24.09.1998

Uncontrollable forces

Michael Malkin discusses the crisis of global financial markets

When George Soros speaks, capital listens. So we should note his warning that there is “an urgent need to rethink, and reform the global capitalist system”; and that world financial markets are dangerously unstable, having been acting “like a wrecking ball, knocking over one economy after another”. These extraordinary remarks were made against a background of increasing alarm about a worldwide financial crisis and the possibility of a “credit crunch” leading to a global recession.

Of course, Soros is hardly an objective observer. He and the ‘hedge funds’ under his control must accept a share of responsibility for the current mess. Every day they move billions in and out of different markets looking for speculative gains. The sheer weight of capital at their command means that they help shape these markets, and this in turn gives their words tremendous power. Readers will remember that Soros’s call for a devaluation of the rouble proved to be a catalyst in the meltdown of the Russian financial system, a debacle which ironically cost Soros’s funds some $2 billion in losses.

There could be a number of motives behind Soros’s comments (made during a speech to the banking committee of the House of Representatives urging them to accept Clinton’s request for an extra $18 billion of emergency funding for the IMF), but the same message can be heard from many other quarters. An international - potentially global - financial crisis does exist, and it is having an increasingly adverse impact on the real economy of many countries. What is at issue is the scale, severity and likely duration of the crisis and its impact in terms of the deflationary pressures that could lead to a wide-scale recession or even a slump.

Needless to say, the current market turbulence has induced a well known conditioned reflex among the Trotskyite left (see Weekly Worker  September 3). Betraying a facile mechanistic inevitabilism, they declare yet again that the collapse of the capitalist system is imminent, and that a socialist revolution will follow. Like the man with the billboard declaring that ‘the end of the world is nigh’, one day they may be right, but in the meantime they only make fools of themselves and, much worse, provide ammunition to those who would ridicule Marxian theory about capitalist crises.

I want to examine the specific nature of the current crisis; to look at its probable effects and to note what methods governments are adopting in dealing with it. First, since this is a financial crisis, we need briefly to look at conventional theory about the pricing of financial assets.

All markets ‘discount the future’: ie, they rest on an ever-changing consensus about what is likely to happen. According to the conventional paradigm, the prices of financial assets such as shares, bonds, etc are determined (in a loose sense) by assumptions about the future level of certain key economic variables, such as interest rates, inflation and GDP growth. Hence, putting it crudely, it is in the real economy - ie, the sphere of production - where changes in the prices of financial assets are supposedly determined. Of course, this is only a schema, with limited explanatory efficacy. As everyone knows, the relationship between the spheres of production and finance is complex - they interpenetrate one another dialectically at every level. Moreover, the whole system is subject to extraneous, often irrational, influences from a range of superstructural factors - eg, ‘market sentiment’: the perennial struggle between greed and fear.

Of course, at one level the current decline in the values of a wide range of assets - not just equities and their derivatives, but also commodities - is just a reflection of the fact that the law of value has a tendency periodically to reassert itself. What is interesting about the present pattern, however, is that it markedly reverses the paradigm I described above. Economic variables that ‘should’ have been shaping asset values are relatively benign, but they are beginning to deteriorate. This deterioration is attributable not to adverse changes in the real economy, but to developments in the financial markets, especially in the credit system, upon which the whole edifice of capitalism ultimately rests.

At the root of this phenomenon is the globalisation of capital. Given the absence of restrictions on the free flow of capital, and with the aid of modern telecommunications, capitalists can move massive amounts of money into and out of any market in the world almost instantaneously. Such a situation obviously promotes not investment, but speculation.

Although ‘speculators’ clearly bear considerable responsibility for the present dire situation in the markets, it would be farcical to ‘blame’ them for it. The historical tendency for the rate of profit to decline means that the developed economies offer a relatively poor, if safe, rate of return on investment. Capital is always driven to seek the highest possible return, even though the risk is much greater. In the last decade or so, investment institutions in general and the hedge funds in particular have ineluctably gravitated to the so-called ‘emerging markets’, such as the ‘tiger’ economies of south-east Asia, the Latin American countries and, most recently, the former Soviet bloc states, where they sought the best opportunities for capital gains, whether as buyer or seller.

On the buy side, if you throw enough money at an asset, the sheer volume of your trade will create a momentum whereby many more buyers are sucked in; you leave quietly with your profit while the party is still in progress. On the sell side, you can ‘sell short’ (ie, you sell an asset you do not own in the expectation that you can buy it later at a lower price and thus meet your commitments). Given sufficient volume, this tactic also creates a momentum of its own and can be very profitable. It obviously encourages speculators to ‘attack’ vulnerable assets, and this is where the current trouble started, in July 1997, when speculators launched an attack on the currency of one emerging market, the Thai baht.

This assault inaugurated the first phase of what developed, to a greater or lesser degree, into a major withdrawal of capital from the financial markets of Thailand, Indonesia, Malaya and South Korea. Futile attempts to defend their currencies from speculative short selling depleted these countries’ foreign exchange reserves and produced serious distortions in their real economies. So long as these states were a source of superior levels of growth (achieved on the back of cheap labour), capital was happy to reap the rewards. Only a matter of a year ago these ‘tiger’ economies were even extolled by our own great prime minister as models worthy of emulation. How he must regret his enthusiasm now. In the aftermath of the speculators’ onslaught, the ‘Asian miracle’ stands exposed as a combination of bent accounting, wholesale corruption and bad loans. Economic dislocation and social unrest were bound to follow. As we write, there is rioting on the streets of Kuala Lumpur.

The ‘Asian crisis’, described rather modestly by the IMF in its annual report as “one of the worst in the post-war period”, produced what the same organisation calls “contagion effects”. The next seat of contagion was, of course, Russia, where the collapse of the rouble led to an effective default on foreign debt payments and a financial meltdown. Subsequently the “contagion” moved on to Brazil and other Latin American states.

Although the ‘emerging markets’ have understandably been the primary focus of attention in recent weeks, the real seat of the current crisis is to be found in Japan, the world’s second largest economy, where the situation has been described as “desperate” (Financial Times September 18). What happens to Japan has a truly global significance - remember, for example, that the Tokyo region alone accounts for some three percent of the world’s economic output. The picture in Japan is depressing: year-on-year figures for the second quarter of 1998 indicate a contraction of almost four percent in output - numbers consistent with a severe recession. This is the third quarter in succession that Japan has reported negative growth, something that has never happened since World War II, and there is no prospect of recovery in sight.

Again, the root of the problem lies in the financial sector. According to recent estimates, Japanese banks have accumulated around $1.2 trillion in bad debts (Financial Times September 20). The precise figure is unquantifiable for two main reasons: first, the banks’ balance sheets are meaningless, since they include shareholdings as part of their capital adequacy requirement and these holdings are accounted at cost rather than at current market value; secondly, the culture of cross-ownership of shares makes it impossible to asses the overall impact of a market decline that has seen the Nikkei 225 index plumb 12-year lows in recent days.

It is actually possible, as Hamish McRae puts it, that “the whole banking system is bust, in the sense that the loans that will never be repaid are larger than the entire capital and reserves of the system” (The Independent September 15). If the massively bureaucratised financial sector is at last to be sorted out, it will require something akin to the Meiji revolution of the 1860s, and so far the omens are poor. After extended negotiations, the Japanese government has reportedly reached an agreement with the opposition Democratic Party about measures to deal with the banking crisis. Under the terms of this agreement, “troubled” - ie, bankrupt - institutions like the Long Term Credit Bank of Japan will first be nationalised and then liquidated.

Central to the new arrangements is the creation of a new Financial Revival Committee (FRC), with supposedly extensive powers to act as judge, jury and executioner in determining which banks are viable and which are not. Whether the FRC will have enough teeth to see off the entrenched interests which dominate Japanese society remains to be seen. The FRC will not begin work until April 1999 at the earliest and, if the present government has its way, much later than that. Unsurprisingly, the market’s reaction has thus far been negative. Once again, the point to note is that adverse developments in the financial sector have determined the current economic stagnation in Japan. In this case, however, the problem has not been created by short-term, speculative intervention, but by long-term structural factors inherent in the bank credit system. While the market was rising, these factors were hidden. Recession has exposed them.

So much for the specific nature of the financial crisis. What about its probable effects on the real economy in Britain?  Institutions are already reporting losses related to the Asian and Russian crises. Barclays Bank, for example, has been forced to write off £250 million of losses, mainly in the Russian bond markets. Other financial institutions, especially those with heavy exposure to the Far East and other emerging markets, can be expected to follow suit.

More ominously, in the real economy a wide range of companies are blaming the ‘Asian effect’ for poor results, or warning the market that current profit expectations are not going to be fulfilled. “Contagion” has apparently spread to sectors that were previously regarded as relatively defensive safe havens, such as telecoms, oil and food retailers. Every day brings news of fresh job cuts. Growth forecasts have been slashed across the board and according to some estimates - eg, the latest figures from the Centre for Economics and Business Research - unemployment in the UK will increase by around half a million from the beginning of 1999. The precise numbers are anybody’s guess, but what is clear is that the acute financial problems originating in Asia and Russia are already impacting on businesses in Europe, even those which were regarded as relatively immune from such adverse effects.

The UK manufacturing sector, burdened by the effects of a strong pound on competitiveness, was in recession even before the market turmoil. Anecdotal reports to this effect will soon be confirmed by official statistics that will add to the pervasive gloom. The lesson for all workers is that in globalised markets no company, however ‘defensive’ its market profile, is secure from the effects of the current crisis - nobody’s job can be regarded as safe.

Governmental reaction to the crisis has been confused and contradictory. Initially there was talk of a concerted lowering of interest rates by the G7 countries, and Alan Greenspan, the Federal Reserve chairman, appeared to endorse such a move. Markets bounced in reaction, but fell back soon afterwards when Greenspan reversed his position and dismissed talk of coordinated rate cuts.

Capital loves cheap money, so there is no doubt that interest rate reductions would be welcomed in the short term. To what extent such putative cuts might do any real good, however, is questionable. Japanese rates have been negligible for a long time without any noticeable benefit. In normal conditions there might be a case for stimulation of this kind, such as was applied after the so-called crash of 1987. Present conditions, however, are far from normal. The economic preconditions for a recession are absent, and yet a recession is already underway. How can this be so? Basically because financial confidence is at breaking point. In such circumstances it would be folly to hazard a prediction, but the most likely outcome would appear to be a deflationary spiral in which asset prices fail to find a floor.

On the political front, reaction to the crisis has been limited to the kind of phrase-mongering typified by Blair’s address to the New York stock exchange on September 21. According to Blair, what we need are “new” financial institutions for the “new” millennium; a “new” IMF and a “new” world bank will be empowered to “deal with” the crises that have been afflicting capital. This may be good politics, but from the economic point of view it is the purest poppycock. The forces unleashed by contemporary finance capitalism are literally uncontrollable - this is what the threatening global financial crisis is all about. No government or financial institution, however powerful, can get this genie back into the bottle without using the kind of extraordinary measures that would amount to the suspension of the free market and all that such a move implies. In any event, everything we know about Blair suggests that when times get hard he will opt for a rightwing, authoritarian approach to class politics.

Whatever uncertainties there may be about the present situation, one thing is crystal clear: the workers, as always, will have to pay the price. Without falling into the dreams and delusions of our Trotskyite comrades about the historical significance of the present moment, we communists stand prepared for a significant intensification of the class struggle.  For us, the potential disintegration of the capitalist financial system signifies that the need to reforge a Communist Party has become even more urgent.

Michael Malkin