bundled together with other investments and sold on Wall Street and within private financial institutions as complex financial instruments.

The interest generated from each deal made it seem like dealers were creating profit and increasing prices.

The dangers inherent in this process are obvious—but that didn’t stop the financial speculators.

The subprime bubble burst when people on low incomes began defaulting on their mortgages and US growth slowed. Investors realised how risky these loans actually were and there was a panic on the money markets—hence the credit crunch, as banks began to refuse to loan money to each other.

This is disastrous for the capitalist system, as money and credit is essential to renew investment—otherwise the entire economy stagnates.

Governments that used to sing the praises of the free market have stepped in to save debt-ridden financial institutions, throwing huge amounts of money at bailing out banks.

The UK and US administrations have spent trillions bailing out Northern Rock, Bear Stearns, Fannie Mae and Freddie Mac. There have also been major bank bail outs in Iceland, Germany, Belgium, Netherlands and Luxemburg.

Understanding the financial system

The current crisis raises questions about the relationship between finance and the real economy.

Costas Lapavitas, a Marxist economist, explains that: “finance has become relatively autonomous from productive enterprises as well as growing rapidly. The process of real accumulation and value generation has not grown to anything like the same extent.”

Marx summed up the role that finance plays in the current system—that of a prophet and of a swindler.

Finance is a prophet in that it is a mechanism for capitalism to continue to expand. It can connect capitalists who do not have an outlet for their profits, but who do have money to invest with those who have no money, but do have a productive investment (such as a business idea).

Jane Hardy describes the relationship well in International Socialism arguing: “…financial capital [acts] as a sort of lubricant by redistributing surplus value created in the process of production. The credit system [makes] capital more mobile geographically, allowing capitalists to expand to other parts of the world, and more mobile in usage, so that there [is] money available to invest in innovation in new areas of the economy.”

It is clear here that you cannot separate money, finance and credit from the real economy. Marx understood that the development of production expands credit, and that the expansion of credit in boom times then leads to an expansion in industry.

The problem is that this seemingly harmonious relationship is only good for the short-term. It is fine in so far as business borrows to expand and individuals borrow to consume.

However, along with this comes finance’s role as a swindler, as in the subprime crisis, where the prospect of profits comes from speculation in unproductive investments.

In the short-term the finance sector may seem to have a life unrelated to the real economy. In the long run however, the finance system is dependent on the profitability of the productive sector.

Jane Hardy says, “In terms of economic crisis then, credit is the lever of overproduction and excessive speculation. It accelerates the material development of the productive forces and, therefore, the violent outbreaks and contradictions in the system that have become deeper and more frequent in the last decade.”

The problems of the system as a whole

Many prominent economists view the problems of the subprime crisis as merely driven by finance and the so-called financialisation of our system. However, if you look deeper you will see this is mistaken.

To fully understand why the problems in the system are not simply related to the finance market, we need to look at the relevance of something Marx stated was central to an understanding of modern political economy—the tendency for the rate of profit to fall.

Marx explained how value in capitalism is the exploitation of human labour—which is realised in the market as profit.

However, in the drive for profit, firms tend to invest more in machinery, plants and technology, rather than in employing and training human labour, in an effort to get ahead of other firms and thus increase their own profit levels.

Any advantage gained, however, is only short term, as other firms catch up and utilise the same technology as the leading firm. Thus in the long-run there is a tendency for the rate of profit to fall as the amount of human labour as a proportion of total investment decreases.

There were unprecedented growth levels in the post-World War II boom. However by the mid-1970s the world economy began to slow down—growth slowed, profits slumped, and unemployment increased.

Numerous studies of profit rates show that from the mid-1970s onwards there has been a a slow recovery in profit rates—but they have not recovered to anywhere near previous boom levels of profit.

There are several possible reasons for the recovery we have seen in profit rates. These include increased military spending, the development of booms within Brazil, Russia, China, and India and the growth of the financial system.

But one of the key mechanisms for maintaining profit growth under neo-liberalism has been control over the workforce. Much of the productivity growth of recent decades has been built on driving down wages and conditions—making people work harder and longer—allowing the bosses to increase what Marx called “absolute surplus value”.

The contradictions of neo-liberalism

Neo-liberalism is riddled with contradictions that demonstrate the more fundamental problems with the way the capitalist economy functions.

Neo-liberalism has given free rein to market forces encouraging what Marx described as the tendency for capital to centralise and consolidate into large firms with monopoly control of the market in particular goods or services.

This has been a growing feature of late capitalism seen in the rise of multi-nationals and their role in the world economy as globalisation took hold.

The continuous bubbles of speculation show how dangerous this consolidation and concentration of capital actually is. For instance the US central bank was recently forced to step in and save financial institutions Fanny Mae and Freddie Mac, which own more than US$5 trillion in US home mortgages, nearly half of the total outstanding mortgages.

Governments can no longer allow large corporations and financial institutions to collapse.

The market share these corporations have means that their collapse can lead to major economic crises—and not only at a national level. Due to increasingly global inter-relationships, any collapse can have global implications.

The US subprime meltdown is not the first such crisis. In 1998, US banks pumped a total of $3.75 billion into Long-Term Capital Management, a hedge fund whose collapse threatened to destabilise the US and world financial system.

The speed and flexibility of the financial system which sends money around the world in search of profits, can also be a detriment to the whole system, as it can just as rapidly transmit crisis in a single economy across national borders. This is known as “contagion”—the crisis in one region spreading very rapidly to others.

Globalisation has left national economies increasingly exposed to the fallout from problems in other national economies.

As is examined elsewhere this issue, the export relationship that China has with the US, Europe and Japan will affect the Chinese boom if there are recessions in those countries.

Marx also argued that during periods of crisis the bankruptcy of firms enables the wiping out of weak capitals, so that the cycle of profit could be regenerated.

Yet as governments inject money into large corporations to prevent them from collapsing this process of wiping out of weak capital is thwarted.

Rather than allowing the possibility of a new period of profitable investment, each injection of money to save failing institutions lays the basis for ongoing and worsening problems of profitability for the system as a whole.

Who will pay for the crisis?

Governments continue to push down working conditions and wages to generate profit while using taxpayers’ money to bail out the executives of large corporations.

It is clear that governments all over the world are looking for ways to push the cost of the current crisis onto the working class. The Bush administration’s bailout plan is but the most obvious example (see page 5).

British Marxist Chris Harman outlines what is key to understanding how we are to respond to the crisis: “Politics, Lenin famously remarked, are concentrated economics. The politics of the period ahead will be determined by the clash between the pressure for governments to impose cuts in living standards and the reluctance of the mass of people to accept them. The key question will be what form those politics take.”

Whilst Sarkozy and others might talk about neo-liberalism being dead, all of their proposals for dealing with the crisis reflect their absolute commitment to free market ideology.

Every proposal from politicians has involved some variation of large-scale corporate welfare and market “solutions” to the massive market failure.

Republicans and Democrats in the US voted down Paulson’s first bailout plan not because they truly were sickened by the concessions to corporations and CEOs or because they want the money to go to the working class people who are losing their homes and jobs.

They voted it down because they knew it was massively unpopular with the bulk of the population who can see straight through the rhetoric. And they know that there is more to come.

But in order for there to be a real break from the neo-liberalism that has wreacked havoc in the US and across the globe, the working class will have to fight for massive changes to ensure that the bosses and the corporations pay for the crisis they have caused.

It is in this spirit that the rest of this issue of Solidarity looks at some of the key battles ahead—over the Northern Territory intervention, climate change and on the industrial front.

How we respond on these fronts is of crucial importance in ensuring that it is not the working class that is forced to bear the brunt of the latest economic crisis.


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