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Shifting Sands of the Crisis

Shifting Sands of the Crisis

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Published by: bowssen on Jun 19, 2010
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Shifting sands of the crisisIssue: 125Posted: 16 December 09Despite the euphoria that gripped the financial markets in the second half of 2009, the world economy continues to be hit by severeshocks. Another hit it in late November. The most surprising thing about the announcement that Dubai World had defaulted on $26 billion of its total $59 billion debt was that it had taken more than two years for the Gulf city state to become a casualty of the globaleconomic and financial crisis. For if there was any single symbol of the overblown financial bubbles that have driven global capitalismfor the past 15 years, it was Dubai.In a brilliant portrait published just over three years ago, Mike Davis wrote:
The coastal desert has become a huge circuit board upon which the elite of transnational engineering firms and retaildevelopers are invited to plug in high-tech clusters, entertainment zones, artificial islands, glass-domed “snow mountains”,Truman Show suburbs, cities within cities—whatever is big enough to be seen from space and bursting with architecturalsteroids…Although compared variously to Las Vegas, Manhattan, Orlando, Monaco and Singapore, the sheikhdom is morelike their collective summation and mythologisation: a hallucinatory pastiche of the big, the bad and the ugly.1
Dubai’s ascension during the credit boom of the mid-2000s depended on the strategic positioning pursued by its autocratic ruler,Sheikh Mohammed al-Maktoum—and on the super-exploited labour of the emirate’s predominantly South Asian migrant workforce.To quote Davis again:
With a tiny hinterland lacking the geological wealth of Kuwait or Abu Dhabi, Dubai has escaped poverty by a Singaporeanstrategy of becoming the key commercial, financial and recreational hub of the Gulf. It is a postmodern “city of nets”—asBrecht called “Mahagonny”—where the super-profits of the international oil trade are intercepted and then reinvested inArabia’s one truly inexhaustible natural resource: sand.2
Symbolic of Dubai’s ascension was the 2006 takeover by Dubai Port World—a subsidiary of the state-owned Dubai World—of P&O,once one of the greatest of British imperial companies (the takeover provoked a huge row in the US Congress over an Arab firmrunning six American ports). But—like the boom itself—the Dubai bubble floated on a vast pool of cheap credit. As the FinancialTimes put it, the sheikhdom became “something resembling a highly-leveraged private equity firm sinking money into fanciful realestate projects and questionably valued assets abroad”.3 It is this frenzied borrowing spree that has now brought Dubai World to its knees under a debt burden estimated at $100 billion and forced al-Maktoum to turn to his oil-rich neighbour and rival Abu Dhabi forhelp.Contradictions of the bailouts Abu Dhabi has twisted the knife in the wound by refusing to bail out Dubai World. But more important than the fate of the bloatedsheikhdom is what its collapse signifies for the broader economic crisis. After the very sharp slump that hit the world economy in the winter of 2008-9, a degree of stability returned in the summer and autumn of last year. Driving this have been the massive staterescues of the banks and the government fiscal stimuli that have been pumped into national economies. A recent Bank of England study estimates that “intervention to support the banks in the UK, US and the euro area during the currentcrisis…totals over $14 trillion or almost a quarter of global GDP. It dwarfs any previous state support of the banking system”.4 China has also played a major role in the state-directed efforts to stave off global depression. On government instructions, the Chinese bankshave behaved very differently from their Western counterparts, lending a mammoth $1,080 billion in the first half of 2009.5State intervention has thus brought the sharp contraction of output and international trade to a halt, for the time being at least. China’sreturn to the high growth rates of the past few decades has also revived the economies that supply it with complex manufactures andraw materials (notably Japan, Germany, South Korea, Taiwan and Brazil). In the US and Britain, the most striking result of thisstabilisation has been the renaissance enjoyed by those banks that survived the financial crash in the autumn of 2008. As the New York Times explains, the boosted profits—and hence bigger bonus pools—announced by the strongest American banks last autumn are adirect result of state support:
Titans like Goldman Sachs and JPMorgan Chase are making fortunes in hot areas like trading stocks and bonds, rather thanin the ho-hum business of lending people money. They also are profiting by taking risks that weaker rivals are unable orunwilling to shoulder—a benefit of less competition after the failure of some investment firms last year.So even as big banks fight efforts in Congress to subject their industry to greater regulation—and to impose somerestrictions on executive pay—Wall Street has Washington to thank in part for its latest bonanza… the decline of certaininstitutions, along with the outright collapse of once-vigorous competitors like Lehman Brothers, has consolidated the
nation’s financial power in fewer hands. The strong are now able to wring more profits from the financial markets andcharge higher fees for a wide range of banking services…A year after the crisis struck, many of the industry’s behemoths—those institutions deemed too big to fail—are, in fact,getting bigger, not smaller. For many of them, it is business as usual. Over the last decade the financial sector was thefastest-growing part of the economy, with two-thirds of growth in gross domestic product attributable to incomes of workers in finance.Now, the industry has new tools at its disposal, courtesy of the government… With interest rates so low, banks can borrowmoney cheaply and put those funds to work in lucrative ways, whether using the money to make loans to companies athigher rates, or to speculate in the markets. Fixed-income trading—an area that includes bonds and currencies—has beenparticularly profitable… To prevent a catastrophic financial collapse that would have sent shock waves through the economy,the government injected billions of dollars into banks. Some large institutions, like Goldman and Morgan, have since repaidtheir bailout money. But most of the industry still enjoys other forms of government support, which is helping to stokeprofits.Goldman Sachs and its perennial rival Morgan Stanley were allowed to transform themselves into old-fashioned bankholding companies. That switch gave them access to cheap funding from the Federal Reserve, which had been unavailableto them.Those two banks and others like JPMorgan were also allowed to issue tens of billions of dollars of bonds that are guaranteedby the Federal Deposit Insurance Corporation, which insures bank deposits. With the FDIC standing behind them, the bankscould borrow the money on highly advantageous terms. While some have since issued bonds on their own, theynonetheless enjoy the benefits of their cheap financing.6
No wonder that George Soros described the banks’ profits as “gifts…from the government”.7The problem of how to deal with financialinstitutions that, because they are deemed “too big to fail”, are effectively being allowed to gamble with very cheap government money,confident in the knowledge that they will be rescued by the state if their bets go bad, has caused much agonising in ruling class circles.From the free-market right Niall Ferguson has denounced the rise of “State Monopoly Capitalism”.8The problem (often described by bourgeois economists as one of “moral hazard”) illustrates one of the main themes of Chris Harman’spolitical economy, which is explored elsewhere in this issue by Joseph Choonara and Guglielmo Carchedi. As capitalism ages, the sizeof individual units rises thanks to the growing concentration and centralisation of capital. This means that the impact of the bankruptcy of particular firms can be very severe. Thus the collapse of Lehman Brothers in September 2008 precipitated the worst global financialcrash since October 1929 and helped to pitch the world economy into the sharp slump of last winter. But when, as they have, states stepin to prevent such catastrophic bankruptcies, they let the overaccumulation of unprofitable capital continue, imposing a heavy burdenon any economic recovery .9In trying to negotiate this deep contradiction, the leading capitalist classes must confront a number of specific problems. The first issimply how broken the global financial system remains despite the bailouts. The Dubai default detonated an exploded bomb left behind by the wild borrowing that both firms and states undertook during the credit boom. But how many other unexploded bombs are there?“After Dubai, will Greece be next?” asked Financial Times columnist Wolfgang Munchau following Dubai World’s default.10 According to Deutsche Bank, the Greek state has run up debt equivalent to 135 percent of national income. Financial markets reacted tothe Dubai crisis by pushing up the interest rate on Greek government bonds and the price of Credit Default Swops (CDSs) insuringagainst Greece defaulting on its debt. Complicating matters is the fact that Greece is a member of the euro-zone. But neoliberals inBrussels and the main European capitals may decide to make an example of Greece, whose recently ousted Tory government hadconcealed the scale of the debt crisis. According to Daniel Gros of the Centre for European Policy Studies, “It is one thing if you are inthe middle of a systemic crisis. Then you can’t allow anyone to fail and don’t worry about moral hazard. Now we are out of the woodsand it may be a good time to reduce moral hazard”.11This kind of reasoning begs the question of whether or not the world economy really is “out of the woods”. Letting Greece go bust is adangerous game. It might further undermine confidence in the European Union, whose response to the crisis has been shambolic.Other member states that enthusiastically helped blow up the housing bubble—from Britain and southern Ireland to Hungary andLatvia—are also struggling with huge debt burdens. Gillian Tett, the Financial Times journalist who was one of the first to blow the whistle on the dangerous levels of debt (or leverage) the banks were building up through credit derivatives during the bubble years,argues:
The events in Dubai—and the Greek CDS price…[are] a welcome wake-up call. In recent months, a sense of stabilisationhas returned to the financial system as a whole, as central banks have poured in vast quantities of support. A strikingliquidity-fuelled asset price rally has also got under way.But the grim truth is that many of the fundamental imbalances that created the crisis in the first place—such as excessleverage—have not yet disappeared. Beneath any aura of stability huge potential vulnerabilities remain.12
Secondly, as Tett points out, the state rescue of the banking system has been followed by marked rises in the price of shares andcorporate bonds, especially in the big “emergent market” economies of the Global South. For apologists and boosters, who have now recovered their nerve after the terrible fright they suffered during the crash in autumn 2008, this is a sign of the intrinsic strength of global capitalism and especially of the much-feted BRICs (Brazil, Russia, India and China).But Nouriel Roubini, another of the handful of establishment commentators who warned against the dangers of the last financial bubble, argues that a new one is emerging, fuelled by “the mother of all carry trades”. A carry trade is when someone borrows in onecurrency, where interest rates are low, to invest in another, where interest rates are higher, thereby making a profit. In this case, the USFederal Reserve Board’s policy of flooding the financial system with ultra-cheap money and letting the dollar fall against othercurrencies to cheapen American exports is encouraging investors to borrow in dollars to buy shares and bonds, particularly in those Asian and Latin American economies where the recovery is strongest. The resulting bubble, Roubini argues, is creating the conditionsfor the next crash:
This unravelling may not occur for a while, as easy money and excessive global liquidity can push asset prices higher for awhile. But the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing assetbubble crash. The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer theyremain blind, the harder the markets will fall.13
The response by an ex-governor of the Fed, Frederic Mishkin, that the new bubble was a benign one was greeted with widespreadderision.14 Washington’s easy money policy is also a source of tension with China, whose status as America’s most important economic partner and rival has been confirmed by the crisis. The conflict is partly because the Chinese state continues to use many of the dollarsearned by its exports of manufactured goods to buy US Treasury bonds, thereby lending Washington the money it needs to continuespending.But the decline of the dollar that is being tacitly encouraged by both the Fed and Barrack Obama’s administration to boost Americancompetitiveness reduces the value of Chinese investments in the US. When Tim Geithner, Obama’s Treasury Secretary, told anaudience of students at Beijing University that these investments were safe, they roared with laughter. But the Chinese government’spolicy of pegging its currency, the renminbi, against the dollar is also a source of tension. Western manufacturing firms complain thatthis policy keeps China’s exports artificially cheap. But when both Obama and an EU delegation pleaded for a revaluation of therenminbi on recent visits to Beijing, they were given the brush-off by President Hu Jintao.China’s economic trajectory is another area of uncertainty. It has become a platitude among global elites that the world economy must be “rebalanced”, crucially by the US saving more and consuming less and by China consuming more and exporting less. But the nexusthat binds the two economies together, with China supplying both the cheap exports and the capital that the US requires for its currentaccumulation path, fits the interests of both ruling classes, despite the tensions outlined above.The giant state rescue of the Chinese economy has concentrated on building up yet more productive capacity in export industries. According to Hung Ho-fung:
Nearly 90 percent of GDP growth in the first seven months of 2009 was driven solely by fixed-asset investments fuelled bya loan explosion and increased government spending. Many of these investments are inefficient and generally unprofitable…If the turnaround of the export market does not come in time, the fiscal deficit, non-performing loans and the exacerbationof overcapacity will generate a deeper downturn in the medium term. In the words of a prominent Chinese economist, thismega-stimulus programme is like “drinking poison to quench a thirst” .15
 Against this background, it’s hardly surprised that policy-makers are divided over how to deal with yet another problem, namely whento end the government stimuli that, in the form of extra spending, have been holding up the world economy. All are agreed that thestate interventions are temporary measures that must, sooner or later, be ended to allow a return to neoliberal normality. But when? If the stimulus is withdrawn too soon, this might push the world back into slump, producing a “double-dip” recession. But if state supportremains in place for too long, then the new asset bubble may become unmanageable and another bout of higher inflation may beignited.Representing one horn of this dilemma, International Monetary Fund Managing Director Dominique Strauss-Kahn said lastNovember, “It is too early for a general exit. We recommend erring on the side of caution, as exiting too early is costlier than exiting toolate.” He was countered by Jean-Claude Trichet, President of the European Central Bank, embodying the other horn: “There is an

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