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Political economy of the Financial crisis: a World-Historical Perspective

Farshad Araghi

The Great Depression crisis was resolved by labour shifting the burden onto capital. This time the likely shifting of the burden of the financial crisis from capital to labour and the middle classes will only deepen it. The two medium-term possibilities are corporate fascism and global Keynesianism. Will the United States President-elect Barack Obama be the representative of the latter? This, unfortunately, is not likely going by the president-elect’s position on the crisis and a possible solution.

The failure of laissez-faire economics to understand the historical roots of the current crisis lies in its success

in severing all ties with historical p olitical economy. To play with Schumpeter’s words, laissez-faire economics is the victim of its own political success. As Marx would have it, the farce of neoliberal defeat follows the collapse of liberalism a century earlier. Writing in an essay precisely entitled “The End of Laissez-Faire” in 1926, Key-nes put it thus:

Let us clear from the ground the meta-physical or general principles upon which, from time to time, laissez-faire has been founded…. The world is not so governed from above that private and social interests always coincide. It is not so managed here below that in practice they coincide. It is not a correct deduction from Principles of Economics that enlightened self-interest always operates in public interest. Nor is it true that self-interest generally is enlightened.

As even Nicolas Sarkozy put it: “Self-regulation is finished; Laissez-faire is fin-ished”. While Keynesianism was histori-cally recognised as a progress in economic thought, it was in fact a theoretical retreat vis-à-vis the socialist challenge in the e arly 20th century. Demand management was to solve overproduction crisis in the short term, and in the long term, as K eynes ac-ceded, we were all dead. The real farce today, however, is not only the second defeat of laissez-faire, but the status of the US economic establishment which has yet to rediscover Keynes (despite the strong encouragement by the Swedish academy).

While Americans at large are tending toward political reformism, mainstream economics is a discipline left behind. Thus The Economist concedes that “capi-talism is at bay” only to conclude that “c apitalism, eventually, corrects itself”. The

success of laissez-faire’s self-imposed historical amnesia is a key to understand-ing The Economist’s logic. Such reifications are usually attributed to the Smithian invisible hand metaphor, but even a cursory reading of Smith would suggest that he, as Marx, understood the “economy” as a profoundly social, and historical reality.

World-Historical context

Understanding the current financial crisis requires understanding its social and p olitical origins in the 20th century. From this perspective, I offer the following observa-tions on the financial meltdown seen in the broader social and historical context.

The similarities between the current crisis and the Great Depression have been noted. There is however one crucial difference: The 1930s crisis was resolved by labour and popular movements shifting the burden of the crisis onto capital (via recognition of a social wage contract, collective bargaining and workers’ rights, national unemploy-ment insurance relief and social security, etc). With socialism as a global alternative in the post-first world war period, and with expanding nationalisms, anticolonial struggles, and labour, farm, and populist movements, a major fraction of American capitalism acknow ledged the need for a reformist compromise of high wages ac-companied by mass consumption. Today however, the crisis is being dealt with by shifting its burden onto the working classes. In other words, whereas the solution to the 1930s crisis involved a downward redistribution of income, financial capital’s response to the crisis (from 1980 to the present) has been one of upward redistri-bution of income, via regressive tax poli-cies, financialisation, and construction of a (global) debt regime. Ironically, shifting the burden of the crisis to capital actually resolved the crisis of the 1930s, whereas shifting the burden of the crisis to labour and the middle classes (or what is left of it) will only deepen it.

roots of the crisis

Contrary to popular perception, the real estate crisis is only a symptom of the larger financial crisis. The real estate crisis is r ooted in the strategy of finance capital to

Farshad Araghi (araghi@fau.edu) is with the Department of Sociology, Florida Atlantic University, Boca Raton, Florida, USA.

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bring in ever more liquidity into lending and speculation. The 401k retirement a ccounts came before, and the privatisa-tion of social security was to come next. Real estate was brought into the specula-tive game by Alan Greenspan’s drastic reduction of the federal funds rate after 2000 to reach a low of 1.13 per cent in 2003, thus inducing a huge migration of fixed income securities to the Wall Street through the mortgage industry. As Green-span put it in his Federal Reserve Board’s semi-annual monetary policy report to the Congress in 2003,

policy accommodation aimed at raising the growth of output, boosting the utilisation of resources, and warding off unwelcome dis-inflation can be maintained for a consider-able period without ultimately stoking infla-tionary pressures (emphasis added).

While the massive transfer of investment capital from federal treasury securities to mortgage-backed securities played an important role in extending the crisis to the housing sector at the expense of turn-ing the real estate into unreal/virtual estate, it did not cause the crisis.

From a broader perspective, the current financial crisis is a continuation of the Keynesian crisis of 1970s, when, in response to “wage inflation”, and amidst competitive pressures and expansion of democratic rights (called the “crisis of democracy” by the emerging conservative think-tanks of the time) business “went on strike” against unionised labour and social democracy. As Paul Volker, president Jimmy Carter’s chairman of the US Federal Reserve, put it in 1979: “The standard of living of the average American has to decline...I don’t think you can escape that” (New York Times, 1979). This was achieved by a mon-etary policy which raised the federal funds rate from 7.9 in 1978 to 16.4 in 1981, thereby forcing an economic recession with the aim of reducing wage inflation and disciplining labour while drawing global finance capital to the US. At the same time, Reagan’s success in breaking the air traffic controllers’ strike of 1981 by firing 11,000 workers signalled a radical change in the state position relative to o rganised labour since the Taft-Hartley Act of 1947.

The rising wages of the Keynesian p eriod, as presciently predicted by K alecki

as early as 1943, were in part a result of full-employment policies and the relative social power of organised labour and s alaried classes. They were also the result of internalisation of high consumption norms by the working and middle c lasses leading to demand for higher wages to s atisfy new consumption needs. The r ejection of the Keynesian social c ontract occurred in the context of rising costs of the empire, the defeat in Vietnam, the oil crisis, and the weakening position of the US dollar in the world economy l eading to the abandoning of the Bretton-Woods agreements by the Nixon administration.

The post-war empire based on credit turned into an empire based on debt from the 1970s onwards. Chile and New York City were the early global and national grounds for the mobilisation against the demands of labour for higher standards of living, a mobilisation that continued in the 1980s through export of jobs to low wage areas, deunionisation strategies, adoption of flexibilisation and flight-by-night poli-cies on the one hand and “financialisation” and mass indebtedness as a solution to mass consumption with low wages on the other. Financialisation, as Krippner shows, led to shifting the centre of profit-making activities to finance at the ex-pense of production and trade. Credit sub-stituted wages and national incomes to boost effective demand, thereby tempo-rarily resolving the underconsumption crisis arising from dismantling the Keyne-sian social compact.

role reversal

The bursting of the financial bubble and the resulting contraction of credit are only at the surface of a much deeper problem of deteriorating effective demand as a direct consequence of dismantling the Keynesian social compact and attempting a major upward redistribution of incomes since the last years of the Carter administration. Hence not only will the Paulson plan not work, but it will deepen the crisis as it makes the US government an appendix of Wall Street. With the Paulson plan (and its later variants), it is as if Wall Street is acting like the state and the state is acting like Wall Street. This role reversal is likely to extend the crisis of confidence to the state itself resulting in heavy downward

pressure on the value of the dollar. With the dollar falling, and with the rising costs of food and energy, inflation will pursue amidst recession, causing one of the economists’ worse nightmares – stagfla-tion. Thus unlike the depression of the 1930s when there was no growth and fall-ing prices (depression and deflation), this time it is likely that the economic down-turn will come with upward pressure on prices (depression and inflation). The reformist solution that could work in the short and the medium term would involve abandoning the debt regime in favour of high wages and full employment policies and massive investment in (green) infra-structural projects. Without such a policy, bailouts and rescue plans will at best have temporary effects. This solution, however, would require the fall of finance capital from commanding heights, some-thing that does not yet seem likely in the US.

american reformism and global Keynesianism?

The era of the US financial hegemony is ending. This, combined with the probable US military failures in Iraq and Afghanistan, will lead to a multipolar global power structure in the short run and contestation over world hegemony in the long run. To further complicate the scenario, there is no long-term Keynesian solution to the crisis. Even if high employment, high wages, and high consumption policies were to be adopted – and this time at a global level – high consumption is no longer eco logically sustainable. High consumption in the form of environmen-tal crisis will contradict the Keynesian solution more severely and more quickly than wage inflation did in the 1970s. Still, there are those who see “greening of capitalism” as a long-term alternative. There are, however, two problems with this line of thinking: (1) “Green production” in the rich countries is likely to be compensated by externalising costs at the expense of poor areas in the world economy, and (2) “green consumption” in the rich countries is likely to be com-pensated by “forced underconsumption” and poisonous consumption elsewhere in the world. The long-term alternative to the current crisis would therefore

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have to go beyond reformist (green) capitalist solutions.

Leaving the long-term prospect aside, there are two medium-term possibilities: Corporate fascism (i e, merger of corpora-tions and the state, heightening inequali-ties, xenophobia, and “Country Über Alles” mentality along with repressive social policies, contraction of democracy and suppression of human rights) vs global Keynesianism (downward redistri-bution of income, equalisation, political

reformism, and respect for human rights). In the US, Bush has been the representa-tive of corporate fascism. Will Obama be the representative of global Keynesian-ism? This is not likely, going by his cur-rent economic and political pronounce-ments. Whatever the answer, Obama is symptomatic of the rising wave of A merican reformism which has very lim-ited prospects, precisely because of its reformist weltanschauung, for the time being, at least.

References

Greenspan, Alan (2003): “Testimony of Chairman Alan Greenspan before the Committee on Financial Services”, US House of Representatives, 15 July.

Kalecki, Michal (1943): “Political Aspects of Full Employment”, Political Quarterly, (4): 322-31.

Keynes, John Maynard (1963): Essays in Persuasion, W W Norton & Company, New York.

Krippner, Greta (2005): “The Financialisation of the Ameri-can Economy”, Socio-Economic Review, (3): 173-208.

New York Times (1979): “Volker Asserts US Must Trim Living Standards”, 18 October.

Polanyi, Karl (2001): The Great Transformation: The Political and Economic Origins of Our Time, Beacon Press, Boston.

The Economist (2008): “Capitalism at Bay”, 18 October, pp 15-16.

six characters in search of a crisis

Tapan Babu

The world continues to be perplexed about which individuals and entities were responsible for the financial crisis and why it took on such gigantic proportions. This article discusses the role of six suspects: Alan Greenspan, Bill Clinton, George Bush, the banks, the system of fair value accounting and the credit rating agencies.

In the play Six Characters in Search of an Author by Luigi Pirandello, six characters try to narrate their story to

the author and end up in a limbo wherein the audience is unable to see any denoue-ment. The current financial crisis has ele-ments of such a Pirandello play. Some of the characters in the current crisis per-haps represent the ultimate/proximate causes of the crisis and depending on the stance of the protagonist, one tends to place specific importance on a particular character. Who are these characters?

alan greenspan

If the seeds of the crisis were sown in the good times, characterised by a lax mone-tary policy and a free macroeconomic environment, then the former Chairman of the US Federal Reserve, Alan Greenspan seems to be a prominent character. Recall that the monetary policy of low interest rates was initiated in response to the col-lapse of the new economy “bubble” and then the post-9/11 recession of 2001. An enormous amount of liquidity was pumped into the global monetary system during 2001-05 with the short-term interest rates reduced to 1% (their lowest level in 50 years). In fact, in order to deal with the economic downturn following the stock market crash, the Fed has driven the cost of capital significantly below the natural rate for over four years (Lombarda and

Sgherri 2007). The artificially low interest rates made excessive risk taking possible, leading to the subprime crisis. In some sense, low short-term rates could have led to the carry trade whereby money went into bonds, stocks, real estate, emerging markets, and commodities – anywhere that it might earn a higher return than the very low rates that were on offer in the US and Japan (Frankel 2006).1 The trouble with the perception of rising housing price is that in the US it created a self- fulfilling prophecy that prices would continue to go up and up and cannot come down ever (Chart 1, p 33).

The responsibility of Greenspan goes beyond maintaining an artificially low interest rate. He could be associated also with lax regulation and supervision. It has been reported that:

Edward M Gramlich, a Federal Reserve gov-ernor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders was luring many people into risky mortgages they could not afford. But when Mr Gramlich privately urged Fed exam-iners to investigate mortgage lenders a ffiliated with national banks, he was rebuffed by Alan Greenspan, the Fed chairman. …Both the Fed and the Bush administration placed a higher priority on promoting “financial innovation” and what President Bush has called the “ownership society”. ….Mr Greenspan, in an interview, vigorously defended his ac-tions, saying the Fed was poorly equipped to investigate deceptive lending and that it was not to blame for the housing bubble and bust (Andrews 2007).

It was only in his 24 October 2008 testi-mony to the US Congress that Greenspan said he made “a mistake” in his hands-off regulatory philosophy. He is reported to have quoted something he had written in March 2008: “Those of us who have looked

Tapan Babu is an economist based in New York.