By Joshua Holland
If the bailout passed last week were to have the desired outcome, kick-starting our ailing economy -- and there’s no reason to believe it will -- we can expect another painful economic crisis in five to 10 years. It may not be an American crisis, and it might get less attention for that reason, but it will happen.
In the meantime, an enormous bubble of paper wealth will grow -- nobody can say in what sector or which region it will occur -- and some people who get out at the right time will make fortunes. But many more will lose their shirts when it all comes crashing down, and crash down it will.
You don’t need prescience to predict this with confidence; those who don’t learn from history are doomed to repeat it. We haven’t learned a thing from recent history -- it would threaten our underlying economic culture to do so -- so we’ll repeat it all over again. Five to 10 years -- mark my words.
In the late 1980s and early 1990s, a huge asset bubble grew up in Asia, as "hot money" -- foreign investment looking to cash in on higher interest rates in those emerging markets -- flooded the region. Japanese housing prices flew through the roof, totally unmoored from the laws of supply and demand. Countries like Thailand, Malaysia, Singapore and South Korea saw growth rates of up to 12 percent, but it wasn’t real growth; as Paul Krugman noted in 1994, it was the effect of tons of new capital flowing in, not real increases in productivity, that created what was then known as the "Asian miracle." When it all came crashing down in 1997 -- the "Asian Financial Crisis" -- trillions of dollars in paper wealth were wiped out and poverty rates spiraled.
Between 1995 and 2000, tech stocks were the Next Big Thing -- the way to get rich in a heartbeat. By the end of the 1990s, the bubble was mammoth, and again, prices of IT sticks had little connection to the sector’s earnings. When the bubble burst, $7 trillion in paper wealth evaporated.
Similar (but not identical) crises have popped up in countries like Argentina, Sweden and Ecuador over the past two decades.
Now we’re facing the consequences of trillions of dollars in overvalued assets in the American real estate market, and we have no idea yet just how much pain that bubble’s deflation will ultimately bring to the global economy.
During the past few weeks, America’s economic and political elites have been running around like the house is on fire, and after quite a bit of arm-twisting, they passed a mammoth banking bailout in an attempt to stave off a complete crash. But nobody dares discuss why this cycle of growing and popping bubbles continues to happen. There’s been some discussion of deregulation, but the simple fact that this pattern is caused by imbalances inherent in our global economic structure has been completely obscured in our mainstream economic discourse.
Only by understanding that some fundamental economic changes that have occurred since the early 1970s have created this cycle of boom and bust can we even hope to prevent the next crisis.
Consider how the following factors play into the investor class’s repeated fits of "irrational exuberance":
- A long-term movement of "corporate globalization," beginning in the 1970s and accelerating through the 1990s, created a global economy in which the wealthy world held onto high-value "core" functions, and farmed out a great deal of nuts-and-bolts manufacturing to the developing world. The problem is that only a handful of people are able to earn a good living from those high-value activities, and the wages of working majorities in wealthy countries have stagnated (more so in the United States than in the social democracies where unions still have some clout). This has led to rising income inequality in the advanced economies.
- The share of the world’s income pulled in by a small elite has grown dramatically, while their share of the tax burden has declined, and those at the top of the economic pile now have more money than they know what to do with. At the same time, global inequality has risen as well, meaning that there’s still a huge portion of the world’s population that doesn’t have the means to be "good consumers."
- That has led to a "crisis of overproduction," with the world now awash in goods -- from microchips to steel to automobiles -- and not enough consumers to absorb all this stuff.
- As a result, the return on real, productive investments like manufacturing and agriculture has declined steadily since the early 1970s, and countries like China only make it work with an almost endless supply of cheap labor -- rural poverty in China is enormous, and as the country’s manufacturing base grows, peasants are simply grabbed from the countryside and stuck onto the factory lines to churn out more crap for Wal-Mart shoppers.
- Since the 1980s, the big multinationals, under the guise of "free trade," have obliterated most domestic regulations on investment capital in countries around the world.
Put all that together, and what we have is a small group of institutions and individuals fat with capital and looking around the world for a better return on their investments than they can get from the "nuts and bolts" economy. All that hungry and lightly regulated capital sloshing around the globe has, in turn, given rise to an enormous speculative economy, and that, in turn, has driven the cycle of boom and bust in recent decades.
The Cycle
All of this comes down to growing inequality, both within and between countries. According to World Bank economist Branko Milanovic, "the inequality between the world’s individuals is staggering," with the top 5 percent of the world’s population controlling the same amount of income as the bottom 80 percent.
That results in a simple aberration: A small fraction of the planet’s population is tied to an economic system in which productivity is effectively an end unto itself. It makes tons and tons of widgets, always seeking new widget markets (and sucking up most of the planet’s raw materials). At the same time, the powerhouses of the global economy -- the United States, Europe, Japan and the "Asian Tigers" -- have given woefully low priority to economic development in the rest of the world. They’ve essentially relegated it to NGOs and an underfunded United Nations, and in their own development funding they’ve prioritized geopolitics -- their "national interests" -- over poverty relief.
That has left much of the rest of the world’s population (and this includes people in the wealthiest countries as well as the poorest) with barely enough money to feed their families, much less to buy all those widgets. According to the UN, 80 percent of the people on the planet live on $10 dollars a day or less, and they’re not going to take many flights on Boeing’s shiny new airplane, buy GE’s dishwashers or use Nortel’s broadband. Over just the past two years, the number of people living on the "edge of emergency" -- in imminent danger of starvation or death from disease epidemics -- has doubled, zooming from 110 million people to 220 million, according to CARE International.
In other words, at the heart of the current crisis, like those that preceded it in recent years, are twin crises inherent in the structure of our global economy: a crisis of overproduction in the "core" states with advanced economies, and soul-crushing poverty in much of the "periphery."
In the booming years after World War II, the wealthy countries, led by the United States, did very well manufacturing goods for the entire planet. But as Europe and Japan rose from the ashes, and later, as production in countries like Taiwan, South Korea and Singapore increased, the industrial world simply started making more gadgets and jeans than there were consumers to purchase them.
Capitalism’s tendency toward overproduction has been something with which thinkers dating back to Karl Marx have wrestled. If, as one definition holds, capitalism is all about maximizing efficiency, what happens when meaningful production becomes so efficient that the system ends up cranking out more goods than the population needs -- more than it can absorb?
The answer is simple. Since the middle of the last century, investors’ returns on real production -- manufacturing -- has been in steady decline. Economist Robert Brenner described it as a "long downturn" in the world’s most advanced economies. He noted that the seven leading industrial economies grew by a steady rate of 5 percent or more annually from the end of World War II through the 1960s, but in the 1970s that fell to 3.6 percent, and it has averaged around 3 percent since 1980.
The social critic Walden Bello has arguably been the clearest voice connecting the problem of overproduction to the rush of speculation that has led to today’s financial meltdown. Bello noted that in the 1990s, the heyday of corporate globalization, the "U.S. computer industry’s capacity was rising at 40 percent annually, far above projected increases in demand."
The world auto industry was selling just 74 percent of the 70.1 million cars it built each year. So much investment took place in global telecommunications infrastructure that traffic carried over fiber-optic networks was reported to be only 2.5 percent of capacity. Retailers suffered as well, with giants like K-Mart and Wal-Mart hit with a tremendous surfeit of floor capacity. There was, as economist Gary Shilling put it, an "oversupply of nearly everything."
A report in the Economist, cited by Bello, found that the world of Bill Clinton’s "New Economy" was "awash with excess capacity in computer chips, steel, cars, textiles and chemicals," and noted that "the gap between capacity and output was the largest since the Great Depression."
An inevitable result of that imbalance was a massive migration of capital from real, productive industry to the "speculative sector" run by financial giants like AIG and Lehman Brothers. As Bello noted:
So profitable was speculation that in addition to traditional activities like lending and dealing in equities and bonds, the ’80s and ’90s witnessed the development of ever more sophisticated financial instruments such as futures, swaps and options -- the so-called trade in derivatives, where profits came not from trading assets but from speculation on the expectations of the risk of underlying assets.
The current crisis is a perfect example. Of late, real estate was the can’t-miss investment, and as an enormously overvalued housing bubble sprang up, Wall Street’s financial whizzes started offering newer and more "creative" investment vehicles, bundling mortgages and selling them off to investors from around the globe.
Without fear of a regulatory backlash, the banks pushed their new investments hard, and speculators seeking better returns than they could hope for in the real, productive economy gobbled them up with glee.
In the end, investors were basically buying up paper that had only a distant relationship with anything concrete. The link that had long existed between homeowners and lenders was broken, and debt -- in this case debt tied to housing, but also commercial and consumer debt -- became a hot investment vehicle.
Convinced that the market would continue to grow indefinitely -- or maybe that they’d get bailed out if things headed south -- investors leveraged their assets further and further, in effect buying on margin just like the bad old days before the Crash.
The banks and investment houses worked hard to find new ways to make their own pounds or rubles, creating not only new types of debt-based securities, but also coming up with new forms of insurance to (supposedly) shield investors against the risk those loans represented.
That was all well and good for them, if not for the rest of us, until the housing market started to tank. Despite assurances from the government earlier this year that the disaster had been "contained" to the subprime market, it began to spread. As those loans -- many of which were taken on investment properties by people expecting a nice, quick turnover -- started to go belly-up, a panic ensued. As the rot spread, banks started going down and investors essentially began a stampede on an already weakened financial sector. It was the modern-day equivalent of a bank run, but on a global scale.
All of this speculation was only possible because of Big Business’s decades-long assault on public interest regulation and economic nationalism under the guise of "free trade" and "limited government."
Here in the United States, the trend of deregulation culminated in 1999 with the death of the Glass-Steagall Act, the New Deal-era legislation that had forced financial institutions to choose between investment banking and commercial lending.
Meanwhile, international bodies like the WTO and the IMF were pressuring the governments of all countries to drop their controls on the flow of cash and goods. Until the era of the World Trade Organization, developing countries often employed various policy tools that forced foreign investors to help boost their domestic economies. Taxes on profits being taken out of the country and "local content" rules that required investors to hire a certain number of citizens or buy a minimum number of locally manufactured parts were routine. But most of those limits have since evaporated in IMF "structural adjustment" agreements and the back rooms of the World Trade Organization, and that has diminished growth in much of the developed world and led to the increasingly speculative tendencies of global investors. Hence, these rising and falling asset bubbles that we see today.
This will continue until we rethink some of the fundamental assumptions of the global economy -- you can bank on it (but not at Washington Mutual).
What to Do?
Re-regulating the American financial system is an obvious response to the meltdown we’re seeing today, but will do nothing to prevent the next one.
It’ll take more than cleaning up the mess on Wall Street. Domestically, tinkering with the tax code could go a long way toward discouraging speculation. Capital gains on investments in productive and sustainable sectors might be slashed, while taxes on short-term investment gains by those looking to turn a quick buck could be raised significantly -- taxing behaviors you don’t want is a tried and tested policy tool. We should be using the tax code to encourage significant investment in new and sustainable energy technologies and to discourage the creation of new speculative asset bubbles.
One idea that’s been kicking around for many years on the international scene is known as the "Tobin tax," a tax on international cash transfers that would go a long way toward curbing the kind of currency speculation that led to the Asian financial crisis.
We can address income inequality at home by raising the minimum wage to a living wage and protecting workers’ right to organize and bargain collectively. In every country that’s seen a decline in unionization rates, it’s been accompanied by a rise in income inequality. An economy as skewed to the wealthy as ours has become completely negates Henry Ford’s idea of paying workers enough to afford to buy the products they create.
Internationally, it’s past time to scrap the one-size-fits-all orthodoxy promoted by institutions like the World Bank, IMF and WTO, and embrace the idea of economic pluralism. That means re-establishing national economies and allowing developing countries to protect their infant industries from foreign competition. The big multinationals have huge advantages in terms of economies of scale, technology and access to capital, and that leaves developing countries only comparative advantages in cheap labor, raw resources and lax environmental standards.
It also means taking economic development in poorer countries seriously -- as not just a moral imperative, but a matter of economic survival for wealthy countries. That would require sustainable, locally driven projects with an independent funding mechanism, as opposed to the kind of big, foreign-run projects favored by institutions like the World Bank and financed with the politically motivated crumbs the global North throws southward today (see, for example, the "Lula Fund" championed by Brazilian President Luiz Inacio Lula da Silva. It would create a global anti-poverty slush fund financed by taxes on weapons transfers).
Short of a massive depression, ideas like these will likely remain on the margins of our economic discourse. That means you can expect another bubble to rise, and burst, within the decade.
Parts of this column were adapted from an earlier piece I wrote, published on Sept. 22.
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