15.10.1998

End of triumphalism

Despite the global financial crisis, capitalism will not collapse of its own accord, argues Michael Malkin

After hubris comes Nemesis. What price now the facile triumphalism of 1991 - the empty boasting about the victory of capitalism in economics and of bourgeois democracy in politics; the ignorant crowing of bourgeois intellectuals about “the end of history”? The period of reaction through which we are living has entered a new phase, in which all the comforting ‘certainties’ that bourgeois ideology derived from the collapse of the USSR are now exposed as mere will-o’-the-wisps.

The existence of a global financial crisis has been confirmed by the highest authority - Alan Greenspan, the chairman of the US Federal Reserve, international capitalism’s spokesman-in-chief. This gentleman’s utterances are normally of Delphic obscurity, so it is significant that he has recently spoken in explicit terms about the acute crisis of liquidity and the credit crunch which now threaten to undermine the foundations of the capitalist system.

It is, of course, premature to talk about the ‘collapse of capitalism’ - a phrase sensibly qualified by a cautionary question mark on the front cover of the latest edition of Socialist Review, the Socialist Workers Party’s monthly (October). Certainly, the capitalist system is undergoing what president Clinton has correctly called its most severe crisis for half a century. Whatever the outcome, there is no doubt that recent weeks have seen the destruction of capital on a momentous scale. According to estimates from the US Federal Reserve, for example, the net loss of wealth thus far amounts to around $1.5 trillion in the United States alone, and equates to some 20% of US GDP. On the other hand, it is quite possible that in a few years time investors will look back on the present time as the best buying opportunity in a generation.

The period since Greenspan’s speech to business economists on October 7 has been marked by astounding volatility in all the major markets: the prices not just of shares, but also of bonds and currencies have been lurching to an unprecedented extent, rising one day on a tide of irrational exuberance; falling the next under the weight of apparent despair. These moves betoken fundamental uncertainty and have what the Financial Times has referred to as an “epoch-making feel” about them (October 10). The Byzantine language of the markets is telling us that a sea-change is underway. But the precise nature, direction and extent of that change are not yet known.

Our primary concern, as always, is with the political consequences of the present turmoil - consequences that are already affecting the political and social fabric of Malaysia, Indonesia, South Korea and Russia. In order to evaluate the potential for similar political repercussions in the main imperialist countries, we need first of all to understand the economic and financial forces underlying the present situation. What interplay of factors can possibly account for the massive devastation of wealth that has already occurred?

The key to the crisis lies in the globalisation of capital. Technological advances in telecommunications and computing have made it possible for capital to be moved around the world almost instantaneously. This development of the ‘productive forces’ of finance capital has opened up undreamed of opportunities for parasitism, epitomised by the activities of the so-called ‘hedge funds’. The raison d’être of these unregulated, secretive institutions is to deploy supposedly ‘scientific’, mathematically sophisticated trading strategies in order to make quick profits. Drawing their primary investment capital exclusively from super-rich individuals and institutions, the hedge funds exploit the sheer volume of their capital resources (often running into billions) in an attempt to manipulate market movements in their favour. Leaving aside the hype, they essentially constitute gigantic pots of gambling money sloshing in and out of markets, not on a daily, but an hourly basis, chasing a quick return wherever it can be found.

The roots of the current crisis of liquidity can be discerned in the near collapse late last month of the splendidly misnamed Long Term Capital Management hedge fund. Headed by a legendarily successful veteran Wall Street bond trader, and with two Nobel prize-winning economists responsible for its investment strategies, LTCM was a particularly prestigious fund with a reputation for a conservative, risk-averse investment policy. Yet LTCM would have gone bust had it not been for the unprecedented intervention of the Federal Reserve. The Fed called an emergency meeting of leading bankers and presented them with a stark choice: stump up £2.1 billion to keep LTCM afloat, or risk allowing the fund’s £60 billionof ‘unclosed investment positions’ (ie, bets on market movements) to initiate a potential systematic failure of the US and European banking system. Needless to say, the banks accepted an offer they could not refuse and they are now effectively the lucky owners of LTCM.

Given its record and prestige, LTCM had no difficulty in borrowing around 30 times its shareholders’ funds from the investment arms of many leading banks, who were keen to share the spoils of an investment strategy so complex that neither they nor anyone else could really understand it. This naivety is symptomatic of relations between the banks and hedge funds in general. The generalised culture of greed and the desire of investment managers to earn fat bonuses by producing above-average returns conspired, not for the first time, to create a disaster. In the immediate aftermath, a few banks have admitted to significant losses attributable to their involvement with LTCM, but the full extent of the damage to banks’ balance sheets will not be disclosed until they publish their results.

The failure of LTCM initiated a fascinating vicious spiral in the markets. Banks that had happily been prepared to ‘invest’ billions of their customers’ money in what was little more than a casino operation suddenly became ultra-cautious. Lines of credit to hedge funds were cut off and existing loans called in. As a result, in order to try and meet their liabilities, the funds had no choice but to liquidate their investments on a massive scale, taking profits where they could and cutting their losses elsewhere. This frenetic trading activity produced some of the most extraordinary and volatile conditions ever seen in the markets.

Normally, a generalised weakness in equity markets results in the dollar and US government bonds benefiting from a ‘flight to quality’. Yet last week, within the space of three days the dollar lost almost 20% of its value against the yen - the kind of violent swing not seen since the break-up of the Bretton Woods exchange rate system in the 1970s. At the same time bond prices were savaged. This extraordinary development was a direct result of an acute crisis of liquidity in the financial system. Any financial asset - be it a share, a bond, a currency or whatever - is only worth what someone is prepared to pay for it. The forced ‘fire-sales’ by hedge funds and banks desperate to close loss-making positions scared most buyers away from the market. At one point dollar-yen trading practically came to a standstill.

In such bizarre circumstances prices inevitably become extremely volatile and irrational. Greed gives way first to fear and then to panic. In a fascinating dialectical process, what is perceived as a sign of instability itself becomes the cause of further destabilisation. In the end no financial asset, however ‘safe’, is trusted. Capital has nowhere left to hide and cash becomes the only refuge. The immediate consequence of such extreme risk aversion is easily predictable: a ‘credit crunch’ or generalised withdrawal of credit in which bad and good risks alike can be swept into bankruptcy.

Central to the current dilemma is the situation of the banks. They are particularly vulnerable in these conditions because their assets are relatively illiquid, whereas their liabilities are quintessentially liquid. If the ‘dash for cash’ gathers significant momentum, then banks in general will be compelled to sell assets and some will struggle to meet their commitments. The ensuing uncertainty adds greater impetus to the vicious spiral and increases the climate of panic.

You do not need to be an economist to perceive that the present situation is fraught with danger for the capitalist system. The flow of capital rather than economic fundamentals has produced the present crisis, but a generalised forced retrenchment and a contraction of lending across the board will inevitably produce significant casualties in the real economy. With the exception of a few politicians, like Gordon Brown, nobody denies that a recession is now inevitable. The only question is how severe it will be.

Concerted interest rate cuts in the developed economies have done something to shore up confidence, but their impact is likely to be short-lived. Interest rates in Japan are virtually zero, yet the Japanese economy remains mired in recessionary stagnation. None of the policy measures suggested thus far has much credibility - certainly not the notion of ‘beefing up’ the IMF. Bankers and bureaucrats favour this option because it accords with the curious received idea that problems can be solved simply by throwing money at them. Such thinking is epitomised in the nonsensical proposition that the Russian meltdown, for example, could have been averted ‘if only’ a few more billion dollars had been injected into the Russian financial system.

In reality, the IMF has been a significant part of the problem, rather than any kind of solution. It was IMF pressure which compelled Asian governments to devalue their currencies and jack up interest rates - a policy that in retrospect can be seen as a contributory factor in the Asian conflagration.

Vacuous talk from the British prime minister and chancellor about creating new global regulatory bodies to oversee the economic and financial policies of states is rightly seen as mere whistling in the dark. The globalisation of finance capital, its development into a supranational, parasitical ‘productive force’, has reached the stage where it is beyond any effective regulation - something one detected in the subtext of Greenspan’s speech last week. The idea that the system may in some significant respects be out of control, or at least in the grip of ineluctable deflationary pressures, was implicit in what he had to say. In trying to describe “a phenomenon that none of us has seen before”, Greenspan more than once emphasised that the ultimate consequences of the current crisis remain unknown. They cannot, in fact, be known because to an appreciable extent they will be shaped not by any rational process, but by emotion. As Greenspan says, the

“major shift towards liquidity protection is really not a market phenomenon ... but a fear-induced psychological response. And markets cannot effectively function in an efficient manner in that environment.”

Although the severity of the coming recession cannot at present be known, it would be premature and foolish at this stage to talk in terms of a slump or depression. However paltry the policy response to this latest crisis of capitalism may be, we can assume that politicians and bankers have learnt something from 1929. In that crisis US policy makers reduced the money supply by over 30% and tried to export their slump by erecting protectionist trade barriers like the notorious Smoot-Hawley Tariff Act of 1930. As a result, world trade was halved in the space of a couple of years. This time round they will at least not make the same mistakes. We can expect a concerted policy of reflation through interest rate cuts and other measures designed to inject liquidity into the system. Crucial to the success of this strategy as a whole will be the way in which the Japanese government comes to terms with its own long-running banking and financial crisis. Even the mere passage of an outline legislative framework for dealing with the banking problem produced paroxysms of relief reflected in a surge in equity valuations across the world on September 13. Perhaps this reaction was symptomatic of the febrile state of the markets in general, but it may represent the most significant pointer to the way in which capital can begin to rebuild confidence in its own system.

Even if the Japanese finally get around to cleaning out their Augean stables, there are still a significant number of potential problems that could exacerbate the crisis. Foremost among them is Brazil, the world’s ninth largest economy, where the situation remains critical. Despite inflation of just one percent and growth of around four percent, foreign capitalists have withdrawn more than $30 billion from Brazil in the last few months. If Brazil falls victim to the current squeeze on liquidity, the effects will be extremely serious for the US economy. Brazil accounts for more than 50% of Latin America’s GDP and is thus a bellwether for the region as a whole. Wall Street has some $60 billion invested in Latin America - well over 10 times its already damaging exposure to Russia - and the region accounts for around 20% of US exports.

Of the other factors which could precipitate a further deterioration in the economic and financial climate, three stand out. In the first place, the savings ratio in the United States is negligible. Americans have grown accustomed to easy profits from a long and unprecedentedly rewarding bull market. American mutual funds, the equivalent of our unit trusts, have been a bedrock of support for Wall Street.

If US small investors decide to cash in their chips, then the consequences could be quite dramatic. Secondly, the collapse of another hedge fund (the Tiger fund was rumoured to be the distressed seller behind last week’s grotesque falls in US bonds) or more particularly a bank would further shatter confidence and possibly lead to a meltdown. Finally, there is the prospect of sheer deflationary pressures on the system. As Japan has proved over the last decade, simply lowering interest rates is no solution. If asset prices fall faster than nominal interest rates, then real rates actually rise to produce a situation that is beyond the control of any central bank or government.

In Britain the situation already looks gloomy by any measure. The Chambers of Commerce quarterly survey paints such a picture. Taking the West Midlands as a guide to the rest, one reads talk of confidence being “wrecked” and of a region heading for deep recession in the manufacturing sector. The service sector, representing more than 50% of the survey’s respondents, also reports a significant downturn in business. This, one should note, is before the impact of recent economic and financial developments has been taken into account.

Undoubtedly, Gordon Brown’s humiliating revision of growth targets for the coming year will not be the last. The interest rate medicine is likely to be applied with enthusiasm, with a low of three percent forecast by the end of 1999. If stimulation of this magnitude does not succeed in boosting the economy, then we shall be able definitively to declare that we are in the grip of a global deflationary crisis.

One thing is certain. The resilience of the capitalist system should not be underestimated. Without the conscious political intervention of the world’s working class, there can be no talk of ‘the collapse of capitalism’.