Most explanations of the US-led global economic crisis in 2008 argue that it began with a financial meltdown triggered by the subprime mortgage crisis and bursting of the housing bubble from 2006 onwards. This paper, using Marx’s Capital and other Marxist writings, argues the opposite: that financial turmoil was just one symptom of the profound crisis into which the US economy had been sinking for years, transmitted to the rest of the world primarily through the use of the US dollar as world currency, and secondarily through the globalization of the world economy.
Finance Capital and Production
The financial system was relatively
undeveloped in Marx’s time, and he would not have been familiar with hedge funds,
mortgage-backed securities, collateralised debt obligations (CDOs), credit
default swaps (CDSs), and all the other derivatives that are now part of the
global financial system. However, he was familiar with securities, speculation,
asset price bubbles and generalised crises, and tried to explain financial
turmoil in terms of what is now referred to as ‘the real economy’: i.e., a
crisis in the accumulation of capital. In his view, such crises are inevitable
in capitalism, because it is a system of production not for human need but for
profit.
In Volume I of Capital, Marx divided capital into constant capital (machinery, raw materials, etc.) which transferred their value unchanged to the product, and variable capital, spent on labour-power. The latter, he argued, was the only creator of value greater than the value it possessed itself – i.e., of surplus value – and thus of profits. (He also referred to constant capital as ‘dead labour’ – objects that embodied past labour – and to variable capital as ‘living labour’, embodied in living workers.) The driving force of capitalism was to ‘Accumulate, accumulate!’ by producing surplus value and investing it in the expansion of production in order to produce even more surplus value.
The financial economy is built on
this ‘real’ economy: ‘The actual capital that someone possesses, or is taken to
possess by public opinion, now becomes simply the basis for a superstructure of
credit’ (Marx 1981, p.570). For example, profits from businesses might be
deposited with banks, which would lend money to other businesses, or make
investments; joint stock companies enable ‘tremendous expansion in the scale of
production, and enterprises that would be impossible for individual capitals’
(Marx 1981, p.567). Marx thus attributed to the financial system of his day a
dual role: on the one hand, it ‘accelerates the material development of the
productive forces and the creation of the world market, which it is the
historical task of the capitalist mode of production to bring to a certain
level of development, as material foundations for the new form of production,’
but on the other ‘it develops the motive of capitalist production, enrichment
by the exploitation of others’ labour, into the purest and most colossal system
of gambling and swindling’ (Marx 1981, p. 572).
Does this ‘superstructure of credit’ create value itself, or simply redistribute value created elsewhere? This is not an easy question to answer. Let us take a simple example of six companies which keep their profits in one bank. Suppose one of them has expansion and modernisation plans. Without credit, it would have to save enough to carry out its own plan, which might take several years. But if it gets credit – for the sake of simplicity, from the profits of three of the other companies, which have no immediate plans to use their funds – it could carry out its plans immediately, thus expanding its profits. It would have to pay back the loan with interest, but there would still be a net increase in its profits over the years during which it would otherwise have had to wait. The bank too would get its money back with interest. In this case, credit would have aided the accumulation of capital, and the bank could be said to have contributed a value-adding service. If the second company used its loan to gamble, and won, both it and the bank would gain, but possibly at the expense of some other party’s loss; if it lost, presumably its loss – as well as the loss of the bank – could well be someone else’s gain. In either case, there would be no increase in total social capital, but there would be a redistribution from one set of capitalists to another. The third company might put its money into prospecting for oil. If it succeeded, both it and the bank would make huge profits, and total social capital would expand as oil was produced. But if the wells came up dry, both the company and the bank would lose their money, and social capital would have been destroyed.
The loan extended to the first
company might carry the least risk, and the interest rate might therefore be
low. The other two loans would be more risky, and their interest rates
therefore likely to be higher. The bank would need to balance the promise of
higher profts against the higher risk of loss, and retain adequate funds to
cope with a possible loss, so that it would still be able to pay back the
deposits of the three companies which had not taken loans, should they wish to
withdraw their money. Both the bank and the companies might want to insure
themselves against loss, and again, the insurance company would probably demand
a higher premium to insure the more risky ventures. Normally, it would make a
profit, since only a small proportion of the companies it had insured would
fail; but if both the companies that are being insured and the insurance
company have taken on excessive risk, then there is a possibility that the
latter will fail, leading also to the collapse of the companies seeking
insurance payouts from it. The whole unstable system could be stabilised if a
state-owned central bank, with its almost unlimited resources, became the
insurer of last resort. But presumably it would do so only if it were sure that
the companies, banks and insurance company had been reasonably prudent. In
other words, it would demand regulation and oversight in return for acting as
insurer of last resort.
It seems that Marx was right in his somewhat ambivalent attitude to finance capital. If prudent and well-regulated, it could act as a powerful motor of capitalist accumulation, but if allowed to engage in reckless ‘gambling and swindling,’ it would merely redistribute or even destroy existing value.
Marx’s Theory of Crisis
Marx called the ratio between constant and variable capital the ‘organic composition of capital’. The competitive character of capitalism enhances the normal tendency in any society for the productivity of labour – i.e., the amount of means of production that one worker can handle – to grow; under capitalism, this growth is reflected in an increase in the organic composition of capital. But, according to Marx in Volume 3 of Capital, the rate of profit – the ratio of surplus value to the total amount of capital, both constant and variable, required to produce it – would have a tendency to fall as the organic composition increases, because surplus value or profit is created only by living labour. Since the purpose of capitalist production is to produce profit, when the rate of profit falls below a certain point, production would cease, despite the fact that human need for the products was unsatisfied. Marx called this an ‘overproduction of capital’ compared to the profit it could produce (Marx 1981, p.359), but it would be equally correct to see it, as Grossmann put it, as an underproduction of surplus value (and thus of profit) in relation to the amount of capital required to produce it (Grossman 1992, pp.79, 87). This would result in a crisis: people might be homeless while properties remained unsold, jobs would be lost while factories remained idle; businesses would go bankrupt and their assets would be taken over by others, leading to a centralisation of capital.
While Marx thought that the
tendency for the rate of profit to fall was inevitable, he also identified
counteracting tendencies which could slow down or even halt or reverse this
fall temporarily. Chief among these was foreign trade, which, by cheapening the
supply of raw materials, would counteract the fall; similarly, foreign
investments in countries where capitalism was less developed, the organic
composition of capital was lower and the rate of profit consequently higher,
would also boost the average rate of profit. Lenin took up this theme in his
pamphlet on imperialism. Their argument suggests that globalisation, which has
vastly increased foreign trade as well as investment in developing countries,
with their lower wage rates and lower overall organic composition of capital,
should counteract a fall in the average rate of profit and prevent a crisis.
Why, then, hasn’t globalisation prevented this crisis?
To answer this question, we have to look at possible causes of crisis that Marx examined less thoroughly than the tendency of the rate of profit to fall, or did not examine at all because they were not operative in his time. In Volume 2 of Capital, Marx draws up schemas for the social reproduction of capital, and they comprise only two departments of capital: one producing means of production (Department I), and the other producing means of consumption (Department II); he subdivides the latter into IIa, producing necessary means of consumption, and IIb producing luxury items (1978, pp.478-87). However, it is significant that luxuries are mentioned only in simple reproduction, when the entire surplus value is consumed by capitalists and there is no accumulation; there is no mention of them when Marx looks at extended reproduction (when accumulation does take place), which defines a capitalist economy.
Marx also defined labour as either
‘productive’ – in the sense that it produces surplus value/profit – or ‘unproductive’,
in the sense that it does not produce a profit (Marx 1976: 1040-41). However,
this definition of productive labour is relevant only from the standpoint of
individual capital: labour is or is not productive according to whether it does
or does not produce profit for the individual capitalist. A problem arises when
we look at production from the standpoint of total social capital, as Marx
himself realised when he considered the capitalist production of articles of
luxury consumption. ‘This sort of productive labour produces use-values and
objectifies itself in products that are destined only for unproductive
consumption. In their reality, as articles, they have no use-value for
the process of reproduction,’ and hence, if there is ‘disproportionate
diversion of productive labour into unreproductive articles, it follows
that the means of subsistence or production will not be reproduced in the
necessary quantities’, and capitalist accumulation will suffer (Marx 1976:
1045-46). We could therefore make another distinction, between ‘socially useful
production,’ the products of which re-enter production, and ‘socially wasteful
production’, which contributes nothing to social reproduction.
Articles of luxury consumption do not re-enter production, either as means of production or as means of consumption for workers who engage in production. From the standpoint of total social capital, they are a dead loss, even though the individual capitalists producing them make a profit. Looked at another way, the total profit is obviously not all used for accumulation; some part of it is used for capitalists’ luxury consumption, and we could call the branch of capitalism producing luxury items Department III. The more surplus value is diverted into Department III, the less there will be for Departments I and II, resulting in a shortage of surplus value for accumulation. It is worth pointing out here that even if it is the state that invests in electricity and railways or healthcare and education, and no profit is made on these investments, they still contribute to accumulation by providing capital with cheaper and higher quality inputs. By contrast, the diversion of resources into socially wasteful and destructive forms of expenditure, such as luxury consumption and militarism, are more powerful explanations of the present crisis than any long-term tendency for the rate of profit to fall.
Diversion of Profits into Socially Wasteful Expenditure
The background to the financial crisis was a period in which ‘the gap between rich and poor widened to a chasm not seen since the turn of the last century’ in the US (Henwood 2008), and this was a key element in the deeper economic malaise. Since the 1980s, policies designed to encourage the expansion of businesses at the potential cost of all other constituencies, notably via deregulation, resulted in an impoverishment of working class families. Jan Breman points out that neoliberalism (as such policies are usually called) constitutes a regulation of the market in the interests of the owners of capital. The right to unionise, for example, is seen as an interference with the free labour market, and across the world, from the US to India, jobs have been transferred from formal workers with relatively strong rights to informal workers lacking the most basic rights. Cuts in social spending on healthcare, education and welfare have also been carried out.
At the other pole, sharp increases
in profitability, rising executive pay and the deregulation of financial markets
from the 1980s onwards resulted in a growing concentration of wealth, capped by
tax cuts for the rich under the George W.Bush regime. ‘As incomes polarized,
America’s rich and the financial institutions that served them found their
portfolios bulging with cash in need of a profitable investment outlet, and one
of the outlets they found was lending to those below them on the income ladder…
They also poured their money into hedge funds, private equity funds and just
plain old stocks and bonds… Regulators stopped regulating and auditors looked
the other way as financial practices lost all traces of prudence’ (Henwood
2008). The explosion of private debt was amplified ‘by the invention of the
home equity loan, which allowed people to borrow against the value of their
house to finance college tuition, vacation expenses, or whatever’ (Henwood
1997, p.63).
Deregulation of finance meant that the Glass-Steagall Act, which had been passed in 1933 amid the collapse of the banking system to segregate commercial banking from the much more risky business of investment banking and had helped to halt a run on the banks, was repealed in 1999. Alan Greenspan, who had been arguing for its repeal from 1987, pursued the ‘securitization revolution’ vigorously under the second Bush administration. This, as William Engdahl argues, is at the heart of the present financial crisis. Many new derivatives are too complex to allow for accurate risk evaluation; CDOs, for example, ‘are securities comprising a bundle of assets that may include loans, mortgages and bonds with different levels of risk and a variety of yields… It is the inability to assess the value of CDO portfolios that caused the current liquidity crisis and the bankruptcy of several hedge funds’ (Reier 2007). CDSs, supposed to insure these deals, instead spread the risk. Encouraging the non-transparent spreading of risk through derivatives – rather like sending bird-flu patients back home without telling them they have got the virus – allowed contagion to spread from infected to formerly healthy institutions. Conversely, as panic spread, there was reluctance to lend to anyone, since it was impossible to tell whether borrowers had been infected or not.
Another problem was the
proliferation of unregulated financial institutions and asset price bubbles
driven by them. Hedge fund managers, for example, had an incentive to take
risks, because they got a substantial proportion of profits but had no
participation in losses. Nor were the wealthy individuals on whose behalf they
managed the funds the only ones to lose in the event of losses, because ‘hedge
funds, which invest in largely high-risk ventures, are not transparent entities
– their assets, liabilities and trading activities are not disclosed publicly –
and they are sometimes highly leveraged, using derivatives or borrowing large
amounts to invest… So.., as FitchRatings put it, because of their leverage,
“their impact in the global credit markets is greater than their assets under
management would indicate”’ (Research
Recap 2007) . This became evident in 1998 when Long-Term Capital Management
(LTCM) had to be rescued by the Federal Reserve.
The LTCM story is significant, because it was a small-scale replica of the current financial crisis. With capital of around US$5 billion, ‘LTCM borrowed US$125 billion from banks and securities firms to achieve a leverage of equity of 25:1 – phenomenal by any standard, even for hedge funds… In addition, LTCM used derivatives extensively. In early 1998, the notional value of its derivatives contracts was in excess of US$1000 billion… In August, it is estimated that derivatives contracts increased to as much as US$1500 billion… But…following the Russian crisis of August 1998, investors stampeded to “quality”, unloading high-risk, illiquid securities and moving into low-risk, liquid securities… By mid-September, LTCM’s equity had dropped to US$600 million’ (Steinherr 2000, p.88). The Federal Reserve bailout was arranged because it was felt that a default by LTCM would have caused enormous losses to its creditors and other market participants, and could have had negative consequences for several national economies, including that of the US. Marx’s statement that ‘What the speculating trader risks is social property, not his own’ ( Marx 1981, p.570), could well have been written about the hedge funds of today! The episode also prefigures the massive bailouts of 2008.
Federal Reserve rates, which had
been cut to 1% in June 2003, started rising a year later, making credit more
expensive. According to Marx, ‘In a system of production where the entire
interconnection of the reproduction process rests on credit, a crisis must
evidently break out if credit is suddenly withdrawn.., in the form of a violent
scramble for means of payment. At first glance, therefore, the entire crisis
presents itself as simply a credit and monetary crisis,’ as it becomes evident
that a tremendous number of the ‘bills of exchange… represent purely fraudulent
deals, which now come to light and explode; as well as unsuccessful
speculations conducted with borrowed capital, and finally commodity capitals
that are either devalued or unsaleable, or returns that are never going to come
in’ (Marx 1981, p.621). Easy credit had encouraged not only subprime mortgages,
but also leverage ratios far higher than that of LTCM: ‘At 2007 year end,
Fannie Mae and Freddie Mac had an effective leverage of an astounding 65x and
79x respectively. And the leverage ratio for the big five investment banks at
2007 year end was 27.8x for Merril Lynch, 30.7x for Lehman Bros, 32.8x for Bear
Stearns, 32.6x for Morgan Stanley, and 26.2x for Goldman Sachs… Add to this
their derivatives-heavy activities including in the toxic CDO and CDS obligations,’ and it is not surprising
that ‘what initially started as a liquidity problem quickly precipitated into a
solvency problem’ (Chitale 2008, pp.22-23).
Financial deregulation killed several birds with one stone. (1) It helped to channel social wealth away from the ‘material development of the productive forces’ and into ‘gambling and swindling’; (2) it helped to conceal the impoverishment of wage and salary earners by extending large quantities of credit to them, thus enabling them to spend money they did not have while paying interest on it; and (3) it thus led to an even greater polarisation between rich and poor in the US. Thus ‘The chief executive officers of large US companies averaged $10.8 million in total compensation in 2006, more than 364 times the pay of the average US worker [compared with 42 times in 1980]… As of February 2008, the average top executive received overall total compensation of $18,813,697’ (AFL-CIO 2008). These CEOs were part of a growing number of multi-millionaires and billionaires worldwide engaged in unproductive consumption of an increasing proportion of global surplus value.
Another index of growing unproductive consumption, calculated from statistics provided by the Bureau of Economic Analysis of the US Department of Commerce, was the ratio of net dividends (dividends paid less dividends received, used here as a proxy for capitalist consumption) to corporate profits: the ratio was stable and the average for the four years from 1976 to 1979 (inclusive) was 20.6 per cent; from 1980, under the impact of policies during Paul Volcker’s chairmanship of the Federal Reserve and Ronald Reagan’s presidency, it started rising steeply; and the average for the four years from 2004 to 2007 inclusive was 42.53 per cent, more than double the ratio in the late 1970s. The average for the first two quarters of 2008 was 56.75 per cent (Bureau of Economic Analysis 2008). The exponential growth of unproductive consumption was one important cause of the crisis and continued even in the midst of it. In the words of Chairman Waxman of the Oversight Committee’s hearings into the American International Group bailout (2008):
There are obvious differences between Lehman and AIG. Lehman is an investment bank, AIG is an insurance company. Lehman fell because it placed highly leveraged bets in the subprime and real estate markets; AIG’s problems originate in complex derivatives called credit default swaps. But their stories are fundamentally the same. In each case, the companies and their executives grew rich by taking on excessive risk. In each case, the cmpanies collapsed when the risks turned bad. And in each case, their executives are walking away with millions of dollars while taxpayers are stuck with billions of dollars in costs… Last month, the taxpayers bought out AIG in an $85 billion bailout. This was a direct result of the mistakes made by Mr Cassano. Yet even today, he remains on the company payroll, receiving $1 million a month. The federal bailout occurred on September 16. Less than one week later, AIG held a week-long retreat for company executives at the exclusive St. Regis Resort in Monarch Beach, California… Invoices provided to the Committee show that AIG paid the resort over $440,000, including nearly $200,000 for rooms, over $150,000 for meals, and $23,000 in spa charges. Average Americans are suffering economically. They are losing their jobs, their homes, and their health insurance. Yet less than one week after the taxpayers rescued AIG, company executives could be found wining and dining at one of the most exclusive resorts in the nation.
The Impact of Militarism
Militarism constitutes an even more important branch of socially wasteful production than luxury production. While Marx considered war to be detrimental to the working class, he did not see it as having a negative impact on capital. This is probably because in his day, war and militarism were needed to secure and keep colonies, which contributed to keeping up the rate of profit. Today, when global trade and investment are better carried out through multilateralism than through colonisation, militarism is no longer a necessity for capitalism.
Luxemburg (2003, p.439) came close to suggesting that military production belongs in a third department, since it constitutes the production of neither means of production nor consumption goods and services. It is clear that military products do not re-enter production, and we could therefore put it, along with luxury production, in Department III. Subsequently, there was a debate among Marxists as to whether a ‘permanent arms economy’ stabilised capitalism, while a more mainstream belief in the positive contribution of ‘military Keynesianism’ gained ground. Yet a careful analysis shows that the state is the buyer of the products of the arms industry, and ‘the state has only taxes and borrowed funds at its disposal, which gives rise to a growing national debt, which in turn can be financed and paid off only through taxes... [I]n international trade too it is governments who buy the weapons, paying for them out of taxes… It is certainly true that the arms industry makes profits and accumulates capital and appears in no way different from other businesses. But its profits and new investments derive from…state expenditures, which are drawn from a part of the realized value and surplus value of other capitals’ (Mattick1981, p.215).
Thus while it may be true that in the short run, the market for military production guaranteed by the state can boost employment in a downturn, thus smoothing over business cycles, it does this by diverting resources from the production of means of production and consumption; executives of military production units and private security contractors like Blackwater may be minting money, but this constitutes a deduction from socially useful production. Seymour Melman (2001) concluded that excessive military spending by the US decimated its manufacturing base, slowed economic growth and reduced employment. In the words of Chalmers Johnson (2008), ‘Military industries crowd out the civilian economy and lead to severe economic weaknesses. Devotion to military Keynesianism is, in fact, a form of slow economic suicide’. This was reflected in the ballooning US national debt, more than $9 trillion by the end of 2007.
Large-scale military spending is a feature of many national budgets, but US expenditure on ‘national security’, according to Johnson, amounts to over a trillion dollars per year: more than all other national defence budgets combined. Needless to say, none of the products of this expenditure return to production, so it is a massive drain on the economy. Worse still, the role of the US dollar as a world reserve currency means that huge dollar reserves of other countries – especially Asian countries, with China and Japan in the lead – are also funnelled into US military expenditure. US ‘national security’, in other words, has been acting as a black hole sucking in surplus value from the whole world. The crisis, consequently, is a global one.
How Do We Get Out of It?
Some socialists have suggested that this is the end of capitalism, but the notion that the divided, confused and demoralised workers of the world are ready to take over and run the world economy sounds highly unrealistic. To adapt a metaphor used by Marx, that would be like performing a Caesarian operation to deliver a 16-week-old foetus: it simply would not survive. Until it develops sufficiently to be able to do so, it is necessary to ensure the health of its capitalist mother, but since the present crisis is the result not of a fall in the rate of profit but of excessive siphoning of resources to socially wasteful expenditure, it can be reversed by redirecting resouces without sacrificing the interests of workers.
A common and understandable response to the crisis is the call for protectionism and deglobalisation, but this would remove the main countervailing factor sustaining the rate of profit, and worsen the crisis. Instead, multilateral agreements (rather than bilateral or regional ones, where a stronger partner can bully the weaker ones) should concentrate on establishing equitable terms on which international trade and investment can be conducted, with strong protection for workers’ rights and the environment. It is neither realistic nor even desirable to abolish finance capital either; as Hilferding pointed out, it allows even small amounts of money to be ‘combined with other sums…and used as industrial capital’ (Hilferding 1981, p.122), and Marx himself saw it as a step towards social control over production. Currently, pension funds built on the savings of wage and salary earners are among the most important financial institutions, and could use their clout to ensure better regulation of financial markets. This might include higher mandatory standards of disclosure, more accurate assessment of risks, and much stronger regulation and oversight of financial markets, financial players and financial products by public institutions whose personnel do not overlap in any way with the personnel of the financial institutions they are supposed to monitor – all on a global scale, since it is now clear that any crisis will be global. Progressive taxation, elimination of tax havens and nationalisation of the Federal Reserve could help to redirect investment to socially useful production. Slightly different measures would have to be taken in different countries, depending on their specific circumstances.
At the same time, there should be global campaigns for defence budgets to be slashed; this would need to be accompanied by signing and operationalising international treaties to ban certain weapons (nuclear, chemical and biological weapons, DU munitions, cluster bombs, land mines, etc.). Nationalist ideologies would need to be combated in all countries. The US, being the biggest military spender by far, would need the most sustained campaign to end its wars, dismantle its foreign bases, wind up covert operations and shrink its military-industrial complex; and until it has done so, other countries should refrain from accumulating foreign exchange reserves in US dollars, because that simply contributes to the destruction of the surplus value produced by their own hard-working people.
If these measures are taken, they would create massive funds for public spending on infrastructure (including water and energy conservation, flood prevention and renewable energy), and the social sector (including healthcare, education and child nutrition programmes), thus increasing overall productivity and creating employment. Workers’ cooperatives should also be encouraged and assisted by the state. All this would reverse the fall in incomes and consumer demand. Social housing could help to eliminate homelessness. Many countries already have programmes that could be expanded as well as adapted for other countries, such as the National Rural Employment Guarantee Scheme in India, the bolsa familia in Brazil, the National Health Service in the UK, and workers’ cooperatives in several countries. Some of these measures were proposed at the G-20 summit in Washington on 15 November, but the most important – radical reductions of military spending and income inequality – were not even mentioned.
It is possible to get out of the spreading recession without allowing it to become a depression if enough people press for decisive action along these lines. Eventually, another crisis will come along, of course: that is the nature of capitalism. But the priority at the moment is to deal with the present one.
(Slightly different versions of this article were published in Polity Vol.4 No.6, November-December 2008 and in Countercurrents.org, 30 October 2008, available at https://countercurrents.org/hensman301008.htm)
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