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Saturday, September 27, 2008

Financial Meltdown: Why Capitalism is in a Mess

Guest commentary by Irish Marxist Kieran Allen,
School of Sociology, University College Dublin
Thursday, 25 September 2008

Most people are amazed to witness a new Wall St crash when the spectacle of the 1929 crash was supposed to have vanished forever.

For the past thirty years mainstream economists claimed that the market worked perfectly provided there was no state interference or strong trade unions. ‘You cannot buck the market’ was repeated like a mantra against anyone who dared to ask for higher wages, better environmental controls or a more developed welfare state. ‘Market forces’ were seen as wise spirits who knew best about how to run an economy. No one knew who or what they were but they appeared to work anonymously behind the scenes to make everything right. In almost every country, people were told to leave matters to these ‘market forces’ and not to seek too much regulation. In reality, these ‘market forces’ were gigantic financial houses which *could move money around the globe at will.

Today this mythology has been shattered. The US government is being asked to provide a $700 billion blank cheque to bail out the finance houses. This follows a series of other bailouts in recent weeks – amounting to another $400 billion. To put those figures into perspective, simply compare how this money could be used to solve world hunger. Each night 850 million people go to bed hungry. If the $700 billion blank cheque had gone to them rather than the finance houses, this dire level of hunger would be wiped out. If the combined package of more than a trillion dollars had been used, the 2 billion of the world’s 6 billion people could be lifted out of chronic poverty. In brief, the trillion which is being handed out to the speculators could have wiped out malnutrition and extreme poverty in the world for ever.

The power to use the latest $700 billion blank cheque will be handed over to Henry Paulson, the US Treasury Secretary. Paulson is the former CEO of Goldman Sachs, whose salary package in 2005 came to $36 million. As Treasury Secretary he has surrounded himself with former Goldman Sachs executives and will use US taxpayers’ money to save his former company which was a big player in the world of speculation. Meanwhile the 10,000 US citizens who face foreclosure each day will watch as the banks - which caused the speculation are saved – but they lose their houses. Instead of a free market, we are witnessing the ‘socialisation of losses and the privatisation of profit’.

The same will happen in Ireland quite shortly. Up to recently, an unholy alliance of the banks, Fianna Fail and the construction industry hyped up a property bubble. It is now estimated that Irish banks have about €7 billion of bad debt on their books. If they are faced with bankruptcy, these banks will look for the same type of handout that was given to AIB in 1985. After the AIB got their fingers burnt in speculation in the London insurance market, they demanded ‘corporate welfare’ from the Irish state. Legislation was quickly rushed through the Dail to give the bank over €127 million. Yet, later, economists from Goodbody Stockbrokers – the speculative arm of AIB - would lecture the population on the need for ‘restraint’ on wages and social welfare, without showing the slightest sign of embarrassment.

This latest crisis of capitalism has been triggered by ‘spivs and speculators’ but it would be wrong to regard them as a breed apart from the wider capitalist class. The division between finance capital and industrial capital has long since broken down and now ALL corporations engage in ‘financial engineering’. A corporation such as General Motors may have problems selling cars but the financial wing of the company made $2.9 billion in profit in 2004. Similarly, the French company Danone no longer simply makes yoghurt but has also engaged in absurd orgies of speculation, buying 31 million of its own shares in the past five years at a cost of €4 billion euros. Speculation is an intrinsic part of the system and there is no fine line between ‘greedy speculators’ and good clean capitalists.

The central issue is why has speculation come to play such an important part in modern capitalism? In the past decade, the system has stumbled from one speculative bubble to another. Think of the bubble in the nineties, the fiasco over ‘emerging markets’ in East Asia which brought their crash of 1997, the near collapse of the shadowy Long Term Credit Management Corporation in 1998 which almost brought the whole financial system crashing down after it lost €5 billion. (In those days, that was still considered a considerable loss.) There have been plenty of warnings but the transfer of resources to speculation has grown continually. It is estimated that FIRE – Finance Insurance Real Estate- accounted for 16 percent of total profits in 1965 but that it now accounts for 40 percent of profits today.


To understand what is happening you need to return to two key contradictions which Marxists have noted about capitalism.

First, it suffers from periodic crisis that result from over-accumulation. Each capitalist seeks to profit by selling commodities. He or she will normally use those profits to re-invest back into their corporation in order to accumulate more profits. Strangely enough, the best capitalists are not those who live a life of absolute luxury –although many do – but those who are driven by the bug: ‘accumulate for accumulation’s sake’. In other words, don’t concern yourself about human needs, simply produce to make profit to make more profit.

Yet despite all the mysticism of conventional economics, the basis of profit is human labour. Each capitalist constantly tries to reduce unit labour costs in order to magnify their profits. The more they cut wages or the more they act collectively to cut the share of an economy distributed to workers, the more profitable they are. Yet if each capitalist is cutting wage costs AND simultaneously each is also trying to produce as much as they can, they run into a fundamental problem. Namely, over-accumulation - because workers cannot buy the goods that are produced. These goods may, of course, be desperately needed by human beings – but if they cannot be bought, there is no market. Sometimes, this problem can be overcome if capitalists themselves stimulate the economy by greater investment in capital goods – in machinery, factory space and office space – which creates more jobs and wage packets. But here the system runs into a second problem.

Capitalism also suffers from a longer term tendency for the rate of profit to fall. Marx’s argument was a little more complex on this score. But, essentially, this tendency arose from the fact that the ‘organic composition’ of capital changes over a period. This means that the level of capital investment to the amount of labour employed shifts dramatically in favour of the former. The first capitalist who tools up with new machinery manages to make greater profits. But as the entry level for capital investment in any one industry increases and fewer workers are taken on, the rate of return on investment drops. This occurs because labour is the source of profit. Different studies have come up with somewhat varying estimates but two French writers, Duménil and Lévy state that “the profit rate in 1997” was “still only half of its value of 1948, and between 60 and 75 percent of its average value for the decade 1956-65”.

In response to these combined problems, capitalists have reacted by intensifying the rate of exploitation within the workplace and by encouraging a debt-induced growth among the population outside the workplace.

Everyone is aware of the former trend as we are constantly confronted with demands for ‘flexibility’, ‘downsizing’ or cost cutting. But less attention has been paid to how the latest stage of neo-liberal capitalism relies heavily on debt. Yet the connection is absolutely intrinsic.


As pressure has grown to reduce wages and shrink the state, working people have been encouraged to take out ever more debt in order to buy the goods produced by the system. The latest stimulus for debt has been the property bubble that has been stoked up in many countries. According the Economist, the world housing bubble between 2000 and 2005 was the biggest of all time, outrunning even that of 1929. On the basis of a supposedly rising assets, millions of consumers were encouraged to take out further debts on the based on the inflated values of their homes. It is estimated that American consumers cashed in about 10 percent of the apparent values of their home to take out new loans for cars, home improvements, and credit card debts. This debt- induced growth fuelled a consumer boom which sucked in goods from other economies around the world.

Debt was like elastic that could be stretched to cover the decline in real wages and used to stimulate economies. It also left working people with a massive hangover. In the US, household debt now stands at $ 12 trillion and the average person spends 14 percent of their income just on servicing their debts. In Ireland the personal debt ratio to disposable income has risen from 48 percent in 1995 to 113 percent in 2004. Debt-induced growth led directly to the sub-prime crisis because the lenders needed to ensure that property prices stayed high if they were ever to be repaid. They developed a strategy of lending to people who had a history of credit defaults or who were originally seen as simply too poor to pay back the mortgages. Through the use of ‘teaser mortgages’ which allowed repayments to start at a low level and then jump swiftly after a few years, they developed a sub-prime market. Today the sub-prime market accounts for 15 percent of all US mortgages and about 5 percent in many other countries.

Rising debt levels, however, are not confined to personal household debt. Government and corporate debt has also expanded dramatically. The US current account deficit runs at around €2 billion per day and its total debt has risen from 1.5 times its GDP in the mid 1970s to 3.5 times its GDP today. The US empire used its military power to ensure that the dollar remained the principal currency of the world. (One of the reasons for the Iraq war, for example, was to prevent Saddam Hussein denominating oil prices in euros rather than dollars) As the dollar was not tied to any fixed standard, they could increase its paper supply and so underpin enormous levels of debt.

These strategies to stimulate global capitalism became known as ‘privatised Keynesianism’ or more simply bubble economics. The system needed speculative bubbles and an intensification of its rate of exploitation of workers to overcome the problems that Marx pointed to more than a century ago.

But while rising levels of debt can sometimes stimulate an economy laid low by constant attacks on working class standards, there is also an intimate connection between debt and speculative activities. Higher levels of debt have helped banks and finance house to gain a greater role in the economy. But it has also co-incided with a host of new ‘financial instruments’ whereby supposedly clever techniques are used to ‘spread risk’. The sub-prime crisis itself is a prime example. This spread beyond the US because banks sought to minimise risk by ‘slicing and dicing’ toxic loans and mixing them with what appeared to be healthy loans and then spreading these throughout the global financial system. Despite claims to be ‘risk takers,’ big capitalists are, in fact, extremely cautious people who turned to the most bizarre strategies to minimise, spread or ‘hedge ‘ against risk. (Watch out in the coming weeks for how the bizarre spectacle of ‘credit defaults swaps’ starts to unwind as the insurance that speculators took out against risk falls apart.)

If debt is one logical outcome of a neo-liberal offensive to reduce the share of an economy going to workers, then ‘excess savings’ is another outcome which has developed at corporate level.

Capitalists, who make huge profits from intensifying the exploitation of workers, have become unsure about re-investing back in industry and services because of the problem of over-accumulation and declining rates of profits. Since 2001, the global system entered a new period of growth but it has been the lowest of any comparable interval since the 1940s. One of the main reasons is that the capitalists do not invest in new plant or equipment or in the creation of new jobs. The capital injected into plant and equipment is only one third of the post war average for the equivalent period in the business cycle while the number of jobs is two thirds below the average. Instead of increasing investment in productive activity, the capitalists have renewed their offensive on working conditions. They want to squeeze ever more productivity out of fewer workers.

The result of this failure to invest is that many corporations have ‘excess savings’. These ‘savings’ have sought a home and have increasingly found it in speculative activities. But, ironically, the more corporations have turned to speculation to use up their ‘excess savings’, the more they have also borrowed to gain more ‘leverage’ to join in the orgy of speculation. If you find for example that you can get a 30 percent rate of return on speculation rather than 7 or 8 percent through investing in industry or services, you will borrow more to take out a bigger bet. You will assume that your debts will be paid off so fast that you can enter new speculative activities. It is, of course, driven by greed – but capitalism is based on organised greed.


The scale of the speculative activity of modern capitalism is truly awesome and we can only offer a sketchy picture. Here are a few pointers:

Stocks and Shares: These are simply pieces of paper that allow individual capitalists to sell rights to a share of the exploitation of workers. But these pieces of paper can become of the subject of speculative activity itself. In other words, bets can be taken not just on how much profit each share will generate but on how share prices can rise or fall. In 1975, 19 million stocks were traded daily on the New York Stock Exchange. Today 1,600 million stocks are traded, valued at $ 60 billion.

Currency: Corporations need to buy and sell currencies in order to facilitate trade. But once again, currency can also become an object of speculation if you think that dollars will fall below euro – or vica versa. It is estimated that less than 15 percent of currency transactions now facilitate trade and the rest is for speculation. In 1977, $18 billion was spent each day on currency transactions. Today it is a thousand time more – $1.8 trillion.

Futures: As speculative active grew, each corporation wanted to ‘hedge’ against rising costs by buying future raw materials or energy at designated prices today. But once again this mildly sensible activity became transformed into speculation. Today only 8 percent of the futures market is spent on real hedging and the rest is pure speculation. So each day 10 billion contracts are made which take bets on the future prices of currencies, government bonds, interests rates or just about anything. There is a whole industry which will speculate on the items such as the price of Argentinean wheat in 2012 in Japanese yen. And it is not because they need wheat to make bread – but just to bet!

Hedge Funds and Derivatives: These are really an extension of the futures market. Hedge funds purport to take the risk out of the market by buying and selling ‘derivatives’. A derivative is anything that derives its income from some other activity. So you can have derivatives based on shares, currencies, interest rates or again just about anything. You can sell and buy rights to buy or just options to buy items in the future. The hedge fund works by charging a fee for this activity and promises its rich participants that they can get an average of 30 percent return from its speculative activity. The most famous hedge fund (because he chose to write about it) is George Soros’ Quantum Fund which gained one billion dollars in speculating against the British pound in 1992. It is estimated that hedge funds are currently playing with $2 trillion of other people’s money and that they have $600 trillion of often fictitious capital floating around the globe. The vast discrepancy arises because hedge funds leverage or borrow cash to speculate.

Leveraged Buy Outs: The nineties saw a wave of mergers as huge corporations such as Pfizer, for example, bought up Warner Lambert to forge mega corporations. But often these mergers were driven by ‘leveraged buy outs’ whereby the predator company put up one third of the price of its rival’s shares and then sought to pay off the rest by loading the company it purchased with debts. Last year, there was another frenzy of mergers and acquisition with $3 trillion spent on buying shares of other companies. According to the Wall Street Journal, 20 percent of companies who issued new shares are so saddled down with debt that might be literally worthless. Leveraged buy outs has become a bizarre game whereby speculative capital seizes weak companies and tears them to pieces. As Business Weeks put it, the aim is to ‘Buy it, Strip it and Slice it’.


These activities have become so obscene that even the right wing French President, Sarkozy is calling for a return to ‘a regular and regulated capitalism’. Yet this dream of returning to the Golden Age when capitalism appeared to respect the rules is a fantasy.

For one thing the sheer scale of the funds controlled by corporations means that any government would find it difficult to control them. Lehman Brothers, for example, made a loss of somewhere between $30 billion and $80 billion. To get that in proportion, the GDP of Kenya is about €30 billion. In other words, more wealth was wrapped up in one secretive speculative company than was possessed by the 40 million people of a middle sized African country. Lehman Brothers may have lost out but others such as Goldman Sachs survive and their man, Henry Paulson, has effectively become the economic dictator of the US. The resources that giant corporations control allow them to evade or re-write regulations in a variety of ways. They employ lobbyists to bribe or buy politicians; they promote their views through a corporate media to shape public opinion; they threaten economic sabotage if any measure decreases their profits. In brief, they engage in a perpetual game of economic blackmail because they hold the vast majority of the resources of society in their hands. Far from states controlling corporations, it would appear that corporations control states and make them serve their purpose.

Secondly, as we have seen speculation is intrinsic to capitalism and this is why every panic over speculation never leads to change – but rather a new speculative bubble. The only answer that capitalists give when their system hits a crisis is to ask working people to accept greater sacrifices. In Ireland, most trade union members are being asked to do without a pay rise for eleven months to ‘help the country’. The €1 trillion that US taxpayers stumped up to rescue the speculators will be taken from budgets for welfare recipients, government employees and the poor generally. But these cries to make the poor pay only exacerbates the problems of over-accumulation and creates ever more surplus capital which seeks new avenues for speculation.

The only rational answer to the obscenities we are currently witnessing is to tackle the very system that produces them. The problems arise from the fact that Boards of Directors – composed normally of about 15 or 20 people of different corporations - make the most fundamental decisions in our society. They form the core of one particular class which dictates the very purpose of human economic activity. Behind the elaborate veil of mysticism, the games on Wall Street are being played with the resources of the world. Some of that wealth is literally fictitious but some has also been drained off from the sweat and efforts of millions of people. Instead of allowing a tiny corporate elite to waste and destroy the fruits of our labour as they have done, we need to take over control of the products of our labour.

Socialism, therefore has returned to the agenda with three simple propositions.

* That instead of bail outs for the rich, banks and large corporations should be taken into public ownership so that the wealth they control is used for the good of society and not squandered on insane games of greed.

* Instead of relying on ‘market forces’ to determine how the resources of society is used, we need conscious democratic planning. Society as a whole should have a say in how our resources are deployed and to what future purposes it is directed.

* Instead of giving CEOs and Boards of Directors a free had to intensify the exploitation of the many, we need economic democracy whereby the producers control units of production.

The fight to replace capitalism with a system that puts people before profit has well and truly begun.

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