US: Will a great depression be avoided?
The House of Representatives’ approval of the Paulson Plan on October 3 was not enough to curb the fall of markets throughout the world. Faced with this situation, the Federal Reserve (the Fed) had to take extreme measures to avoid financial collapse and, above all, remedy the lack of financing for firms, which could precipitate the beginning of a Great Depression.
Thus, the monetary authority will pay interest to banks for the reserves they have in the Fed, with the aim of improving the conditions of liquidity of financial entities. But, still more important, it announced the setting up of a fund to buy IOU’s of firms that have remained without financing in the credit markets. The creation of a “Commercial Paper Funding Facility” (CPFF), announced by the Fed, has the aim of providing liquidity to firms that issue private debt and every time find fewer buyers in the markets.
But this is not enough either, and the stock markets continue to drop. This time, the cause was the speech by the Chairman of the Fed, Ben Bernanke, who asserted that he would be “reconsidering whether his current position – keeping interest rates at 2% — continues to be adequate in light of events” and left the door open to lowering interest rates in the short term, in the face of “the worsening prospects of economic growth.” These statements, that show that the crisis is going to continue to worsen, unleashed the panic. Numbers in red seized the banking sector. Sovereign, Wachovia and National City, that were the only ones that had registered increases as October 6 began, fell by 15%, 11% and 9%, respectively. Meanwhile, firms like Citigroup, Goldman Sachs or JP Morgan fell between 8% and 13% at the close. One of the most punished banks was the Bank of America, with a collapse of more than 26%.
The seriousness of the crisis is shown by the powerlessness of the monetary and political authorities. A good example is the opposite effect of that expected from the approval of the $700 billion bailout plan, or the negative reaction to the Fed’s buying up the debts of firms.
The concerted attempt by the main central banks of the world to lower the interest rates by half a point scarcely had a limited impact.
Everything seems to indicate that, more and more, a perverse logic based on the certainty that, in the face of the magnitude of the crisis, any intervention is a drop in the ocean, is beginning to install itself.
A savage US financial and economic decline
The conviction that no measure will work expresses the profound deterioration of US finances and economy. To make a metaphor, the “circulatory system” of capitalism is obstructed. This dictates there are parts that the blood — money and credit — does not reach, which threatens to kill the patient, the economy. Even the imperturbable Warren Buffett, the richest man on earth, who, with this private rescue of banks and firms, has become the modern J. Pierpoint Morgan 1, has said that the “credit drought” is “sucking the blood” out of the economy.
We are going through a critical period when the mechanism of transferring funds from savings to investment could be seriously affected.
Inter-bank credit has become so expensive as to make transactions practically impossible, owing to the fact that no bank believes it will recover the money lent. This distrust is now moving to society, as the beginning of the run on various segments of the financial and banking system shows. The situation is beginning to resemble the 1929 crash, when any mechanism to encourage liquidity was completely useless. A vicious circle had been established: the banks were using government money to solve their problems and not for giving credit. This lack of financing was stifling the real economy. To avoid suffocation, firms were withdrawing their funds from financial institutions, to be able to maintain their activity and face up to their current expenses. The result was that the banks needed more money from government to clean up their balance sheets.
The Fed’s financing of firms seeks precisely to avoid this scenario. Will it arrive in time or are the damages already irreversible?
Data on the real economy are more and more worrying. In September alone, 159,000 jobs were lost, the biggest monthly decline since March 2003. But the current rate of unemployment, that is around 6%, will be insignificant if the system of financing the economy collapses.
There are already symptoms of what might happen. For instance, California, the most populous state in the US, has revealed in advance that it will need a $7 billion US government loan to be able to pay for public services like police, hospitals and firefighters. Leading businesses, like General Electric (GE), are desperately seeking financing. General Electric managed to get Warren Buffett’s company Berkshire Hathaway, to buy preferred shares for $3 billion dollars. But not all companies are as lucky, and many firms are deeply in debt. This rise in the cost of financing will not only make investment plans more conservative, but will affect profits. Although, unlike the collapse of the “dot com” bubble, most companies are less exposed – an expression of the fact that accumulated profit has not been reinvested – many automotive and auto parts companies and retail merchants, have mountains of debts.
European (Dis)Union: The crisis could hit the euro really hard
For the European Union (EU), unlike the US, the current crisis could become a crisis of the monetary system. The widening of the current banking crisis to the EU could destroy its common currency, the euro, whose creation was never accompanied by the establishment of adequate institutions to face financial crises. This is not an accidental oversight, but has to do with the structural weaknesses of the EU project, and sharply expresses its insurmountable contradictions.
The thing is that the EU largely facilitated the integration of European banking, by creating giants that were beyond its ability to administer at a continental level. Now that credit markets are paralyzed, these institutions have a credit (liability) exposure that exceeds the tax ability of the countries of origin, by several times. This is the case with the German Deutsche Bank, with a liability that exceeds by 1.5 times what goes into the government coffers by taxes, and Barclays, of England, whose liability is two times England’s tax ability. This contrasts with, for example, the liabilities of the Bank of America, which are approximately half of US tax revenues.
The current crisis, that is fully striking at the main European banks, has shown this weakness of the EU project, by triggering a policy of “every man for himself” among its member countries.
There is an accelerated process of re-nationalization of financial policies in the 27 member states of the EU, which are not now looking to Brussels (headquarters of the EU institutions) before acting. For instance, Ireland decided to guarantee all deposits (including debt) of the banks for two years, which precipitated a war for deposits within the EU. The unilateral step taken by Germany, after a coordination meeting in Paris with France, England and Italy to find common measures for the crisis, was a pathetic sign. Subsequently, the commitment reached on October 7 among the finance ministers of the 27 countries (Ecofin) is far from establishing a common standard for protecting deposits. They agreed to increase the guarantee for individuals with a sum of at least 50,000 euros. But the initial proposal to raise it to 100,000 euros was not agreed to. Some countries, like those of Eastern Europe and Finland, among others, considered that such a high ceiling would involve a very heavy burden, while Greece, Spain, the Netherlands, Belgium and Austria announced that they will raise the guarantee limit to 100,000 euros. But this could be insufficient to respond to the real problem: the danger of flight of medium-high assets that exceed this quantity toward other European countries that have guaranteed 100% of deposits, like Germany and Ireland. This risk continues to exist because, as the collapse of the British banks shows, widespread mistrust continues. Some media give a more optimistic view of the finance ministers’ meeting. For instance, Financial Times Deutschland emphasizes the statements by the French Minister, Christine Lagarde, that the UE will not accept its own version of Lehman Brothers (the US investment bank whose fall signified a before and after in the world financial crisis). According to this daily paper, there is no massive rescue plan, like the one France suggested and rejected, but there is a coordination of national efforts. Angela Merkel, the German head of government, announced that she is working to establish criteria that would make it possible to distinguish between institutions that are systematically important and those that are not. This criterion could become the mother of all disagreements. If the US Congress split up over the plan to bail out US banks, who can guarantee that the 27 will manage to agree on which banks to save when the national interests of the member states are at stake? This policy can only end up exacerbating the disputes within the EU.
The fundamental problem is that stronger countries like Germany are unwilling to use their tax resources to save, for example, Spanish banking, whose rescue would cost more than 500 billion euros. In this context of European dis(unity), it is not surprising that the stock markets continue to plummet.
The bailout plan of the British government, that announced an assistance package of $62 billion, was not enough to calm the panic. According to the finance minister, the money will serve to buy shares in the main banks of the country – a partial re-nationalization – that on October 7 suffered steep falls that amounted to around 40% in the case of the Royal Bank of Scotland (RBS). So far, the institutions that have confirmed their participation in the recapitalization program are Abbey, Barclays, HBOS, HSBC, Lloyds TSB, Nationwide, RBS and Standard Chartered.
The case of Iceland, one of the weakest links of Europe, shows the extremes the crisis could reach if it continues to develop in the countries of the Continent. Iceland is in advanced “Argentinization” (referring to the Argentinean economic crash and default of 2001); its currency has been devalued by 50% in a single year against the euro and the dollar, losing, in fact, its ability to serve as a means of payment. Icelandic authorities complained that the friends of the country have not offered financial assistance, forcing it to seek an injection of money from Russia. But it would not be necessary to reach this point for the Eurozone to be put into doubt. For instance, the abandonment to its fate and the possible collapse of Italian finances or the Spanish banking system 2 would put the EU’s integrity at risk. And that could happen very quickly in view of a bank crisis of great magnitude, for instance, the Italian Unicredit, strongly exposed in Eastern Europe and the Baltic countries, or from some government crisis.
Many people cling to the idea that the history of the EU is marked by crises that threatened to destroy it, but, as a last resort, ended up strengthening it. Without going further, the establishment of the euro practically required the collapse of the European Monetary System of 1992-1995. For many people, this could be repeated, resulting in the rise of a Federal Europe where the central government takes significant powers to such an extent that, for instance, France in the Eurozone would be like Texas in the US. But the existence of strong national interests makes this scenario highly unlikely, or even utopian. For “France to be Texas,” changes greater than the current ones would be necessary — that the crisis be much more devastating, or the conquest of new zones of influence, etc., — that could sweep away the differences that separate the 27 states of the EU, especially the different interests of the powers, since there is no evolutionary road towards greater integration. On the other hand, if the crisis deepens, it is highly likely that it will hit the euro really hard.
What will happen to the dollar? Is the situation headed towards fragmentation of the world market?
Astonished, the short-sighted analysts of The New York Times say, “The stock markets are plummeting; the credit market is still frozen, and some foreign officials predict that the US will lose its financial superpower status. However, the dollar, the most visible symbol of US financial power, is rising.”
A combination of factors explains the strength of the dollar.
In the first place, the dollar’s increase corresponds to the repatriation of funds of US financial institutions to the US, that they need so much, alongside of the fact that speculators are getting rid of their positions throughout the world, by “taking refuge” in US Treasury bonds. The dollar has been strongly supported by the Federal Reserve, that established a monetary exchange network with the European Central Bank, the Bank of Japan, the Bank of England, and other banks to provide foreign banks with dollars. The Federal Reserve had to expand dollar liquidity to the international financial system on an unprecedented scale, to the extent of $1.25 billion.
In the second place, the dollar has recently risen owing to the momentary fact that US economic indicators in the second quarter were better than those of Europe and Japan, that have already entered a recession, at the same time that the previous devaluation of the dollar pushed US exports, especially agricultural products, to the world.
In the third place, the countries of Asia, in large part, supported the dollar as part of an aggressive export policy that allowed them to maintain high growth rates after the 1997-1998 crisis. As various analysts suggest, when Chinese consumption is hardly more than 30% of GDP, the transition to an economy based on the internal market is not something that can be done rapidly and without shocks; that is why these countries have a strategic interest in avoiding a rapid depreciation of the dollar. The massive accumulation of reserves, a result of this aggressive commercial policy, led to these countries’ buying US Treasury bonds or bonds from enterprises like Freddie Mac and Fannie Mae, that is, financial assets. Now, when there is a big question mark over the future of the euro, sovereign funds have to be prudent in a policy of diversification.
That said, we must consider political factors. The problem is, if US dominance was based on the control of the dollar as the world’s reserve currency, this privilege was sustained, not so much by the weight of the US economy in the world, which had been receding in recent decades, but fundamentally because after the collapse of the former USSR, the US was the only superpower, based on unquestionable military supremacy and international influence (“consensus”). These factors had been severely eroding recently, as the disaster in Iraq and Afghanistan and the recent conflict between Russia and Georgia show. The fact that Germany, a key part of NATO, committed itself in Moscow not to support the entry of Georgia and the Ukraine into NATO, amplifies the weakness of the US.
If the dollar managed to maintain itself, that would be a blow for the European Union and the euro. However, the worsening crisis in the US and internationally undermines the bases that until now have supported the dollar’s strength, at the same time that the massive bailouts of the financial and corporate system in the US and the geometrical growth of US government indebtedness are sinking its bases of support. It would appear that the question is whether there is going to be a run against the dollar.
In this framework, the current international financial crisis that has its epicenter in the US, and that is, at the same time, a crisis of the Anglo-Saxon model, and, even more important, of the “pattern of growth” promoted through the indebtedness that allowed living beyond one’s means for decades, is a blow that could be too strong for the US capacity for leadership and the strength of the dollar. In great part, this will depend on the handling of the current crisis by the US authorities, that, as last week’s crisis in Congress has shown, had rarely manifested such impotence and cowardice, and such a “leadership vacuum,” on the part of the administration, the Congressional leadership, and the two presidential candidates. In this context, the hypothesis that Jacques Sapir, French economist and historian, brings up, cannot be ruled out: “Whether the most dreaded scenario develops or not, depends on the way the managers of private funds in Asia and in the Middle East decide to improve their stockholders’ portfolio strategy. If the feeling of uncertainty about US leadership and its ability to administer the current crisis leads them to lose their confidence (at least a ‘confidence with problems’), leading them to get rid of their stocks in dollars, then the sovereign funds would have to follow them rapidly to avoid big capital losses. A fall of 25% to 35% in the value of the dollar against other currencies, together with dramatic changes in the capital flow movements and commodity prices, would then become quite a probable fact. This would create great uncertainty throughout the world and push towards ever larger fragmentation of financial space, with the probable emergence, as a result, of regional reserve currencies” (“How far could the US dollar fall?” Real-World Economics Review, issue no. 47). In this sense, voices are already beginning to be heard, like that of the former President of Thailand, Thaksin Shinawatra, who was the first to distance himself from the IMF’s post-Asian crisis orthodoxy by suggesting the need for an “Asian bond that could save us from the dollar” (Financial Times, October 6, 2008). The possible fall of the dollar, which would mean the loss of the main international reference and exchange currency, would lead to the rise of different currency zones, that is, to a situation of greater anarchy and inter-capitalist struggle on a world level, with tensions and conflicts between states, and also opportunities for class struggle, of comparable size to those experienced in the first half of the twentieth century. Those decades showed the sharp development of the epoch that Marxists called that of “crises, wars and revolutions.”
Translation by Yosef M
|↑1||JP Morgan: legendary financer and one of the great barons of capitalism who saved it from the debacle of the 1907 crash, back when the Federal Reserve did not yet exist, and had to engineer a bailout among the banks themselves.|
|↑2||Current crisis winners such as Santander could also come into question. The violent crash of Latin American markets, with Mexico and Brazil leading the way, bodes additional pressure for Santander and BBVA. The Latibex, the market for Latin American companies listed in euros, plunged 20% on Monday, the biggest fall in its history, beset by the appreciation of Latin American currencies and the dollar against the euro. More than a quarter of the banking business of the two largest Spanish banks comes from the Latin American continent.|