frontline volume 2, issue 7 June 2008
World Economy in Meltdown - Q & A
Raphie de Santos is an economist and SSP member. He is also the author of the recent SSP pamphlet on the economic crisis. Here he answers some questions on the current situation.
Some commentators are saying this is the worst financial crisis since the 1930s what do you think?
Yes as we said in Scottish Socialist Voice in January of this year a number of factors have combined at the same time and within the context of a globally integrated financial system which could create a slump of 1930s proportions.
What are these factors?
At the root of this crisis is a housing and credit boom that started in the United Sates (US) at the turn of the millennium which was fuelled by the Federal Reserve, the US central bank, cutting interest rates to revive the economy and the stock market after the dot com bubble burst. This created a wave of very liberal lending policies and to finance these loans complex structured financial products were created and put on banks' balance sheets. Some of these were off loaded to other financial institutions such as pension and insurance funds and speculative trading vehicles (hedge funds).
This housing bubble is actually worse in the UK because of our withdrawal from the Exchange Rate Mechanism (ERM) in 1993 and the accompanying sharp drop in UK interest rates. This helped the UK avoid the global recession of 2000/2001 and it is the coat tail that New Labour has been riding on for the last seven years..
What are the other factors?
One is inflation and it is a global inflation. I believe that it is a permanent factor in modern credit capitalism. Eventually the excess credit was going to feed into higher prices. Add to that the increased demand from the growing Chinese economy and middle classes and capitalism as we said in January capitalism is caught between needing to cut interest rates to stimulate the economy and put interest rates up to curb credit and inflation. The US and UK erred to the latter course in 2006/2007 and burst the goose that laid the golden egg.
In addition capitalism structural problems of the late sixties and early seventies that led to first synchronised global recession since the 1930s remain. That is the decline in the rate of profit that is inherent in a mature production process because of the replacement of living human capital (manual and intellectual labour) with dead capital (automation and machines).
On top of this you have depleting natural resources and a new big shiny capitalist power which is a threat both economically and militarily a threat.
Where does the credit crunch come into this?
It's a result of the housing bubble bursting and the structured loan products on banks and other financial institutions not being worth nearly as much as was thought. These products have fallen from the equivalent of $100 to about £50 with many analysts myself included believing they are worth about $20-$30. Nobody knew exactly who had these products and how much of them. As the price of them fell the major lending banks where unwilling to lend money at market rates to the second tier institutions in the fear that they would go bust. No matter how low central banks cut the rates they where willing to lend to the big lenders it would not reduce the unknown risk of lending this money on. This is what caused the Northern Rock crisis. They were borrowing from the money markets to fund their mortgage book and in August when their loans run out nobody would lend to them at market rates. It threatened to cause a hole in the financial markets leading to domino collapse of these financial markets. That's why the Brown and Darling stepped in with the largest nationalisation in world history - enough to pay off the poor world's entire debt to the rich north's banks!
How Will Long Will This Credit Bottleneck Take to Clear Up?
I think two to three years. The banks have exposure to another type of potential time bomb called credit derivatives. These are insurance against companies going bankrupt. We are going into a recession and the rate of bankruptcies will increase and the rate of recovery from the bankrupt companies could well be lower than the banks are estimating. There is $30 trillion of this insurance outstanding which could mean another $1-2 trillion of further losses! In addition the banks have a big exposure to products based on interest rates and currencies which have been subject to big swings since August 2007. This effect of ll this will be to tighten up credit to everyone from the largest company to the poorest in society.
Effectively capitalism main tool for avoiding recessions - over production and under demand - has been paralysed for several years and will never be the same again.
What about china - some commentators believe it will be capitalism's knight in shining armour?
China is a dilemma for the established mature capitalist economies. On the one hand it is a cheap production base for them on the other hand it is new competitor with higher profit rates. 40% of its economy is exports which shows it is a serious competitor but also open to a slowdown in the world's economy. People forget that China is still only 10% of the world economy and the US is around 35%. So the old adage that when the US sneezes the rest of the world catches a cold still holds. In April we saw a decline in industrial production in China with factories being closed down and workers being laid off. China may not go into recession but its economy will slow dramatically. Its growing rate of profit cannot compensate for the structural weakness of the mature global economies which dominate the world. At the same time it is fuelling inflation with increased demand. This is feeding through to global producer and commodity prices which would normally be declining at this stage in the economic cycle. The Chinese government have reacted by putting up interest rates to dampen demand just at the point that there economy is slowing down.
But capitalism is very inventive, can it find new solutions to this crisis?
They have exhausted all their previous solutions. They would require markets to conquer and exploit. Short of colonising planets I can't see this happening. The other route is a major new technological breakthrough such as based on bio-research. But this seems decades off from making a real impact and fuelling a new growth spurt. The other way is the destruction of existing capital. This will be done through competition with the companies going bankrupt and being taken over by their more profitable rivals. Of course the people who will suffer are the workers who will be made redundant. The highest form of capitalist competition is war and that is how capitalism resolved its crisis of the 1930s. We could see a war this time over resources with the US and UK lined up against China and Russia. It really could be, as Rosa Luxembourg said, Socialism or Barbarism.
How is the crisis affecting the poor world?
We can see a further reneging on the aid and debt relief promised by the rich north. Particularly from the banks who are tightening their belt on their debtors as they try and repair the damage they have done to their balance sheets with structured financial products linked to the US and UK housing bubbles. As we have pointed out the banks have already written off a multiple of the debt owed by the poor south to them and the UK government found the equivalent of the whole debt owed by the poor south to the banks to save Northern Rock and the money markets. It gives credence to our demand that all the debt to the poor south should and could be written off.
At the same time the increase in basic food prices because of the demand from China and their use in bio-fuel production is causing hunger and starvation for the poor of the world. For poor of the south capitalist barbarism already exists.
How will the crisis affect scotland?
The structure of our economy has changed dramatically over the last thirty years. We are now a service economy which is heavily dependent on financial services, tourism and public services. The banking sector will be very heavily hit. HBOS is the UK largest mortgage lender and has heavy exposure to the money market. Its share price has slipped below where it was trying to raise fresh funds. The Royal Bank of Scotland is heavily exposed to all types of structured financial products and that is why it needed to raise $26 billion to cover existing and future potential loses. Both will have to try and cut jobs. The other parts of the sector will try to cut costs as revenues fall or stagnate.
The tourist sector will be hit by a reduction in international and domestic travel and by people dealing with the recession by staying more at home.
The public sector is already facing cuts this year with council tax being frozen which is in effect a real cut as inflation is running in real terms at over 5%. In 2009/2009 we will see an all out assault by central government on services and jobs as the tax revenues come in way below projections as the recession hits corporations and individuals
What about the price rises of commodities in particular oil, what's behind that?
Commodity prices have been rising consistently since the start of this century. This was at first being driven by increasing demand from the growing Chinese economy. Recently other factors have come into play. One is that the US dollar is weak because of the weakness of the US economy and that global commodities are priced in US dollars and there prices rise to keep their 'real' value. Another is inflation which eats into the value of cash so there is a preference to hold commodities which are seen as a better bet of keeping their value. Thirdly, a lot of the known commodity reserves are in regions that are politically hostile to the west or production is being interrupted by local insurgents. This is particularly the case for oil. Think of the major reserves being in Venezuela, Iraq, Iran and Nigeria and you can see why Bush and the financial markets are worried about supply side breaks. Finally, the perception that these resources are depleting and known reserves will soon not be able to meet global demand. This has of course encouraged speculators to take positions in commodities as well as traditional investment vehicles such as pension funds and insurance companies. This means that over the medium and long term the price of commodities is only going to continue to rise.
The consequence of all this is a disaster for capilatism putting up production costs. We are already seeing producer prices rising globally at a time when demand for products is decling. Capitalism is really caught between a rock and several hard places.
Should socialists be optimistic about the future?
While the recession will cause great suffering to the workers and poor of the world as they will bear the 'solution' to capitalism's crisis it does break the political hegemony of capitalism. Capitalism and Neo-liberalism has clearly failed. There is no real alternative apart from socialism. Socialism is back on the agenda and we have space to talk about it as alternative. For me that's a rationally planned economy involving all the consumers and producers in the decision making and running at society. I believe that the only solution given our finite and depleting resources is to have an allocation of global resources at a global level. But the participative discussion and decision about priorities can take place at the local level all the way up to a global assembly of world's workers and poor. Implementation and management would take place at a local level with maximum involvement. It may seem utopian but it is the only rational alternative to the potential destruction of the planet that capitalism offers.. The SSP are well positioned to be part of building a movement/party not just at a Scottish level but at international level to help create such a society.
I think we have to start putting together our view about how this society will work. We should also use tools such as operational research which is widely used within the capitalist enterprise to organise and allocate recourses to attempt to plan the economy as whole.
It is a gigantic task but we should start the debate on the left on a future society and have different points of view put to assemblies of activists and militants. In many ways it will be a microcosm of the future society we are trying to build with a range of views being put forward by experts but debated, modified, decide on and implemented by the mass of people.