Our Capitalist System Is Near Meltdown

The ailing euro is part of a wider crisis. A 1930s-style crash threatens us and our financial partners. Collective action is the only solution.

By Will Hutton, Guardian UK

“Eighty years ago, faced with today’s economic events, nobody would have been in any doubt: we would obviously be living through a crisis in capitalism. Instead, there is a collective unwillingness to call a spade a spade. This is variously a crisis of the European Union, a crisis of the euro, a debt crisis or a crisis of political will. It is all those things, but they are subplots of a much bigger story: the way capitalism has been conceived and practised for the last 30 years has hit the buffers. Unless and until that is recognised, western economies will be locked in stagnation which could even transmute into a major economic disaster.

Simply put, the world has trillions upon trillions of excessive private debt financed by too many different currencies whose risk is allegedly mitigated by even more trillions of financial bets which in aggregate do not minimise the systemic risk one iota. This entire financial edifice, underwritten by tiny amounts of capital, has been created over three decades backed by the theory that markets do not make mistakes. Capitalism is best conceived and practised, runs the theory, by hunter-gatherer bankers and entrepreneurs owing no allegiance to the state or society.

This is nonsense. Business and the state co-generate wealth in a system of complex mutual dependence. Markets are beset by mood swings and uncertainty which, if not offset by government action, lead to violent oscillations. Capitalism without responsibility or proportionality degrades into racketeering and exploitation. The prospect of limitless pay is an open invitation to bad, or even criminal, behaviour. Good capitalism cannot happen without referees to blow the whistle or robust frameworks in which markets can function; neither is reliably created by capitalism itself, hence the role of democratic government. Yet the world is trying to solve the legacy of the last 30 years as if none of this were true and, instead, that the practice and theories that created the mess are still valid.

US treasury secretary Tim Geithner, joining EU finance ministers in Poland as again they pondered how best to end the ongoing euro crisis, was at least recognising today’s interdependencies between countries when he urged his fellow ministers to stop bickering because the markets were terrified by the threat of a catastrophic event – with all the risk that posed the US.

George Osborne was also right to declare that a strong euro was in Britain’s interests. But worrying about how a failed euro might impact on yourself is old speak. What the markets need to hear is that western politicians – whether in the eurozone or not – see the euro as part of the potential solution to capitalism’s current crisis, not its cause, and that they are prepared to do all in their power to support the reforms necessary to make the euro survive and take other measures vital to make the world financial system functional again. Geithner and Osborne must put some money where their mouths are.

The euro’s critics, endlessly emphasising that it is a monetary straitjacket and that the best reform now would be its break-up, miss the point. It was not this so-called straitjacket that is the cause of today’s euro crisis. It is the interaction of the euro system with a once-in-a-century crisis of capitalism that its designers and supporters, like its critics, never anticipated. Yes, what the crisis has exposed is that the eurozone needed a ¤1trillion-plus fund to recapitalise bust banks and underwrite sovereign debt write-downs; this was not written into the original treaty. And that the investment and retail banking arms of the EU’s universal banks need to be ringfenced or formally separated, as Sir John Vickers‘s banking commission proposes for Britain – if they are to be remotely safe. But neither notion was a battle cry of the eurosceptics over the last 10 years.

In fact, the existence of the euro has, until now, been a bulwark against disaster. Suppose it had not been created and that the financial crisis in 2008 had broken over a Europe with multiple floating exchange rates and no European central bank – the eurosceptic utopia. The Irish, Portuguese, Greek, Spanish, Italian and French banking systems would have stood alone and they would have collapsed in a domino effect, interacting with the mega-crisis in Britain and the US. Even some German banks would not have been immune. There would have been a 1930s-scale slump, the break up of the EU and a rise in beggar-my-neighbour devaluations and trade protection.

We have not yet escaped that prospect. If the euro breaks up, the cascade of subsequent bank failures and debt write-downs will be no less threatening and Britain will be pulled into the vortex. The EU has created a “financial stabilisation facility” to try to hold the line. But there is no urgency in launching it; it is still not a proper fund but, rather, a stop-gap provider of borrowing facilities and it is too small. As bad, the German and French governments are wedded to collective European austerity; they want to impose long-term balanced budgets not only on themselves but chilling austerity on the unfortunate states which have to borrow to support their banks and bond markets.

An entire continent is to be blighted by lack of demand in the midst of a capitalist crisis, compounded by Britain’s scorched earth, deficit-reduction plans. Already, many European banks are technically insolvent, recognised by Christine Lagarde, the IMF’s new managing director, if not by the banks themselves.

Last week, the Bank of England joined the US Federal Reserve, the Bank of Japan and the Swiss central bank in promising Europe’s banks vital liquidity in dollars, easing the crisis for a while. Time has been bought; we are pitching in to save ourselves. But the outside world needs to go much further. Europe’s stabilisation facility must become a fund with a capacity to lend and intervene to see off speculators: Britain, the US, Switzerland and Japan, along with China and oil-rich Arab states, need to contribute alongside Germany.

In return for coming to the relief of the German taxpayer, we should demand two key concessions: one, that Europe sets about ringfencing its universal banks’ investment banking operations to make them less vulnerable; and second, that no international cash is forthcoming unless the EU commits to a formal plan for growth in which its stronger countries, notably Germany, promise to stimulate their economies. As part of the package, Britain should agree to defer its own deficit- reduction plans and to issue bonds denominated in euros to contribute to the new euro fund.

We are living through the most dangerous confluence of economic circumstances in modern times. Trying to pretend the interdependencies do not exist or that the collapse of the euro is the answer can only make matters worse. It is a straight choice: we do all we can to help each other or risk going down in what could be the worst economic contraction for a century.

Emphasis Mine


Give Karl Marx a Chance to Save the World Economy: George Magnus

s he wrote in “Das Kapital,” companies’ pursuit of profits and productivity would naturally lead them to need fewer and fewer workers, creating an “industrial reserve army” of the poor and unemployed: “Accumulation of wealth at one pole is, therefore, at the same time accumulation of misery.”

Karl Marx and the World Economy

By George Magnus

Policy makers struggling to understand the barrage of financial panics, protests and other ills afflicting the world would do well to study the works of a long-dead economist: Karl Marx. The sooner they recognize we’re facing a once-in-a-lifetime crisis of capitalism, the better equipped they will be to manage a way out of it.

The spirit of Marx, who is buried in a cemetery close to where I live in north London, has risen from the grave amid the financial crisis and subsequent economic slump. The wily philosopher’s analysis of capitalism had a lot of flaws, but today’s global economy bears some uncanny resemblances to the conditions he foresaw.

Consider, for example, Marx’s prediction of how the inherent conflict between capital and labor would manifest itself. As he wrote in “Das Kapital,” companies’ pursuit of profits and productivity would naturally lead them to need fewer and fewer workers, creating an “industrial reserve army” of the poor and unemployed: “Accumulation of wealth at one pole is, therefore, at the same time accumulation of misery.”

The process he describes is visible throughout the developed world, particularly in the U.S. Companies’ efforts to cut costs and avoid hiring have boosted U.S. corporate profits as a share of total economic output to the highest level in more than six decades, while the unemployment rate stands at 9.1 percent and real wages are stagnant.

U.S. income inequality, meanwhile, is by some measures close to its highest level since the 1920s. Before 2008, the income disparity was obscured by factors such as easy credit, which allowed poor households to enjoy a more affluent lifestyle. Now the problem is coming home to roost.

Over-Production Paradox

Marx also pointed out the paradox of over-production and under-consumption: The more people are relegated to poverty, the less they will be able to consume all the goods and services companies produce. When one company cuts costs to boost earnings, it’s smart, but when they all do, they undermine the income formation and effective demand on which they rely for revenues and profits.

This problem, too, is evident in today’s developed world. We have a substantial capacity to produce, but in the middle- and lower-income cohorts, we find widespread financial insecurity and low consumption rates. The result is visible in the U.S., where new housing construction and automobile sales remain about 75% and 30% below their 2006 peaks, respectively.

As Marx put it in Kapital: “The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses.”

Addressing the Crisis

So how do we address this crisis? To put Marx’s spirit back in the box, policy makers have to place jobs at the top of the economic agenda, and consider other unorthodox measures. The crisis isn’t temporary, and it certainly won’t be cured by the ideological passion for government austerity.

Here are five major planks of a strategy whose time, sadly, has not yet come.

First, we have to sustain aggregate demand and income growth, or else we could fall into a debt trap along with serious social consequences. Governments that don’t face an imminent debt crisis — including the U.S., Germany and the U.K. — must make employment creation the litmus test of policy. In the U.S., the employment-to-population ratio is now as low as in the 1980s. Measures of underemployment almost everywhere are at record highs. Cutting employer payroll taxes and creating fiscal incentives to encourage companies to hire people and invest would do for a start.

Lighten the Burden

Second, to lighten the household debt burden, new steps should allow eligible households to restructure mortgage debt, or swap some debt forgiveness for future payments to lenders out of any home price appreciation.

Third, to improve the functionality of the credit system, well-capitalized and well-structured banks should be allowed some temporary capital adequacy relief to try to get new credit flowing to small companies, especially. Governments and central banks could engage in direct spending on or indirect financing of national investment or infrastructure programs.

Fourth, to ease the sovereign debt burden in the euro zone, European creditors have to extend the lower interest rates and longer payment terms recently proposed for Greece. If jointly guaranteed euro bonds are a bridge too far, Germany has to champion an urgent recapitalization of banks to help absorb inevitable losses through a vastly enlarged European Financial Stability Facility — a sine qua non to solve the bond market crisis at least.

Build Defenses

Fifth, to build defenses against the risk of falling into deflation and stagnation, central banks should look beyond bond- buying programs, and instead target a growth rate of nominal economic output. This would allow a temporary period of moderately higher inflation that could push inflation-adjusted interest rates well below zero and facilitate a lowering of debt burdens.

We can’t know how these proposals might work out, or what their unintended consequences might be. But the policy status quo isn’t acceptable, either. It could turn the U.S. into a more unstable version of Japan, and fracture the euro zone with unknowable political consequences. By 2013, the crisis of Western capitalism could easily spill over to China, but that’s another subject.”

(George Magnus is senior economic adviser at UBS and author of “Uprising: Will Emerging Markets Shape or Shake the World Economy?” The opinions expressed are his own.)

To contact the Bloomberg View editorial board: view@bloomberg.net.

emphasis mine