Monday, 3 February 2014


“In 1857, the crisis broke out in the United States. A flow of gold from England to America followed. But as soon as the bubble in America burst, the crisis broke out in England and the gold flowed from America to England. The same took place between England and the continent. The balance of payments is in times of general crisis unfavourable to every nation, at least to every commercially developed nation, but always to each country in succession, as in volley firing, i.e., as soon as each one’s turn comes for making payments; and once the crisis has broken out, e.g., in England, it compresses the series of these terms into a very short period. It then becomes evident that all these nations have simultaneously over-exported (thus over-produced) and over-imported (thus over-traded), that prices were inflated in all of them, and credit stretched too far. And the same break-down takes place in all of them. The phenomenon of a gold drain then takes place successively in all of them and proves precisely by its general character 1) that gold drain is just a phenomenon of a crisis, not its cause; 2) that the sequence in which it hits the various countries indicates only when their judgement-day has come, i.e., when the crisis started and its latent elements come to the fore there.”

The process Marx describes here is being replicated currently in international markets, but is so far only manifest in the emerging economies. What is the process Marx is describing. As Marx and Engels describe in Capital III, the period from around 1842 to the late 1860's, was a period of prosperity and boom. Increasing trade and economic activity, fuelled a rising rate and volume of profit similar to that which occurred after 1999. In the preceding period of stagnation, rising rates of profit combined with a low level of demand for money-capital to cause interest rates to fall, again as was the case in the period from the late 1980's. By the late 1840's, these low rates of interest and abundant supply of money-capital that caused them, encouraged speculation, again much as was seen in the 1990's, and after. It led to the Railway Mania, which burst in 1847, in similar fashion to the bursting of the Tech Bubble in 2000.

The 1847 crisis was a financial crisis that was caused by a sharp rise in the demand for money, largely due to crop failures, under conditions when the Bank of England was constrained in supplying liquidity due to the 1844 Bank Act. In that respect it was like the financial crisis and credit crunch of 2008. Like 2008, the financial crisis was resolved, in 1847, by the supply of the necessary liquidity into the economy, as the Bank of England was forced to suspend the 1844 Bank Act. As with 2008, what was a financial crisis spread out into effects on the real economy, but that was quickly ended with the supply of the necessary liquidity. The boom continued much as globally, after 2008, the boom has continued, with economic problems re-appearing in some economies like the UK and peripheral Europe, after 2010, due to misguided, austerian policies and political crises rather than being directly related to the financial crisis itself, or any fundamental economic crisis of Capitalism. A look at the typical “V” shaped recovery in those economies prior to 2010, and the much better recovery of the US, which mostly avoided those policies, demonstrates that fact.

The 1857 crisis was itself also mostly a financial crisis that spills over into the real economy, but as Marx sets out the basis of the financial crisis in 1857 was more closely tied to what was happening in the real economy than was the case in 1847. There were many aspects that were the same such as the low interest rates, and availability of money-capital encouraging speculation, and the fact that this was a period of boom, and high profits. Marx sets out “...the example of Ipswich, where in the course of a few years immediately preceding 1857 the deposits of the capitalist farmers quadrupled), what was formerly a private hoard or coin reserve is always converted into loanable capital for a definite time, does not indicate a growth in productive capital any more than the increasing deposits with the London stock banks when the latter began to pay interest on deposits. As long as the scale of production remains the same, this expansion leads only to an abundance of loanable money-capital as compared with the productive. Hence the low rate of interest.” (ibid)

Especially when interest rates are low, these small money-hoards are frequently mobilised into larger pools organised by the banks, and today by the insurance companies, mutual funds and so on, and used for the purpose of speculation in property, bonds, shares etc. solely on the basis of obtaining quick sizeable capital gains, which causes asset price bubbles of the type we have seen in all these areas grow larger and larger for the last 30 years.

The problem with these asset price bubbles is that they do not create any additional wealth, even though from the perspective of the person who owns the house, whose price has bubbled up, or whose share and bond portfolio is at ever new highs, it certainly seems to have increased their wealth considerably. Yet, the house, the shares, the bonds are the same today as they were yesterday. All that has changed is their current market price. The house provides no more shelter than it did yesterday, the share in the company produces no more widgets off the production line at £2 than it did at £1. The wealth, the apparent capital, is illusory, it is fictitious capital. Only investment in real productive-capital – buying additional factories, machines, material and labour-power – can increase real wealth. The further problem with this fictional capital is that because it creates the illusion of wealth, it encourages consumers to consume more because they feel “wealthier” - the so called wealth effect – and because they can, and are more prepared to borrow against this “wealth”, and it encourages capitalists to increase their output to meet this additional demand, again by borrowing to cover it. 

The more money is diverted into speculation in property, bonds and shares and the more this seems an easy way to get rich, the more money is encouraged in to blow up such bubbles. In economies where control of investment is in the hands of professional managers, also the more this becomes the case. So, for example, we see today that such managers in the US, sitting on $3 trillion of cash, are under pressure from stock markets to use that money to buy back shares, rather than to buy additional productive-capital. Those same managers whose share options rise as a result have other incentives to use the money in that way too. This merry-go-round may continue for so long as the asset prices continue to rise, but when that stops, the foundations of the building are shown up as being very shaky indeed. Yet, it has been precisely on this basis that the Federal Reserve and Bank of England have argued the need for QE, though the real reason for it is quite different. The real purpose of QE has been to keep these asset price bubbles inflated, because otherwise the banks will be exposed as bankrupt.

That is effectively what happened in 1857. A financial panic broke out in the US, whose economy had been growing rapidly in the preceding period sucking in large amounts of imports from Europe, particularly Britain - 30% of UK exports went to the US. Marx wrote a number of articles for the New York Daily Tribune at the time on the crisis e.g. The Bank Act of 1844 and the Monetary Crisis in England. Marx in this article makes clear that the effects of the 1844 Bank Act had effects far wider than just in the UK, just as today the policy of QE has effects far wider than just in the US. Rather as happens today with China supplying credit, Britain supplied large amounts of credit to the US. US banks had already become more cautious in their lending earlier in 1857, as the end of the Crimean War had led to a restoration of agricultural production, which meant the need for US agricultural imports declined. When the panic erupted in the US, with the collapse of Ohio Life Insurance and Trust this quickly spread into the economy causing demand to fall, with a consequent effect on US imports from Europe. The US continued to send its shipments of cotton and other goods to Britain and Europe, but now, without revenue from exports to cover them, Britain had to pay with gold. Hence the “flow of gold from England to America”. But, the consequence is then that British exporters having lost markets have to cut production, lay off workers, and go bust. That means Britain in turn buys less imported cotton etc. from the US. As US exports then no longer cover its imports from Britain, it has to pay for them with gold, the flow goes back the other way from the US to Britain. Hence the description of volley-firing.

China and other newly industrialising economies occupy a similar situation today that Britain occupied in 1857 both as producers of manufactured goods shipped all over the globe, and as providers of credit to deficit countries, most notably the US and UK that use this credit to buy these manufactured goods. These newly industrialising economies also occupy a similar position in that they suck in large quantities of raw materials and foodstuffs from around the globe, frequently from other countries in the process of economic development, but also from the US, as a major agricultural producer.

In the last 30 years the low interest rates caused by the excess supply of potential money-capital, together with the availability of credit provided by surplus economies like China facilitated this borrowing in deficit countries to enable consumption within them to continue. By this process, a similar situation to that described by Marx is facilitated whereby overproduction and over trading can continue to develop, facilitated by this credit. In the context of rapidly falling commodity values, as productivity rises sharply, the US as the global reserve currency also acts to prevent deflation, which represents a serious threat to big industrial capital, by printing increasing quantities of money tokens, and creating increasing amounts of credit through its banking system. The inflation of asset price bubbles is both a consequence of, and facilitator of this process, as increased borrowing by the private sector – households, banks and other businesses – is made possible using inflated asset prices as collateral.

China as an increasingly powerful economy refused to allow the US to use its currency against it. China pegged its currency to the dollar so that as the US devalued its currency so the Yuan was depreciated too. That meant that as China continued to drive up its efficiency, and drive down its prices, its success in exporting these commodities was not undermined by an appreciating currency against the dollar. The consequence was, however, that China also had to increase its own money printing. With the main banks in China state owned, this was less of a problem, and China was able to direct the provision of credit through these banks to investments that met the requirements of its Five Year Plans. But, the side effect of this was that other businesses obtained funds via a shadow banking system, which utilised the availability of large quantities of cheap credit to lend to them. As with the Ohio Life, and as with other financial crises such as that which began with Northern Rock, and continued through Lehman Brothers, and has been manifest in the Eurozone banking crisis, many of these loans were not well considered. The fact that these loans in many cases are bad has been hidden by the extent of money printing due to QE, as well as by the low level of interest rates. As stated above, this is why QE has been continued long after the initial credit crunch was resolved. It is an attempt to deal with insolvency via increased liquidity, an attempt which must fail and yet leads to financial crises as soon as the amount of liquidity is reduced.

This is the real difference between now and 1847 and 1857, which is that on a global scale a large part of the banking system is insolvent, because it has continued to expand its balance sheets for the last 30 years on the basis of astronomical levels of fictitious capital in the form of the property, bond and equity markets. The real economy remains in a relatively healthy condition. Productive-capital continues to produce large amounts of surplus value, but it is undermined by the size of money-capital and its power. That power has continued to be mobilised to drain surplus value from the real economy to cover up the essentially bankrupt condition of the global banking system. The money crises currently manifesting themselves in various emerging markets, are just the latest manifestation of that reality, in the same way that it was manifest in the collapse of Northern Rock, Lehman Brothers etc., in the collapse of the banks in Greece, Portugal, Ireland, Spain, and Iceland in 2010, and later in Cyprus, with the question only being whose banks will be next to go under – Luxembourg, Malta, Slovenia, Hungary etc – and when. It is the same power that is used to water down regulation and evaluation of the banks, for example, the sham nature of the European bank stress tests.

These various financial panics going back at least to the Asian currency crisis and Rouble crisis of the late 1990's, are not in reality separate crises, but interlinked events in the same process. The periods between them were separated by larger time periods, but as the denouement of that process approaches, the time periods are becoming shorter in the way Marx describes. Looking at the situation facing economies such as Turkey, South Africa, Argentina and Brazil in the current crisis it is different to that facing China, but only because of the different nature of these economies. 

An economy that produces commodities and is able to export them obtains a flow of money as a result. This flow of money that comes into the economy, enters the bank accounts of domestic producers as their money, available for them to spend or advance as capital. This process, where the exports are greater than the country's imports, leads to an increased demand for the country's currency, pushing up its value relative to other currencies. This will tend to make its exports less competitive, which is why China pegged its currency to the dollar, its main export market with whom it had a trade surplus – China actually has a trade deficit with the EU meaning the Euro would tend to rise against the Yuan. If economies are able to still export their commodities despite a rising currency – which, for example, Germany has done – then this means that its value rises even more, and the cost of its imports tends to fall, creating disinflation.

Whilst QE continued, reducing the value of the dollar, the value of currencies such as the Turkish Lira rose, reducing its import costs, whilst its exports continued to rise fuelled by consumption in the US and other economies. Economies like South Africa, which provide large quantities of raw materials, saw their currency appreciate because the global boom sent primary product prices higher on the back of demand from China and other industrialising economies. That meant that these economies could also import the things they needed from the US at a lower cost in their own currency.

As described recently - Chickens Start Roosting – it can then be seen why the tapering of QE causes a problem. In order to avoid a sharp reduction in the value of their currency, which would lead to inflation and associated problems, these economies are led to raise their interest rates. A similar thing happened in 1992, on Black Wednesday, when the UK was led to raise interest rates to 15% as the £ came under attack. A number of economies including Turkey, Brazil, South Africa, India and Argentina have already raised their official interest rates by anything up to 50% from previous levels. Turkey increased its rate by more than 50% from nearly 8% up to 12%. In a number of these economies capital controls are being discussed, which would limit or prevent money being withdrawn from banks or taken out of the country, similar to those imposed previously in Cyprus. Interestingly, the IMF now believes that, in such conditions, capital controls, which were once anathema, are an effective policy tool.

High interest rates prop up the currency, because they lead to money flowing into the economy either directly as bank deposits, or else as purchases of bonds, whose yields have risen, and thereby into bank deposits. But, unlike money flows into the economy to pay for exported goods, this “hot money” still belongs to the person who has deposited it. Given that they have only deposited it, or bought bonds with it to take account of the high rate of interest, they can just as quickly remove it, if some other country offers a higher rate of interest. It can be seen how the same kind of process of “volley firing” described by Marx can be set in place with speculators attacking one currency after another, to force them to raise interest rates. A similar thing happened with the Eurozone crisis in 2010. That was only subdued by the ECB saying it would do whatever was needed – essentially threatening to print money to buy up the bonds of economies under threat – to prevent such speculation.

As the pace of volley-firing intensifies, and one currency after another has its feet put to the fire, countries will have two choices. Either they raise interest rates to defend the currency, or else allow the currency to depreciate, and suffer rapidly rising inflation, which will lead to their interest rates rising anyway, as lenders will seek to protect the real value of their money. That process, in a globalised economy, cannot be limited to just the emerging economies. It must necessarily impact the emerging Central and Eastern European economies that are part of the EU. Those economies whose banking system has already been exposed as being at high risk, such as Slovenia may be amongst the first to suffer the inevitable banking crisis, but other economies like Luxembourg (21 times) and Malta (7 .6 times) whose bank assets are many times the GDP of the country, and far greater than was that of Cyprus, are unlikely to escape in such conditions.  Given the interlinked nature of the global banking system, and the extent to which large European banks like Deutsche Bank have massive debts hidden off balance sheet, such a crisis cannot be limited simply to a few bad banks.

The destruction of fictitious capital values that must ensue in such a process will once more turn the attention on peripheral Europe, as well as upon the asset price bubbles in property, bonds and equities in the US and UK. Its unlikely that the ECB would be able to muster the resources required to “do what was necessary” in such circumstances. In fact, its unlikely that even the “Bank Deposit Guarantees” could be maintained in the face of one European bank after another going bust. Its one thing for the capitalist state to bail-out bankers, they have been far less interested in protecting ordinary depositors.

2008 did not represent the end of the financial crisis. It was just the opening salvos. The really volley-firing is yet to occur. The current money crisis in emerging economies might be its manifestation. Time will tell, but sooner or later the inevitable will happen.

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