Marxist economists comment again on the crisis: 6. Costas Lapavitsas - The debacle of financialised capitalism

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Costas Lapavitsas

What sort of new shape of capitalism do you think might emerge from the shake-out of this crisis?


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First of all, we have to see how capitalism looked before the crisis. My own view, as I argued previously, is that capitalism has been financialised. Finance has penetrated every aspect of economic and social life, and turned towards extracting profit from individual income. It has also substituted itself for the public provision of various services, and now mediates them - housing, pensions, health, education... It has done a very bad job of it, not only in terms of the everyday inequalities and inefficiencies, but also in terms of the gigantic crisis that has now manifested itself and its disastrous effect on the lives of many, many people.

Is that trend going to be reversed? At the moment I don't see any serious thought put in to reversing it, from the top. There are plenty of steps taken and noises made as regards macroeconomic policy. Monetary policy has lost influence compared to its previous status, and fiscal policy has been adopted. But in terms of restructuring finance, in terms of altering the relation between the productive sector and the financial sector, in terms of reorganising the capitalist economy as a whole, I see no serious proposals or serious thought from the mainstream.

From those who make policy, it's not clear where they're going to go. Part of the reason, of course, is the residual strength of the financial system. It's enormous. So despite all the talk from Obama, for example, that he is going to change everything, his economic team comprises people who were there in the Clinton era and who are beholden to Wall Street.

Any big change will take time to materialise.

Leo Panitch talks about the possibility of a "social-democratisation of globalisation", and Simon Mohun says that we could see something more like the regime of 1945-73...

I am far more sceptical about that. In the medium-term - give it a few years - I do expect changes to happen - possibly in that direction, in that we will see direct intervention by the state across the economy. Whether that can be called social-democratic or not, we need to discuss, but it's possible.

In the short-term, we are seeing increasing intervention by the state, but it is not leading towards that medium-term possibility yet. The governments are not willing to touch the financial system at present. They are not willing to intervene there, or, when they do intervene, they are not willing to draw the conclusions of their own interventions.

But they do have a problem. Expansionary fiscal policy, as they want to pursue it, and not touching the financial system, are not particularly compatible. They will have to do something about the financial system at some point if they want to sustain this expansionary fiscal policy.

They will have to confront the problem of the enormous growth of finance and the enormous power of finance. It will probably take them some time to realise that. When they come to confront the problem, it is not clear how they will go about it.

How do you think the present financial system undermines fiscal policy? More generally, the economists are dragging everything they can out of the lessons of the 1930s and of the Japanese depression of the 1990s to look for ideas. What critical assessment can we make of the ideas for stabilisation that they are coming up with?

They are not exactly squeezing out all the lessons of the thirties. Actually they have been very careful. In the 1930s, for example, there was imposed a clean separation of investment banking activity and commercial banking activity in the US. There has been none of that. It is true that they have brought interest rates down, but even that they have done by putting enormous amounts of liquidity in. They haven't done it by putting formal controls on interest rates and the way finance lends. They are allowing, for the moment, a market determination of those things.

So it's not true that they have done everything that they did in the thirties. They are very careful not to stop on the toes of the financial system.

They have been using the lessons of the 1930s, as far as they understand them, to promote expansionary fiscal policy. But that will mean state debt, and it may also mean printing money. It is not easy for the US or the UK state to borrow now, and not because they are over-borrowed - actually their debt is quite low. There are no domestic savings for them to borrow from, because of the policies they have been following for the last 15 to 20 years, so they have to borrow abroad. That is not easy, certainly not for the UK. It is easier for the US, but even in the US there are serious problems in relying on Arab money, or Russian money, or Chinese money, for expansionary fiscal policy.

Finance will not like the increase in debt, and they will not like the increase in money supply that may be necessary to support fiscal policy. Finance will act as a brake on these things. Finance will also act as a brake in the sense that while the state will be spending and expanding fiscal policy, finance will actually be reining in demand, because banks are over-extended and they need to adjust their balance-sheets.

Finance is also a problem in the sense that individual people are hugely over-extended with debt. That debt is like a ball and chain on people. For many decades we have been told that debt is good. Now people are going to discover that debt is not good.

Finance will be acting as a pressure on individuals, extracting income, stopping the economy from expanding. The governments will have to do something about it. They will have to restrain the strength of the financial interest. But it will take them a time to see that they have to do it. And it will not be easy, because the financial interest is still very strong.

We talked before about the fact that many of the securities being traded had their prices worked out by mathematical formulas. Some writers have suggested that the calculations were faulty, in the sense that they disregarded highly improbable turns of events, while in fact, given the scale of the markets, those highly improbable things were going to happen.

There is definitely something to do with that argument. It has to do with the ideology of risk management, and the practice of risk management adopted by the financial institutions in recent years, whereby financial institutions seem to have become less capable of assessing creditworthiness. They used to assess creditworthiness in a relational way, by accumulating knowledge, by knowing the debtor and finding out about the debtor's business and prospects. In recent years that has largely be replaced by mathematical and quantitative handling of risk based on assumptions about probability distributions which drew on past events and correlations between variables.

The assumption made by the people who built these models is that extraordinary events happen very, very rarely, so they could afford to disregard them. But capitalism generates the extraordinary quite regularly! And lo and behold, it has happened.

On top of that there has been a question of problematic practice in the financial markets, not just because they made the wrong assumptions about what might happen, but also in terms of how these large capitalist institutions work internally. They may seem to be buccaneering enterprises, but in fact they are very large bureaucracies, stodgy, multi-layered. People were passing estimates from desk to desk without doing any serious work, as long as the right boxes were ticked. The end result was disaster, because problems were accumulating that nobody knew about, or that everybody turned a blind eye to.

It is yet another example of the inefficiency of modern capitalism. It likes to pretend that it is very competitive, very efficient, but even in the competitive environment of those large financial institutions, internally they were very inefficient.

The total outstanding notional value of financial derivatives in the world is over $600 trillion - over $100,000 for every person in the world. There are different ways of counting the total, but however you count it, it is an enormous amount. And a lot of it must be the same underlying assets repackaged again and again. So isn't it a case of some problems being invisible because of the scale and speed of the markets?

I was thinking more of how the mechanics of risk management operate within the large investment banks. It's important, because these banks are supposed to be the social institutions that assess risk in a market economy, but in fact they don't do it very well.

I'm not sure that the size as such is a problem. The nominal sums are misleading. It is an example of Marx's "fictitious capital". But those who run the big business were losing sight of who owns what, where, and in that sense the system became less easy to read, more opaque, as it became more and more multi-layered.

Looking back on it, the mortgage crisis in the USA seems very small compared to the repercussions. How can we explain that this relatively small disturbance - on the scale of world capitalism - had such huge repercussions?

This is not a crisis in the normal mould, and Marxists would do well to appreciate that, in order to say useful things about it. The mortgage market is sizeable, but obviously it is not on a par with what has happened in recent months.

It is securitisation that has done that - the fact that on the back of a fairly moderate amount of debt from poor people in the United States an enormous structure of other debt had been developed, owned by financial institutions across the world.

That is not all. The money markets are frozen. The way the crisis unfolded, and the way the authorities have mishandled it, allowed the money markets to freeze completely. Lehman Brothers was a critical moment.

Any capitalist financial system pivots on the money market. If the money market - that is, the market in which banks exchange reserves among themselves and facilitate their other transactions - doesn't work, then everything is frozen. That is what magnified the effect of the disturbances and made them spread across the world.

On top of that, large numbers of working people in key developed countries are over-indebted. They have been hit very badly, and can't spend at the same level. The combined effect of the money markets freezing, and therefore credit freezing, and ordinary people suffering loss of buying-power, has catapulted the productive sector into a major crisis.

The money market is important, not only because a freeze there means that banks do not lend to other banks, but also because it makes it more difficult for industrial corporations to issue short-term debt to obtain cash to pay wages and so on. Working capital for big business has been very hard to procure, and as a result they have cut back output and employment. So you get unemployment rising.

In recent years, the New York financial markets, operating with cash put in from all across the world, have acted as a sort of lender of last resort to the world. Is there a prospect that they won't be able to do that any more? That we will have a world without a lender of last resort, and so a severe disruption of the world system and also a rebalancing of it so that New York will no longer be central?

There has been a period of US hegemony, including in finance. The major financial institutions are either US-owned or multilateral institutions which are US-backed. US hegemony in the political sphere has been matched by US hegemony in the financial sphere, and the US has been one of the main drivers of the financialisation of world capitalism.

But in the last 20 years, that has been done while the US has been suffering from structural balance-of-trade deficits. It has been done on the basis of other people giving the US money to borrow. In the 1990s, that tended to be the Japanese and the Europeans. In the last decade, the Japanese have remained significant suppliers of finance, but in the last four or five years it has been more the emerging capitalist economies in Asia. Some very, very poor countries have been sending funds to the US.

So the US has been absorbing funds from across the world. The US has a unique advantage, because it issues the money that is best available approximation to world money, the dollar. It can impose a sort of tribute on the rest of the world because of imperial power. The rest of the world, in a sense, sends money over to enable it to use the dollar.

Can this be maintained? Will things change? In the medium term I think they will. This is a major shock to the United States. The crisis is to do with US-centric methods of financial capitalism, and the crisis is very severe in the US specifically. In the medium term I expect US hegemony, in the sphere of finance and perhaps more broadly, to suffer.

But I stress: in the medium term. In the short term it is different. The dollar has become stronger, for a variety of reasons, but its use as a last resort has something to do with it. And one of the main providers of funds globally, to allow smaller capitalist countries to keep ticking over, has been the Federal Reserve. They have provided, of course, enormous amounts of money to capitalist firms in the US, but they have also created new and unprecedented facilities for Brazil, Mexico, Singapore, and South Korea, as well as allowing other central banks across the world access to dollars. The Federal Reserve has emerged as a major player globally in the stabilisation effort.

It is not as if the US is on its last legs, and Sarkozy and others are making all the running. That is not what's happening. But in the medium term the omens are not good for US hegemony.

How might a world with reduced US hegemony look? If the dollar is not the world money, what will be?

That, in a sense, is the major problem of capitalism today. Marxists had better appreciate that and start discussing it. Domestic financial systems and monetary arrangements are always problematic for the capitalist classes, but over the years they have developed institutions and practices to handle the problems - not always successfully, and with contradictions, but they have mechanisms in place.

On the global level, it is different. The history of the last thirty-odd years, since gold was finally detached from the dollar and stopped functioning as a world money, has been one of tremendous unrest, volatility, instability. And that in turn has boosted financialisation.

The options for finding a reliable world money to replace the dollar are very limited. At that level the contradictions are very hard to reconcile. Maybe they are impossible to reconcile with a capitalist organisation of production. It is possible that without the dollar as world money, then, as far as the eye can see, the world economy, if it continues on a capitalist basis, will subsist on the basis of global instability, with unstable exchange rates and unstable flows... maybe bilateral arrangements, maybe a number of competing world moneys.

What might a limited decline of US financial hegemony look like, then?

A rise in the power of China, in the first instance - and a more confident role for Chinese capitalism, if it doesn't itself implode. China possesses enormous financial reserves. It might invest them in other parts of the world. We might see multinational Chinese corporations emerging. And then, gradually, if China manages to find some modus vivendi, there might be some Asia-centred monetary system emerging. But the problems are enormous in that respect, mainly political problems.

Do you think that the monetary policies followed by the governments in the last few months are likely to lead to high inflation after the period of low inflation, or deflation, which seems likely in the coming months since we know that oil prices and basic commodity prices have gone down already? The central banks have done all the things which they said absolutely must not be done for fear of causing inflation.

It's quite incredible what the central banks have done. I looked at the balance sheet of the Federal Reserve. Bank deposits with the Federal Reserve, "high-powered money", the basis of the money supply, are now about a trillion and a half dollars, up from about $800 billion in the space of just a few months. The Federal Reserve has increased the supply of money to the banks phenomenally, by buying from the banks financial assets which it would not have dreamed of buying just six months ago.

But the banks have been sitting on the money. At the moment, monetary policy does not work, for reasons that Marxists have long known about. Keynesians call the liquidity trap - not exactly the same, but a related idea: that there comes a moment in a crisis at which money is the only way to hold value. So we have financial institutions hoarding that the central banks are providing to them.

Potentially this could lead to inflation. But I doubt it, because of the severity of the crisis and because of the previous experience of Japan. The Japanese central bank did the same thing - it bought all kinds of assets and expanded the money available to banks. It never led to inflation. In fact, prices maintained a downward slope.

The reason was, again, hoarding. In Japan, people and institutions have been hoarding money, and they have been doing it because of their predicament. Over-borrowing, uncertainty about the future, uncertainty about jobs, make people and institutions more conservative.

That is what I think will happen. No-one knows for sure, but at the moment it looks like falling prices rather than inflation. It looks like a major shock to prices, because capitalist operations cannot borrow, consumers cannot borrow, no-one is spending. Given the over-extendedness of borrowing consumers, that is not likely to change soon. People are hugely over-borrowed in this country, to the extent of 160% of disposable income. It is similar in the United States.

In other words, monetary policy has shot its bolt. The ruling class has begun to realise that and turn to fiscal policy.

Fiscal policy opens up all kinds of possibilities for the left. Fiscal policy has been the great unmentionable for many years past, because financial interests do not want it.

Fiscal policy allows the left to argue on a different basis about what needs doing in the economy, and which way it should be directed - should it be tax cuts, or targeted state spending, and so on? It takes us back to a terrain which is far better suited to the interests and the desires of the left.

It also presents the possibility of arguing for socialism. Fiscal policy is where the governments are heading to, but the financial system will keep dragging it back. The left should then be arguing for true socialisation of the financial system. Private finance has failed, and failed abysmally.


December 2008. Costas Lapavitsas is a Marxist economist specialising in the study of financial systems. His writings include The Political Economy of Money and Finance (with Makoto Itoh), and he is a lecturer at the School of Oriental and African Studies in London. Interview by Martin Thomas.