Risky Business

According to the lead editorial in the October 19th New York Times, which illustrated the paper’s currently tough tone on this subject, “By now everyone knows that reckless and even predatory mortgage lending provoked the financial meltdown.” Bad though the subprime mortgage disaster is, the Times continued, even more serious is the fact that “the easy money also fed a corporate buyout binge,” resulting in “a potentially sharp increase in corporate bankruptcies.” The paper of record called on Congress to prepare for the consequences by extending unemployment benefits and by figuring out “what reforms are needed to make sure these disasters don’t happen again.”

During the Great Depression preceding the passage of the Social Security Act, “soup kitchens” provided the only meals some unemployed Americans had.
This particular soup kitchen was sponsored by the Chicago gangster Al Capone. Source: http://www.ssa.gov/history/acoffee.html.

This view—typical of economic commentary in its explanation of the current financial crisis as stemming from a toxic mix of reckless greed and insufficient regulation—is a step in the direction of realism; it takes us beyond the early 19th-century view that a general crisis of the economic system is simply impossible. That outlook was revived in recent decades by theorists of the rationality of markets like Nobel laureates Milton Friedman and Robert Lucas, and made the foundation of regulatory practice by former Fedmeister Alan Greenspan. But that was yesterday. Today’s call for reinvigorated government action is, of course, only a retreading of the step already taken by J.M. Keynes in his General Theory of Employment, Interest, and Money of 1936, in which the celebrated economist both argued the theoretical possibility of the crisis by then underway for seven years and asserted that proper governmental response could counteract it. But the current neo-Keynesian critiques fall well short of facing up to the actual state of affairs facing global capitalism.

That state of affairs is generally referred to as a “global financial crisis.” But the financial crisis, though as real as can be, is only a manifestation of other problems that have yet to emerge clearly into public view. As I pointed out in the first of these articles (see www.brooklynrail.org/2008/10/express/up-in-smoke), the subprime mortgage meltdown that appeared with the deflation of the housing bubble is not unrelated to stagnant or falling wages and rising unemployment. These phenomena have been a common subject for wonder in economic commentary in recent years—how can so many people be doing so badly in prosperous times? Such questions are born both of a narrow conception of prosperity (if the stock market is still up, all must be well) and of a short attention span: in fact, an adequate comprehension of what is going on in the economy today requires a look back in history. Even a brief review of the past sixty years will show not only the recurrent difficulties generated by the capitalist economy, but also the limited ability of governmental action to offset them.

The most recent worldwide Great Depression (the moniker was earlier applied to the international downturn of 1873-96), conventionally reckoned to have begun with the crash of the U.S. stock market in October 1929, came to an end soon after World War II. While the coming of the war had returned the United States to full employment, this was only by way of government deficit-financed spending for war production, not because of the revival of the private-enterprise economy. The same was true of Japan and Germany, which in any case, along with the rest of Europe, ended the war in a state of economic ruin. Leaving a fuller discussion of the cycle of crisis and prosperity for the third essay in this series, I will note here only that the revival of the capitalist economy after this lengthy period of economic depression and physical destruction followed, in broad outline, the pattern set in previous episodes of economic collapse and regeneration.

In the words of Angus Madisson’s report on The World Economy in the Twentieth Century (1989), written for the OECD, the club of advanced capitalist nations, “The years 1950 to 1973 were a ‘golden age’ [which saw] a growth of GDP [Gross Domestic Product, i.e., the total value of goods and services produced in a given year, expressed as a sum of money prices] and GPD per capita on an unprecedented scale in all parts of the world economy, a rapid growth of world trade, a reopening of world capital markets and possibilities for international [labor] migration.” This is not an idiosyncratic view: all commentators agree on describing this period as a golden age of capitalism. However, the success story is less straightforward than may appear (even if we leave out of view the years of economic misery and the war, with its tens of millions dead, that form its foundation).

To quote Madisson again, “A major feature of the golden age was the substantial growth in the ratio of government spending to GDP,” which “rose from 27 per cent of GDP in OECD countries in 1950 to 37 per cent in 1973.” In most countries this was due largely to increases in welfare-state spending on such matters as social security, education, and health care. In the United States it included sizeable sums spent on war and preparations for war. In the words of economist Philip A. Klein, writing for the conservative American Enterprise Institute, “America’s ‘longest peacetime expansion’—from 1961 to 1969—was influenced greatly by the redefinition of the term ‘peacetime’ to include the Vietnam War and the increase in defense spending from $50 billion in fiscal year 1965 to $80 billion in fiscal year 1968.” It was this American expansion that, in turn, helped power global growth, notably by way of the revival of Japan and the takeoff of Korea, particularly stimulated in the Vietnam War period.

In other words, the capitalist economy proper—the private enterprise system—was not by itself able to produce a level of well-being sufficient, in the eyes of state decision-makers, to achieve a politically desirable level of social contentment. Thus, for example, when a Republican government, acting on its anti-spending, pro-free enterprise ideology, cut defense spending after the Korean War without offsetting increases in domestic expenditure, the United States experienced a sharp drop in production and a correspondingly sharp increase in unemployment. Despite its wishes, the Eisenhower administration quickly acted to lower interest rates and increase government spending, including public works (on the scale of the interstate highway system) as well as military projects. In the United States, in fact, political economist Joyce Kolko noted in 1988, “roughly half of all [U.S.] new employment after 1950 was created by state expenditures, and a comparable shift occurred in the other OECD nations.”

Keynes’s idea had been that the government would borrow money in times of depression to get the economy moving again; when national income expanded in response, it could then be harmlessly taxed to pay back the debt. In reality, crisis management turned into a permanent state-private “mixed economy” and the national debt, far from being repaid, grew steadily, both absolutely and in relation to GDP. The growing national debt made itself felt in a tendency towards inflation, as businesses increased prices (and workers tried to catch up) to offset the rising chunk of national income taken by government, and as the Treasury printed dollars to finance American government operations. Under the postwar arrangement entered into by the world’s capitalist nations, the dollar, representing a fixed amount of gold, served as a standard against which the value of other currencies could be measured, thus facilitating international trade and investment. By 1971, so many dollars had been created that the U.S. had to sever the dollar’s tie with gold, to avoid the possibility that Fort Knox might be emptied as other nations cashed in their greenbacks. While this move, contrary to the opinion of many, did not basically alter the nature of money, it did signal how far the world economy had moved from the self-regulating mechanism imagined by free-market enthusiasts towards a system dependent on constant management by governmental authorities—and one in which the relaxation of management would make way for dire developments.

The golden age was real, whatever its limits. This is visible in the fact that it came to an end around 1973, when world growth slowed dramatically. At the time this was blamed on the “shock” of a rapid rise in oil prices, engineered by the OPEC countries, in collusion with oil companies, in an effort to increase their share of the world’s profits and to offset the fall in the value of the dollar, the currency in which oil prices are set. But the fact that growth on the earlier scale did not resume when the world economy adjusted to this change (and even when oil prices declined again) indicates that some more fundamental change in the global economy was at work. Warning signs had been visible for a while. As economist William Nordhaus observed in an article published by the Brookings Institution in 1974, “by most reckonings corporate profits have taken a dive since 1966,” even taking into account the record profits of the oil companies in 1973. “The poor performance of corporate profits is not limited to the United States,” he continued. “A secular [long-term] decline in the share of profits has also occurred in most of Western Europe.”

Capitalist business enterprise is oriented towards profit. It is the expectation of future profit that drives the level of investment and the forms that investment takes. With the decline in profitability it is not surprising that corporations used the funds available to them less for building new factories to produce more goods than for squeezing more profit out of existing production by investing in labor and energy-saving equipment and setting up assembly plants in low-wage areas. (Results included a sharp rise in unemployment in Western Europe and in what became the Rust Belt of the U.S., as factories became more efficient and were moved south and abroad.) In addition, the widely observed speedup, dismantling of occupational safety measures, and extension of the work week, along with increasing employment of part-time and temporary workers, also helped lower the average wage and so increase profitability. Especially in the U.S., the steadily increasing facilitation of consumer debt, from credit card financing to easy-to-get mortgages, was another means, like inflation, to lower wages by raising prices: the additional cost of items is collected by financial institutions under the name of interest. Pension plans made part of workers’ earnings available for use by brokerage firms, banks, and other financial institutions; their replacement by 401(k)s, like the weakening or elimination of health-care plans, further diminished labor costs.

At the same time, corporations began to spend vast sums they might earlier have used to expand production to buy up and reconfigure existing companies, selling off parts of them for quick profits and manipulating stock prices to make money on the stock market. In the late 1980s, it has been calculated, about 70 per cent of the rise in the Standard & Poor index of stock values was due to the effects of takeovers and buyouts; over the next twenty years the excess of stock prices over the underlying values of the companies they represent continued to grow. Thus the merger and acquisitions boom of the 1980s shaded into a larger pattern of speculating in financial markets rather than investing in productive enterprises. To take just one area of speculation, the value of funds involved in currency trading—buying and selling different national moneys to take advantage of small shifts in exchange rates—rose from $20 billion in 1973 to $1.25 trillion in 2000, an increase far greater than the growth in trade of actual goods and services. To explain the rise of debt-financed acquisitions and other modes of speculation as the effect of greed, as is often done today, is doubly silly: not only does it leave unexplained the sudden increase of greediness in recent decades, it also ignores the basic motive of capitalist investment decisions, which must always be guided by the expected maximum profits achievable in a reasonably short term. Similar to the way that playing the lottery, despite its multimillion-to-one odds, represents the most probable path to wealth for the average worker, speculation simply came to offer business-people better chances for higher profits than productive investment.

The “globalization” of capital is part of this pattern. While often imagined to consist in a worldwide expansion of production and trade, it has consisted largely in trade and financial flows among the OECD countries, together with the relocation of some production operations to a few low-wage areas. The United States remained the world’s top manufacturing nation in 2006, producing almost a quarter of global output (although increasingly plants in the U.S. are owned by foreign companies). To take the latest focus of economic excitement for contrast, China’s output is still less than half of the U.S.’s, and largely consists of the final assembly of components manufactured elsewhere. Like domestic investment, the export of capital—which in any case has remained overwhelmingly within the capitalistically developed economies of the OECD—has been driven, in the words of economic analyst Paolo Giussani, “by sectors more or less directly tied to finance and short-term speculation.”

And all of this activity came to rest increasingly on debt. In general, an inflationary economic environment encourages borrowing, since the falling value of money acts to lower interest costs. As the golden age came to an end, the slowdown in productive investment meant an increased availability of money to be loaned for other purposes. In the United States, companies had traditionally financed expansion out of their own profits, but in 1973 corporate borrowing exceeded internal financing and this was only the beginning. (Around the same time France saw a U.S.-style move to borrowing, the traditional mode of corporate financing in Germany.) The increasing uncertainty of economic affairs led in particular to a growth in short-term debt, though this in itself helped produce a rising rate of corporate bankruptcies, as sudden fluctuations of fortune could make it impossible to repay loans in short order. Increasingly, money was borrowed to finance mergers and acquisitions and to speculate on the various financial markets. Avenues for speculation were multiplied by the invention of new “financial instruments,” such as derivatives, swaps, and the now infamous “securitization” of various forms of debt, including home mortgages. For an idea of how far the imaginative mirroring of actual invested money by the creation of new saleable claims to it went, consider the fact that by the time of the crisis of mid-September, the world’s estimated $167 trillion in financial assets had given rise to $596 trillion in derivatives, basically bets on the future movements of asset prices.

The 1970s had seen rapid growth in lending to underdeveloped countries, as commercial banks replaced governmental and international agencies as the main sources of borrowed money. Between 1975 and 1982, for example, Latin American debt to commercial banks grew at over 20 percent a year. Debt service grew even faster, as refinancing piled interest charges on interest charges. The result was a series of debt crises that wracked Latin America after the early 1980s. Eventually it became apparent that these debts could simply not be repaid; one consequence was the abandonment of internal economic development projects in these countries in favor of the export-oriented economic strategies demanded by the international economic authorities (the World Bank and International Monetary Fund) that oversaw the restructuring of debt. A similar fate was in store for loans advanced to the centrally planned economies of Eastern Europe. Their disastrous entanglement in debt, which seemed originally to provide a way out of the declining fortunes of the state-run systems, was an important step towards the integration of the former “communist” world into the global capitalist system. (I remember, fifteen years ago, suggesting to a Hungarian dissident, György Konrád, who had just finished extolling integration into the world market as a solution for his country’s problems, that the East might be joining the West just as the capitalist economy’s happy days were over; he replied that he had finally met in me someone more pessimistic than a Hungarian.) By 1984, America joined this club, taking in more foreign investment than it exported, and a year later the U.S. became a net debtor. It gradually turned into the world’s largest recipient of investment and the world’s largest debtor, seriously dependent on foreign lending to finance both its wars and its unhinged consumption of much of the world’s production.

In all these ways, then, debt—promises to pay sometime in the future—took the place of the money the slowing capitalist economy failed to generate. Such a state of affairs is necessarily unstable, open to disruption by forces ranging from the speculative activities of individuals, such as when George Soros forced a devaluation of the British pound in 1992 (earning an estimated $1.1 billion in the process); and to the decisions of scores of businesses to move money in and out of national and regional economies, as when the weakening of the Thai real estate market in 1997 led to the collapse of the Thai currency, the baht, and then to credit crises in places as distant as Brazil and Russia. Meanwhile, the deeper reality at the bottom of the wild swings of speculative fortune—the insufficient profits earned by money invested in production, relative to the level of economic growth required to incorporate the world’s population into a prosperous capitalism—had multiple repercussions. These included the depression, born of the fizzling of a real-estate bubble, that has afflicted Japan since 1990; the continuing high unemployment in relatively prosperous Europe; the stagnation of the American economy, with falling wages, rising poverty levels, and dependence on constantly increasing debt—personal, corporate, and national—to maintain even a simulacrum of the fabled “American standard of living”; the continual slipping back into economic difficulties of the nations of Central and South America, despite periodic (though uneven) successes in mastering them; the relegation of most of Africa, despite its vast natural resources, to unrelenting misery except for the handful of rulers salting away the proceeds from oil and mineral sales in Swiss banks; the analogous limitation of Russian and Chinese capitalism to the machinations of former party apparatchiks-turned-millionaires; and the historically unprecedented accumulation of hundreds of millions of un- or under-employed people in the gigantic slums in which the majority of the world’s population now live. This is the reality that has persisted beneath the alternating contractions and expansions, the debt crises and their temporary resolutions, the currency collapses and financial panics that have shuttled from one part of the world to another over the last thirty years.

And this is the reality that finally claimed the attention of Americans this September. Americans were taken aback by Al-Qaeda’s successful attack on the World Trade Center seven years ago, but the surprise at learning that the United States has enemies intent and able enough to do some real damage soon faded, for all practical purposes. The current threat is a more serious one and it will have a bigger impact, because it comes not from without, from some inscrutable foreign enemy that hates “our values,” but from within—from those values themselves, from the love of freedom, at least the freedom to do business.

For this very reason, the nature of the problem is difficult to understand, even for those who might wish to understand it. Hence the constant railing, by politicians, pundits, economic writers, and plain citizens, at greed, corporate irresponsibility, inadequate government regulation. Our survey of the postwar economy confirms the point made in the first of these articles, that the dismantling of the regulations put in place during the Great Depression to limit financial hijinks—at the behest of the largest banks, with the intention of controlling marginal but competitive operators—was what made possible the level of well-being achieved, along with its increasingly unequal distribution, over the last two decades. Without the exuberant expansion of credit during these years, we would long before now have been brought uncomfortably face to face with the economic decline that showed itself in the mid-1970s. Today, the economic gains of yesteryear are melting away like glaciers under the impact of global warming, as trillions of dollars vanish from stock markets around the world, while the nine largest U.S. banks have lost more money in three weeks than they made in profit during the three years after 2004. But despite the surprising readiness of publications like The Economist (whose October 18, 2008 issue featured a story on “Capitalism at Bay”) to consider the economic system as truly imperiled by its current disorder (not to mention the horror with which true-believing Republican politicians discover “socialism” in government aid to the banking establishment), it is still difficult for people to understand that the current crisis is a result not of greed and deregulation but of the long-term dynamic of capitalism itself. The next and last article in this series will explore that dynamic, as an aid to grasping the situation in which we find ourselves—a situation that brings both danger and the possibility of change for the better.


Paul Mattick

PAUL MATTICK'S book, Business as Usual: The Economic Crisis and the Failure of Capitalism (Reaktion, 2011) is based on articles written for the Rail.