16 September 2013 Comments Off on Causes of Global Financial Crisis III: The New Millenium

Causes of Global Financial Crisis III: The New Millenium

All three parts in one place for readers convenience: The Global Financial Crisis of 2007

A link to the published version in Express Tribune (which is unfortunately, mangled by editing)

Part III: The New Millenium
Asad Zaman

Karl Marx was deeply moved by the plight of the exploited laborers in industrialized England in late nineteenth century. He theorized that the dynamics of capitalism would lead to increasing exploitation, until the laborers revolted against the system. After the revolution, the laborers would create a new economic and political system, which would be far more equitable than capitalism.  This Marxist prophecy was wrong, but did contain one core truth: increasing exploitation of workers did lead to a breakdown of capitalism during the Great Depression. The same dynamic has repeated itself in creating the global financial crisis of 2008. This article explains the parallels.

We can partition the economy into a real sector and a financial sector. The real sector is where the production takes place; these are the farms, factories, and other industries which produce real goods and services directly beneficial to human beings. The financial sector is based on activities which are not directly productive, such as lending money for interest, speculating on stocks, foreign exchange, and using derivatives and insurance contracts to gamble on the outcomes of real activities. In the roaring 20’s, wild appreciation in stock prices led to a situation where it became substantially more profitable to gamble on stocks than to invest in real productive activities. Increasing shares of wealth in hands of gamblers and decreasing returns to productive activities cannot be sustained for long, and led to a collapse of the real sector, which is called the Great Depression.

Collapse of the real sector led to massive unemployment, and human misery on a large scale. It is correctly said that Keynes rescued capitalism from the fate Marx had prophesied. Conventional economic theory holds that market forces of supply and demand will automatically eliminate unemployment. Keynes revolutionized economics by repealing the law of supply and demand in the labor market, and urging the government to intervene to help the unemployed laborers. The Keynesian compromise provided relief against the worst effects of capitalism, and prevented the more radical changes suggested by Marx.

In her brilliant book, The Shock Doctrine, Naomi Klein has provided a detailed picture of how a counter-revolution was planned and executed by a small segment of society which was unhappy with the Keynesian compromise. An opening was provided by the 1970’s oil crisis which led to stagflation in the USA, contrary to central premises of Keynesian theories. The monetarist school of Chicago was quick to stage a comeback. They argued that the Great Depression was caused by government mismanagement of the money supply, rather than a failure of the free market.  Using strategies described by Klein, these free market theories were applied all over the world.

Reagan and Thatcher implemented these free market policies in the USA and UK with predictable results. From 1980 to 2006 the richest 1% of America tripled their after-tax percentage of our nation’s total income, while the share of the bottom 90% dropped over 20%. Between 2002 and 2006, it was even worse: an astounding three-quarters of all the economy’s growth was captured by the top 1%. The same pattern of sharply increasing inequality holds globally; the wealthiest 250 people have more than the poorest 2.5 billion people on the planet.

Superficially, “Laissez-Faire” or no interference in markets seems like a fair and equitable philosophy – let everyone do whatever they want. In fact, it is highly inequitable; the poor don’t have choices, while the rich and powerful take advantage of this liberty to extract money from the less rich. Financial wheeling and dealing is used to transfer money from the real sector to the financial sector controlled by the wealthy. A simple method is the leveraged buy-out, which allows the wealthy to purchase a real productive business for peanuts, and extract all profits for themselves. More complex methods like CDO’s (collateralized Debt obligations)“… may not be properly understood even by the most sophisticated investors,” according to financial wizard George Soros. Just before the global financial crisis, the value of financial derivatives (which represent different types of complex gambles) alone was 10 times the GDP of the planet. The worth of the financial sector was more than 50 times that of the real sector. This illustrates the increasing inequity that arose between the real productive sector and the financial sector which ultimately broke the backs of the working people. Many people ranging from religious scholars to financial wizards have correctly traced the roots of the global financial crisis to the limitless greed of capitalists. Removal of traditional restraints to this impulse have led to an extraordinary concentrations of wealth combined with extraordinary exploitation and injustice.

Related Articles:

For a collection of writings presenting critiques of conventional economic theories, see: Guide to Economics.
Book Review of Why Capitalism by Meltzer, posted on Amazon.com
The Crisis in Economic Theory, article published in The News.
Flawed Theories and their Harmful Effects. Draft of an article, under preparation.
Failures of the Invisible Hand. article submitted to JPKE
Critiques of Economic Theories – a list of references with different types of critiques of current economic theories.

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