Max McGuinness on the Crisis of Capitalism
Like most people, I have spent the past week trying to understand the enveloping economic crisis, lavishing levels of concentration on the Financial Times and Barron's normally reserved for Heidegger and Proust.
Like, it seems, anyone who ever bought or sold a Credit Default Swap or a Collaterised Debt Obligation, my comprehension of what they are remains at best hazy -- CDOs involve inherently risky mortgage-based debt; CDSs are insurance against default in the CDO market. The fiendish complexity of the various financial instruments now going up in smoke has been regularly adduced as one reason for the continuing meltdown.
Wise financiers like Warren Buffet and George Soros always steered clear of these toxic derivatives, insisting that they would never invest in something that they did not understand (in the process, they made much more money than anyone who ever worked at Lehman Brothers). And these speculative sophistries in fact obscure a simple yet fundamental problem with the global economy, particulary, its Western component -- twenty-five years of excessive debt.
For the drama of the past few weeks has not just been about short-selling or the demise of independent investment banking (note that universal banks are no panacea -- remember Northern Rock?). Rather, the lunacy of an economic model based exclusively on an ever increasing quantity of credit, derived from an essentially stagnant pile of deposits, has been revealed. It's not as if we weren't warned: bubble after bubble has burst since the late 1970s -- oil prices in 1981, the stock market in the late 1980s, housing around 1991-92, the stock market again in 2000, housing again last year. Each time a bubble has burst, investors have just moved on to another bubble, all the time stoking up a much bigger super-bubble which was the uncontrolled expansion of credit itself.
That bubble has now exploded, spraying economic blood and pus in all directions.
Without the massive intervention by federal banks and government since last year (which has reached its zenith with Hank Paulson's proposal to spend $700 billion buying up toxic debt), the entire global financial system would have completely collapsed. It had already gotten to the point earlier last year where banks had stopped lending to each other, let alone anyone else. Absent a functioning banking system, anarchy is just around the corner. Civilisation itself is under threat. This is euphemistically dubbed a "liquidity crisis" and in a sense that's what it is...but the real liquidity has been going on for decades as an ever increasing amount of debt has been extracted from a stagnant amount of real money.
Banks and insurers are essential but they are supposed to be at the service of the productive sectors of the economy -- lending money to, and managing the deposits of, people who actually make and grow things. The enforced nationalisation of AIG last week shows exactly how the opposite now applies -- what was once the world's largest insurer exposed its entire balance sheet to the risk posed by insuring debt, which should never have been insured in the first place.
If this sounds hopelessly old-fashioned, that's because it is. The world economy took a wrong turn in the early 1980s, largely to overcompensate for an earlier wrong turn during the 1960s and 70s. Deregulation and non-intervention became the new mantra after the inflationary interventionism of the Sixties and Seventies along with the excess of union power which had made Western industry uncompetitive.
But downward pressure on real wages has been so effective that growth since then has been fuelled entirely by credit. It's only now that the cheque has finally arrived after the biggest splurge of all since the late 1990s.
Median real incomes have not increased at all in the United States over the past eight years yet, bafflingly, house prices soared. In the UK, incomes are up a little bit but this is attributable to a) government redistribution policy and b) the impact of easy credit on the wider economy; house prices went up even faster than in the US. Yet the productive capacity of the economy in both countries has hardly increased as shown by the stagnation in the stock market:
FTSE 100 2 January 1998: 5,193;
FTSE 100 22 September 2008: 5,236.
S&P 500 2 January 2008: 975.04;
S&P 500 22 September 2008: 1,207.09.
If the productive sector of the economy had grown at all, then the assets of the companies involved in this growth would have appreciated in value. The only assets which really went up in value were houses, and, tied to them, banks (though not as much as you might have thought given their huge profits -- this should have been an early warning of the maelstrom to come). These increases in wealth have now proved to be illusory. It might be a very long time before house prices go up again -- it's been like that in Germany for ten years now but, then again, they make useful things there like cars and machine tools.
The problem is that the "Anglo-Saxon world" basically abandoned the productive economy in the 1980s, running down manufacturing in the belief that financial services would take up the slack. For many years, this seemed to be correct. American and European manufacturing had become uncompetitive in many areas because of low-wage competition from the Developing World. The US and the UK imported goods, sold some services in return, and borrowed the rest. But the current crisis has thrown this entire macro-economic model into doubt. The main engine of growth (and a major source of tax revenue) in both countries has broken down and it is hard to see how it will be ever be fully repaired since its expansion was essentially based on a delusion. So much for exporting financial services too...Who is going to trust American insurance and investment banking or British mortgage-lenders now?
The effects on the real economy of this crisis are only just being felt. In the next year or two, there will be a vast unravelling as banks remain reluctant to lend and a succession of private equity outfits go bust, depriving thousands of firms of the finance they need to keep going. Look out for a really big default in Detroit where either GM or Ford could rapidly run out of credit, putting hundreds of thousands out of work. The US Treasury's rescue package will at best stop the rot; the collapse in confidence will remain for years to come. And don't even bother hoping for a new "New Deal" if Barack Obama is elected president. The US deficit is already so huge that the levels of spending needed to reflate the economy are not feasible and Obama, like McCain, has shown no sign of knowing what to do. Instead both men have lined up to take easy pot shots at Wall Street.
Meanwhile, a longer term crisis of capitalism threatens to take hold. Western economies abandoned their industrial base many years ago and have since been reliant on financial services for comparative advantage. Once the structural contraction in banking, trading, corporate law, and insurance sets in, it will become apparent that there are not many jobs left for which Westerners can demand big Western salaries. There are no uplands left in the global economy to which Western workers can ascend once they have acquired new, even more sophisticated skills. Mass unemployment and declining incomes will then become a realistic possibility in the West. In turn, China and India will have no-one left to sell their exports to. The solution lies with resurrecting the productive sector in the West...and no-one has a clue how that can be done.
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