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Really too big to fail.

datePosted on 12:34, August 17th, 2011 by Pablo

Market responses to the US debt crisis and financial downgrade have been like king tides as of late, and inevitably speculation centers on the possibility of a “double dip” global recession (this speculation is more than rhetorical. Gold and other precious metal prices have spiked overt the last three weeks as investors flee the stock, bond, commodity and currency markets). There is much talk, some fearful and some hopeful, of a global meltdown of epic proportions. The argument goes that downgrading the US credit rating devalues US Treasury bonds and the dollar, which slows US private investment at home and abroad, decreases domestic consumption, increases unemployment and generally prolongs the recession begun in 2008. This ripples negatively across the globe given the interconnectivity of commodity chains and the central role of the US in them. Be it on the Left or the Right, the belief in state bankruptcy is taken as an article of faith.

The reality is different. What is happening is a fiscal crisis of the Western State rooted in a cyclic crisis of capitalism. Arguments about the blown-out US public debt obscure the fact that it is the result of the same conditions that produced the 2008 recession and which are at root the cause of the next one. For the last thirty years the ‘bubble” of private debt was replicated by the US Government, in the last decade under the strain of simultaneously fighting two prolonged low intensity conflicts. In Europe public debt was in part procured in order to compensate for private debt (via the provision of subsidized entitlements). Capital was lent on looser and looser terms as interest payment calculations came to rival returns on productive investment as the dominant macroeconomic logic. The market in financial derivatives boomed, then busted, bringing with it a crisis in small scale property ownership at the same time that major manufacturers were being bailed out by the US government.

There is a difference, however, between the private sector and the State when it comes to fiscal crises. The analogy between States and firms is overdrawn. Firms go bankrupt; States do not. States may default on loans and suffer the indignities of downgrading by financial institutions, but they do not go out of business. The reason is simple. States  with a presence in the global economy may fail but they do not cease to exist.

Modern states are political entities with other measures of power beyond economic resources, are rooted in historical and cultural ties within more or less fixed borders, have distinct political systems and political regimes that govern them, and are therefore sheltered from the hard realities that beset wayward market agents in a globalised system of production, service and exchange. More importantly with regard to the social and political relations of production, the modern nation-state supercedes the market at any specific moment even while being generally subject to its rhythms and dictates. It is, after all, a capitalist type of state that is not reducible to the productive apparatus.

Imagine even if the US defaulted on its current obligations. Its credit rating would fall further in parallel with the value of its currency, but how long will that last? Even if the US fails its financial obligations, it would be the markets that push for a debt restructuring favourable to it.  As the core of the global economy, the US is simply too big to fail because its financial collapse would reverberate widely and deeply through the world. In fact, with the exception of undeveloped failed states and microstates with minimal economic resources to promote, virtually all modern states can survive a fiscal crisis and default.

 Take Argentina, which in 2000 defaulted on its foreign loans, uncoupled its currency from the US dollar and then renegotiated the terms of its obligations. Since most of the outstanding balance was interest rather than principal, foreign creditors were eventually forced to settle on terms favourable to the Argentines (about 60 cents on the dollar lent). The weakened Argentine peso stimulated commodity exports and attracted foreign investment in resources and primary goods. In spite of endemic corruption, political interference and a multitude of market inefficiencies, over the last five years Argentina has averaged growth rates in excess of six percent and attracted the highest levels of foreign investment ever even while maintaining a large public deficit.

 Greece, the poster child of all that is supposedly wrong with governments and societies that do not couple entitlements with production, is another such case. What would happen if Greece defaulted on its recently rescheduled loans? Will it cease to be? what it could do is drop out of the Eurozone, replace the Euro with the much less expensive drachma, and print money to fund its domestic obligations. Somee foreign investors may flee, but local capitalists will continue to engage the domestic market, people will continue to consume, albeit at lower rates with regards to imported goods, tourists will still flock to see the historical sites and visit the islands, and the country will continue to exist. In fact, should it be successful at restructuring its economy on more internally-focused terms out from under the straitjacket of Eurozone obligations (say, by making its tax collection system more rational and efficient), it could serve as a model for the other “PIGS” nations—Portugal, Ireland and Spain—as well as Italy.

It was Northern European, mostly German capital, directly and channeled through the European Central Bank, which sought to recycle in the European periphery the super-profits accrued during the last two decades of derivative market expansion. These are the creditors who took the risk in the PIGS and who now demand debt repayment schedules rooted in austerity measures and privatization programs. They are also the beneficiaries of a strong Euro, unlike the weaker Southern European economies now under siege. Should debtor countries in Europe decide to reconfigure their economies around a devalued national currency a la Argentina, the European Union will be finished as a currency regulator. Here the sub-regional ripple or contagion effect makes each of the PIGS too big to fail, something that is magnified in the case of the US. Loss of credit rating and a high debt to GDP ratio, in others words, does not translate into State bankruptcy.

 The larger point is that states can default but they cannot be bankrupted because they are not solely economic agents but instead sovereign political actors with interests that transcend a financial bottom line. They can be upgraded and downgraded as financial risks, but even if investment falls and inflation rises, they will not disappear. Think of Brazil and Argentina in the late 1980s when inflation ran at over 1000 percent per year. Did they disappear? Did all foreign investment dry up? Did local markets crash?

Truth be told, capitalism, led by finance capital, was on overheated overdrive for the two decades before 2008, only slowing down briefly after events such as 9/11, even when objective conditions advised against the maintenance of the macroeconomic policies private agents used to calculate the speed of their returns. Western States emulated private agent logics, whereas Asian banks and sovereign wealth funds  were less keen to adopt derivatives-led financial approaches backed by increasingly unsecured loans (although some of that did creep into Asian markets as regional economies attracted Western investment).

Here is where global networks come in. Rather than wage war on States with economies in default, other States that are debt free or less indebted work to cover their investments, and those of their private agents, in the debtor States. This means that even if private agents in the debtor States fail as a result of their market excesses or miscalculation, and State treasuries do n not have enough reserves to cover their debts, States remain open for business, perhaps even on more favourable terms depending on the nature of sovereign debt restructuring agreements (public debt for equity swaps are one measure that can improve State efficiencies as a result of restructuring). Inefficient producers are expelled from the market; inefficient States muddle along.

The entire Western capitalist combine was due for a retrenchment given the downward slope it has been on since spending, both public and private, exceeded productive output in material goods and services. So long as money could be made off of lending money and risks were passed on to increasingly lower-level actors, early 21st century capitalism saw States tax and spend without coherent productive purpose (which mirrored the approach of the financial markets). This was a good political calculation but not a sound economic grounding for future productive growth within current capitalist parameters. Thus the turn towards private sector retrenchment in 2008, with public sector retrenchment now following.

We hear about the demise of various States because they can no longer afford to repay what they have borrowed in order to maintain whatever it is that is considered precious to national identity and political stability–public goods and entitlements in Europe, a war machine in the US. Retrenching Western States may not be able to provide these services in the measure they used to, but thy remain (however diminished) as linchpins of an international system that has its origins in the Treaty of Westphalia rather than Bretton Woods or the Washington Consensus. States are the ties that bind that global system of exchange, and Western States continue to have a central role in it even as the system moves towards increased multipolarity.

Markets and politicians alike need to be cognizant of this fact, because as Keynes pointed out, it is political conditions, not economic conditions, that are the best guarantors of long-term investment. Rather than the economic particularities of a given investment climate at a specific moment in time, political stability offers better conditions for secure future private return. A stable national polity is the best guarantee of profit even if the public books are not balanced. That is the political cost for the social peace that is the basis for economic stability.

Ironically, it was the short-term focus of the macroeconomic logics that propelled the “bubble” that led first to the financial crisis of 2008 and now to the current conditions of political impasse and social instability in many liberal democracies. That is where the convergence of the fiscal crisis of the Western State and the cyclic crisis of capitalism can lead to liberal democratic State failure: when it produces a crisis of legitimacy of the political elite, often confused with regime crisis, that once rooted in and superimposed on the economic downturn and social unrest constitutes an organic crisis of the State. The UK evidences these type of pre-conditions.

Rather than demand zero-sum tax cuts and a diminished State role in guaranteeing the social relations of production,  the priority of the market during a State fiscal crisis should be to to express confidence in the State because delegitimisation of the latter is an absolute guarantee of disasterous market consequences for the private actors involved with them in the event that they are overthrown or fragment. That is where market ideologues have failed in their basic obligation: to help foster the political and socio-economic conditions in which stable rates of private return are generated. Instead, they are exacerbating the crisis with their jitters, demands and panic trading. This will not lead to an organic crisis in most liberal democratic states (which will muddle along), but it could produce legitimacy crises in newly democratic states or those with significant social cleavages. Even then the prospect of State, as opposed to regime or private sector failure, is unlikely.

All of which is to say that when it comes to the fiscal crises of modern Western States, this too shall pass.

 

 

7 Responses to “Really too big to fail.”

  1. Job on August 18th, 2011 at 11:40

    The world economy (or, to use a more Marxian term, global capitalism) is certainly in the midst of a crisis bigger than any for several generations. Whether or not this crisis can be overcome, and stable conditions for capital accumulation (i.e. economic growth) reestablished is, I think, at this point a genuinely open question.

    In considering the future of the economy I think due attention must be paid to the resource constraints that will shortly face (that are already facing) the world economy and that threaten its future expansion.

    The contemporary Marxist scholar David Harvey has identified what he calls the ‘capital surplus absorption problem’ as a key obstacle to be overcome for the successful expansion of capital — avenues for the profitable re-absorption of accumulated capital (i.e. productive investment) must be found, lest its value be destroyed. For Harvey, the history of capital for the last three decades has been of an increasingly desperate search to find productive outlets for accumulated capital, hence massive rounds of what he calls ‘accumulation by dispossession,’ roughly equivalent to Marx’s primitive accumulation. Through privatisation, whole areas of the global economy have been opened up to private capital in a massive round of enclosure of previously common resources. I think the austerity programmes currently being implemented throughout the world can be seen in such a light, as another, even more massive, assault on the global commons.

    I think this is an ominous pointer towards the future of the global economy — as opportunities for new production dry up, due to depletion of natural resources, capital will increasingly need to resort to rent extraction on already-existing production, rather than investment in new production, to get returns on its investments. This new rentier economy is, I think, already visible in embryo in today’s world.

    All of these developments hinge, however, on whether there can be effective popular resistance against them. As a good Marxist, I hope with every fibre of my being that such resistance does arise. There is already plenty of resistance (maybe anger would be a better word) out there, from the Greek protests to the British riots, but so far too much of it is without the focus or the organisation that can make it effective. One of the most interesting questions of the next decade will be whether the current revolutionary wave can lead to a revival of strong left-wing forces in global politics.

    By way of response to your original post, Pablo, I suppose what I’m saying is I’m not quite so confident as you are in the world economy’s ability to return to something resembling the business as usual of the last few decades (maybe even past two centuries)!

  2. SPC on August 18th, 2011 at 18:09

    We survived a past crisis when the oil money was deposited with western banks who lent this to third world nations (who needed debt bail outs). However this crisis is one within the western economy and it does question the capacity of nation states to maintain their sovereignty because the west is no longer in a position to determine a new Bretton Woods resolution – as it would have to include other parties who would either obstruct or determine the shape of the outcome.

    In so far as the West can act, in Europe the obvious way out of their difficulty is via Eurobonds that would reduce the interest cost of public debt for the weaker Euro zone members. However Germany, the main benefactor of an equalised European currency, is in the prime position to dictate the terms of this and they include fiscal policy regulation of the nation states of either this zone or the entire European Union (that could well include balanced budgets, common taxation of corporates etc). That will be a constraint on the national sovereignty within Europe.

    Whatever form the new rearrangment for the federal USA, by their own determination and unrelated to international reform, they will be under budgetary constraint in responding to future national development opportunity and response to global trading outcomes. Even if national sovereignty over the economy is maintained this restraint will impact on the political society.

    This century is not be about the story of the end of history but a battle for national survival in a global market economy with developing problems that can only be resolved at the world level.

    A certain elite with skills and wealth will have more in common with each other than the poor of the world, and will have an interest to keep democratic nation state populations docile. In that climate of budget scarcity, will western democracies see maintaining their liberal society/equality of opportunity as sufficient as the dispartity of wealth and income grows and grows? And can these nations maintain sufficient size to their middle class that this has a willing mandate. And if the middle class does reduce in size, will there be any remaining capacity for a nation state to opt out and determine on a new course?

  3. SPC on August 18th, 2011 at 18:50

    We survived a past crisis when the oil money was deposited with western banks that lent this to third world nations (which later needed debt bail outs). However this crisis is one within the western economy and it does question the capacity of nation states to maintain their sovereignty, because the west is no longer in a position to determine a new Bretton Woods resolution – as it would have to include other parties who would either obstruct or determine the shape of the outcome.

    In so far as the West can act, in Europe the obvious way out of their difficulty is via Eurobonds that would reduce the interest cost of public debt for the weaker Euro zone members. However Germany, the main benefactor of an equalised European currency, is in the prime position to dictate the terms of this and they seem to include fiscal policy regulation of the nation states of either this zone or the entire European Union (such as a call for a balanced budget requirement, common taxation of corporates etc). That will be a constraint on the national sovereignty within Europe.

    Whatever form the new rearrangment for the federal USA, by their own determination and unrelated to international reform, they will be under budgetary constraint in responding to future national development opportunity and response to global trading outcomes. Even if national sovereignty over the economy is maintained this restraint will impact on the political society.

    This century is not be about the story of the end of history and the triumph of the western democratic nation state model but a battle for national survival in a global market economy.

    A certain elite with skills and wealth will have more in common with each other than the poor of the world, and will have an interest to keep democratic nation state populations docile. In that climate of budget scarcity, will western democracies see maintaining their liberal society/equality of opportunity as sufficient while the dispartity of wealth and income grows and grows? And can these nations maintain sufficient size to their middle class that this approach has a willing mandate. And if the middle class does reduce in size, will there be any remaining capacity for a nation state to opt out and determine on a new political, economic and societal course?

    The hope of western nations safely navigating through this period may well be in vain, managing our way out of this economic crisis without reform of the less than reliable international financial sector (apart from new Basel standards and greater transparenty to new financil products) is a high risk strategy in itself. But to take this course with other risks, such as planetary scarcity and prospective environmental instablity are left to be tended to later, is suggestive of a civilisation in decline and one now only capable of responding to each crisis as this is required.

  4. Pablo on August 18th, 2011 at 18:57

    Thanks Job, for the excellent comment (although a legitimate email address would be nice. We only get your IP number). I knew that this post was long and not focused on NZ or the minutia thereof, so did not expect anyone to voice an opinion.

    Capital absorption: so bad yet so good. To admit its progression as described in your comment about Harvey is to admit defeat. There IS a better way, and it involves meso and micro-level production linked upwards yet controlled by those who produce, not those who speculate or consume. It means lower profits for the corporate retailers but better profits for the producers. That is a very big task given current structures.

  5. laminarflow on August 18th, 2011 at 23:23

    Check out the role of ESF series of videos

    Factor in that recently, Venezuela pulls their gold from New York, London.

    This 1981 movie Rollover foreshadowed the events leading up to the end game.

  6. Pablo on August 19th, 2011 at 08:00

    SPC: I found your comments in the spam folder. Let me know if you want both to remain or which one to remove (they both are good as far as I am concerned).

    My basic point is that even if the world economic system is in a transitional phase that necessarilly carries with it crisis and retrenchment, the state system (and inter-state system) will endure without much modification even if states are less able to do the material things that they used to do. That is where the Harvey thesis noted by Job comes into play, because the sell-off of state assets and public goods may be as much an ideological imperitive as it is an economic requirement.

  7. SPC on August 19th, 2011 at 11:20

    As you will note from my latter post (made when the former did not appear to go through) I am not so sanguine about the outcome of the constant series of challenges to the democratic nation state.

    The declining capacity of the nation state to provide is already combining with ideological victory for those who see the potential for populism as an unwelcome threat to the primacy of capital and the free market in any case.

    This will ultimately leave the nation state citizens feeling powerless, little more than minority shareholders, as governments operate as corporates functioning within an international cartel responsible for their prudential management of units of a world economy (as the Germans seek Europe to be).

    The economic direction of western capital seeking to imbed itself globally in extracting rent rather than production is only going to contine (ironically with Germany a notable exception) and the failure of western nations to effectively direct their economy towards necessary reform to meet the known challenges of planetary scarcity and environmental risk, leads to only one conclusion, a civilisation in decline.

    The victory of those who want to reduce society to the protection of property and the celebration of the pursuit of profit and wealth, however imprudent that maybe to longer term economic well-being and societal inclusion will have consequences. The idea of an effective political citizenship in the nation state, the corner stone of democratic participation, is coming under threat as people can so easily be categorised as no longer having any reason to be loyal to the society in which they live (and treated as potential threats accordingly). The likely decline in civil liberties in the nation state is obvious as are the growing international connections between groups of the disaffected.

    The UK government’s recent fear of the peoples social communication (and response) may be prescient as to how even democratic activism will one day be seen.

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