The pressing question now is whether or not the system has passed the point of no return – in other words, whether it can still be repaired and saved. Perhaps we can modify or improve it from within? Alas, this doesn’t seem very likely. The corporate and finance capitalism that has been unleashed in the last forty years has gone too far, and actually against some basic tenets of the system such as thrift, competition, and innovation. So, capitalism is already mutating. If we take the analogy of a sick patient, the tumour has become so overgrown that it cannot be operated on without risking the immediate death of the patient – one can only ease the pain. Capitalism could be saved from communism and similar threats that previous generations worried about so much, but it cannot be saved from itself. In an attempt to clarify why this is the case, we will focus on the financial sector, as it has been implicated in most of the crises in capitalism’s past. There are several interrelated issues that make it extremely hard if not impossible to prevent the next one:
The beast has been bled: the state is a thorn in the eye of the corporate and finance sectors, as it is supposed to protect the interest of all its citizens and is the only body that could restrain and keep these sectors in check. So, these industries have always tried to undermine the power of the state, which was the central aim of the neo-liberal counter-revolution too (Reagan famously exclaimed: “government is not the solution to our problem; government is the problem”). They succeeded remarkably well, especially in the US. Enforcing regulations is an expensive endeavour, so one of the most effective ways (although not the only one) of achieving this goal is by depleting the state of its resources – which is usually achieved through reducing taxation and incurring unnecessary expenses upon the state. This is called ‘bleeding the beast’. For example, when George W. Bush took office, his first task was to create a deficit and reverse the healthy financial state left by his predecessor, Bill Clinton. It has been, and still is, a neo-liberal belief that it is too dangerous to allow the state not to be in deficit. The result is that not only the US but many other countries are now too weak to regain control as they sometimes did in the past. But this is not all. There are other compound factors.
Knowledge deficiency: no one understands the derivative risk positions of big banks such as Barclays or Bank of America. There is presently no way to measure the risks involved in the leverage, quantity of collateral, or stability of counter-parties for these major institutions. According to a National Bureau of Economic Research study, without access to confidential internal data about these risky derivative positions, the regulators cannot react in a timely and measured fashion to block the threat to financial stability. Larry Summers, Harvard economist and a former supporter of the neo-liberal doctrine, claims that the Federal Reserve System is simply not capable of understanding even when a member bank becomes insolvent. The so-called stress test has become standard procedure to ensure that banks can weather a future crisis, but it was not originally created for that purpose and may create a false sense of security. Bloomberg opinion editor, Mark Whitehouse, writes:
As things stand, passing a stress test shouldn’t be seen as certifying that a bank is safe. And it’s dangerous if investors and officials think it does, because they’ll stop demanding more equity and allow standards to erode even further. As a result, one of the past decade’s biggest innovations in financial supervision could help bring about the crisis it was supposed to prevent.
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Furthermore, the regulatory institutions do not have any oversight powers over the shadow banking system, which amounts to $75 trillion worldwide of financial activities by non-banks. Shadow banking runs the gamut from money market mutual funds to short-term repurchase financing agreements, commercial paper and other aspects of investment banking. However, it is inherently fragile, due to the lack of a central bank safety net and the insurance that supports bank deposits, and can easily trigger panicky runs on the financial system. The whole inter-relationship between shadow banking and traditional banking is not very well understood, but there is no doubt that shadow banking increases the systemic risk. Many financial problems are hidden in the plumbing of the financial markets, which are not transparent and make the financial system exceptionally vulnerable. To some extent, we are always flying blind.
The powerlessness of regulations: Wall Street is a highly concentrated, politically powerful industry. By contrast, its regulators are a highly fragmented group of institutions like the Fed, the Securities and Exchange Commission (SEC), the Treasury and the Federal Deposit Insurance Commission (FDIC), which are not used to working together. This is exacerbated by regulatory and political defragmentation among countries: according to a House of Representatives report published in July 2014, while the corporate world is globalised, there has been very little progress on building an international framework to resolve failed financial firms. The US Treasury Secretary at the time, Jack Lew, warned that: “the failure of Lehman Brothers demonstrated that the absence of cooperation between domestic and foreign authorities to resolve a financial company can endanger the global financial system.” In her 2014 speech, Christine Lagarde, former Managing Director of the IMF, described this absence of a cross-border regime for resolving large banks as ‘a gaping hole in the financial architecture’. Too little has been done to close that hole since. In his book The Shifts and the Shocks, Martin Wolf summarises the situation: regulators lack the resources, the motivation and the knowledge to keep up with the main players in the financial sector. This creates a highly volatile situation as the world is financially deeply interconnected, and it only takes one piece of that web to fray for the rest to start unravelling. In desperation, many put their faith in self-regulation, but this cannot and does not work as it is innate to the system to speed up and favour instability (e.g. traders earn more if the market veers wildly than they do when it is stable). So, each financial institution has a strong incentive to refrain from restraining financial booms until the danger is clear, but by that time it’s often too late to defuse it. With governments that would rather stimulate than regulate, it is only natural that the system is speeding up again, hurtling headlong towards the next crisis.
In a Forbes article, Robert Lenzner concludes: “as former Treasury Secretary Timothy Geithner puts it, ‘financial crises cannot reliably be prevented.’ There is a Black Swan tail risk in our future some day. We just don’t know when and how it will happen.” Claudio Borio, the chief economist for the Bank for International Settlements (BIS), the central bankers’ central bank, seems to agree. In November 2018, he remarked on the fragility of the global economy, and suggested that we were on the verge of a significant relapse similar to the global crash experienced in 2008. Among the parallels he perceives: the proliferation of “collateralized loan obligations (CLOs), which are ‘close cousins’ of the infamous instruments known as collateralized debt obligations or CDOs, and securities – backed by residential mortgages,” the prevalence of which sparked the 2008 crisis. But we all depend too much on financial institutions to rock the boat, even if the boat is going straight in the direction of an iceberg.
Some may say, “we may not be able to prevent the next crisis, but perhaps we can let the crisis be a corrective mechanism itself”. This is what Friedrich Hayek recommended in his early writings. Let the fallers fail and the system will correct itself. This time, however, it is too late for such spontaneous corrective mechanisms for the reason that some financial institutions are simply too big (too important) to be allowed to fail. A good deal of the system (e.g. pension funds) depends on banks and financial trading. If we allow major banks to collapse, it would lead to an aforementioned domino effect and it is likely that capitalism itself would collapse too. Considering the highly unpredictable consequences of this, no politician is prepared to take that risk, especially in countries such as the US and the UK that benefit most from the status quo. The re-introduction of regulations to curb the sector after the 2008 crisis was lacklustre to say the least, not only because governments were too weak, but also because the real economy in the leading Western countries had been in a decline for decades and was not sufficiently robust to be sustained without the shenanigans of the financial sector. The major reason why banks and other large financial institutions were bailed out at great expense was fear of a credit freeze. But the bailout made them even bigger and more indispensable. A sound idea of cutting them down to size can only be wishful thinking in the present circumstances. According to Geithner, “there is no pragmatic method that readily comes to mind that involves breaking up the Too Big To Fail banking system while maintaining a market-based financial system.”
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We may not be able to prevent the next crisis or let it correct itself, but perhaps we could save the system after the crisis? After all, this has happened many times in the past. However, it seems that we have run out of options to do so. US globally no longer has either the capacity or the resources for this task – quite simply, we have run out of ammunition. There is no margin for error as the economy falters. Stephen King from HSBC warns that global authorities have alarmingly few tools to combat the next crunch, given that interest rates are already at or close to zero across most of the developed world, debt levels are at or near record highs, and there is little scope for fiscal stimulus. “The world economy is sailing across the ocean without any lifeboats to use in case of emergency,” he said. The US Federal Reserve has had to cut rates by over 500 basis points to right the ship in each of the recessions since the early 1970s. That kind of traditional stimulus is now completely ruled out. Meanwhile, budget deficits are still uncomfortably large. Each of the past four US recoveries has been weaker than the previous one. The average growth rate has fallen from 4.5 per cent in the early 1980s to nearer 2 per cent this time. The US fiscal deficit has dropped to 2.8 per cent, but is expected to climb again as pension and health care costs bite, even if the economy does well. The US cannot easily launch a fresh New Deal. Public debt was just 38 per cent of GDP when Franklin Roosevelt took power in 1933, and there were few contingent liabilities hanging over future US finances. ”Fiscal stimulus – a novel idea at the time – may have been controversial, but the chances of it working to boost economic activity were quite high, given the healthy starting position. Today, it is much more difficult to make the same argument,” King says. It is true that quantitative easing sort of worked after the 2008 crisis (it still hasn’t been repaid even though we have been paying for it since), but that rabbit cannot be pulled out of the hat with impunity. In 2020, The Fed was not only doing the traditional quantitative easing, but also buying other assets like corporate bonds, which is something it has not done before. In 2021, the newly elected president, Joe Biden, borrowed $1.9 trillion dollars for his American Rescue Plan which raised the federal deficit to $3.1 trillion in 2020 from $1 trillion in 2019, and we are officially not yet in a crisis! Economic recovery will have to be truly amazing to beat the rising inflation at its heels. If it fails, there will be very little that can be done to stop the falling dominos.
Can emerging economies such as the BRICS (Brazil, Russia, India, China and South Africa) and MINT (Mexico, Indonesia, Nigeria and Turkey) nations save the world’s bacon? Can they pick up the pieces when the system goes over the cliff in the West? This is unlikely, even if they have no troubles of their own (which they do) and even if there was willingness in the West to pass the mantle to them quietly (which there isn’t). The main reason is because, as mentioned above, every country is interlinked within the whole system. Even countries that have steered away from neo-liberalism may be in trouble because of it, and the solution for one problem may simply create another one elsewhere. China, for example, has been facing huge challenges because of its overheated economy. Although its government has more power to do something about that, it is between a rock and a hard place: any solution for its own economic survival would almost inevitably involve resorting to ‘beggar thy neighbour’ policies, triggering a global crisis – which will ultimately be detrimental for China and its political establishment too. The same applies to another big economic bloc, the European Union, although disunity within the bloc makes it even harder to make decisive moves.
A large body of evidence seems to be pointing in the same direction: the capitalist system cannot be saved in its present form. Anglia Ruskin University’s Global Sustainability Institute (GSI) is working on a project called the ‘Global Resource Observatory’ (GRO) with support from a UK government task-force. The project has developed a model which shows that on a business-as-usual trajectory, industrial civilization as we know it is likely to collapse from within. The OECD is also predicting a collapse in the near future. Understandably, most politicians, business people, and for that matter, most people neither want to see or listen to these warnings. In a similar vein, scientists are often ignored about climate change as it requires making hard choices. So, the runaway train is likely to continue while it can. It is difficult to say for how long (MIT, for example, predicts the next crisis will occur around 2030, but this may be overly optimistic). Our best hope is that the runaway train will run out of fuel rather than crash. In any case, we should start getting ready. After all, a collapse can be also seen as an opportunity to create a better system. Humpty Dumpty cannot be fixed, but perhaps something better can be made from his pieces. If the above is correct, all we do by trying to save the system is slow down (or perhaps even inadvertently speed up) its demise. A better way forward would be to start building a new system, something that is fit for purpose. Just about everybody, irrespective of their culture, religion, gender or age can contribute. But how? Before we consider many specific ways of doing so in the following chapters, let’s see first what general form this change should take.