The Great Depression: then and now
The 1920s were good years for the world economy. They were years of boom. Boom and speculation go together like strawberries and cream, and there was speculation aplenty as well. In such a period of ‘irrational exuberance’ the illusion spreads that the good times will go on for ever. Sound familiar? On the eve of the great 1929 stock exchange collapse, a journalist asked a speculator how so much money was being made on the market. This was the reply: “One investor buys General Motors at $100″ (he meant a GM share) “sells to another at $150, who sells it to a third at $200. Everyone makes money”. This seems pure magic, but for a while it can work. In a ‘bull market’ as in 1925-29 nearly all share prices go up and up. Over those years US industrial shares trebled in price! We all know what happened next.
Another feature of the 1920s boom was the massive global imbalances. Briefly Anglo-French imperialism had emerged militarily victorious from the First World War, but economically wounded and forced to borrow from the USA to cover their war debts. The only real victor was the USA, which had showed itself to be the mightiest economic and military power in the world. American bankers, as creditors to the British and French, demanded their pound of flesh. These governments in turn decided the only way to pay the USA was by squeezing defeated German capitalism, demanding war reparations from the stricken German economy.
Reparations flowed out from Germany, and then flowed straight out of Britain and France to the USA. So the upshot was that the poor subsidised the rich.
The Great Depression of 1929-33 produced male unemployment at one time of more than 30% in Germany whose economy was totally dependent on the health of the world economy. But if Germany could not pay reparations, how could Britain and France pay their debts to the USA? So the Depression destroyed this mad flow of money, and with it the delicate balance of the global economy. The collapse of world trade (falling from a factor of 10 in 1929 to 3 in 1933) in turn further impacted on the major national economies. But as ever it was the small and poor nations that fared the worst. This remains the case today – as we shall see.
There are startling similarities between the boom of the 1920s and its inevitable sequel in bust from 1929 to 1933 and the present decade. As we all know the boom in the advanced capitalist countries was fuelled by a housing price bubble – a situation where prices go up because people are buying and people are buying because prices are going up. Huge amounts of fictitious capital, pure paper wealth, were created. For instance the annual output of the world in the year 2007 at the end of the boom was about $64trn. At the same time the amount of financial assets in the world was $196trn. And the amount of total trades in that year was $1,168trn – seventeen times as much as was produced. This was literally a paper merry-go-round.
These pieces of paper were ‘valued’ at what they were likely to deliver in the future. As anyone who knows that what goes up must come down would realise, these expectations of ever-expanding wealth were impossible to achieve since this wealth ultimately had to be generated in the real capitalist profit-making economy. So the unstable boom eventually came to an end with a sickening crunch.
That much of the capital built up over the boom was fictitious is shown by one stark fact. The total value of quoted shares on the global stock exchanges was $63trn in October 2007. A year later in November 2008 it was $31trn. More than half the value of the world’s bourses had gone up in smoke! Though we have seen a ‘bull’ market in shares since March 2009 on most exchanges, this fact illustrates the phantom nature of this wealth. The same applied to the price of houses. In the early years of this millennium they were seen as not bricks and mortar but appreciating assets. Not any more. All kinds of other paper assets, created by financial ‘innovation’ during the boom, were also on the slide.
This in turn hit the banks and credit institutions. Their lending was based on holding assets which turned out not to be assets at all. This was catastrophic, particularly since the financial institutions, in order to fill their boots in time of boom, had ‘leveraged’ themselves by thirty times or more. This technical expression means that they had lent thirty times more money than they actually had. Rather than holding the loans on their books the official banks bundled them up and passed them on as fantastically complex financial assets.
But these assets were by no means ‘out of sight, out of mind.’ They passed into the hands of the secondary banking sector. The central institutions of this shadowy nether world of finance are the hedge funds. Hedge funds are melting away. Those that handled more than $1bn (small change to them!) fell by 40% last year. They are disappearing because they are losing money on the recondite financial institutions they bought from the main banks. And their losses mean the official banking sector has to take a heavy hit. Lehman Brothers went under in 2008 because they were more exposed to the dodgy dealings and had more links to the secondary banking sector than the other major players
Inter-bank lending, the essential oil of the world’s monetary system, ground to a halt. No bank would lend to any other because they didn’t know what their own assets were worth, if anything, and they realised that all the other banks were in the same position.
Martin Wolf sums up the present imbalances in the world economy (Financial Times 08.03.09):
“How did the world arrive here? A big part of the answer is that the era of liberalisation contained seeds of its own downfall: this was also a period of massive growth in the scale and profitability of the financial sector, of frenetic financial innovation, of growing global macroeconomic imbalances, of huge household borrowing and of bubbles in asset prices.
“In the US, core of the global market economy and centre of the current storm, the aggregate debt of the financial sector jumped from 22 per cent of gross domestic product in 1981 to 117 per cent by the third quarter of 2008. In the UK, with its heavy reliance on financial activity, gross debt of the financial sector reached almost 250 per cent of GDP…
“These huge flows of capital, on top of the traditional surpluses of a number of high-income countries and the burgeoning surpluses of oil exporters, largely ended up in a small number of high-income countries and particularly in the US. At the peak, America absorbed about 70 per cent of the rest of the world’s surplus savings.
“Meanwhile, inside the US the ratio of household debt to GDP rose from 66 per cent in 1997 to 100 per cent a decade later. Even bigger jumps in household indebtedness occurred in the UK. These surges in household debt were supported, in turn, by highly elastic and innovative financial systems and, in the US, by government programmes.
“Throughout, the financial sector innovated ceaselessly. Warren Buffett, the legendary investor, described derivatives as ‘financial weapons of mass destruction’. He was proved at least partly right. In the 2000s, the ‘shadow banking system’ emerged and traditional banking was largely replaced by the originate-and-distribute model of securitisation via constructions such as collateralised debt obligations. This model blew up in 2007.”
How has the world recession impacted on the poor nations? We shall examine the fate of the former Stalinist countries in particular. These Eastern European economies saw an unprecedented economic collapse with the downfall of the Stalinist regimes after 1989. Russia, for instance, saw the biggest fall in production since the invasion of the Mongols, who left pyramids of skulls in their wake. In the early years of the present millennium these countries reached rock bottom and began to bounce back. They re-emerged as hapless client states of the major capitalist powers.
Most of the East and Central European economies have been growing at around 5% a year since the past boom gathered speed in the early years of the century. As a result many of their political leaders have developed a cargo boat cult of capitalism and tried to pass it on to the population. They have seen their future as ‘emerging’ capitalist economies. They have copied the worst excesses of the advanced capitalist economies. And the present world recession has brought them to their knees.
Accepting that their fate lies with capitalism, these economies have relied on trade with the West. Their ‘comparative advantage’ lies in wage differentials with the North American and Western European economies of the order of 7:1. Canny capitalists in Western Europe located more and more production processes in the East, hollowing out manufacture in the West as a result.
Basic manufacturing processes are being transferred to the East. The Ukraine, for instance is a massive exporter of iron and steel to Western Europe. You might have thought that the Eastern countries would enjoy an export surplus with the West. The opposite has been the case. They were on a treadmill – running fast and going nowhere. East and Central European countries have run deficits of the order of 5-10% of GDP with the West. Latvia managed 23% at one time and Bulgaria 27%. This means these countries were spending about £5 for every £4 they were earning. This can not go on! These current account deficits were only covered by capital inflows from the imperialist heartlands. Capital inflows were as much as 5-8% of GDP and funded about 70% of East and Central Europe’s deficit.
So corresponding to the outflow of basic industrial production from the East has been vast capital inflows. In effect the Eastern countries have been borrowing the money from the West – to buy the West’s products! Suddenly, just when the money is needed most, the tap has been turned off. Capital inflows have collapsed. According to the Financial Times (28.01.09) “The Institute for International Finance predicts that net private sector capital flows to emerging markets will be no more than $165bn this year, less than half the $466bn inflow in 2008 and just one fifth of the amount sent in the peak year of 2007.” In the case of the Central and East European six nations inflows will fall from $161.9bn in 2008 to $59.5bn this year.
Now comes the collapse of this dependent growth. To take just one statistic – Russian industrial production fell by 20% in the month of January 2009 alone. These are figures only matched by the economic wipe-out of 1929-33.
In the meantime nations such as the USA and Britain have been in effect living at the expense of the rest of the world, running trade deficits with other nations and borrowing from them in order to maintain consumption levels. For instance the American trade deficit with China is closely matched by the inflow of Chinese money into the USA. So China is lending America the money to buy its exports – but China is a much poorer country than the USA. This daisy chain of payments is remarkably similar to the pattern of monetary flows of the 1920s. The destruction of these capital movements in the Depression did much to make the slump deeper by drying up world trade. Could this happen again? Sure it could.
In recent years the deficits in the household sector, government sector, financial sector and with the rest of the world run by countries such as Britain and the USA have spiralled as the world boom became more and more obviously based on speculation. Similar deficits and speculation is mirrored in the Eastern countries. There has been a housing bubble in the Baltic countries. Banks, learning from the West, have invented exotic financial instruments and floated such deals as mortgages denominated in yen, since Japanese interest rates were low. In Hungary they preferred mortgages in Swiss francs
All this was fine as long as the exchange rate remained stable. But instability in capitalism means instability in exchange rates. This instability in turn is a product of the unevenness that is an inevitable feature of capitalist development. These imbalances are ultimately unsustainable. Their ‘resolution’ is having catastrophic consequences for the people of the region
All this is a repetition on a larger scale of the imbalances of the interwar period. So the Chinese have been kind enough to lend the Americans the money to keep on buying Chinese goods in the form of acquitting US government securities. Clearly this can’t go on for ever! But the situation is likely to persist until the Chinese government foresees a wholesale depreciation of the dollar. Yet, as long as the American economy runs these huge deficits, the counterpart is bound to be a net outflow of dollars to buy foreign goods. And if speculators perceive that the USA is living at the expense of the rest of the world by printing dollars, a flight from the US currency is inevitable.
Once again imbalances become causes of contention in a crisis. The flashpoint of national conflicts, as capitalist nations try to unload the effects of the crisis on to other nations as well as their own working class, is bound to be the exchange rate.
The ECE countries are small economies. That means that they are dependent on the fate of the major imperialist powers. The same is true of their currencies. After all, who in Britain but a pub quiz nerd has heard of the Ukrainian Hyrvania? Usually these nations have fixed their currencies against the dollar or the euro. The transmission mechanism of crisis from one country to another works through trade and monetary flows. These currencies naturally are a flash point of the stresses and imbalances that are tested to the limit in the recession.
These fixed rates of exchange can be washed away by a giant wave of global money, with catastrophic effects on the economy. While their exports are cheaper as a result of the depreciation, each good sold abroad earns less foreign currency and their debts become more and more expensive to service in the national money. And those exotic mortgages denominated in Japanese yen and Swiss francs don’t look such a bright idea when the local money tanks against the major trading currencies of the world.
Financiers are essentially gamblers. They would bet on two flies climbing up a wall. And they also bet on the prospects of countries going bust. These bets are called sovereign credit default swaps. From this point of view Ukraine looks like a derby winner. Their CDS rate is 3,700 base points (these are in effect the odds on a default) compared with 1,000 for Latvia and 560 for Hungary, two other high risk economies. The money men (and women) are gambling that a whole nation is unable to pay its bills. And they complacently await a sovereign default – a whole country going under – so they can collect their winnings.
Iceland has already in effect defaulted as a nation. Last October it was discovered that the wizards of high finance had produced a situation that Icelandic banks owed six times as much as the people of Iceland produce in a year. In Western countries when the banks turned up their toes, finance ministers rushed to save them on the grounds that they were ‘too big to fail.’ But the Icelandic banks were ‘too big to save’! Naturally the people of Iceland are to pay for the crimes and stupidities of their bankers.
The knock-on effects of the crisis have already hit Hungary, Lithuania and Latvia. Other countries in the region are also in the firing line. Governments are going down like ninepins. There is no end in sight to the economic and political turmoil. In Iceland the left has been swept to power by a ‘pots and pans’ revolution, but they have been given the job of pulling the chestnuts out of the fire for capitalism and making the cuts demanded by the International Monetary Fund.
The IMF is the financial sheriff. It stabilises capitalist economies at the expense of the common people. For instance Estonia’s deficit with the West has fallen to 15% of GDP. In order to cut their coat according to their cloth, GDP must fall by 15%. That is the IMF’s remedy.
Like the spectre at the feast the IMF always turns up when things look bleak, and helps make them worse. What do they propose? They demand that countries at their mercy cut government spending. Latvia has pledged to cut $913m (5% of GDP), a huge sum for a country of only 2 million people. One country after another is now lined up outside the head’s office for chastisement.
Readers will notice that countries under the cosh of recession such as Britain and the USA allow government deficits to balloon. They are reluctant to cut government spending as they know it will make the recession worse. Yet that is exactly what the IMF is insisting upon. The IMF is deliberately making unemployment, and the plight of the poor, worse. What sort of medicine is that? It represents the interests of the capitalist class in the dominant imperialist countries.
The Observer (26.04.09) reports from the economists blowing the whistle on the IMF. “An analysis of the new wave of loans, by Mark Weisbrot and colleagues from the Washington-based Centre for Economic Policy Research (CEPR), finds that every one contains pro-cyclical policies.” (i.e. it makes the slump worse) “While the IMF has led the argument for large-scale fiscal stimulus in the rich world to kick-start economic growth, at the same time, the CEPR argues it is still forcing the countries that come to it for emergency loans to cut back on spending and reduce budget deficits.
For example, Pakistan had to promise to cut its deficit from 7.4% of GDP last year to 4.2% this year. ‘While this might be a desirable goal, it is questionable whether this reduction should all be done this year, when the economy is suffering from a number of external shocks that are reducing private demand,’ Weisbrot and his co-authors say…” But who cares about the Pakistani poor? Not the IMF.
“Duncan Green, head of research at Oxfam, says that whatever the message from HQ in Washington, IMF staff on the ground can’t help handing out tough medicine: ‘It’s in their DNA.’”
At the G20 in the beginning of April the big capitalist nations pledged with great fanfare to increase the IMF’s funding to ‘help out’ the poor nations who are at the sharp edge of the crisis. Amid silent recrimination the rich nations have been unable to agree as to who is to stump up the cash. It is a measure of the depth of the crisis that the IMF, and the rich countries it represents, has lost control of the situation.
All in all things look bad for the ‘emerging economies.’ This is already having predictable political repercussions. According to Jason Burke (Observer 18.01.09): “Eastern Europe is heading for a violent “spring of discontent”, according to experts in the region who fear that the global economic downturn is generating a dangerous popular backlash on the streets.
Hit increasingly hard by the financial crisis, countries such as Bulgaria, Rumania and the Baltic states face deep political destabilisation and social strife, as well as an increase in racial tension…
“According to the most recent estimates, the economies of some eastern European countries, after posting double-digit growth for nearly a decade, will contract by up to 5% this year, with inflation peaking at more than 13%. Many fear Romania, which joined the European Union with Bulgaria in 2007, may be the next to suffer major breakdowns in public order.
‘In a few months there will be people in the streets, that much is certain,’ said Luca Niculescu, a media executive in Bucharest. ‘Every day we hear about another factory shutting or moving overseas. There is a new government that has not shown itself too effective. We have got used to very high growth rates. It’s an explosive cocktail…’
“Marius Oprea, security adviser to the last Romanian government, said the economic crisis would mean ‘serious problems for the middle class.’” (and not just them!) “He added: ‘There will be a fall in tax revenue which will lead to major problems for state budgets. The numbers of state employees will also be cut right back and their salaries will be worth less and less…’”
Dr Jonathan Eyal, a regional specialist at the Royal United Services Institute thinktank in London, said eastern European countries were ill-equipped to deal with the impact of the global downturn and risked ‘social meltdown’.
‘These are often fragile economies … with brittle political structures, political parties that are not very well formed and weak institutions. They are ill-prepared for what has hit them,” Eyal said. “Last year it was the core western European countries which were shaky; now it is the weaker periphery that are getting the full blast of the crisis.’”