Marxist economists on the crisis, 2nd round: 4. Andrew Kliman - The level of debt is astronomical

Reclaiming Marx's Capital

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Andrew Kliman

Do you think a markedly new regime of capitalism is going to emerge out of this crisis?

I don't think we can assume that capitalism will emerge from this crisis. Things are still very dicey. There is an acute lack of confidence. There are acute problems with the availability of credit. The Fed, the Treasury, and so forth have been able time and again to stop the panic from breaking out into more severe panic, but only temporarily, and the underlying problems are getting worse.

Much of what is happening is unprecedented. The future will largely be shaped by the exigencies that emerge in the crisis. The authorities will do whatever it takes to save the system, but what that means will depend on particular circumstances. For instance, we all knew that the Treasury Secretary, Hank Paulson, is not an advocate of nationalisation, but that is what it took to stave off collapse thus far. I think we are going to see similar things down the line.

That said, I expect that for a while we are not going to see anybody attempting to return to the free market or so-called neo-liberal policies. In the 1970s, with the high inflation and the economic crisis, there was a consensus that Keynesianism was no longer the way to structure the economy. It seems that a similar consensus is now emerging that they should not be going back to neo-liberal policies.

I think they are going to keep the economies open to foreign trade and investment, try to develop export-oriented economies, and so on. But they are also going to try to prevent crises recurring, by means of new regulatory measures. I don't think that will succeed, and I think they're aware that it won't succeed, but they will try.

Regulation is not mostly an ideological issue. It's mostly a pragmatic issue of what is needed to keep capitalism afloat. It's not conceivable that the government can say it's guaranteeing private loans or whatever, but at the same time allow banks and other corporations to go ahead and take whatever risks they want.

It will be very interesting to see if they try to outlaw certain kinds of financial products, certain kinds of derivatives, and certain kinds of behaviour, for example what they call naked short-selling. Those are fairly minor matters in the end. We will have a lot more government ownership, a lot more government regulation, a lot more implicit or explicit government control. Coming out of the crisis - if they do manage to come out of it - we are going to see a lot more nationalisation and a lot more government control over financial institutions and activities that they don’t nationalise.

Also, Wall Street is basically a thing of the past. Three of the five firms that dominated Wall Street are gone, and the remaining two, Goldman Sachs and Morgan Stanley, have turned themselves into bank holding companies, that is, companies that own commercial banks and so fall under existing banking regulation. We already have a system extremely different from what we had just a few months ago.

Beyond that, our ability to forecast the future is so meagre at this point. Everything is in great flux. You can't even say that there are specific camps within the ruling class in terms of what they're trying to do. They're all just trying to get through the crisis as best they can.

Sure. But it's useful to get a view of possibilities. Is one possibility that we get a lot more regulation of financial markets, but that goes along with neo-liberalism as regards labour-market policies, contracting-out, the end of welfare, and so on?

That is a likelihood if they do manage to get through the crisis. Our notion of the New Deal and regulated capitalism comes from the 1930s, when regulation came at the same time as a social safety net. But there's nothing about a regulated capitalism or state ownership that automatically means you're going to get progressive policies. In the 1930s you had more closed economies, especially in the USA. Today, in order to keep remain competitive in many industries, each country’s ruling class will continue to need to keep labour costs down and promote labour flexibility.

Economic stabilisation has traditionally been understood as a combination of regulation and Keynesian pump-priming. I don't think that automatic association is correct any more.

I doubt whether the tactics used by the governments so far are really going to work. "Quantitative easing" [measures for the government to try to pump more credit into the economy even when official interest rates are reduced to zero or near-zero] did not really work in Japan. They supposedly ended quantitative easing there in 2006 because the deflation was over, but the deflation actually didn’t end until the latter part of 2007. Of course, it may be that the quantitative easing prevented even worse deflation.

The deflation in Japan in the 1990s and the early part of this decade was not very drastic. The governments are worried about much worse deflation now. Today’s problems are continuations of trends over the last 30-odd years. You have had debt crises, papered over by more debt, and then more severe debt crises.

At the point where things are now, you'd have to throw in a lot of dollars over a long period of time to change the perception in financial markets that assets are overvalued and that prices will come down. Financial assets are not worth what they were originally, but no-one knows what they are worth now. It is hard to prop up the system when such information, which is necessary for capitalism to function, has been distorted so much.

The Federal Reserve is creating dollars at an amazing rate - injecting liquidity into the system in a way that is the equivalent of printing dollars on a phenomenal scale. But to stabilise the economy will require much more than solving short-term liquidity problems.

House prices in the US have collapsed. They could go down a lot more. One recent projection is that the total decline will be 40%. If job losses continue at the rate we've seen recently, then surely the house price collapse will continue. That is because the crisis in the real economy will lead to further pressure in the financial markets, which in turn will react back on jobs and incomes in a spiralling fashion.

If the crisis in the real economy, in jobs and production and incomes, continues and accelerates, it is going to react back strongly on home prices, which are at the core of the crisis. Each problem is going to feed back on the others. That is already starting to happen. I can't make a prediction as to how far things are going to fall. But there is a danger of a collapse of prices and jobs well beyond the government's ability to manage.

In recent decades, New York has acted as a sort of lender of last resort for the world economy, lending other people's money. It may be that the global financial markets centred in New York can no longer keep the credit going at that level. What are the implications for the balance of power in the world system?

I tend to think that these matters are effects of power rather than causes of power. The supremacy of the dollar is due to the supremacy of the United States, and that supremacy largely boils down to the United States being the sole military superpower. That is not likely to change.

The economic crisis shows very strikingly something that is always the case: capitalists like stability. For their system to function, there has to be a certain stability. And I think capitalists around the world look to the United States to provide that.

But once again, it's very hard to say. The authorities are no longer in control. The exigencies of the crisis are in the driver's seat. Assuming they get through this, we're more likely to see the relative economic power of the United States increase than decrease.

The entire world economy is being propped up by the guarantees of the United States government to lenders. Other governments are also making guarantees, but those of the US are crucial, because the US is where the losses are biggest. So now, when the US government is committing itself to trillions of dollars in guarantees, they are nevertheless having to pay almost no interest when they borrow. It's a very perverse situation. The US government is at greater risk, but relatively speaking, in a situation of higher risk everywhere, US government securities become a much better bet in investors' eyes. Buying Treasury debt is so much safer than anything else.

The capitalists care about a stable, secure environment, and any stability there is, is coming from the might of the US government.

On the other hand, the obligations of the US government are huge. It could come to pass that the financial markets look at all this and say that the US government is overextended - that it won't pay back, or it will pay back with dollars grossly devalued by high inflation or a falling exchange rate - then we could see the loss of US supremacy very, very quickly. Still, what is holding the system together at present is the guarantees of the US government.

Up to this point, the US government has done more and more and more, and it has quelled the panics, more or less. It's hard to say whether it can continue doing that. But I don't see how capitalism can emerge from this crisis without the US continuing as hegemon.

You linked the US's hegemony in the world financial system to its military superpower. How do you see that link working?

The capitalist world has to have a regime which exercises power, or the threat of power, sufficient to maintain the stability of the system. If you don't have that, you have blocs vying for power, and you have World War One, or the Cold War. Right now, the military might of the US, its ability to intervene on behalf of property rights, is fundamental to keeping things together.

But neither the Afghanistan war nor the Iraq war helps global capitalist property rights in any clear way...

That's right. The motives behind these particular wars are rather different. But underneath it all, the system requires the stability that comes from military might, and there’s a fundamental question of whether the system is going to make it through this crisis. George W Bush said that he had to sign the $700 billion bail-out bill because otherwise "this sucker could go down". It's an amazing statement from a sitting President.

The key issue here is fear and lack of confidence. The system has come close to panic. The guarantees of the US government have been very important. Then you have to ask, why do the guarantees of the US government matter in a way that the guarantees of, say, the government of Iceland do not matter?

The US has a certain hegemonic status. The source of the hegemonic status is not the US having the strongest economy. It is the biggest economy in the world because the US is a big country, but in terms of GDP per person or similar measures, it is not significantly ahead of other powers. The US is not an especially great technological leader. Productivity is no longer significantly greater in the US than in other developed countries.

So why does the US remain the undisputed world power, in the sense that people and institutions are willing to hold dollars, denominate their debt in dollars, and so forth? I believe that it is to do with the military supremacy of the United States.

Military power can often be tacit. It does not need to be exercised because people know it is there.

The subprime mortgage crisis is very big for the people who are losing their houses, but in terms of the world economy the sums involved are small. How is it that such a relatively small financial disturbance triggers this enormous collapse?

I don't think it was ever a subprime crisis as such. It was a house-price bubble that burst. Its impact came most severely and first among subprime mortgages, but the source of the problem was the collapse in house prices.

The reason why the crisis is so much bigger than it seemed, say, a year ago, is that there has been a continuing fall in house prices. The fall has accelerated; the great bulk of the fall has come during the past year. The latest data indicate a fall to date of 22%. Now a much larger part of the mortgage market than just subprime is involved.

Then there is securitisation of the mortgages. The banks pool mortgages, and the investors buy paper which gives them a share of the whole pool of mortgages. The risk gets spread throughout the financial system.

Twenty years ago we had in this country a Savings and Loan [equivalent of building societies] crisis. It was a crisis confined to one sector. Now we have the crisis spreading throughout the US economy and across the globe, engulfing institutions that are very far removed from mortgage lending.

Even more important is the degree of leverage, of debt, in the system. Wall Street institutions were able to acquire, say, $100 of assets by borrowing $97 while only having $3 of actual assets to back it up. The commercial banks had leverage of about 10 to 1: for each $10 of assets, they could purchase another $90 using borrowed funds.

When house prices were going up, a lot of debt was being created. When the process goes into reverse, what is lost is not only income from mortgage payments; the debt build-up also goes into reverse. We see firms re-capitalising – in other words, banks and other institutions are taking the money that's coming in and shoring up their cushion against losses. They’re doing this because what they regarded as assets that they owned are no longer worth as much as they thought, or they may not be sellable at all. This is a main reason why there’s a big drop in lending

The leverage in the system created a lot more obligations over and above the obligations to repay mortgages. So the bursting of the bubble has caused a deleveraging and a shrinkage much in excess of what you would expect just by looking at the amount of mortgages unpaid.

Also, there are a lot of fancy derivatives now. Derivative prices are very tricky. They are all based on guesses as to future cash flows. In a profound crisis like the one we have seen, what derivatives are worth becomes very much up in the air. That greatly increases firms' aversion to taking risks.

It was always a misnomer to call it a subprime lending crisis. It was an asset bubble that burst.

How is all this connected to the fundamental mechanics of capitalism?

My view is a classic view that comes from Karl Marx - the way the capitalist system gets out of crisis is fundamentally by a destruction of capital - partly physical destruction of machines and so on that are left to lie idle, but mostly a collapse of the value of assets, a destruction of ‘capital’ that is fictitious, overvalued, phoney. When the asset values go down, that is a spur to a new boom, because if the new owners buy the assets at say one-tenth of what they cost before, then their rate of return on capital is ten times as great.

In the Great Depression and World War 2 there was a massive destruction of value, which laid the basis for the ensuing boom. After 1973 we had a new crisis, but this time the system did not experience the destruction of value seen in the Great Depression of the 1930s and after. There were mechanisms which prevented the system from fully collapsing the way it did in the Great Depression - but the prevention of collapse also prevented a real new boom.

What we’ve seen since 1973 is the management of a system which has not fully recovered. Between 1950 and 1973, GDP per head went up by an average of 2.9 per cent a year, world wide. From 1974 to the early part of this decade, the rate was 1.6%, or if you exclude China 1.1%.

That is because there has not been a major purging of value from the system. Governments and banks have been throwing debt into the system to prevent that from happening. That has also meant an entire history of debt crises and burst bubbles over the period since 1973. There was the Third World debt crisis of the early 1980s, the Savings and Loan crisis of the early 1990s; the currency crisis of 1997-8 that begin in East Asia and spread to Russia and Latin America 1997-8; the bursting of the ‘dot-com’ bubble at the start of this decade; and others.

My belief is that the authorities have been trying to prop up the economy by artificial stimulation when there are not the conditions for it to trigger sustained growth. They can paper over bad debt by issuing further debt. This process can go on, even up to today. But the level of debt is becoming just too astronomical. You have to wonder whether we are going to reach the point that the financial markets are going to say that they no longer have confidence in the US government.


December 2008. Andrew Kliman is the author of Reclaiming Marx's "Capital" and many articles, and professor of economics at Pace University, USA. http://akliman.squarespace.com/