Behind the world financial crisis

First published: February/March 1998

The financial crises which began in east Asia and Japan in the latter half of 1997 hit what had been the most dynamic part of the world economy – cross-Pacific trade overtook trans-Atlantic trade a decade ago. Together with the gyrations they produced on world financial markets, these events showed that the world capitalist economy is nowhere near the new ‘golden age’ of prolonged economic growth predicted by some bourgeois economists in the United States. On the contrary, the chain of economic events which started in October 1997, with the greatest stock market crash since 1929, is continuing to work its way through the international capitalist economy. The crash of 1987 was followed by the 1990 collapse of the Japanese stock market, the crash of world bond markets in 1994, the Mexican crash in the same year, prolonged stagnation in the early 1990s in Japan and most of the European Union and, now, the crises of the Asian ‘tigers’, recession in Japan and consequent turbulence on world stock markets, with severe knock-on effects in Latin America, eastern Europe and Russia.

The fact that this chain of economic instability has worked its way through every continent of the world demonstrates that its underlying causes are located not primarily in the failings of individual economies or regions, but in the functioning of the world capitalist economy as a whole. Their underlying root is that capital accumulation, that is in the share of the economy available for and devoted to investment, has declined in the most advanced capitalist economies.

The precondition for re-launching any new period of prolonged economic growth of the world capitalist economy, akin to the post-war boom, would be the reversal of this decline in capital accumulation. But the figures show that this has not happened and there is no tendency in that direction. As a result, economic growth on a world scale runs up against an international shortage of capital preventing synchronised expansion of the main centres of the international capitalist economy.

For capital as a whole, the only way to reverse this decline in capital accumulation is to restore a high rate of profit by drastically increasing the rate of exploitation of the working class. The efforts to drive down real wages and dismantle the welfare state in western Europe and the United States precisely reflect capital’s efforts to reduce sharply the share of the economy going to the working class. However, what has been done so far on this front is totally insufficient to reverse the decline in capital accumulation and has the political effect of radicalising the working class. Thus after the low point of 1989–91 there has been a rise of working class struggle through the latter half of the 1990s.

If the only way out of this situation for capital as a whole is to drive up the rate of exploitation of the working class, individual capitals, conceived as separate companies and capitalist states, have an additional option – that is to increase their share of the total surplus value produced by the working class at the expense of other capitalists. At the level of the world economy as a whole, this takes the form of increasing competition between the main imperialist powers.

To get a sense of the scale of what both of these capitalist ‘solutions’ to the crisis involve, it should be recalled that transition to the last great re-launching of the world capitalist economy – the post-war boom – involved two world wars, the Great Depression of the 1930s, fascism in most of Europe and tens of millions of deaths. These had the effect of massively increasing the rate of exploitation of the working class in western Europe and Japan and for the most powerful group of capitalists, the US, militarily crushing its rivals and reorganising the world economy under its leadership. They also, however, had the effect of a third of the world’s population overthrowing capitalism altogether in Russia in 1917, Eastern Europe and Yugoslavia after 1945, China in 1949, Cuba in 1959 and Vietnam in 1975.

The fundamental point about the present situation is that, notwithstanding its advance into eastern Europe and the former Soviet Union from 1989, international capitalism has not created the preconditions, in terms of a sharp rise in capital accumulation, for a new period of prolonged economic growth. Therefore the worst is yet to come both at the level of attacks upon the working class, the third world and the intensification of inter-imperialist conflict.

It was precisely intensifying competition between the imperialist powers which sparked the crises in east Asia, as western Europe and Japan devalued their currencies in attempts to escape from five years of stagnation.

At the level of competition between the major capitalist powers, while the supply of capital available for investment has declined on a world scale, Japan and east Asia have established a new benchmark of the level of investment necessary to compete with the most dynamic economies.

In 1996 Japan’s gross domestic fixed capital formation was 29.6 per cent of GDP – a decline from its peak of 30–35 per cent of GDP, but far in advance of its main capitalist rivals. To reach that Japanese level Germany would have to increase the share of investment in its economy by 8.6 per cent of GDP – that is by £103.4 billion a year; the US by 12.4 per cent of GDP – equivalent to £571.4 billion a year; and the UK by 14.2 per cent of GDP – £105 billion a year.

Those figures show the enormous increase in the supply of capital which would be necessary to generalise the Japanese level of investment to the other main centres of the world capitalist economy.

Given that every percentage point of GDP devoted to investment is not available for consumption, such a shift in western Europe and the USA is completely impossible without the most colossal social and political upheavals.

The slowdown in capital accumulation has the result that the world capitalist economy as a whole does not have sufficient capital to finance economic recovery in all of the main imperialist states simultaneously. As a result, economic growth in one part of the world takes place at the expense of recovery elsewhere.

At the same time, the struggle, in particular by the United States, to alleviate this problem by seizing as much as possible of the capital accumulated elsewhere in the world has resulted in successively greater shocks being transmitted through the world’s financial systems.

The starting point of this process was the transformation of the relationship of the United States to the world economy as a whole in the middle of the 1970s. Between 1950 and 1979, the US was a net exporter of capital to the rest of the world economy – thereby acting as a ‘locomotive’ for the world economy as a whole. From 1979 the US became a net importer of capital, financing part of its domestic investment with resources drawn on a massive scale from the third world and Japan. In its current economic recovery, net US borrowing from the rest of the world has increased from $50.5 billion in 1992 to £149.5 billion in 1996.

This shift in the relation of the US to the world economy opened a new period in the relations between the leading imperialist states. In essence the US was able to partially compensate for its relative economic decline by drawing on the resources of the rest of the world economy, and thereby striking blows against its capitalist rivals – with large parts of the third world being hurled backwards as a result, and Japan and Germany having their growth rates pulled below that of the United States in the 1980s and 1990s.

Without the flow of capital from Japan through the 1980s and 1990s, the US economy would not have been able to carry out the scale of military build-up which was critical in breaking the Soviet economy, nor to sustain a higher rate of economic growth than Germany or Japan.

However, although Japan has the largest pool of capital available for investment in the world, events have shown that even Japan is not capable of simultaneously funding economic growth domestically and in the US. As a result, the impact of the 1987 stock market crash was simply transferred from the US to the Japanese economy, and every subsequent attempt to revive economic growth in Japan simultaneously with the United States re-created a world shortage of capital. The resulting rising international interest rates then choked off the recovery in Japan, the US or both.

It was the rise in interest rates in West Germany and Japan in 1987 which triggered the US stock market crash of that year because they reduced the flow of capital into the US and so undermined its economic growth.

The subsequent sequence of events was as follows. The Japanese decision to cut interest rates following the 1987 crash – faced with the choice of giving in to the US or seeing the world economy come apart – allowed the United States to escape with an economic recession rather than a 1930s-style slump.

But the price paid by Japan was to transfer the financial crisis to Tokyo, undermining its financial system and creating a period of stagnation from which it has still not escaped.

The US recession after 1987, which resulted in George Bush losing the presidency, then eased the pressure on the international supply of capital, allowing interest rates to fall and a flow of capital to Latin America and Eastern Europe.

But the recovery of the US economy from 1993, and with it the resumption of capital imports from Japan, once again pushed up international interest rates, culminating in the bond market collapse in 1994 – which involved the biggest financial losses since 1929. Simultaneously, rising international interest rates, reflecting a renewed shortage of capital as the major capitalist economies attempted to move out of recession, resulted in funds being pulled out of Latin America and Eastern Europe, causing the 1994 financial crashes in those countries and necessitating the IMF’s biggest ever financial package (until Korea) to prevent a financial meltdown in Mexico.

Having experienced five years of the worst stagnation of any major capitalist economy, Japan at the beginning of 1995 tried to revive economic growth by cutting interest rates to 0.5 per cent. However, as the Japanese economy started to revive, in the context of rapid growth and therefore demand for capital in the US, the world shortage of capital again emerged, pushing up long term interest rates first in Japan, then the US, UK and Germany – choking the Japanese recovery.

The ability of Japan to bail out the US economy after 1987 by the resumption of a massive influx of capital – to the tune of $100 billion a year – illustrated the key advantage of the world capitalist economy vis-à-vis the Soviet Union – it was able to function on an international level. The function of the deregulation and globalisation of capital markets was to allow the US to prop up its own economy on the basis of capital flows from Japan and elsewhere. As events since 1989 and 1991 have shown, the planned economies in the Soviet Union and Eastern Europe were more efficient than capitalism has subsequently been in those countries. But the Soviet Union faced not merely individual capitalist states, but an international capitalist economy – which the strategy of ‘socialism in one country’ was unable to overcome. This was because, on the one hand, it weakened the most important ally of the Soviet Union, which was the class struggles in Asia in the post-war period, and, on the other hand, it alienated the Soviet working class by subordinating their living standards to heavy industry in a utopian struggle – in the framework of the economy of one country – to catch up with the most advanced capitalist states.

Although it succeeded in cracking the Soviet economy, however, this effort of funding both its own investment and the United States’ placed an enormous strain on the Japanese economy. In the first place it cost Japan literally hundreds of millions of dollars.

Secondly, it created the ‘bubble’ on Japanese stock and property markets which finally ‘burst’ with the collapse of both in 1990. Japan had reduced its interest rates to zero in real terms, taking account of inflation, which had the effect of channelling a vast flow of capital into the US. This prevented the financial melt-down which otherwise would have followed the 1987 crash. However the effect of such low interest rates was to fuel a mass of speculative investments in Japan – inflating the bubble – which then became unprofitable when Japanese interest rates finally started to rise at the end of the 1980s – bursting the bubble.

That in turn undermined the Japanese banking system – the 50 per cent fall in the stock market in 1990 and the 70 per cent fall in property prices wiped out a large part of the asset base of the banks. At the same time, companies which had borrowed money for investments at ultra-low interest rates could not repay the loans once interest rates rose above the rate of profit on those investments at the end of the 1980s – creating the raft of non-performing loans which still threatens the viability of a significant number of Japanese banks today.

The resulting ‘credit crunch’ has kept the country on the verge of recession ever since. The Japanese economy, which had grown at an average rate of 10.5 per cent a year in the 1960s, 4.5 per cent in the 1970s and 4 per cent in the 1980s, essentially stagnated in the 1990s – with growth averaging little more than one per cent a year.

It was the way in which Japanese capital, from spring 1995, tried to pull itself out of this period of stagnation which underlay the crises in the east Asian ‘tiger’ economies. Traditionally the motor of Japanese economic growth had been exports, which in the 1960s grew at an average rate of 15.9 per cent a year – 50 per cent more rapidly than the economy as a whole.

By the 1990s, however, the Japanese economy was so large – with an annual GDP two thirds the size of that of the US – that a Japanese export offensive would destabilise other key areas of the world economy, notably the US.

US capital therefore urged a different course upon Japan: Keynesian stimulation of its domestic economy, by cutting interest rates and public spending programmes, together with the deregulation of its inefficient agricultural and service sectors, where, unlike in manufacturing industry, productivity lagged far behind that of the US. This would have had the advantage for the US of allowing it to penetrate those sectors of the Japanese economy where US capital had a competitive edge. It had the disadvantage for Japanese capital of creating political instability because either the Japanese working class or petty bourgeoisie would have to pay for the public spending programmes necessary to stoke up domestic demand.

The attempt to make the Japanese working class foot the bill, with the collaboration in government of the Japanese Socialist Party, simply resulted in a growing switch in votes to the Japanese Communist Party.

Secondly, pressure for deregulation of Japanese agriculture and services threatened the entire Japanese political party system – whose linchpin, the Liberal Democrat Party, is dependent on the urban and rural petty bourgeoisie for a very large part of its electorate.

Thirdly, a strategy of developing domestic consumption would reduce the share of profit in the Japanese economy, which was not an attractive proposition for the Japanese bourgeoisie.

This course was therefore abandoned in spring 1995 in favour of trying to restore economic growth by a new export offensive. The mechanism for this was to push up the exchange rate of the dollar against the yen, by a flow of Japanese funds into the US. As a result, between spring 1995 and the first week in December 1997 the exchange rate of the yen fell by 28 per cent against the dollar.

In consequence, the Japanese balance of payments surplus started to increase rapidly – impacting particularly in Asia which absorbs 40 per cent of Japanese exports. It was this fall of the yen against the dollar, together with the rapid rise in China’s manufacturing capacity and a 35 per cent devaluation of the Chinese yuan in 1994, and significant devaluations of those European Union currencies tied to the German D-mark, which put the competitive squeeze on the east Asian ‘tiger’ economies whose currencies were tied to the dollar.

South Korea’s balance of payments deficit, for example, rose from $4.5 billion in 1994 to $23.7 billion in 1996. This rapidly became unsustainable, and the crisis-ridden devaluations in the second half of 1997 were the result.

These then knocked into the financial systems in the region – because South Korea, Thailand, Indonesia and Malaysia had become dependent on large volumes of short terms loans denominated in dollars. Massive devaluations against the dollar meant that these loans could not be repaid without a colossal level of financing by the IMF – with South Korea receiving the biggest IMF-organised financing package in history, $57 billion, linked to conditions which are already provoking massive domestic opposition to the mass redundancies and opening up of the economy to foreign capital which will follow.

The unfolding financial crisis in east Asia then impacted back into the Japanese banking system, with the collapse of its fourth largest investment company and threatening many others. This will get worse because the profits of Japan’s big industrial companies will be hit by the devaluations in east Asia – which are essentially a defence mechanism against Japan – and in western Europe. That would leave the US as the principal target of a Japanese export offensive, hitting US industry and provoking rising trade tensions.

The demand by the Japanese banks that the government bails them out will pose anew the political problem of how to make the Japanese working class and petty bourgeoisie pay for a crisis which is ultimately the result of Japan’s role in propping up the US economy.

Finally, the link between the bubble on Wall Street and the situation in east Asia is that it has been the flow of capital from Japan to the US which has fuelled the rise of American stock markets to historically unprecedented – and unsustainable – levels. By the second half of 1997, US dividends had fallen to their lowest levels in history, roughly a quarter of the interest rate on 10-year government bonds. Rational investors would put their money into shares rather than bonds only on the basis of the expectation that share prices would continue to rise. If the expectation became that share prices would fall, this would create a panic to get out of shares, provoking a crash. For the yield on US shares to rise to that of US government bonds, the stock market would have to fall by something like 75 per cent. That would far exceed anything which happened in 1987 or 1929.

Furthermore, unlike in 1987, Japanese capital probably could not bail out the United States a second time. With Japanese interest rates at 0.5 per cent, it would not be possible to reduce them further to aid the US financial system – so that the consequences of a financial crash for the US real economy would be far more severe than the recession which followed 1987.

The trigger for such a Wall Street crash would be any reversal of the flow of capital from Japan. At present it is profitable to invest in US shares on the basis of funds borrowed in Japan because Japanese short term interest rates stand at 0.5 per cent and are negative for investors in the US because they have to be paid back in a yen which is falling in value against the dollar. However, a rise in Japanese interest rates, or rise in the exchange rate of the yen, or both, would make investments in the US less profitable, quite probably provoking the fall on Wall Street which could then trigger a severe financial crisis in the US. It is the fact that Japanese interest rates did not rise during the latter half of 1997 which provided an element of stability to US stock markets.

The east Asian link in the chain of financial crises will have significant results. First, as growth stalls in the ‘tigers’ world economic growth will slow. Second, devaluations by the former ‘tigers’ will intensify competitive pressure on the European Union, and above all upon the high exchange rate countries – the US and Britain. Third, the attempts to make the working class of the region pay for the financial crisis will start to break up political stability and result in rising class struggles – already evident in South Korea. The role of the US and IMF in this, that is their efforts to seize control of chunks of the ‘tiger’ economies, will lead to anti-US political currents and weaken the bloc of the ‘tigers’, US and Japan against the rising weight of China.

Overall, these events show that no new prolonged upswing of the world capitalist economy is imminent. The necessary preconditions – a qualitative rise in the level of capital accumulation in the major imperialist states – do not exist. Notwithstanding the immense negative impact of capitalism’s breakthrough into eastern Europe and the Soviet Union in 1989/91, there is no coherent imperialist strategic project, analogous to that of the US at the end of the Second World War, for resolving this situation. The only way out for capital as a whole – to drive up the rate of exploitation of the working class – is creating significant political radicalisation: in Russia, western Europe, east Asia, and even a shift to the left at the top of the trade unions in the USA. And, at the level of ‘many capitals’, the US seizure of surplus value accumulated by other capitalists, notably Japan, is putting increasing strain on the ‘globalised’ capitalist economy, the chain of financial crises being a symptom of this.

This inability of capital to consolidate its gains of 1989/91 has allowed the left wing international workers’ movement to start to recover. Regroupment has begun on the basis of the re-emergence of significant working class mobilisations – on their greatest scale in Russia, but also in the EU, South Korea, Latin America, South Africa and in the United States.