Robin Blackburn
NO
Anatole Kaletsky
Dear Anatole
7th October 2008
Is this the big one? The long-foretold crisis of capitalism? It is, in any case, the 42nd major financial crisis since Nixon pulled the rug from underneath the Bretton Woods system in 1972. But the size and scope of the crash is already bigger than anything that went before, and that will also be true of the consequences.
Groups of leftists used to spend their time devising scenarios to discredit capitalism and to allow them plausibly to demand nationalisation of the banks. In a world where socialists have become an endangered species, the strategists of capitalism have done the subversives' work for them, by endorsing reckless experiments in "financial innovation" and priming the western banks for socialisation.
At its core, the crisis has been caused by politicians who believed in the magic of markets. They did what the consultants and special interest lobbies told them made business sense. Tame regulators were found who contemplated great mountains of debt with equanimity, and who found nothing amiss in "self-cert" mortgages, buy-to-let bubbles, CDO pyramids, and an entire, off-balance-sheet, shadow banking system. The Fed and the SEC and the FSA only needed a subscription to the FT and WSJ to know what was going on. What was lacking was the desire or will to take away the punch bowl and sober up the revellers.
US households became the world's "customer of last resort" but went deep into debt in the process. Investment banks were no longer barred from retail finance and the pressure to financialise became ubiquitous. We were encouraged to see ourselves as two-legged profit and loss centres. Households were meant to behave like businesses, businesses to behave like banks, and banks to behave like hedge funds.
The derivatives revolution that took off in the 1990s made poor people's debt the caviar of the finance houses. Sub-prime mortgages could be sold on to institutional investors which were themselves the repositories of the savings of those on middle or even low incomes. When even these buyers became stand-offish, the absence of paying customers was no bar to obscene fees and bonuses. Bankers booked fees in advance and used "over the counter" transactions to sell credit derivatives to the unwary—or to off-balance sheet entities which they themselves controlled.
Free market economists had always warned that planned economies could not work for long because they used administered prices. Clinton, Blair and Brown completed the work of Thatcher and Reagan, "liberating finance" and cultivating a market in everything from public services to student debt. Yet in the end they created a world whose "light touch" regulation allowed the heart of the financial system to be clogged up with non-performing and unpriceable assets—a predictable recipe for a heart attack.
No one knew the problem better than the banks themselves. A spate of defaults in 2007 led them to refuse to lend to one another. The central banks sought to revive them by offering great dollops of liquidity. But giving easy loans to institutions suffering from insolvency simply delays the day of reckoning. With much of the financial system bankrupt, was Washington's "cash for trash" the answer? Will Brown's bailout of the British banks work? Without a mechanism for price discovery or a public plan, the results are bound to disappoint and to leave much of the real economy paralysed.
The Scandinavian experience of 1988-1992 suggests that what is needed is for governments to use their bailout powers and cash to enforce recognition of losses, to take commanding stakes in the financial system and then to use public credit to revive the real economy, with an emphasis on investing in infrastructure and the knowledge economy.
Anglo-Saxon economics was based on the centrality of a national debt. The folly of financialisation added to this massive levels of personal and finance-sector debt. Under New Labour Britain has sought to convert itself into a cross between a tax haven and a hedge fund, exposing the citizenry to the vicissitudes of the financial sector. But the states that thrive today are those which balance a public debt with a sizeable publicly-managed pool of assets, like Norway's state pension fund, Australia's future fund, Singapore's provident fund, or Sweden's national research foundations, created in 1992 with the assets of social funds set up a decade earlier with the proceeds of a levy on corporations.
The current crisis should spawn new global institutions—a world bank with Brazil, Russia, India and China (the BRICs) at the top table, not the Wasp-ish IMF, and a global network of social funds, not the World Bank's "Wall Street-Washington Consensus"—a set of rules designed to benefit the money men. Also an international derivatives board, with a monopoly on the registration of valid contracts.
Without a global fiscal authority, there can be no hope for combating global poverty or climate change. Those who urge "regulation" without massive public equity stakes, and without an end to the tax havens—most of which are British Crown territories—are either fooling themselves or trying to fool others.
So it must be back to the mixed economy and back to Bretton Woods, but this time with "future funds," a reconstruction fund and proper representation for all the world's population. Leftists are apt to cite the New Deal, but really the most effective US economic agency of the mid-century was the Reconstruction Finance Corporation (RFC) set up by Herbert Hoover. It used over $39.5bn to build the factories that abolished unemployment and built the weapons needed to win the war. These plants were leased to corporations who had to give the RFC stock in recognition of the help they had received.
Within each major global economic zone, social funds should be established to promote sustainable development. They could be financed using the share levy, a fiscal device recommended by Rudolf Meidner, the chief economist of the Swedish trade unions and architect of the Swedish welfare state.
The funding for Sweden's research foundations stemmed originally from Meidner-style social funds set up in the 1980s. He urged that the best way to build up a future fund was to require all corporations above a certain size to issue the fund with new shares each year equivalent to a tenth of their profits. The securities would not be sold but held for future income. And the levy would not weaken cash flow or employment but simply dilute a little the incomes of rentiers. Such a levy would constantly redistribute from private to public and from rich to the generality of citizens through a regional network of social funds.
While nationalised industries were the anchor of the old mixed economy, the new model mixed economy should be drawn along by a team of tugboats, each based on a social fund. The state would be needed to monitor, but not to run things.
So it is not about back to the future. But we desperately need economic institutions capable of allowing us to take responsibility for our fate. This does not mean suppressing the market or capital, but rather socialising and democratising them. Karl Marx helps to identify the problem, but for the solution we need Karl Polanyi and Rudolf Meidner.
Yours
Robin Blackburn
***
Dear Robin
9th October 2008
Maybe you are right that this will be the "big one," the final crisis of capitalism which Marxists have been anticipating ever since the 1860s. But the odds are stacked high against you. You may be surprised that I agree with most of your analysis of the incompetence and dishonesty of many bankers and of the inherent absurdity of many of their schemes. Where we part company is in our conclusions about the economic and political outlook outside the world of finance.
As you note yourself, this is the 42nd "major" financial crisis since 1972. To me this not an indictment of global capitalism's instability but a testament to its extraordinary resilience. In the past 30 years, financial markets have moved up and down violently and financiers have made multi-billion fortunes and quickly lost them, but the world economy has scarcely missed a beat, lifting more people out of poverty than any previous generation in history and not suffering a single serious recession since 1982. I would not claim that this period of extraordinary stability, described as "the great moderation" by Ben Bernanke and clearly visible in all statistics relating to real economic activity and employment, will last forever. It is almost certain that 2009 will see the first simultaneous GDP decline in the US, Britain, Europe and Japan for almost 30 years. But a year or two of declining living standards and rising unemployment will not mark the end of capitalism as we know it—and the probability of a much deeper or longer period of stagnation remains quite small.
In saying this, I do not deny that this crisis, viewed from a purely financial standpoint, is the worst since 1929. But the straight line you draw from the world of finance to the non-financial economic seems to me spurious and your political conclusions far-fetched.
It is, after all, perfectly possible, after the enormous over-expansion of financial activity which you describe, to see a drastic shrinkage of the financial system, with dozens of banks shutting and tens of thousands of financiers losing their jobs, without much impact on the "real" economy of non-financial businesses and jobs. Some 70 per cent of the growth of debt relative to the size of the US economy has occurred within the financial sector—banks and hedge funds lending simply to one another just as you say—and all this activity could, in principle vanish overnight without hurting anyone except the financiers themselves. Of course, the rest of the economy would suffer knock-on effects from the loss of bankers' spending power. But in a flexible market economy, the redundant bankers would find jobs elsewhere and the economy could be kept near full employment using the standard tools of demand management—interest rates, fiscal policy, currency depreciation and so on.
That this isn't just a theoretical speculation is demonstrated by what has actually been happening since the credit crunch started. The US economy, in particular, has defied expectations of a slump—at least until September 2008. While housing and finance have collapsed, other industries—especially exports—have taken up much of the slack. In mid-August, unemployment was still low, consumer and business confidence (outside the financial sector) was rising, property markets were stabilising and the OECD actually increased its 2008 growth forecast from 1.2 per cent to 1.8 per cent.
All this has now changed and people like me who predicted that the US would avoid recession have been proved wrong. But this sudden deterioration has been driven by a series of unexpected events: the US treasury's astonishing decision in September to wipe out private shareholders in Fannie Mae, the equally deliberate move to drive Lehman Brothers into bankruptcy, the subsequent seizure of AIG and the fiasco of Henry Paulson's $700bn bank bailout. Before this series of destructive actions by the US government, there was plenty of evidence that the non-financial economy would adjust to the shrinkage of finance and housing, as it adjusted eight years ago to the sudden loss of dotcom profits and jobs. Paulson turned a chronic but manageable malaise into a life-threatening crisis.
Given that this life-threatening phase of the crisis has lasted for less than two months, sweeping conclusions about its transformational effect on the 300-year history of capitalism are premature. But to the extent that we can try to peer into the long-term future, let me now explain why I don't think this financial crisis will trigger the end of capitalism—or even a very serious economic downturn.
The unprecedented stability, as well as growth, of the world economy in the past two decades has not been a confidence trick or an illusion. It can be explained by four big structural changes which began in the early 1980s and gained momentum after the collapse of communism in 1989. One of these trends has now run out of steam and gone into reverse, but the others are still very much in force.
Firstly, there was the sudden addition of 3bn new producers and consumers to the global capitalist system. Secondly, the elimination of trade barriers and communications costs which created unprecedented opportunities for the international division of labour. Thirdly, a financial revolution which democratised credit, allowing previously illiquid assets, especially property, to be used as collateral by ordinary households and small businesses. This allowed consumers and businesses to maintain spending power and employment through temporary fluctuations in the economic cycle, in a way that was previously only possible for big companies and millionaires. Finally—and most importantly in the present context—the invention of pure paper money. Since the breakdown of Bretton Woods in 1972, which you appositely take as the beginning of your version of this story, the whole world economy has been operating—for the first time in history—on a system of pure paper money not linked to gold, cowrie shells, dollars, foreign exchange standards or anything else. The liberation of economic activity from all these barbarous relics created huge inflationary crises in the 1970s and 1980s. But from the mid-1980s onwards most of the world learned, rather surprisingly, to use this newfound freedom in a responsible way—at least for the time being.
As a result, central banks can now support economic growth instead of using all their monetary firepower against inflation. They can also counteract financial crises in a way that was impossible in the days of the gold standard and exchange rate systems such as Bretton Woods or the ERM. The commitment of mind-boggling billions to financial rescues in America and Britain would have been impossible if the dollar were still linked to gold, or if sterling were pegged to the dollar or the euro. Then the transmission of financial collapse into economic depression, which you take for granted, might really have been inevitable.
This brings me to the nub of our disagreement. I believe that a banking crisis is no more of a systemic threat to a properly-managed capitalist mixed economy than a hurricane or an earthquake. If market principles are used as the main tool for allocating resources, but a strong role for government is recognised in managing macroeconomic demand and guaranteeing financial stability, then controlling bank runs and offsetting financial contractions should present no great problems. Given that the Fed is now run by a man who has spent his academic career studying the great depression it seems reasonable to expect the US government in particular to follow the well-known policies which would protect real economic activity from a financial collapse—unlimited deposit guarantees, ultra-low interest rates, temporary capital injections and so on. Unfortunately, reasonable expectations are not always justified—and never have apparently unreasonable risks of government inaction or incompetence been higher than they are in America under President Bush.
What we are seeing in the world today is not a breakdown of capitalism but a breakdown of competent government. Paulson was CEO of Goldman Sachs and is therefore assumed to be a brilliant financier. But this was just what people believed of Andrew Mellon, the US treasury secretary from 1926 to 1932. Mellon was head of the Mellon Bank, America's most prestigious financial institution after JP Morgan. But despite his prestige, or perhaps because of it, Mellon made arrogant misjudgements which were partly responsible for the great depression. Paulson did the same in September.
In short, there was nothing inevitable about the present crisis, rooted in the contradictions of capitalism. Just as Iraq was a "war of choice," this has been a crisis of choice. Paulson has been to finance what Donald Rumsfeld was to military strategy, Dick Cheney to diplomacy and Michael Chertoff to flood relief.
The incompetence of a venal right-wing government is not evidence of capitalism's systemic failure, nor of its imminent demise. Luckily, the Bush era will be over on 20th January—and once the US economy is under new management, the banking crisis should not take very long to resolve. It is probably now too late to avert a world recession, but capitalism will recover as it always has in the past.
Regards
Anatole
***
Dear Anatole
10th October 2008
Despite trenchant points about the remarkable expansion of capitalism in recent decades—and about the mismanagement of the crisis by the US authorities—I believe that you underestimate the scope of the crisis and the radical implications of the measures that will have to be taken to meet it and other threats.
In the Bretton Woods era growth rates were higher and there was a link between economic and social advance. Recent growth has been lopsided and uncoordinated. The poorer half of humanity live in a growing zone of slums and the mix of prosperity and poverty threatens the very habitability of the globe. A new Bretton Woods would not need to revert to the gold standard but would try to tackle grotesque global imbalances and inequalities, with new agencies of regulation and redistribution.
The huge inflation of household and financial sector debt was itself in large part a response to China's vast trade surplus and its willingness to buy US securities. Global expansion would have been healthier if based on less debt for western consumers and more pay for Chinese workers and farmers, or more Chinese social expenditure. A fundamental recasting of international institutions should represent the new economic powers. The G7 meeting without China is ridiculous.
What persuades me that this time we really may be reaching capitalism's limits is that the inadequate measures so far taken still represent a huge dose of collectivism at the heart of capitalism. New Labour has been obliged to take big stakes in several of our most important banks. David Cameron not only accepts this—he insists that it must mean no bonuses for senior executives at the affected banks.
The hapless policy of the US authorities has meant that what is left of Wall Street has survived in part thanks to sovereign wealth funds. The world's 300 largest pension funds controlled $11 trillion of assets earlier this year—two thirds of them are public sector based. While they will be hit by collapsing stock markets they bought few credit derivatives. So here is another semi-collective dimension of the economic landscape. (And reports of the death of collectivism in China should be weighed against the growth of $1.8 trillion in such funds.)
Britain's rescue involved some incipient socialisation but not enough. The large banks remain waterlogged with debt. Their efficiency as creators of credit for small and medium business is weakened by bureaucracy, aloofness and unrecognised losses. The Brown/Darling package once again relies on private partners who will disappoint. Why not adopt a more grassroots approach with a regional network of social funds, based on a massive capital injection into the fully nationalised banks and with local government entities encouraged to use this network, with a deposit guarantee? At a European level the European Investment bank could play a similar role.
If the financial crisis is as bad as 1929 then the counter-measures must be much more ambitious. By comparison with Glass-Steagall, the SEC, the Social Security Act, the Reconstruction Finance Corporation (with its $39.5bn, worth $4 trillion today), the Tennessee Valley Authority, the WPA and so much else, what we have seen so far is just tinkering.
The New Deal itself only really took off with the advent of war. Between 1944-49 collectivism made great strides in the US but—thanks in part to red scares—it stayed within a clear capitalist framework. Today the arena is wider and the stakes higher. Socialism has disappeared as a programme or political option, but, paradoxically, this makes it easier for pro-capitalist politicians to inject doses of socialism into the system. As we wrestle with continuing market paralysis more radicalism will be needed. We will have to relearn how to tax capital and to channel resources to where they are really needed. We will need more institutions, like mutually-owned building societies, that incorporate non-capitalist principles. Climate change and aging will demand a quantum leap in public resources.
Like you, I look forward to the departure of the present incumbent of the White House but unfortunately his likely successor has much the same economic team as Bill Clinton—people like Robert Rubin who helped to kill Glass-Steagall and to incubate bubble economics.
Yours
Robin
***
Dear Robin
13th October 2008
Our views are not as far apart as we might have imagined. I would not claim for a moment that the post-Bretton Woods "anarchy" of global capitalism has produced the strongest, fairest or most sustainable system that is possible. I have never denied that better and stronger government institutions are needed, not only to regulate global finance but also to deal with the many important instances of market failure and the even more important challenges to public policy—poverty, education, basic healthcare, basic science and so on—which cannot be addressed with market forces at all.
But this broad agreement begs many important questions, which opponents of global capitalism tend to ignore or answer with wishful thinking. It is easy to say, for example, that a more regulated economic system could be better for the poor or less damaging to the environment. But where is the evidence that governments tend to be wise, just and responsible—especially in the poorest countries? And if many governments have, in practice, been incompetent, corrupt and reckless, why should we expect them to improve their performance if we give them more power over private economic decisions or bring them together into bigger international bureaucracies?
In principle, we can always postulate omniscient governments that will solve problems better than the chaotic operation of competitive markets. In practice, however, the conditions for such models of "perfect government" to be successful are even more demanding and implausible than the far-fetched conditions postulated by economic models of perfect markets. Let me illustrate what I mean with one of your most cogent points.
You are right to say that expansion of the US and European economies would have been "healthier if based on less debt for western consumers and more pay for Chinese workers and farmers, or more Chinese social expenditure." But who was responsible for this imbalanced pattern of global growth? It wasn't greedy Wall Street bankers. It was the Chinese communist government, which has consistently resisted demands from western economists and politicians to raise domestic wages and consumption, to spend more money on welfare by providing state-financed health, education, and unemployment insurance schemes.
Nonetheless, I am as opposed as you are (well almost) to market fundamentalists. That is why I argued throughout last summer that the damaging surge in oil prices had nothing to do with supply and demand fundamentals and was driven largely by financial speculation, which regulators ought to have curbed. That is also why I believe that much of the blame for the present banking crisis should fall on the recent introduction of market fundamentalist accounting rules.
The market is merely an ingenious mechanism, like a steam engine or a pulley. It just happens to be the most powerful mechanism ever invented—more powerful than any engineering marvel by a factor of some 6bn (or whatever is the current global population) since it allows the interaction and multiplication of the labour, ingenuity and ambition of every individual human being. But the market should never be mystified as a totem, an ideology or a god. It is merely a mechanism with no moral significance or inherent qualities. Sometimes markets work very well without any modification (for example in trading vegetables or ball-bearings), sometimes they need supplementing with subsidies and regulation (for example in banking, health and education) and sometimes they have to be totally banned (for example the trade in human organs or nuclear weapons).
The question raised by the financial crisis is therefore not whether the use of markets should be abandoned and replaced by government decisions or collectivist institutions. The idea of giving politicians or bureaucrats direct control over banks and financial institutions is a non-starter, since they tend to make bad investment decisions and are prone to capture by interest groups. The same is often true of collectivist institutions, although I agree that some quasi-market institutions, such as building societies, municipal banks and co-operative insurers, should be protected and fostered to provide a healthy ecological diversity for any financial system. But the real lesson for public policy from the financial crisis is simply that banks should be regulated much more carefully. The need is not for more regulation but for better regulation.
Many of the causes of the present financial crisis—the absurdity of mark to market accounting, the shift to risk-based capital requirements, the abolition of bank liquidity rules, the reliance on private rating agencies instead of central bank credit judgements—derived ultimately from a profound fallacy: the idea that regulators, whose raison d'etre is to deal with situations where markets give the wrong signals, should rely on market signals to decide whether anything is wrong. This meant, for example, that regulators of Northern Rock assumed that the bank had a sound business model because its share price was rising. And because regulators thought this, so did investors—assuring that the shares kept going up and the regulators stayed reassured.
Politicians and officials need to understand markets, but they also need to understand that governments should sometimes use judgement to override market signals. Unfortunately many politicians and regulators, especially in finance ministries and central banks, did not seem to understand this balance. While this crisis does not show that government is always right, it does prove that a complex financial economy cannot be run by ideologues who believe that government is always wrong. The role of the Bush administration, in the boom and the bust of this crisis, recalls PJ O'Rourke's remark about the Republicans' ideological contempt for the idea of government: "The Republicans are a party who believe that government doesn't work— then get themselves elected and prove it." Thanks to the financial crisis, it looks like the American people have finally taken note.
Yours
Anatole
***
Dear Anatole
13th October 2008
My aim has been to urge a bolder and more experimental approach to embedding global finance and markets in structures of accountability and security. While public regulation and public enterprises should be part of this, my core argument is that social funds set up by—but not controlled by—governments have a vital role to play.
Remarkably enough—as our letters have gone back and forth—the British government has moved halfway towards such a model by taking huge stakes in the British banking system. The Norwegian social fund was shaped by the Scandinavian banking crises of 1988-92. Downing Street could be even more radical, taking full control and then handing it over to an autonomous network of public agencies, with carefully framed objectives and responsibilities.
We also need to engage the BRICs. These governments have their problems but disdaining them for their supposed lack of "competence" (compared to who: the White House? Berlusconi? Downing Street?) is presumptuous and self-defeating. And in the FT magazine last October, the paper's Beijing bureau chief contradicted the view—which you echo—that China is hell-bent on ever larger export surpluses. He insisted that many in China were urging greater domestic expenditure and that Hu Jintao's call for a "harmonious society" encompassed boosting home demand.
A forum representing the BRICs as well as G7 would allow for new trans-national understandings and coalitions. One of the things that such a forum should consider is a global network of social funds, each set up with the proceeds of a very modest global financial transaction tax or corporate share levy (see Clive Cowdery's article).
I would like to second the call of Paul Craig Roberts, Reagan's assistant treasury secretary, for help to those facing foreclosure, and for a rundown of US and British military expenditure in Iraq and Afghanistan, which might loosen purse strings in the middle east. More important, it would show that the Anglo-Saxons had finally realised their global girdle of military bases was provocative as well as costly.
Yours
Robin
***
Dear Robin
13th October 2008
I agree with you that the global economy could benefit from a wider variety of institutional structures, especially for finance. Banks owned by governments, foundations and long-term national pension schemes would certainly be desirable to promote wider social goals, as well as creating some financial biodiversity. Recent events have confirmed the dangers of a financial monoculture which treats market prices as the only measure of economic values and short-term profits as the only permissible economic objective.
But I do not share your hope that government financial intervention will transform the nature of global capitalism. This is for both pragmatic and philosophical reasons. At the practical level, it is socialist wishful thinking to believe that government investment in banks will fundamentally change them. And indeed, governments all over the world have promised not to try to influence the commercial behaviour of the banks in which they invest. If they are unwilling to promote a new philosophy of public ownership in the present conditions of populist backlash against the bankers, it is hard to imagine when they ever would.
More importantly, I disagree with your axiom that governments serve human needs more reliably than markets. The market can be parodied as a jungle of greed and fear, but greed and fear are natural and indispensable emotions. Greed motivates work and progress, while fear keeps greed in check, inspiring prudence, foresight and social cohesion.
Anti-capitalists rail against greed and fear, but when they try to suppress them, they end up suppressing humanity—see the work of ideologues from Lenin and Stalin to Mao Zedong and Pol Pot. It is better to channel these emotions, which is precisely the function of capitalist financial markets. Every now and then, greed or fear may build up too much pressure and break out of their channels. When this happens, governments must be ready to effect urgent repairs. That is the stage we have reached with the present financial crisis.
Yours
Anatole
