The gravity of the present world economic
crisis comes in part from the spectacular imbalances and crazy capital flows
that occurred in the years of the boom that finally juddered to a halt last
year. Martin Wolf, an eminent spokesperson for big capital, warns in the
Financial Times (02.12.08), “The world has run out of willing and creditworthy
private borrowers. The spectacular collapse of the western financial system is
a symptom of this big fact… In the long run, the global economy will have to
rebalance.” If it doesn’t work out, “The open world economy may even break
down. As in the 1930s, this is now a real danger.”
He goes on, “In 2008, according to
forecasts from the International Monetary Fund, the aggregate excess of savings
over investment in surplus countries will be just over $2,000bn…In 2008 the
big deficit countries are, in order, the US, Spain, the UK, France, Italy and
Australia. The US is far and away the biggest borrower of them all. These six
countries are expected to run almost 70 per cent of the world’s deficits.”
Global imbalances
This is not supposed to happen. The
countries mentioned are the heartlands of world imperialism. Imperialism,
according to Lenin’s classic account, is characterised by the export of
capital. That means the imperialist powers are supposed to lend to the poor
countries. But in the twenty-first century they have been running huge deficits
in trade with the rest of the world. They have become the borrowers!
Who has been lending them the money to live
beyond their means? According to Wolf it is the oil exporting countries, then
China, Germany and Japan. China alone has a surplus of $399bn. Yet compared
with the USA, China is a poor country. But for years past the bilateral surplus
China runs with the USA on trade is closely mirrored by the capital flows from
China to the USA, in the form of huge acquisitions of mountains of American
government securities. In effect China has been lending the USA the money to buy
Chinese imports!
The very same countries that have huge
current account deficits with the rest of the world have exhibited similar
financial recklessness at home. US household debt stood at 128% of income. But
the champion was the UK, with consumer debt at 175% of earnings. Consumers in
both countries have been spending like there’s no tomorrow. And they haven’t
been spending their own money. They’ve been buying on the ‘never never’.
Their governments have been doing the same.
The US under Bush has amassed a public debt of $10.6trn. Though New Labour
showed greater ‘prudence’ till recently, the government spending splurge
intended to get Britain out of the recessionary mire will definitely see the
government running a deficit so big that they will be spending 8% more than the
nation produces – which will send our debt rocketing. Marx once said that under
capitalism the only part of the national wealth common people really own is the
national debt.
So both the private sector and the
government have been spending money they haven’t got. And both countries have
been living at the expense of the rest of the world. That sounds just like
imperialism! All this has only been made possible by huge capital flows. In
effect these flows have created these global imbalances which now come crashing
down around our ears.
Imperialism and the export of capital
It should have been clear for years that the
situation described could not go on. But that is not the end of the tale of the
money-go-round. For those imperialist countries have also been lending their
money back out. In particular their targets have been a selected few of the
poor countries, and also the former Stalinist states. This does not include
countries in Africa south of the Sahara, the whole of which is cynically
written off by capitalists with an eye to the main chance as a ‘basket case’.
The countries that have been the lucky
recipients of western investment and western loans are described as ‘emerging
markets.’ This phrase displays a touching optimism as to the ability of
capitalism to raise the living standards of all the people, as their countries
are progressively integrated into the world market. As we see, this optimism is
misplaced. Instead these unhappy lands have been integrated into a world of
crisis and declining living standards. The imperialist powers are determined to
make them the principal victims of the present crisis. The harsh medicine to be
meted out by imperialism amounts to holding their heads beneath the waters till
bubbles cease to rise to the surface.
The gross imbalances in the world economic
system are stacked on top of one another like a house of cards. The slightest
breath of wind could cause the whole elaborate edifice to collapse. The nodes
or junctions between the different units of this structure are the currency
exchange rates. The stresses and imbalances in the world economy express
themselves in monetary crisis and exchange rate instability. The economic
crisis calls out international monetary system into question. But, as Martin
Wolf warned, if the world economy breaks down, the present crisis could become
as grave as that of the 1930s.
Fixed exchange rates
The system of fixed exchange rates
established by the post-War settlement in 1944 broke down in 1971 when the USA
refused to exchange dollars for gold – which was the foundation stone of the
original deal. The Bretton Woods agreement collapsed, not because of a failure
by its founders to adequately grasp the concepts of monetary economics, but
because the world had changed in the meantime. At the end of the Second World
War the USA dominated world trade, it was the hegemonic capitalist power, and the
only capitalist creditor nation. The dollar really was as good as gold. Naturally
it was the basic unit of world trade, and most countries held their reserves in
dollars. The post-War boom led to the revival of rival capitalist economies,
most notably in Germany and Japan. Ironically, these countries began to export
more and more effectively to the USA, and dollars flowed out of America to pay
for them. Over the course of the long boom the USA moved from the status of creditor
to debtor nation. In 1971 the USA effectively devalued the dollar and reneged
on the system that had served its interests so well in the past.
Under a system of fixed exchange rates the
authorities have to meet any demand for the national currency with the
equivalent in foreign exchange. This means that they have to keep trade with
the rest of the world roughly in balance. If the country is running a big deficit,
it will run out of foreign exchange to pay for all the imports. Under a regime
of fixed exchange rates, capital movements are subordinate to the movement of
money to pay for goods. All the big countries maintained systems of capital
controls in order to keep the exchange rate stable. Big capital movements
against a currency could destroy this stability and cause a devaluation.
Floating exchange rates
After 1971 the world moved to a system of
floating exchange rates. Here the rate of exchange is not fixed by the
government, but is set by supply and demand according to market forces. The
exchange rate is determined by monetary flows in and out of the country
conducted by speculators. Since the government is not trying to maintain a
fixed rate of exchange, there is no need to keep capital movements in a tight
corset. Monetary movements are no longer the counterpart of goods transfers,
but became increasingly dominated by capital flows, which take on a life of
their own.
Vast capital movements are a feature of the
modern era. In the new millennium capital flows overwhelm trade payments in the
formation of exchange rates by a factor of 100:1. Speculation in foreign
exchange becomes a major motive for monetary flows. Yet 90% of this speculation
is in half a dozen major currencies. Among the ‘emerging economies’ most
governments fix their national money against one of the global currencies, such
as the US dollar or the Euro. In doing so, they expose their currency to
speculation by the ocean of money that these global capital flows represent. When
the balance of payments looks precarious, the speculative sharks gather round. They
bet on a devaluation. A fixed exchange rate under siege offers a one way bet. If
the currency doesn’t devalue, the speculators have lost nothing. If it does,
they can make 10% or 20% (whatever the devaluation is) in a day. So they wait.
In doing so, they make devaluation a certainty. This is the process we are
watching now in one country after another. It is brutal and inexorable, and it leads
to the impoverishment of already poor countries.
Borrowers and lenders
Another feature of the modern era is the
fact that some countries can maintain a position as borrower nations for years,
as long as they are prepared to pay the interest on their loans, and the
markets have confidence the situation can continue. In 1967 a balance of
payments crisis forced the Labour government of the time to devalue. The
International Monetary Fund intervened, demanding that the Labour government of
the time stop its profligacy. The supposedly sovereign government was
humiliatingly forced to tear up the reform programme the British people had
voted it into office to carry out, and to move to counter-reforms in order to
reassure the foreign speculators.
Yet the deficit Britain was running
amounted to less than 2% of GDP. In recent years Britain, like the USA has been
running deficits of 5-6% year after year without anyone calling the British government
to order. How can this be? Capital can
on no account be allowed to lie idle. It must be given things to do, whatever
mischief it causes. A function of these huge capital flows, anxious to go
anywhere in search of a return, is that imbalances can be created, balloon and
be allowed to fester, apparently oblivious to elementary principles of
accounting known to all. Even Mr Micawber, in Charles Dickens’ Pickwick Papers could recite,
"Annual income twenty pounds, annual expenditure nineteen nineteen and
six, result happiness. Annual income twenty pounds, annual expenditure twenty
pounds ought and six, result misery." (In modern currency this translates
as £19.99 and £20.01 respectively.)
Fictitious capital
This capital that caused so much damage is
fictitious. It consists entirely on pieces of paper that represent claims on the
unpaid labour of workers somewhere. The ‘GDP’ of the planet, the amount of new
values we collectively produced each year, increased by 4% or 5% p.a. in the
early years of the new century through prodigious efforts on the part of
earth’s 6 billion inhabitants. This credit mountain of fictitious capital built
itself up with perfect ease over the same period like an enormous parasitic
growth. It now comes to about $600trn, compared with a world GDP of $50trn in
2007.
This
capital may be fictitious, but it has real effects. It demands imperatively to
be paid and, in the process, it can cause bubbles, panics, crashes and manias
that can devastate real productive capacity. Actually all this shows is that
,with big capital flows, you can get yourself in a much bigger mess with much
more massive debt than was possible forty years ago. As Joe Louis used to say,
“The bigger they come, the harder they fall.”
The ‘carry trade’
Usually investment in poor countries by
rich countries, or loans to the poor countries, is seen as some sort of
assistance for them. Surely that is better than leaving them to pull themselves
up by their own bootstraps! Actually one reason for these capital flows was the
‘carry trade,’ discussed in our recent article on Iceland. The importance of
the carry trade is that it shows capital movements are purely in search for a
fast buck. They do not represent a rational transfer of resources to countries
that most need them. Capital involved in the carry trade moves purely to take
advantage of interest rate differentials.
In the case of Iceland Western capitalism
poured money into a country with a population the size of Coventry not to help
the Icelanders but to take advantage of their relatively high interest rates. This
was sheer speculation. Jack Smart explained, “This is a way for capitalist
speculators and swindlers to borrow money outside Iceland, e.g. in the
Eurozone, at low interest rates, exchange it into Icelandic Krona, and to lend
it to banks, companies and individuals in Iceland at higher interest rates. The
difference between the two interest rates was pocketed by the capitalist as
profit…The FT reported on 8 October 2008 that according to the central bank
of Iceland, the money owed by the country’s banks to foreigners amounted in the
second quarter of 2008 to six times Iceland’s GDP (annual national income).
Iceland had become in capitalist eyes a ‘reasonably large banking system with a
small country attached’ (FT 8 October 2008), but the banking system itself was
in crisis.” (https://communist.red/iceland-what-happened.htm)
Any sane person could have predicted that
national bankruptcy would be the inevitable result of loading up the Icelandic
economy with debts equal to six times its productive capacity. But the
speculators roam in packs. Their motto is, ‘the devil take the hindmost.’
So the carry trade has led to perverse
investment flows. So long as interest rates varied between different countries,
then speculators could exploit those interest rate differentials to make money.
This activity was completely risk free – as long as the money kept flowing. The
collapse of Lehman Brothers in September 2008 meant that the money fountain suddenly
stopped. As a result the whole spider’s web of global transactions was rent asunder,
and capitalists and whole nations left hanging in mid air.
Emerging into what?
Growth in Eastern Europe has been quite
impressive over the past five years or so. This has fed the illusion that these
economies are indeed emerging on to the world market as equal partners with the
classic imperialist countries. But, throughout this period of growth, they were
carrying massive levels of debt and running big deficits with the West. As we
now see, this was like riding a high geared bike. The rider has to pedal
furiously to avoid falling off – as has now happened. Their growth was at every
stage limited and determined by the great capitalist powers. And when things
get sticky, the little countries are the ones that get it in the neck. They are
all about to share, to a greater or lesser degree, the fate of Iceland, known
in stockbrokers’ newsletters as ‘the canary in the coal mine.’
The banking collapse has brought the free
flow of funds, and with it the carry trade, to an abrupt halt. Economist Paul
Krugman explains the consequences for Japan of the credit crunch. Japan is a
much bigger player in the world economy than Iceland, the second largest
national economy in the world. “The conduit of funds from Japan and other
low-interest nations was cut off, leading to a round of self-reinforcing
effects. Because capital was no longer flowing out of Japan, the value of the
yen soared: because capital was no longer flowing into emerging markets, the
value of emerging-market currencies plunged. This led to large capital losses
for whoever had borrowed in one currency and lent in another. In some cases,
that meant hedge funds…began shrinking rapidly. In other cases, it meant it
meant firms in emerging markets, which had borrowed cheaply abroad, suddenly
faced big losses.”
The collapse
So the credit crunch impacted on the
‘emerging markets’ through a drying up of funds from the West, after it had
lumbered them with monster foreign debts they could only finance through exports. As the crisis took hold in the West, these
export markets also dried up. This in turn caused a crisis in the world market
for the commodities supplied by the poor countries, and a collapse in the price
of commodities by which they hoped to make a living in the world. The West was
then forced to contemplate a serious prospect of default on their debts in the
‘emerging markets’. This provoked a flight of capital from the dependent
countries and put extreme pressure on their currency to take the strain. This
is why we live in a period of extreme exchange rate volatility. They are the
transmission mechanism that reflects the pressures upon the unbalanced world
economy. Exchange rates take the strain, and if it is too great they break.
Ukraine
A classic example is Ukraine, now
undergoing treatment from the IMF. As the Financial Times pointed out (Kiev
crunch 03.12.08), the impressive growth seen in the country over the past five
years is all based on foreign investment. “Foreign banks bought local subsidiaries
and foreign lenders piled in, raising the ratio of external debt to gross
domestic product from 45 per cent in 2005 to nearly 60 per cent at the end of
last year and a forecast 78 per cent next year, according to the IMF… With
the current account deficit widening to an estimated 10 per cent this year,
external funding evaporating and the currency falling fast, Kiev turned to the
IMF to help fund its external financing needs of about $50bn a year.”
The article continues, “The authorities
expect about a third of the country’s 170 banks to close or merge. Other
industries with opportunities for bottom-fishing investors include property,
manufacturing and metals.” Of course a tragedy for a country such as Ukraine is
a profit opportunity for the sharks. That’s all on top of the country being
under the cosh of the International Monetary Fund, the financial sheriff.
“The impact of the crisis on the real
economy is only beginning to emerge, with a 20 per cent drop in industrial
production in October. As well as steel workers and coal miners, employees in
every sector from banking to bars fear for their jobs.” A 20% drop in output in
a single month. Welcome to capitalism!
Ukraine was heavily dependent on exporting
iron and steel to Western Europe. Now, because of the economic crisis, the
bottom has dropped out of their main market. Not only that. The price of the
iron and steel they do manage to sell abroad is falling precipitously.
But the debts they hoped to pay off with
steel exports remain. In fact they will get more onerous for most ‘emerging
economies’ as their currencies collapse as a result of the devaluation. They
will have to pay out more and more Ukrainian Hryvnia for each dollar of debt.
Trouble piles on trouble.
Russia
Ukraine’s bigger neighbour Russia is
struggling from the same disease. Here’s Paul Krugman on their plight. “In
Russia, for example, banks and corporations rushed to borrow abroad because
foreign interest rates were lower than rouble rates. So while the Russian
government was accumulating an impressive $560bn hoard of foreign exchange,
Russian corporations and banks were running up an almost equally impressive
$460bn foreign debt. Then suddenly, these corporations and banks found their
credit lines cut off and the rouble value of their debts surging. This, truly,
is the mother of all currency crises, and it represents a fresh disaster for
the world’s financial system.” Political forecasting agency Stratfor says that
Russia is experiencing “a comprehensive flight of foreign capital.”It seems the
prudent (and ultimately pointless) stockpiling of foreign exchange affords no
protection against predatory capital flows. No country is big enough to take on
global finance capital. Not only are the rouble and foreign exchange reserves
at risk. $230bn has been wiped off the value of oligarchs’ shares on the stock
exchanges. As panic struck in September, the authorities had no alternative but
to suspend trading.
National defaults?
As we now know, speculators will bet on two
flies crawling up a wall. They have evolved elaborate instruments to wrap up
their bets. Credit Default Swaps can be made up not just to measure corporate
risk, but also against government securities. In effect you can bet on the
chances of a country defaulting. Let’s check out what odds the bookies are
offering. Here are the current odds.
- Pakistan
is reckoned to have a 90% chance of defaulting. - Argentina’s
chances are 85% of blowing it. - Ukraine
and Iceland have a 60% probability of going down the pan.
Other countries are in the firing line –
Kazakhstan (60%) and Turkey (35%) are two.
The first country to crash out of the
financial whirligig apart from Iceland has been Hungary. Hungarian capitalists
borrowed extensively from abroad. As the credit crunch dried up international
capital flows, international financiers bet against Hungary’s survival. In
doing so, they made the collapse happen. The Hungarian forint lost 20% of its
value. The central bank raised interest rates from 3% to 11½% to prop up the
currency, to no avail. The IMF beat a path to their door, offering a
substantial loan of $25bn, equal to one fifth of the country’s GDP. The
downside was that, as ever, conditions were attached. The Hungarian working
class are expected to put up with cuts of more than 300bn forint (more than $1bn).
They have already indicated that they have no intention of doing so. http://www.marxist.com/hungarys-growing-strike-wave.htm)
The Rumanian authorities resorted to even
more desperate measures to preserve the value of their currency, the leu. At
one point they were charging overnight interest rates of 900% to keep money in
the country. Imagine the effect on domestic industry. No capitalist economy can
survive 900% interest rates for any period of time. The Polish zloty and Czech
koruna have also been having a torrid time on the foreign currency exchanges.
It seems that Eastern Europe and the other ‘emerging economies’ are being set
up to take the rap for the economic crisis.
Latvia
Latvia’s national income has fallen by 4.2%
in the third quarter of 2008 alone. Tiny Latvia has been running a current
account deficit of 22.9% of national income with the rest of the world. That
was obviously a disaster waiting to happen. Money that poured in from the West
to create a classic housing bubble has suddenly stopped and turned about, and
house prices have fallen by 21% this year as a result. Latvian banks employed
such ‘innovative’ techniques as setting mortgage terms in Japanese yen. Now they’ve
been caught out.
"If
the situation were to worsen, Latvia could be forced to seek
balance-of-payments support from the EU or the International Monetary
Fund," said Kenneth Orchard, senior analyst at Moody’s. "The global
liquidity crisis will probably cause a shock to the Latvian banking system,
which will reverberate throughout the rest of the economy. Unless there are
major improvements in the European syndicated loan market by early 2009, the
government will be forced to take remedial action."
Oskars
Firmanus, head of the Latvian consultancy Paus Konsults, said the Parex rescue
had badly shaken depositors in Riga. "It has come as a big surprise. The
bank has been very secretive and did not tell anybody there was a problem.
People have been lining on the streets over the weekends trying to get their
money out of ATM machines," he said. This story is replicated in all the Baltic
states.
What happened last time
This has happened before. In 1997 all the
East Asian economies struck a reef and foundered. Like the East European
economies, they had been growing fast. Like them they were highly geared with
debt, and had to grow fast just to keep the wolf from the door. There was the
same lack of caution and lack of regulation. Finance in East Asia was treated
like the wild west, where fortunes were quickly to be made, in the run-up to
the shipwreck. When the collapse came, East Asian growth was seen as haplessly dependent
on financial flows from the imperialist powers.
As with Eastern Europe, a myth had grown up
around the Asian economies. Nations like Korea were at one time growing faster
than any other capitalist country had ever grown before. They were described as
‘miracle economies’, as ‘Asian tigers’. Those myths were laid to rest by the
1997 crisis. These countries were permanently scarred by the process and some
have never fully recovered from the experience. The era of the ‘East Asian
miracle’ was definitively at an end.
There were important differences as well.
The East Asian economies were typically lumbered with a 6% deficit with the
rest of the world. In Eastern Europe the average was 10%, with some countries
running crazy 20% and more deficits. In other words finance capital was even
more liquid, even more irresponsible, more footloose and fancy free than in
1997.
As today, the crisis took the form of
ballooning balance of payments deficits and runs on the local currencies. It is
not quite true to say that the 1997 East Asian crisis came out of a clear blue
sky. Never the less, the contrast with the present crisis is stark. The crash
that is in process among the ‘emerging economies’ is the direct result of the
crisis in the West. The capitalist world as a whole is facing the most serious
crisis since the Second World War. In 1997 the big capitalist countries were
able to quarantine the infection in East Asia. Workers in the region bore the
brunt of the crisis. This time there is no doubt that the crisis of the
emerging economies, produced by the crisis in the capitalist heartlands, will
spread back to the major capitalist economies in Western Europe and North
America.
Backlash
Eastern Europe and Russia borrowed $1,600bn
in five years, and now the West has suddenly stopped lending. It wants it all
back. These nations like Ukraine, and the region as a whole, have been running
deficits of more than 10% with the rest of the world, mainly with the
imperialist countries. This is like a person earning £100 a week and spending
£110. They have made up the difference by borrowing. Now the loans are being
called in, just as the markets in the West where they hoped to pay their way
are drying up. This puts pressure on the local currency, as outgoings massively
exceed money coming in. Sighting easy pickings, speculators start to bet
against the beleaguered national money. A wall of money makes it impossible to
defend the exchange rate when the balance of payments is in crisis.
The catastrophic economic situation faced
by these ‘emerging economies’ is not good news for the Western nations that
have lent so much, so recklessly. Austria is particularly dangerously exposed.
We have been warning about the dangers for months past, as Matthias Schnetzer
did. (http://www.marxist.com/go-east-where-skies-are-blue.htm)
Austria has loans outstanding equivalent to 85% of its GDP (about $300bn). It
has more loans in East and Central Europe than Germany, a capitalist powerhouse
with ten times the population of Austria. If these loans are defaulted on then
the crisis, begun in the West and exported to the East, could reverberate back
on to Western nations with redoubled force.
Another dangerously exposed country is
Sweden. The three tiny Baltic countries owe an incredible $123bn. $83bn is
outstanding to Swedish banks. Default is a near-certainty. We wish Swedish bankers a heart attack-free
future, but a Baltic default is likely to have wider effects on the whole
Swedish economy through the mechanism of bank failure spreading misery to jobs,
production and housing.
We wish all our readers a happy New Year –
but you’re going to have to fight for it.
