WHAT'S HAPPENING TO THE ECON With the first bank run in Britain for over a century and the threat of a sharp slowdown in the housing market questions of the economy are at the forefront of media and political discussion. Yet these surface phenomena mask a deeper set of problems that arise both from the international context and from the development of British capitalism over recent years. Here Andy Kilmister analyses these problems and initiates a broader discussion about economic prospects in the coming period. 2
IOMY? hree significant events have T shaped the world economy over the last year; the problems of the financial markets originating in the USA, the decline in the value of the dollar, the rise in commodity prices and in raw materials prices, especially food and energy. All of these are closely interconnected and mark a clear break with the pattern of accumulation that has typified the last two decades. The immediate location of financial turbulence has been in the American housing market. On its own the build up of bad debt here is sufficient to cause serious problems. Federal Reserve chair Ben Bernanke has had to raise his estimate of the losses up from $50-100 billion to $150 billion over the course of the autumn, while Deutsche Bank has put the figure at up to $400 billion of which $130 billion is held by banks.' However, the implications of the 'sub-prime' mortgage debacle are even more serious than this for three reasons. Firstly, the continuing uncertainty about just how many risky loans are in the system has raised the possibility of a dramatic squeeze on lending by banks and other institutions. As The Economist puts it, No one is yet sure how tight credit will get. It depends on how big the losses from the subprime-related mess turn out to be; who holds those losses; how far banks are forced to take troubled assets, such as those in structured investment vehicles, onto their balance sheets; by how much they cut back lending in response; and how far the Federal Reserve reduces short-term interest rates to compensate.? The single biggest element in this uncertainty is 'securitisation', the repackaging of debt into securities comprising mixtures of lending of different degrees of riskiness that are then sold on in secondary markets. Widely heralded as making the system immune to risk this now turns out to have had the consequence both of spreading bad loans more widely and of making it almost impossible to tell just how many such loans there are. Secondly, it is important to look at just why mortgage lending boomed so much in the US in the first place. The roots of this lie in the weakness of productive activity in the The continuing uncertainty about just how many risky loans are in the system has raised the possibility of a dramatic squeeze first half of the 1990s and in the impact of the financial crises in Asia and elsewhere in 1997 and 1998. In order to stop a generalised slowdown in the world economy the Fed lowered interest rates and encouraged a speculative boom that initially centred on the stock market.3 The bursting of this bubble with the end of the 'new economy-dot com' hype and the wave of corporate scandals in 2000 left investors looking for a new location for surplus funds and the housing market fitted the bill. The end of speculation in 3 housing will not remove the weaknesses that initially led to that speculation. Not only that, but US growth has increasingly come to depend on borrowing fuelled by rises in house prices, with the ratio of household debt to disposable income now at 130 percent (up from 80 percent in the early 1990s) and with consumer spending 70 percent of GDP. Thirdly, easily available credit and the belief that securitisation has eliminated risk have led to a surge in other forms of debt-financed activity, notably the rise in takeovers based on private equity, which in turn has led to a revival in the stock market. A credit squeeze resulting from problems in mortgage lending could have severe implications for this activity and for share prices as well." The fall in the dollar predates the current financial problems and results from record American trade deficits. Against a broad range of currencies the dollar has lost a quarter of its value over the last five years and measured against the basket of leading currencies tracked by the Federal Reserve, it is now at an all-time low. What is more serious for capital, however, is the possibility that this gradual decline may turn into a speculative rout. The reason for this is the massive amount of dollar foreign exchange now held by countries running balance of payments surpluses, mainly Asian exporters and oil producers. Globally, foreign exchange reserves have tripled to $5.7 trillion since the beginning of this decade, with 65 percent or 1. The Economist (November 17 2007) 'Briefing: America's Economy' p. 82 ibid 3. R Brenner (2002) The Boom and the Bubble: The US in the World Economy, Verso. Brenner gives a good account of this; see especially chapter 7 4. T Jackson 'Prospects of an equities fall are as worrying as the credit crisis' Financial Times (December 3 2007) p.22 5. The Economist (December 1 2007) 'Briefing: The falling dollar' p.83
as the 'Bretton Woods 2' theory. According to 9. This regime was based on arrangements worked out more of this being held in dollars. ESP These dollar holdings are vulnerable because of a growing lack of confidence in the US financial system and because of the possibility of a self-fulfilling prophecy, where expectations of a fall in their value and a consequent capital loss for those holding the AMES currency trigger a selling spree. In addition, any move by the Fed to lower interest rates in order to boost US spending will make the dollar less attractive. The impact of these factors has already been felt with a fall in foreign net purchases of US securities from the average of $70 billion a month in 2005 and 2006 to an average of minus 58 billion a month in July to September 2007.° Another factor leading surplus countries to move away from holding dollars is the increasing rate of inflation particularly in so-called 'emerging economies'. While rates are still low compared to the 1970s there has been a marked upturn over the last year or two which has caused serious worries given the dependence of capitalist strategies for the last two decades on low commodity prices coupled with a tight lid on labour costs. The Financial Times reports that, Energy prices have been surging for several years, but the take-off in food prices is more recent, accelerating over the past year with rising milk and dairy prices in Europe, more expensive beef in the US and soaring pork prices in China. Many economists believe the two phenomena are now interacting with each other, as high oil prices prompt farmers to set aside land for the production of biofuels, reducing the amount available for food production. An intense debate is under way in central banks across the world as to whether the recent rapid rise in food and energy prices will continue - and what, if anything, they should do about it.? One possible solution for countries like China is to allow their currencies to rise in order to lower import prices. Since most such countries currently fix their exchange rates against the dollar this would mean selling dollars and would push the value of the US currency down even further. The End of 'Bretton Woods 2'? The most widely discussed framework put forward by orthodox economists for understanding these developments is known this approach capitalism has alternated over time between regimes based on fixed and floating exchange rates. The fixed exchange rate regimes have been based on a distinction between 'core' and 'periphery' regions. The core region is able to run a balance of SHINGTON payments deficit since its currency forms the main element in international foreign exchange reserves and so other countries will accept it in payment for exports to the core. The periphery is prepared, according to the theory, to hold these reserves in the currency of the core because by doing so they prop up the value of this currency and keep their own currency values low which allows them 4 to follow a strategy of export-led growth. But eventually, the contradictions of this arrangement, with periphery countries having to invest their trade surpluses in low yielding assets denominated in the currency of the core rather than getting the benefits of cheap imports by letting their currency rise, lead to a breakdown in the system and a shift to floating exchange rates. This shift lasts until the uncertainty and instability of floating rate systems encourages a shift back to a core-periphery framework. Proponents of this theory point to two fixed exchange rate regimes in the post World War 2 period: the Bretton Woods regime which lasted from the late 1940s to 1971° and the In many ways British capitalism has followed a very similar path to the USA in recent years period which began in the late 1980s. The intervening period was one of floating rates. The two fixed rate regimes are very similar; in each case the USA has been the core region, with the dollar as the international currency, hence the description of current arrangements as a 'second Bretton Woods'. The difference between them lies in the make-up of the periphery; in the original regime export-led growth was based in Japan and Europe (especially West Germany), now it is located mainly in Asia (especially China). What is currently being debated amongst central banks and economic analysts is the possibility that the fixed rate arrangements that have lasted for much of the last two decades are now coming to an end. Financial 6. W Münchau 'Dollar's last lap as the only anchor currency' Financial Times (November 26 2007) p. 13 7. K Guha 'Cooler yet the pressure rises: Why a Seventies-style whiff of stagflation may soon be in the air' Financial Times (December 3 2007) p. 15 8. The theory was put forward in a number of articles by Deutsche Bank economists Michael Dooley, David Folkerts-Landau and Peter Garber and has been subject to a great deal of critical discussion. See M Dooley et al, 'The Revised Bretton Woods System' at http://ideas.repec.org/a/ijf/ijfiec/v9y2004i4p307 313.html at a conference in Bretton Woods, USA in 1944, which among other things laid the basis for the International Monetary Fund (IMF). In the Bretton Woods framework each currency fixed its value against the dollar, which in turn was fixed against gold. 10. Munchau op cit 11. M Wolf 'Who will pick up the thread after the great unwinding?' Financial Times (November 21 2007) p. 1 12. A number of writers have argued that in fact the theory only fits relations between the USA and China and is not applicable to other Asian countries. 13. M Wolf "Storm clouds gather over Brown' Financial Times (May 20 2005) p. 19 14. In recent weeks the 'yen carry trade' has changed its direction allowing the yen to rise somewhat, but still by a relatively small amount compared to the surplus funds available. 15. S Daneshkhu 'The iron currency: Britain learns to live with a strong sterling' Financial Times (July 12 2007) p. 11
Times columnist Wolfgang Münchau writes 'it has been one of the most influential that, theories about exchange rates in the age of globalisation and it may be about to go up in smoke', '° while in the same newspaper Martin Wolf talks of a 'great unwinding' which will involve a lengthy slowdown in the USA and shedding of dollar assets internationally. He takes the view that, 'the great unwinding is a turning-point for the world economy'." These developments pose two central questions for Marxists in Britain. Firstly, how should we analyse the significance of these international events and secondly what are their implications for British capitalism? The rest of this article is devoted to these questions. The Meaning of Current Developments From a Marxist perspective the 'Bretton Woods Z' approach has two great strengths. Firstly, it recognises (though without a theory of imperialism it cannot adequately analyse) the division of the world into different regions of unequal strength. Secondly, it grasps, though again it does not analyse in depth, a key contradiction within capitalism. Capitalism, by its nature constantly revolutionises production conditions but capitalist enterprises also require a stable environment to plan the long-term investment that allows such changes in production to take place. Floating exchange rates allow for a flexible response to the changes but cannot provide stability. Fixed exchange rates provide stability but, because they do not respond to changing conditions, they allow massive transfers of value between countries that eventually themselves become destabilising. As a result global capital is forced to oscillate between the two kinds of arrangement as the theory predicts. However, the theory also has two central weaknesses. Firstly, in its current version it seems to apply only to relations between the USA and Asia. Other regions, especially Europe, do not fit easily into the pattern. 12 Secondly, and more importantly, it focuses on trade relationships at the expense of looking at the internationalisation of production and the investment flows that result from this. Both of these issues become important when assessing the implications of current events for Britain. Prospects for British Capital Any attempt to analyse the British economy in Marxist terms quickly comes across a striking paradox. In many ways British capitalism has followed a very similar path to the USA in recent years. Like the US it has seen debt-fuelled consumption based in large measure on a housing boom coupled with a large balance of payments deficit and a growing government budget deficit. Net household savings are as low in the UK as in the US with the ratio of debt to disposable incomes rising from less than 110 percent in 1998 to 140 percent in 2003.13 To that extent the difficulties faced by capital in the UK parallel those in the States: financial turbulence is likely to slow down spending and may cause a recession but any attempt to lower interest rates to boost the economy risks both encouraging further debt and raising inflation at a time when prices are already moving upwards. Yet, there is also an important difference between the situation of the US and the UK - while the dollar is plunging the pound remains relatively strong. The explanation for this lies in the two weaknesses of orthodox analyses of global imbalances mentioned above. The weakening dollar coupled with Chinese and Japanese determination to keep their currency values down has left large amounts of speculative capital swirling around looking for a home.' Much of this has ended up being invested in Net household savings are as low in the UK as in the US with the ratio of debt to disposable incomes rising the euro, pushing up its value dramatically, but there has been enough left over to keep currencies like sterling high. However, surplus funds cannot be the only explanation for the willingness of international investors to fund the British trade deficit, since it is still necessary for speculators to expect profits from such investments. Here current trends in international production become crucial. The strength of sterling in the last decade has rested on two key factors. Firstly, the 'terms of trade' for Britain (the ratio of export to import prices) have been unusually favourable. As the Financial Times puts it, Demand for services that the UK is good at - such as investment banking, accountancy and law - has been rising, while Britain's imports comprise goods such as computers and clothing, where prices have fallen. Inflation has been held down by those cheap imports, enabling the Bank [of England] to keep interest rates lower than would otherwise have been the case. Consumers have meanwhile been able to increase their spending in real terms. This benign outlook cannot remain for ever and there are some signs that it has begun to change. '5 The impact of this can be seen in estimates that the UK financial sector made up 9.4 percent of the economy in 2006, contributing 30 percent of corporation tax revenues and accounting for 30 percent of GDP growth between 2004 and 2007.16 Equally important though have been the earnings obtained by British capital from past investments abroad. In 2004 the surplus on investment income was enough to halve the UK trade deficit." The strong pound has 5 also allowed British manufacturing to stage a minor revival from a low base through sourcing components cheaply abroad and selling in higher value segments of the market where price is less important. ' This combination of factors has allowed UK capitalism temporarily to resolve a number of the contradictions highlighted by the 'Bretton Woods 2' theories. The strong pound has ensured low inflation and stable trading conditions with key European and Asian markets while simultaneously Britain has been able to follow an American style credit based expansion domestically. But it has also involved intense reliance on being able to extract value from the rest of the world through the twin mechanisms of low commodity and manufactures prices (with all the dire ecological consequences associated with these) and repatriation of foreign profits. This is particularly the case because New Labour has spectacularly failed to transform production conditions at home. The key index here is productivity growth which, at 2 percent between 1995 and 2004, remained below that of the US and insufficient to close the gap in absolute productivity levels with France, Italy and Germany. ' Dependence on imperialist exploitation is closely linked with domestic weakness. As the world economy now falters and as food and energy prices rise, UK capital appears uniquely vulnerable to global economic shocks. Conclusion The central economic issue for the ruling class internationally in the next few years will be the attempt to move away from reliance on US growth and the stimulus this gives to exports from elsewhere, especially Asia, towards a new pattern of accumulation in which the so-called 'emerging economies' play a much greater role, a role in which domestic consumption will be key rather than export-led growth. Achieving this kind of transition in the anarchic world of global capitalism will be intensely difficult, as is shown by the case of Japan, where this process has led to two decades of near stagnation and growth which currently remains exceptionally fragile. The British economy is likely to exemplify the conflicts that are likely to arise in a particularly acute way and these conflicts will provide many opportunities for socialists to argue for an alternative economic system. 16. The Economist (December 1 2007) 'Briefing: The City of London's tumble' pp.29-32 17. FT Cave 'Overseas investment income helps to prof up current account deficit' Financial Times (March 30 2005) p.3 18. Daneshkhu op cit; J Willman and W MacNamara "An uplifting experience: How British industry is once more finding ways to make a profit' Financial Times (September 7 2007) p. 13 19. M Wolf 'Britain must get to grips with lacklustre productivity growth' Financial Times (November 9 2005) p. 19