Here’s my next article for the Southeast Voice, here in Ireland.
Crisis, Crisis – What’s really going on?
“Oh what fun, to be master of the universe!”
The banking crisis and government responses
Every bank has both assets and liabilities. The net worth of a bank is equal to its assets minus its liabilities. Its assets include loans, cash reserves, and investments. It’s liabilities include deposits and debts to other banks. The nature of the current financial crisis is that many of the ‘assets’ will need to be written off; that is, they can never be collected. In the case of Ireland, that seems to be mainly loans to contractors, who have built properties for which there are no buyers, and mortgages, car loans, and credit card debts that customers won’t be able to repay. In addition, Irish banks have purchased some of those worthless, ‘toxic instruments’ that Wall Street has been aggressively marketing over the past several years.
In addition to this, we need to take into account the ‘fractional reserve’ banking system. What this means is that banks are allowed to make loans for many times the value of their assets. Even if only a fraction of their loans and investments need to be written off, those write-offs can easily exceed the value of the actual collectable assets of the bank. In other words, given the collapse of the Irish housing market and construction industry, and the investments in toxic instruments, Irish banks are now insolvent. Their liabilities exceed their real assets; their net worth is negative. This is why the banks came running to the government for bailouts.
When people begin to realize that the banks are insolvent, they are likely to begin withdrawing their money from their accounts. Once that starts, justifiable panic ensues, and we have a full-blown run on the banks. Everyone will want to get their money out before accounts are frozen and ATM machines close down. The guaranty made by the government to depositors does nothing to make the banks solvent, rather it is intended to prevent a run on the banks. Such measures can only delay panic, not prevent it indefinitely. When people realize that the government doesn’t have the funds to cover all the deposits, the eventual panic will be worse than if the government never intervened. People will be afraid not only of losing their deposits, they will also be afraid of government insolvency, and the collapse of the economy. The situation in the rest of Europe is even worse than in Ireland, as European banks are even more over-extended than Irish banks, and they have invested more heavily in Wall Street’s toxic instruments than Irish banks have.
Governments and banks are well aware of this situation, and that’s why European governments all rushed last week to inject capital into the banks. They knew that guaranteeing deposits was only a temporary measure, and now they’re attempting to keep the banks solvent as well. But there’s no way they can do that. EU governments are all on tight budgets, and they don’t have the reserves to keep the banks solvent, not any more than they have the reserves to cover all deposits. If governments begin to default on their promised guarantees, then the whole system comes crashing down very quickly. In order to delay or prevent such defaults, governments have no choice except to borrow the money needed to honor their guarantees. But who are they going to borrow from? And if they can find a place to borrow, how can they ever repay those new loans? Why would anyone want to loan money to governments under these circumstances? More about this further on down.
Why the crisis will get much worse quickly
Here’s a current news report about the situation in Iceland:
“Almost overnight people saw years of savings wiped out, and thousands of banking jobs disappeared as the country’s failed banks were almost totally nationalized last week. Food prices have soared and there have been reports of widespread hoarding of imported foodstuffs. The krona has become a pariah currency, and Icelanders are now permitted to buy only a few hundred euros if they want foreign currency – and even then they must present airline tickets as proof of imminent travel abroad. In just two weeks Iceland went from being one of the wealthiest countries in Europe, in terms of per-capita Gross Domestic Product, to one of the poorest, banging on the doors of Russia, its Scandinavian neighbors and the International Monetary Fund begging for assistance.”
Iceland shows how quickly things can collapse, but of course conditions are different in each country. The US is probably the worst off, not so much because the crisis started there, but because America is already the deepest in debt of all nations, has a very bad trade imbalance, and is already operating on astronomical budget deficits. Russia, China, and Japan have an advantage in dealing with the crisis, due to their substantial reserves, but it’s not clear if they will fare better than anyone else if the whole global economy shuts down.
Ireland has it’s own special circumstances as well, and they are not at all encouraging. We had a period of high inward investment (aka, the Celtic Tiger), and that has left us with a very high level of personal debt. Inward investment then moved on to Eastern Europe, where labor and other costs are cheaper, and Ireland has kept itself afloat with a construction boom and a housing bubble. The boom is over, the bubble has burst, jobs continue to disappear, and the Celtic Tiger has left us with only debt as a reminder of its visit.
We are well-positioned in Ireland for a rapid declining economic spiral. Every time someone loses a job, and are unable to continue their debt payments, that’s a triple whammy to the economy. Their PAYE disappears from government income, their unpayable debts add to the losses of the banks, and presumably the family will be seeking government benefits in order to survive. In addition, that’s one less family that will be house hunting, buying a car, or otherwise keeping the consumer economy going. As business slows down, we get more redundancies, business slows down more, the squeeze on banks, individuals, and the government increases, and so on – a downward spiral feeding on itself. And of course this locally-generated downward spiral will be accelerated by the economic problems the rest of the world is experiencing.
No, this is not like the Great Depression: this is a much deeper crisis
The Great Depression of the 1930s was only one of many cyclical events in the long history of capitalism. As I explained in one my early articles here, bubble & burst, aka boom & bust, is part of the normal cycle of capital accumulation. Every growth cycle becomes a bubble, because of the way the capitalist market operates. Capital tends to concentrate where the returns are greatest. As everyone tries to get a piece of the latest action, that leads to excessive investment in the current growth sector – dotcom, manufacturing, housing, whatever. Excessive investment accelerates the process of diminishing returns, and when the returns in the sector turn sour, investors flee with the same herd mentality that originally drew them to the sector. This leads to debt defaults by those who got into the game late, a sudden surge in business failures and redundancies, and that’s what we all a bust, a recession, or a depression, depending on the scale. Our own construction / housing collapse has been a typical example.
This boom & bust dynamic applies to nations and empires as well as to market sectors. The decline of the British Empire began when investment in Britain began to suffer diminishing returns, and London financiers moved their funds elsewhere. The American decline began similarly, when investors found they could make more money by investing in manufacturing in the ‘underdeveloped’ world. This led to a more general movement of capital outside national boundaries, aka globalization, and to the decline of the nation state generally as a focus of economic activity in the West.
What we are experiencing now is the bust of global investments generally. Capitalism itself has peaked. In fact it peaked some time ago. That’s why the fake derivative economy was created, to provide an artificial, paper-only bubble, so that investors could keep playing the game a bit longer. The housing collapse was the trigger, but the bubble that burst was immensely bigger than just the housing sector. As resource limits are being reached, and we run out of new territories to invest in, there’s just nothing left that can support further growth of the global investment pool.
The media and officialdom are talking about ‘restoring confidence’, and getting the economy ‘back on track’. It just isn’t going to happen. ‘Back on track’ mean more cars sold every year, more houses and highways built every year, greater GDP every year, more of everything every year. That just isn’t possible any more. The Earth is finite and we’ve exceeded its capacity to support that kind of growth. Most people involved in the system don’t realize this yet, but the financial elites understand perfectly. Just as the top management in a company understands the ‘big picture’ of the company in a way that the line workers can’t, so the financial elites understand the ‘big picture’ of capitalism and the global economy much better than those involved in the day-to-day business of corporations, commercial banks, and governments.
Regime change and finance as power
As capitalism has evolved over the past five centuries, power over world affairs has become more and more concentrated in the hands of the financial elites. Central banks, such as the Federal Reserve, control the currencies of nations, initiate and finance the wars, and keep the nations in perpetual debt. By means of campaign financing, control of the media, and other corruption mechanisms, the financial elites are also able to control politicians and the political process. Capitalism began as a way to make fortunes, and gradually transformed into a mechanism of political and geopolitical power. The ones at the top of the power pyramid, the financial elites, have no intention of giving up their throne. They know that capitalism has passed its sell-by date, and their concern is not with preserving capitalism – their concern is with maintaining the power of their clique of families, what we might think of as the ‘neo royalty’.
They created this final bubble, this paper derivative economy, and they intentionally infected it with the subprime virus. In that way, they aimed to bring the whole global economy down at once, so that they could better manage the the transition to a new economic regime, and ensure that they remained in charge of the political regime. Meanwhile, they managed to purge all socialist and nationalist thinking from the ranks of Western political leadership, so that when collapse came, governments would see no alternative to their plight, other than to hope for magic from the markets to pull them through. And when you’re looking for magic from the markets, you naturally turn to the magicians of the marketplace – the technocrat agents of the financial elites.
Look at the timing. Just prior to the bubble bursting, in both the UK and Ireland, we saw an arbitrary mid-term transfer of leadership from a party leader (Blair & Ahern) to a finance minister (Brown & Cowan). And now they’ve got Henry Paulson – direct from Wall Street – as the new US Czar of the Economy. And in Britain they’ve created the National Economic Council, playing a similar role, ruling Britain on behalf of The City. Thus the agents of the financial elites are now enthroned on the seats of political power. It matters not at all that they were never elected to such a position. Such is the nature of coups.
Earlier I talked about how governments are guaranteeing the liabilities of the financial system, and I pointed out that such guarantees are worthless and meaningless unless the governments can somehow borrow the money to back them up. The sources of that financing will obviously be the central banks – the Federal Reserve, the Bank of England, and the European Central Bank. As we’ve seen, these central banks can conjure up billions at the drop of a hat, as they ‘inject liquidity’ into the banking system. It’s all just paper with ink printed on it, or perhaps it’s just bits in a computer database, but somehow the world has been entranced into accepting it as ‘the real thing’ in exchanges.
So what we end up with is bankrupt governments, going down on their knees before the financial elites, begging for some of that magic paper so that they can continue operating. In other words, Western governments have all at once been put in the same position as third-world countries, who go bankrupt to the IMF, begging for their loans to be refinanced. And just as with the third-world countries, the price of the financing – besides the interest – will be ‘conditionality’. Things like further privatization, the elimination of social services, the end of regulations, and all those other curses that have plagued the third world.
This is all so unnecessary
We’ve heard a lot of talk recently about how governments must work together, and adopt a coordinated policy for dealing with the crisis. As it turns out, their ‘coordinated policy’ has been to commit suicide en masse, as political leaders. They’ve basically said, to their financial superiors, “We give up, you take things from here.”
How unfortunate that they didn’t get together and come up instead with a sensible coordinated policy. They might have started by canceling all debts to banks, particularly central banks, and starting over with a whole new currency under the control of governments instead of central banks. There is no reason at all why our economies need to grow in order to be prosperous, apart from the incremental growth that comes with increasing population or more real economic activity. The ‘exponential growth imperative’ is something capitalism needs, not something that any real economy needs.