TAYLAN TOSUN: Your forthcoming 2015 book, Transitions to Global Depression, suggests we’ve been moving in that direction. What has changed since the late 1970s that suggests the system is shifting from productive investment to more financial asset speculative investing, which you argue is fundamental to the instability in the global economy?”
RASMUS: The 1970s was a decade of severe economic crisis, especially for the advanced economies of the U.S. and Europe. A quarter century of U.S. economic dominance and easy growth since 1945 was coming to an end. Competition between capitalist economies was intensifying, with the recoveries of Europe and Japan. Internally, unions and labor parties were demanding a bigger share of the national income, with some successes. The then communist countries were making inroads in what we now call the emerging market economies. In response, key capitalist sectors and politicians began restructuring and developing new strategies they would then develop further over the next three decades.
The first fundamental change was the U.S. abandonment of the old Bretton Woods international monetary system, where the U.S. dollar was pegged to gold and other currencies, loosely, to the dollar in turn. That would result in capitalist economies’ central banks—especially the U.S. Federal Reserve—constantly pumping “fiat” money—currency delared legal tender, aka “toilet paper money”—supply into the U.S. and global economy. Over time, this led to the creation of new, highly liquid, financial asset markets to new forms of financial securities trading in these markets and to the rise of a new global financial elite with massive economic power and eventual unprecedented political influence as well. Soon after the collapse of Bretton Woods and the rise of central banks’ excess liquidity policies, which were, up to that point, controls on international money capital flows were eliminated as well, led by the U.S. and quickly followed by others. This accelerated the development of global speculative finance, since it paved the way for true globalization. Banking regulations domestically, especially in the U.S., were removed as well to allow this to happen.
A lot of that occurred in the 1980s. This was followed in the 1990s by a revolution in digital technology and the Internet, which further contributed to globalized finance capital in its new forms. Absurd “free market” ideologies justified it all. An economic revolution of exploding inside credit accompanied the fiat money explosion created by central banks. Together, they provided the excess global liquidity that fueled financial asset investing and speculation that, in turn, provoked more frequent and wider financial instability events and financial crashes. Capitalist investors discovered that it was easier to make money by creating money and speculating in financial assets they created instead of making (producing) real goods and assets.
The returns on financial asset investments were greater in the short run, there were lower costs of production and goods, the profit turnover was faster, and it was easier to exit the highly liquid financial markets once the money was made. Financial asset investment was relatively more profitable than investing in real goods and services—again, at least in the AEs, where virtually all finance originated at this time. What I refer to in my books as the global money parade is is the combination of highly liquid financial asset market globally—the new financial securities that are constantly created to trade in those highly liquid markets—and the new financial institutions also created to invest in those securities and markets on behalf of the new global finance capital elite—the latter sometimes referred to as ultra high net worth investors with an income flow of $30 million to invest and re-invest annually.
There’s about 200,000 of these people today worldwide and they control investable assets of around $30 trillion, which are projected to rise by $10 trillion every 2-3 years this decade. Their wealth and income is accelerating from speculating in stocks, bonds, foreign exchange, derivatives of all kinds, various kinds of traded funds, real estate and properties, and other financial securities assets. They are the new, increasingly dominant, global finance capital elite, whose economic and political power continues to grow almost exponentially yearly. Other capitalists, industrial and small business, are following their lead, also investing more in financial speculation instead of re-investing in goods production. Financial asset investment is therefore crowding out real asset investment slowly worldwide—with the exception, perhaps, of emerging markets where opportunities for infrastructure development and commodities expansion still exist for a while.
Global capitalism is slowing its rate of real investment. That’s why it is having trouble creating jobs and incomes for the rest. That’s why consumption is stagnating in the west and why consumer debt is being offered as a substitute to households lagging in income growth. And that’s why the AEs are experiencing this stop-go economic growth that continues. It’s a lack of real investment. But that is traceable to the shift to speculative investment which is so much more profitable for the new finance capital elite.
Mainstream economists in the west and AEs, even nobel prize winners like Paul Krugman, George Stiglitz, and others, don’t understand this because they don’t understand financial asset investment and its relationship to real investment. They were trained only to look at the data content of their National Income Accounts on which they build their models.
Similarly, many Marxist economists (not all), have this fetish about real production and surplus value from real production, which is the focus of Marx’s volume 1 of Capital. But they don’t understand where Marx was going in his unpublished notes in volume 3 on banking and credit. Marx never got to a deeper analysis of what he called exchange values in forms of capital. So many Marxist economists think volume 1, the production of value (and the related concept of the Falling Rate of Profit tendency) is Marx’s final word on explaining capitalist instability. It’s not. But they refuse to be open minded. So they too, like mainstream capitalist economists like Krugman and others, don’t understand the role of finance in capitalist global instability either.
Why do you define the last financial crisis as an epic recession, as a separate phenomenon from normal recession?
I chose the term epic recession to distinguish it from what has been called the great recession that happened in 2007-09. I have a problem with that latter term. It was created by mainstream economists in 2009 in order to try to explain how that recession was different from the prior ten recessions in the U.S. since 1948—i.e. that were normal. But the great recession concept used by Krugman and others simply means it was worse than a normal recession and not as bad as a depression. That really tells you nothing.
If one is to explain how 2007-09 was different from previous recessions, iIn the first two chapters of Epic Recession (2010), I provide a list of variables that constitute an epic recession. Moreover, these variables are not static, but determine each other. My epic recession concept also argues that recessions don’t end just because GDP does not continue to decline further. A recession ends when a broad list of key economic indicators, at minimum, recover to levels previously attained before the recession and downturn began. A full cycle must occur, not just a half cycle. To this day, many of the key variables have only recovered partially in the U.S., so the epic recession there continues, albeit in a bated form.
In Europe and Japan, which have experienced double and triple dip recessions and appear headed to further contractions in 2014, the recovery has been less complete. The differences between the U.S. and Europe/Japan recoveries are due to the degrees of fiscal-monetary responses by each and the fact that the U.S., with its global reserve currency, has the ability to engineer global capital inflows from the rest of the world and its central bank advantages, has been better able to artificially prop up its recovery better than the Europeans or Japanese.
Returning to the subject of normal recession vs. epic, it has always amazed me how little agreement there is between mainstream economists when it comes to a theory of recessions and even more so concerning consensus on what causes depressions. Depressions are viewed as just normal recessions writ large.
That’s nonsense, of course. The dynamics of a depression are quite different from a normal recession, but academic economists can’t agree on what causes a depression. Their explanations are all over the place, emphasizing this or that particular variable as the key cause none of which is convincing. In contrast to depressions, normal recessions are typically caused by external shocks—supply shocks or demand shocks. And economists think that’s all there is to it. Because normal recessions are due to shocks that destabilize the economy, traditional fiscal-monetary policies in capitalist economies since 1948 were able to restore stability. But depressions don’t respond to traditional fiscal-monetary policies very well. Nor do type II epic recessions, which are anterooms to a possible eventual depression. Type I epic recessions are not as severe and can return to a normal recession condition. But Type II epic recessions have a tendency to transform into depressions.
You describe inner dynamics of three successive phases: debt-deflation-default. How does this sequence lead to a big financial crisis?
The explosion of excess liquidity globally by central banks plus the expansion of inside credit by the private banking system together mean there is now massive total credit available for borrowing—far more than is needed to finance real asset investment. Investors and financial speculators put up part of their own money capital, but borrow the larger percentage. That’s called leverage.
If you look at the total debt picture in the AEs, what’s risen the most and fastest is business debt and financial institutional debt in particular. It’s not government debt, which rises due to the need to bail out the system periodically and because of slow real economic growth and constant tax cuts, mostly for businesses, that also adds to government debt. So government debt is a consequence of the crises becoming more frequent and more severe.
Consumer and household debt rises too over time, but not as severely as business/financial debt. It is the consequence of low wage growth for decades due to various causes, some related to the repeated crises, some due to capitalist policies of free trade, union destruction, labor market changes, and so forth. So the big culprit in total debt is business debt. Even government data show this clearly. The price system plays a key role in debt escalation, especially financial speculation debt by banks, investors and businesses. But there’s no such thing as the price system, rather, there are several price systems and they behave differently, which mainstream economists don‘t understand.
When financial assets collapse in a banking crash, as happened in 2008, asset deflation occurs. Asset deflation then spills over to goods inflation, as lending by banks to non-bank businesses dries up and those businesses have to lay off millions. Mass layoffs mean less household income to purchase real goods and services. That, in turn, leads to rising business inventories and business price reduction for real goods—i.e. deflation. So asset prices drive goods prices in a crisis. The deflation, in turn, leads to rising defaults, as businesses can’t generate income to service their debt and previous loans. A similar process occurs with consumer households. Losing jobs and income leads to inability to service (make interest and principal) payments on home mortgage, auto, student ,and other loans. Local governments may also default on their loans, especially cities, school districts, and so on. Maybe even some states. Federal governments don’t default because they can, and do, simply create more fiat money if they have to in order to repay debts.
So what we have is a chain reaction, from excess debt created during a financial asset price boom that, when the boom ends and asset prices collapse, it spills over to goods prices and eventually to wages (or prices for labor). There is a three price system behind the debt-deflation-default process that links the process. Financial asset prices artificially boosted during the financial boom phase are the driver when the financial bust phase begins. The entire process is not linear as there are significant feedback effects that occur simultaneously, defaults in even more asset deflation. The prospect of default may lead to taking on more debt in order to avoid default when businesses may layoff even more workers, leading to more goods price deflation, and so on. It’s a very dynamic process where debt, deflation and defaults—both businesses and households—interact and determine each other. Government sector defaults also come into play at later stages. Mainstream economists do not understand the relationships between financial asset price changes and goods markets changes and labor market price (wage) change. Nineteenth century price theory tells them there’s only one theory of price for all these sectors and price always adjusts to supply and demand over the long run. They are wrong. There are several price systems and they don’t respond the same to supply and demand. Financial asset prices, for example, are largely driven by demand—both in the boom and bust phases—and supply is a negligible force in financial asset price determination. Keynes and a few others raised the possibility of a two price system, but I believe there is a three price system (financial asset, goods and services, and wages) that interact in the contraction phase after a banking crash. The bigger the initial crash, the sharper and deeper the contraction of financial assets. The greater the defaults in business, household, and even local government, the faster the rate of deflation, as the real economy contracts sharply and deflation sets in. We see that in Europe today, for example, and before that in Japan. The run-up in private and household sector debt was not worked off after the crash. Investment does not recover. Wages and incomes don’t recover. And goods deflation slowly, but steadily, sets in. In the U.S., financial asset deflation was offset more quickly by massive, multi-trillion dollar liquidity injections by the U.S. central bank, the Federal Reserve. That dampened the asset deflation and bailed out banks and companies from greater defaults. Europe and Japan did not do this as quickly, efficiently, or as massively as the U.S. Also, U.S. deficit cutting (austerity) by government was not as severe as in Europe.
Excess debt accumulation in the wake of a crash accelerates the deflation processes and leads to defaults, while deflation and defaults feed back on debt and keep the process of debt-deflation-default going. Governments must intercede quickly to halt the deflation-defaults and remove the debt. Instead they engage in superficial traditional fiscal-monetary policies that don’t fundamentally correct the problem long-term and make it worse, as in the case of austerity policies or partial money injections to bail out banks, which is the case of the Eurozone today.
In your book you refer to the shadow banking system as a vehicle of the financial crisis. How’s that different from the classical banking system and how do shadow banks contribute to financial breakdown?
Shadow banks are the preferred financial investment institutions of the finance capital elite, that’s because they are basically unregulated. When a crisis occurs and the State intervenes to bail out the banking system with massive liquidity injections, a period follows when the State imposes some degree of financial regulation on the banking system, including the shadow banks. But capitalist investors eventually find a way to do a run around the regulated banking system and create new, unregulated financial institutions again. They prefer the unregulated because the shadow banks allow them, the investors, to take big risks and speculate big time.
Big risks mean big profits. Average investors aren’t allowed to participate in the shadow banks because it takes millions of dollars just to get the privilege to participate. So following a crisis, investors rebuild their shadow banking system again.
As this occurs the former, regulated banking sector demands the State allow them to engage in the risky high profit return speculative investing as well. They complain they can’t compete with the shadow banks. They want a piece of that speculative action. The problem is, the commercial banking system (i.e. non shadow) also takes deposits from the average public. So they are initially prevented from joining the shadow banks, whose depositors are only the super wealthy. The commercial banks then demand financial deregulation. They eventually get it from the State, and the two sectors, commercial regulated, and shadow unregulated merge in various ways.
For example, one of the prime shadow institutions, hedge funds, before 2007 were a favored place for the super wealthy to put their money and speculate. But bank deregulation in the U.S. allowed commercial banks to lend to the shadow banks and then to create their own internal hedge funds and what were called structured investment vehicles, SIVs, that kept separate books from the commercial banks in which they undertook risky investments like subprime mortgages, and asset backed securities, etc. So the two sectors blend over time, become more deregulated, engage in more risky investing, that is, in turn, linked to other non-risky lending by banks to non-bank businesses, households and local governments. So when the financial crash occurs, it drags down first the shadow banks (that lend to each other), then the commercial banks (that create their own shadow banks and lend to other shadow banks), and then to local governments and households with mortgages.
Because the shadow banks are linked to the commercial banks and, in turn, the real sector of the economy, when the shadow banks go bust in a crash, it spreads to the entire financial system and drags the entire edifice down. The banking system freezes up in the wake of a crash and no one can get credit—including non-bank businesses, households, and even local government.
The bigger the shadow system, the greater that the percentage of total investing is in financial asset speculation, the greater the risk factor of those investments, the more that debt has been used to finance the speculation—and the greater the eventual financial bust when it comes. That is, the faster and deeper financial asset prices collapses and the faster that that asset deflation is propagated to the rest of the banking system and then to the rest of the non-bank economy.
The shadow banks are critical to generating the excessive speculative boom and then transmitting the bust throughout the rest of the economy. For example, business sources estimate today that the shadow banking system controls more than $70 trillion in investable assets. About half that is held by the ultra high net worth investors mentioned previously, i.e. those with a minimum of $30 million in investable assets to commit annually. The shadow system today is larger in terms of assets than the commercial banking system.
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