Global financial crisis and International Monetary Fund - Part I

Crisis began in US and spread throughout Europe and Asia:

Jayatilleke DE SILVA

The global financial crisis began with the sub-prime mortgage crash in the United States (US). The crash was precipitated by the large number of foreclosures from March to September 2007. These foreclosures were a result of unprecedented high risks taken by fund managers and investment bankers in the wake of long-term high investment growth and low financial market volatility. New credit instruments were innovated. These include hedge funds, derivatives etc.

The development of information communication technology enabled the electronic transfer of colossal sums of money across the globe at the push of a button. Speculative capital increased several fold. The relation between real material capital and fictitious capital became more and more distant that the latter almost assumed the form of an independent existence.

The underlying relation between the two comes in bold relief at times of crisis when there is a run on money and a large part of the fictitious capital, i.e., bills of exchange, derivatives etc., becomes unredeemable and vanish into thin air. This is exactly what happened with the advent of the present global financial crisis.

Way back in 1993, when the financiers were celebrating the demise of the Union of Soviet Socialist Republics (USSR) and the end of history (or at least communism) H. Minsky prophetically wrote; “...the main purpose of those who controlled corporations was no longer making profits from production and trade but rather to assure that the liabilities of the corporations were fully priced in the financial market....The question of whether a financial structure that commits a large part of the cash flows to debt validation leads to a debacle such as that took place between 1929 and 1933 is now an open question...In the present stage of development the financiers are not acting as ephors of the economy, editing the financing that takes place so that the capital development of the economy is promoted. Today’s managers of money are but little concerned with the development of the capital asset of an economy....Today’s financial structure is more akin to Keynes’ characterization of the financial arrangements of advanced capitalism as a casino”. (Minsky, 1993)

What Minsky saw empirically one and half decades ago, Marx saw theoretically over a century and a quarter ago. In Capital Volume III he said: “In a system of production, where the entire continuity of the reproduction process rests upon credit, a crisis must obviously occur - a tremendous rush for means of payment - when credit suddenly ceases and only cash payments have validity.....And in fact it is only a question of the convertibility of bills of exchange into money. But the majority of these bills represent actual sales and purchases, whose extension far beyond the needs of society is, after all, the basis of the whole crisis. At the same time, an enormous quantity of these bills of exchange represents plain swindle, which now reaches the light of the day and collapses..” (Marx, 1894)

The daily turn over of financial markets exceeded US $ three trillion. Financial capital received an unprecedented mobility. Global cross-border capital flows more than doubled between 2002 and 2007, with foreign investors holding one in four debt securities and one in five equities. (Blankenburg and Palma, 2009)

It is in this context that the subprime mortgage crash occurred. Soon the crisis spread to the entire non-bank financial sector or the shadow financial sector. Nor could the formal banking sector remain unscathed. The fall of Lehman Brothers, the bankruptcy of Merrill Lynch etc. became part of history. The contagion effect resulted in an unprecedented banking crisis.

The crisis, originating in the US soon spread throughout Europe and Asia. Finally, all countries, even those less immersed in the globalised economy were affected by the crisis. The depth of the crisis could be witnessed from the flowing data. The accumulation of toxic debt is enormous. US financial institutions have written off US $ one trillion and are expected to write off another US $ 3 - 5 trillion (Tett, 2009). According to Alan Greenspan, the aggregate equity loss of financial and listed corporate sector, non-listed corporate and uncorporated business concerns and homes would exceed US $ 40 trillion, equivalent to a two-thirds of the global Gross Domestic Product (GDP) in 2008.

The International Labour Organisation estimates that world-wide unemployment could rise between 2007 - 2009 by at least 30 million people and could even rise up to 50 million, if conditions deteriorate.

There is unanimous opinion that the present financial crisis is the worst since that of the 1930s which followed the Great Depression of 1929.

Its effect is greater since the world is more globalised and world population has grown much bigger. In fact it is the first such crisis after the new wave of globalisation set in. It is also the first crisis in the 21st Century.

The primary cause of the crisis lay in the new financial architecture caused by the explosive growth of fictitious capital and the deregulation of financial markets, especially capital account liberalisation. Major developed countries including the US and the United Kingdom (UK) resorted to large-scale regulation of the banking system following the crisis, thus reciprocally proving that deregulation was a cause of the crisis.

There was much more. The whole ideology behind economic management was flawed. Former Chairman of the Federal Exchange Alan Greenspan admitted before a Congressional hearing that the ideology he believed in, the model he perceived was flawed. This ideology, this model was none other than neo-liberalism, first introduced with much fanfare by Margaret Thatcher and Ronald Reagan.

Courtesy: The Economic Review