Prophecies of Downfall
The fact that Marx finally began with the composition of his long-planned economic work in the winter of 1857/1858 was directly occasioned by the economic crisis that broke out in the autumn of 1857 and the concomitant expectations of a deep trauma from which capitalism would no longer recover. “I am working like mad all night and every night collating my economic studies so that I at least get the outlines clear before the deluge,” wrote Marx to Engels in a letter from December of 1857 (MECW 40, p.217). The crisis of 1857/1858 was in fact the first true global economic crisis of modern capitalism, which involved all major capitalist countries of that time (England, the USA, France, and Germany). In the Grundrisse that emerged during this period, one can find the sole unambiguous passage of Marx’s work that can be understood as a theory of capitalist collapse (MECW 29, p.90 et sqq.). This collapse, Marx was convinced, would unleash revolutionary movements. In a letter to Ferdinand Lassalle from February of 1858, he even expressed his fear that in light of the expected “turbulent movements” his work would be finished “too late” and thus “find the world no longer attentive to such subjects” (MECW 29, p. 271). Marx was right about the fact that he wouldn’t finish his work (the first volume of Capital was published nine years later), but this first global crisis of capitalism led neither to a collapse of capitalism nor to any sort of revolutionary movement. The crisis had already been overcome in the early summer of 1858, and the capitalist system even came out of it enormously strengthened. Marx learned a lesson: in capitalism, crises function as brutal acts of purification. The destruction wreaked by crises removes previous impediments to accumulation and frees up new possibilities for capitalist development.
Marx fundamentally broke with the notion of a final crisis of capitalism. When Danielson, his Russian translator, asked (once again) in 1879 when he could finally expect the sequel to the first volume of Capital Marx answered that he had to wait for the end of the then-present crisis, which exhibited a series of distinctive features, in order to incorporate the analysis of that crisis into his work, and noted in conclusion: “However the course of this crisis might develop itself — although most important to observe in its details for the student of capitalist production and the professional théoricien — it will pass over, like its predecessors, and initiate a new ‘industrial cycle’ with all of its diversified phases of prosperity, etc.” (MECW 45, p.355).
The fact that Marx, with good reason, bid farewell to theories of capitalist collapse did not prevent many Marxists from remaining loyal to such ideas. In the “Marxist” Social Democracy before the First World War as well as in the Communist Parties of the 1920s, it was regarded as a foregone conclusion that capitalism would perish as a result of the increasingly strong crises it generated. Every recovery was interpreted as a last rearing up before the final and inevitable collapse, which frequently led to grotesque political misjudgments. In the early 1990s, the theory of capitalist collapse celebrated a joyful resurrection in the newly-united Germany, furnished with the pretence of being a new idea. The crises that followed — the East Asian crisis of 1997/98, the stock market crash that heralded the collapse of the “New Economy” bubble in 2000/2001, and the crisis in Argentina in 2001/2002 — were interpreted each and every time as a sure sign of the final crisis of capitalist collapse. But all these crises were over relatively quickly. They led to processes of enormous immiseration (particularly the crises in East Asia and Argentina), but the capitalist system, contrary to all prognostications of collapse, emerged rather strengthened from these crises. Meanwhile, there is once again a new crisis as well as new predictions of the imminent downfall of capitalism. By now bourgeois economists and even the International Monetary Fund are also issuing warnings of the danger of an international financial crash with severe consequences for the global economy.
From the American Real Estate Crisis to the International Financial Crisis
This crisis deserves a closer look. It began with an act of overtrading culminating with a burst of the speculative bubble. Ever since the Dutch tulip mania in the early 17th century, such crises of speculation have always run the same course: a particular asset (whether stocks, homes, or even tulip bulbs) continuously increases in its estimated value, which further stimulates demand for this asset, because everyone wants to share in the seemingly unstoppable rise in value. People use their own wealth, and ultimately take out loans, in order to acquire the object of speculation. Prices climb even higher on the basis of increased demand, which leads to a further increase in demand. But at some point the rise is exhausted. It becomes more difficult to find new buyers, and initial investors want to sell in order to realize their profit. The price of the object of speculation falls. Now everybody wants to get out of the market in order to avoid losses, which leads however to a further fall in the price of the object of speculation. Many who started speculating late in the game and bought at a high price now incur high losses. Since these losses are combined with a general slump in demand, such a speculative crisis can have effects on the entire economy. In principle, the course of such speculative crises is known these days even to those who participate in them. But it is never clear to participants exactly what phase of the speculation they find themselves in: more or less at the beginning, where good chances for making a profit still exist, or closer to the end, shortly before the bubble bursts. Everyone hopes to be counted among the winners, even if he or she knows that the crash is coming.
After the bursting of the New Economy bubble in the year 2000, the Federal Reserve lowered the federal funds rate from 6.5 to 1 percent between January 2001 and the middle of 2003 in order to stimulate investment through cheap credit. For two or three years, the federal funds rate was even lower than the rate of inflation. Falling interest rates also made the buying of homes attractive, and living in the privacy of one’s home is a widely accepted goal among all social classes in the USA. Between the years 2000 and 2005 the amount of mortgages almost tripled. The strongly growing demand for homes caused real estate prices, despite increasing construction, to increase 10-20 percent per year, which enticed banks into granting increasingly risky loans. Purchasing prices were now financed up to 100 per cent, and equity was no longer required of buyers. Normally, banks only finance 60-80 per cent of the purchasing price, so that the bank has a security cushion and incurs no losses in case of a foreclosure sale of the house (as a consequence of insolvency on the part of the debtor). Even if the house doesn’t realize the original purchase price through the foreclosure sale, there normally remains enough for paying back the loan, and the loss is incurred solely by the debtor. In the case of strongly rising real estate prices, bank managers believed that nothing could go wrong, and that the safety cushion was automatically provided by climbing prices. However, many homeowners used the climbing real estate prices to increase their loans in order to finance their personal consumption expenditures. The establishment of a safety cushion was therefore further postponed. Moreover, the banks began to issue so-called “Ninja” credits, which stand for “no income, no job, or assets” on the part of the borrower. Such loans constituted a big part of the “subprime” loans that are such a frequent topic of discussion these days. These are loans to borrowers who can’t really afford the loans, which means that there is a high risk of default, which the banks make up for by charging extra high interest rates. Above all, such “subprime” loans are then resold by the banks, whereby they are rid of their worries concerning insolvent debtors.
Real estate loans of varying quality were bundled together in a relatively complicated way to serve as collateral for bonds that are given such beautiful names as “collateralized debt obligations” (CDO). These were then successfully sold to other banks and funds. Such bonds offered high returns on the one hand (since real estate buyers had to pay such high interest rates) and seemed on the other hand to be a relatively safe investment, since they were covered by real estate. In order to keep these transactions off the books of the purchasing banks and thus hedged by their own capital, so-called “Structured Investment Vehicles” (SIV) were founded, which acted as foreign subsidiaries. They refinanced the costs of these investments with short-term bond issues at much lower rates of interest than those of the speculative bonds collateralized by mortgages. In Germany, it was not only private banks that followed this method of legally evading the scrutiny of regulatory bodies, but also public banks such as the Landesbank Sachsen.
With the rise of interest rates in the USA between 2005 and 2006, the rise in real estate prices was slowed down, but the interest burden of mortgages rose, since in most cases variable rates had been stipulated. Most notably in the “subprime” sector, where the interest rates were already high, the number of loan defaults strongly increased. As a result, the number of foreclosure sales increased, which further beat down real estate prices. Now the rise in prices was no longer slowing down; at the end of 2006, prices stared sinking.
With the increasing insolvency of real estate buyers, the bottom fell out of the interest revenues of the bonds based upon these mortgages, and with sinking real estate prices, the collateral of these bonds was also gone, and their prices fell. This forced the banks and funds that had bought these bonds to engage again and again in “value adjustments” of their balances, a process which probably still has not reached an end.
Distinctive Features of the Present Crisis
The phenomena described thus far do not yet constitute anything unusual in the history of capital. The current crisis is notable because of the role the banks have played in it. In stock market crises, the losers are frequently the many small investors who put their nest eggs into stocks and who find themselves holding worthless paper after a crash or who are even in debt because they financed their stock purchases with loans. In the case of the American real estate crisis, the aggrieved parties are the banks and speculative hedge funds that bought the real estate loans (or bonds covered by the loans) from the issuing banks. Many insolvent homeowners have lost their savings, which they put into their homes, as a result of foreclosures. But at least the easy credit offered by the banks permitted a higher level of consumption over the years. This time, it wasn’t small savers putting their meagre capital into fly-by-night stocks, but rather banks financing the purchase of overpriced real estate and the consumption expenditures of homeowners.
The extent of the losses that individual banks have had to absorb (not just American banks, but also for example public and private German banks that took part in the ostensibly safe speculative transactions) is however not yet clear. Not only because banks are reluctant to make the extent of their losses public knowledge, but also because it is frequently the case that they are themselves not fully aware of the exact extent. When engaging in the purchase of the bonds covered by real estate loans, the banks blindly trusted the judgment of the so-called “rating agencies.” But the highest quality “AAA” ratings were paid for by the very banks that issued the bonds, which was not necessarily helpful as far as the objectivity of the ratings was concerned. Since nobody knows exactly which bank is holding on to how many rotten loans or maybe even facing bankruptcy, distrust between the banks has grown which in the last year has almost paralyzed interbank trading. In interbank trading, banks grant each other short-term loans without any formalities in order to ensure that business proceeds smoothly. But if one bank has to take into account that the other bank might be bankrupt tomorrow, the typical “over night” loan also becomes a risk. Bigger problems have been prevented so far only because central banks reacted with a quick expansion of their lending.
Shifts within Capitalism
The enormous losses which have been the topic of discussion so far — at the end of April, the banks had written off around 270 billion dollars, but the total could also end up being around 400-500 billion — are also an expression of the structural changes which have occurred within global capitalism in the last 30 years: since the global economic crisis of 1974/75 and the neo-liberal policies introduced as a result of it, the distribution of wealth in the leading capitalist countries has shifted considerably to the benefit of capital and high-income individuals. Real wages have risen only a little bit since then, the increase in social wealth has benefited almost exclusively those already possessing high-incomes and great wealth. A large amount of these income gains, as well as a part of increasing business profits, was invested in the financial markets, which successfully courted investors with increasingly novel types of speculative financial instruments (so-called “derivatives”) since the sweeping deregulation of the markets in the 1970s.
Various “pension reforms,” all of which have been instituted at the expense of state pension systems, have also led to attempts by many employees to improve their future pension payments through “pension funds,” so that lower-income individuals also ended up investing indirectly in the financial markets. As a result of these developments, the volume of financial wealth has grown far more strongly in the past few decades than aggregate output. And there is a constant search for further investment opportunities for this enormous increase in financial wealth, which greatly stimulates speculation.
However, the losses mentioned above only constitute a fraction of international financial wealth, which amounts to about 150,000 billion U.S. dollars. The global losses up to now of around 270 billion dollars are at the scale of the annual federal budget deficit of the USA and can easily be absorbed by the global financial markets. But it may well be that one or two large banks will run into difficulties similar to those encountered by the fifth largest American bank Bear Stearns, whose bankruptcy could only be avoided by its sale at a knock-down price –brokered by the Federal Reserve — to J.P. Morgan Chase, the second largest American bank.
New Centers of Capital Accumulation
As a consequence of the financial crisis, a recession has begun in the USA (even if this has not been officially acknowledged). Banks have reined in their lending, and private consumers who have just lost their homes cannot continue to consume at the same levels. Considering the significant weight that the domestic market has for the U.S. economy, a cyclical downturn might be unavoidable, even with a weak dollar making U.S. exports more competitive on the global market. It is notable, however, that this downturn has so far had relatively minor effects upon the global economy. In Europe and particularly in Germany, growth predictions have been revised downwards, but with the “upturn” of the last few years, a cyclical downturn was in the cards anyway. The USA are still the strongest economic power by far, but with the developing countries of Asia and parts of Latin America, new centers of capital accumulation have emerged that are no longer merely a “periphery” of a global economy driven by Western Europe and North America. To some extent, they can compensate for the demand shortfall in the USA. That Indian companies are making a name for themselves with spectacular takeovers (Jaguar was bought by Tata Motors, the largest European steel company Arcelor was bought by Mittal Steel), and that the Chinese central bank holds massive foreign currency reserves, are merely the obvious expression of this development. Global competitive capitalism is becoming increasingly multi-polar, a development accompanied by the relative loss of the USA’s economic significance (see “Profit without End: Capitalism Is Just Getting Started,” MRZine, 28/07/07).
New Forms of Regulation — And New Crises
The current crisis also indicates something else. Around 30 years ago, the era of Keynesianism ended: Keynesian economic policies that had been reduced to “deficit spending” were replaced by neo-liberal concepts that proceeded from the assumption that “the markets” are the best and most efficient entities for regulating the economy. Since the 1980s deregulation, flexibilisation, and privatisation occurred worldwide as much as possible. Today, financial markets most closely approximate the neo-liberal ideal of a free and flexible market: state regulations were radically cut back, and due to the nature of the objects being traded, time lags and transaction costs are minimal, the “impulses of the market” can therefore impose themselves without hindrance. But it is precisely these deregulated financial markets that have proven to be extremely unstable and prone to crisis. Even Josef Ackermann, head of the Deutsche Bank, had to recently admit that he no longer believes in the often-invoked “self-correcting powers of the market.” And the International Monetary Fund, which up until now has obligated every developing country in need of credit to “more markets” (also and especially in the financial sector), has discovered in light of the financial crisis that the international financial architecture displays “dramatic shortcomings” and that more state control and regulation is necessary. But whether such regulation is actually coming soon is uncertain: Ackermann did not intend for his criticism to be understood as a plea for more state intervention. Instead, he presented a voluntary code of conduct which financial institutions should adhere to in the future. The proposals discussed by the IMF also remain extraordinarily vague. It’s possible that a further crisis is necessary before a new regulatory wave can begin. But the period of naïve market euphoria seems to be over for now.
Even if a new era of regulation for the financial markets is on the way, however, it will not make capitalism free of crises. When analysing capitalism, one has to distinguish between institutional arrangements that favour crises, and capitalism’s fundamental tendencies towards crisis, which are rooted in the contradictory determinations of capitalist production on the one hand and capitalist circulation on the other hand. Institutional arrangements can be altered, and as a rule, crises tend to induce such changes. That the goal of capitalist production is profit-maximisation and that this is partially mediated by speculation, however, cannot be changed, or at least not without abolishing capitalism.
There are also indications of new crises. The enormous rise in consumption in the last few years has led to climbing raw material prices and a current rise in the price of foodstuffs. In the case of rising prices and the expectations of a further rise in prices, speculative investment will increase, in which assets are purchased solely with the intent of selling them at a higher price. There are already conjectures that the price rise for crude oil and wheat is partially a result of speculative futures contracts, so that new speculative bubbles are emerging.
The rising price of foodstuffs has already had a considerable economic impact: in India and particularly China, they are fuelling the already high rate of inflation. The possibility cannot be excluded that the Chinese central bank will attempt to fight inflation with a rise in interest rates or with a tightening of the money supply, thus choking off the hitherto extraordinary rates — annual rates of 8-9 percent — of growth. Then the flip side of the multi-polar structures of global capitalism would become evident: an economic crisis in China would not just be a Chinese problem, it would be a problem for the entire global capitalist economy. Even without the dreaded collapse of the financial system, the prospects of global competitive capitalism are anything but rosy.
Michael Heinrich is a mathematician and political scientist in Berlin. He is managing editor of Prokla — Journal of Critical Social Science.