Archive : Socialist Outlook series 3 - monthly newspaper : 19 - 1998

The world economy in crisis

Could "it" happen again?

Analysis of the 1998 collapse of Long Term Capital Management
Andy Kilmister

Newspapers and political pundits have begun to talk about the worst economic situation since the 1930s.

Politicians like Tony Blair and Gordon Brown, who only a year ago praised globalisation and claimed that international economic developments were outside the control of national governments, now argue for worldwide financial reform. How serious are the problems facing international capitalism? Could the crisis of the 1930s happen again? ANDY KILMISTER reports.

The current crisis is actually made up of a number of different developments, each of which affects the others. Three are particularly important. First, and probably most serious, is the continuing slump in Japan.

This is significant because of the size of the Japanese economy and because of its international links. Japan is a key trading partner with China and South East Asia and the leading investor in the region. Any recovery there depends to a large extent on an upturn in the Japanese economy. Japan is also important because of its trade with the US. As the yen has fallen and Japanese demand has decreased the Japanese trade surplus has grown dramatically. So has the US trade deficit.

In this way the problems of Japan threaten continued US growth. Not only this, but international investors and policy makers increasingly fear that the unstable Japanese banking system and financial infrastructure may collapse altogether, triggering a catastrophic recession and threatening existing and new Japanese investment abroad.

The second problem lies in the major capitalist economies of the US and Europe. US growth has already lasted longer than most expected.

The likelihood is that the American economy will ‘overheat’ and that inflation will rise. If the US Federal Reserve acts to slow down inflationary pressures then the economy will slow down and could enter a slump.

This dilemma has provoked a continuing argument among American policy makers. On the one hand some argue that deregulation and technological change have changed the structure of the economy so that the old pattern of booms and slumps no longer holds.

They claim that increased international competition has fundamentally lowered inflationary pressures, so that interest rates can be cut and growth maintained indefinitely. On the other hand though, other observers point out that that high US investment in recent years has not yet delivered major productivity improvements and that personal and corporate debt in the US are at record levels.

The proposals being put forward by Blair and Brown to reform the system are exceptionally reactionary

In addition the US stock market has long been recognised to be highly overvalued. Set against this, the decision by the Federal Reserve to cut rates is a gamble which risks helping to build up an increasingly shaky financial structure which will eventually collapse.

The near collapse of the ludicrously named ‘hedge’ fund Long Term Capital Management a fortnight ago underlines this point.

What the US would like to see is interest rate cuts and growing demand from Western Europe. But this is not happening because of the project of the single currency. European governments will not reflate their economies for fear of making the Euro appear weak.

The third issue is the continuing wave of currency speculation which is sweeping the globe. This ultimately rests on the lack of productive investment opportunities in the industrialised economies.

It is important to understand just how this can feed into the developing global crisis. In theory a currency collapse is redistributive. If one country’s currency falls then the speculative funds buy another. So currency speculation does not on its own cause a problem for global capitalism, only for individual countries or regions within it.

However, in practice things are not so simple. Currency crises can cause deeper problems in a number of ways. Firstly, this happens through their effect on debt repayments. If a country’s debt is measured in, say, dollars, then as its currency plummets in value the debts become impossible to repay. This is what happened to South Korea last year and to Russia this year.

This then threatens to bankrupt the banks and other institutions who lent the money, and transmits the crisis across international borders.

Secondly, the fall in currency values cuts incomes dramatically.

If workers resist this, or if companies try to recoup profits by raising prices then hyperinflation can set in and threaten political stability.

Thirdly, the sheer instability of the global financial markets disrupts trade and investment.

Fourthly, if currency values fall then foreign investors, both in financial assets and in productive activity, can lose substantial amounts of money. If this then affects their lending elsewhere or causes them to go bankrupt then again the crisis is transmitted internationally.

Each of these problems individually would be unlikely to cause the panic of the last few weeks. It is the combination of the three which raises the possibility of a major crisis. How likely is such a crisis to occur?

In the short run the two key countries which global investors are nervously watching are Brazil and China.

Brazil is important both in itself and because of its influence in Latin America, a region which takes about 20 percent of US exports (as compared to Russia’s 2 percent). The Brazilian government budget deficit, widely believed by institutions like the IMF to be a key predictor of currency crises, is at a level of 7 percent of GDP (over twice that prescribed by the Maastricht convergence criteria) and foreign exchange reserves are dropping fast.

A collapse of the Brazilian currency would have very serious implications. It would be likely to lead to a general currency crisis in South America, a region which is key to the global strategies of many US corporations.

This would then probably cause a major decline in the US stock market, which might easily swing the US into recession. A US recession would remove any possibility of recovery for Japan and the rest of Asia.

Small wonder then that the US is currently organising a $30 billion rescue package for Brazil.

China is by far the largest recipient of foreign investment outside the industrialised economies. The growth rate is slowing rapidly there, and exports are facing massively increased competition from the rest of South East Asia following their devaluations.

In certain Chinese regions, notably Hong Kong, the situation is even more serious. In Hong Kong unemployment is rising fast and the stock market has only been saved from collapse by huge government purchases of shares. The Chinese banking system is exceptionally fragile with high levels of bad debt.

A Chinese devaluation would probably trigger off a further round of currency speculation in Asia and would write billions off the value of investments in the region. But continued stagnation threatens a wave of bankruptcies and a stock market crash which could be equally destabilising.

In the medium term each of the three main areas of the industrialised world faces major challenges. The issues in Japan have been widely discussed, as have those around EMU in Europe.

But the US faces equally searching questions. US companies, households and stock market investors have been involved in a huge gamble over the last period, building up high levels of debt on the expectation of continued IT fuelled growth. If it does not pay off then a US financial crisis could be central to global economic disorder.

There are two dangers facing socialists as we try to analyse the current international turbulence. One is to minimise the difficulties facing capitalism on the grounds that, with the exception of Japan, the major industrialised countries continue to grow.

Not only does this ignore the hundreds of millions already facing destitution as a result of the crisis, for example in Indonesia, it also overestimates the stability of growth in Europe and the US. ]However, it is also important not to view the current situation as inevitably leading to a crisis like that of the 1930s or the 1970s. Much of the current turmoil is rooted in the financial sector. ]Financial crises under capitalism have important effects, but only threaten the system as a whole if they are linked to struggles over real production.

That may well happen in the present crisis but it is by no mean inevitable. One advantage for the capitalists is that so far the crisis has been centred on a region of the world – East and South East Asia – where until recently working class organisation, with the exception of South Korea, has been weak.

It has also happened at a time when the working class has internationally been pushed onto the defensive. However, this can change very quickly. The intensity of the debates among imperialist leaders shows the seriousness with which they view the situation.

The problems of the last two years have caused significant divisions within the institutions which try to manage global capitalism. The IMF has tried to use the crisis to reassert the role of US style free market capitalism and to break up the networks of influence which characterised Asian economies, notably in South Korea.

Some people like World Bank Chief Economist Joe Stiglitz increasingly favour some kind of capital controls, or a tax on international financial transactions. They look to Chile, where capital controls appear to have insulated the economy to some extent from speculative crises since 1983, as a possible model.

At an extreme in these debates the Malaysian Prime Minister Mahathir Mohammed has rejected the IMF strategy of global financial integration and imposed sweeping controls on currency movements. This has fed into and helped to intensify the political crisis in Malaysia based on disagreements between Mahathir and his former deputy Anwar Ibrahim, an advocate of free trade and greater integration.

The Malaysian government has long argued for tighter regional co-operation and less reliance on relations with the US.

Socialists cannot take sides in these arguments. The Keynesian strategy of government intervention in the international financial markets will not avoid the underlying problems which currency and stock market movements reflect.

Like Keynesianism on a national level it will simply postpone the development of such problems into fully fledged crises.

Neither is economic nationalism a solution in a world dominated by multinational corporations and international finance. But we should recognise the role currently being played by the British government in these debates.

The proposals being put forward by Tony Blair and Gordon Brown for reform of the international financial system are exceptionally reactionary. Essentially they are calling for a ‘new’ IMF which would deal with financial issues rather than trade issues.

Such a body would replicate the policies of the old IMF but with potentially even more power. The same kind of ‘structural adjustment’ programmes which we have seen used against countries with trade deficits or debt problems, reducing public expenditure and wages and increasing privatisation, would now be used against countries in danger of currency slides.

Which countries faced this danger would be dictated by the international financial markets. The ‘agreements’ which have been imposed on Russia, Indonesia and South Korea (and the one which is in preparation for Brazil) would be replicated on a global scale.

Socialists must expose and criticise the agenda being put forward by Brown and Blair. But this cannot be done by relying on alternative approaches for tinkering with the international financial system.

A real alternative must begin with the resistance of those affected by the current crisis in Asia, Russia and beyond. This resistance is still in its early stages and by no means certain to succeed. But solidarity with it is crucial in determining the outcome of the current crisis and whether it challenges or reinforces the rule of capital over the global economy.

Andy Kilmister is Senior Lecturer in Economics at Oxford Brookes University, where he researches industrial restructuring and structural change in Central and Eastern Europe since 1989. Andy is a member of the International Socialist Group and of the editorial collective of the journal Labour Focus on Eastern Europe. He is co-author of ’Critical and Post-Critical Political Economy’.

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