World financial crisis - A self-feeding crisis mechanism

Sept/Oct 1998

It is hardly a year since the south-east Asian financial crisis sent shockwaves across every stock exchange in the world, following the collapse of the Thai currency in July 1997. Yet before the damage caused by this crisis could be fully assessed, let alone patched up, another commotion has already struck the world financial system. This time round, the detonator happens to have been the collapse of the Russian rouble, in mid-August.

Of course, the economic problems underlying the currency meltdowns in Thailand and Russia were very different, both in their nature and their scale. Yet, despite these differences, the mechanism which precipitated the meltdown in both cases - large- scale speculation against the local currency - was very similar. So too was the subsequent shockwave which affected stock markets across the world, including in the richest countries, producing serious cracks in the economies of a number of poorer countries.

If there were noticeable differences, apart from local differences in scale, they had more to do with the speed with which the stock market convulsion spread. Between the initial fall of the rouble, on 17 August, and the 512 point drop of the New York Dow Jones, on 31 August, just two weeks elapsed. By contrast, in 1997, it took more than three months for the collapse of the Thai baht in July to result in the 554 point drop on the New York stock exchange which took place on 27 October.

But as to the mechanisms by which this new crisis has affected the world financial system, they are definitely identical. Few economic commentators still deny today the decisive role played by the uncontrolled and uncontrollable movements of international floating capital in generating and spreading the disease. In fact, most "experts" have even come to admit, albeit reluctantly, that the prolonged financial crisis in south-east Asia and the shockwave sent across the world by the collapse of the rouble are interconnected parts of the same process. Only their servility to the capitalist system prevents them, therefore, from drawing the obvious conclusion.

Indeed it is clear that these devastating pendulum movements of the financial system are neither accidental nor mere "corrections", as has been the official line for so long. On the contrary, they are part of the "normal" behaviour of the world capitalist system, crippled as it is by a crisis which became permanent more than two decades ago. Each time these pendulum movements reach a crisis point, control is only regained by stoking up even more explosive material for the next crisis, so that every successive crisis is less and less controllable.

From Thailand to Russia

So, how do the detonators of the two crises - Thailand in 1997 and Russia in 1998 - compare? What are the similarities and what are the differences?

In Thailand, as in most south-east Asian countries, an artificial financial bubble developed in the 1990s, fed by international floating capital attracted by a stable currency pegged to the US dollar, cheap labour, lenient regulations and, above all, the prospect of high returns. The apparently inexhaustible short-term credit on offer (at a high price, of course) fuelled a speculative spree - in real estate, in particular. Grandiose infrastructure projects mushroomed, profiting the construction and engineering multinational companies, but nobody else as it turned out. Because these projects made little economic sense and soon failed to find buyers, thereby generating a growing mountain of "bad" debt. Eventually, the crunch came when international fund managers decided that it was time for them to withdraw gracefully, if possible at a profit. It was this move that precipitated the currency crash.

In the case of Russia, on the other hand, the hope that the introduction of the capitalist market in the former Soviet Union would offer real bargains and new market opportunities initially attracted only a small amount of capital. Instead, the havoc caused by the break-up of the USSR combined with the hijacking of the economy by rival bureaucratic cliques led to economic disaster. The bargains proved limited, the new markets elusive. Far from working miracles and bringing prosperity to the Russian population, as the western media had promised, the introduction of market mechanisms only made the looting of the economy by the old state bureaucracy more damaging.

What eventually attracted large amounts of speculative capital into Russia was the introduction, in March 1995, of a new kind of Treasury bond with the vocal support of the IMF and the promise of more IMF-backed international loans. Therefore, instead of financing a relative (even if artificial) economic development as in south-east Asia, in Russia speculative capital provided the various bodies and appendages of the state machinery with the credit and foreign currency they needed to patch up, at least temporarily, their enormous and growing deficits. However, new resources failed to materialise - due, in particular, to the incapacity of the central state to enforce its own tax rules and the ongoing downward slide of the economy - and these deficits turned into a black hole.

Speculators, Russian and foreign, began to bet on a fall of share and bond prices, shifting part of their holdings out of Russia. From April, the papers reported heavy sales of debt bonds in general and government securities in particular. In May, an attempt to float a 75% share of Rosneft, the last big oil firm controlled by the central state, was a complete flop. By the end of the month, Yeltsin passed a drastic package of spending cuts, while the state bank tripled some of its benchmark interest rates - to no avail.

In July, the IMF intervened to pre-empt a possible bankruptcy of the state, with an unprecedented $22.6bn package, the third largest ever, in history. But this pre-emptive rescue proved just as futile. By mid-August, the government dropped its effort to sustain the fixed rate of the rouble against the dollar. On 17 August, the rouble was allowed to float within fixed limits. This amounted to a 34% devaluation of the Russian currency. At the same time, trading on short-term government bonds was suspended and a 90-day moratorium on all foreign debt repayment was declared.

This did not prevent the Russian stock exchange from having another fit just nine days later, on 26 August, with a 10% drop, while the rouble came dangerously close to its minimum value. This threatened to be the final blow for many Russian banks, already plagued by enormously inflated foreign debts. As an emergency measure, they were allowed to use part of their statutory reserves to face immediate payments. But instead, the banks changed most of this fresh cash into dollars, thereby pushing the rouble even further down. This prompted the government to resort to even more drastic measures the following day. Not only did the central bank suspend trading of roubles for dollars but it announced the compulsory exchange of short-term government bonds (which earned, by that time, sky-high interest) for new longer-term bonds carrying a much lower interest. To all intents and purposes, this amounted to the Russian state defaulting on part of its debt - partial bankruptcy in disguise.

So, while the final forms of the crises in Thailand and Russia were similar - a currency crisis - the mechanisms which produced them were quite different, despite the common label of "emerging markets" which was usually applied to both countries by the western media.

There is nothing surprising in this, as the "emerging market" label was designed to confuse things and generate illusion rather than describe the reality. In fact, it was already misleading, in and of itself, to apply this label to Third World countries like those of south-east Asia - in so far as the limited industrial development experienced by these countries until last year never gave them a chance to build up a fully-fledged industrial economy, let alone to join the ranks of the rich countries, contrary to what this label implied. But applying this label to Russia and its collapsing economy was verging on outright farce. A graphic illustration of this was given, for instance, by an estimate of western capital exposure to Russia, published in the Financial Times on 28 August: out of a total of $205bn, only $11bn involved shares and assets in the real economy, the rest - 95% of western capital "invested" in Russia - represented loans and debt bonds. In reality Russia did not, and still does not, have a real market for capital, not even of the limited kind that existed in the south-east Asian countries before the 1990s. So that a more accurate label for Russia would have been that of "non-existent market".

In the end, the only common feature in the Asian and Russian crises was the role played by international floating capital in accelerating the financial meltdown and precipitating the crisis in both cases.

Are the "bad guys" in Moscow or in Tokyo?

Significantly, the general fall of stock markets across the world on 31 August and the following day, came after a relatively long, albeit slower fall, which was briefly accelerated by the collapse of the rouble. In the case of south-east Asia and Latin America, this fall began in March or April, resulting, by mid- September, in a drop of 18% for Japan, 34% for Hong Kong and 61% for Brazil. In the rich western countries, on the other hand, the slide began in July. Shares in New York, for example, had already lost 14% of their value before the biggest drop on 31 August. In other words, the Russian shockwave across the world took place in parallel with the final slide of the rouble, anticipating its outcome and magnifying its impact outside Russia, rather than being triggered by the rouble's actual collapse.

But, at first at least, this did not stop economic "experts" from blaming Russian politicians, almost unanimously, for their "mismanagement" of the economy, if not their "nostalgia" for the days of the Soviet Union - this last accusation is all the more ironical as no Russian politician today would even consider abandoning willingly the significant advantages that the introduction of the market has awarded the privileged layers to which they belong!

The British business weekly The Economist, for instance, resorted to an amazing sleight of hand in an editorial article on 5 September: "Although the economic pain that is being inflicted on Russia and the ex-tigers is out of all proportion to the policy errors of their governments, the fact remains that the vulnerability to financial crisis was created not by international speculators, and other bogeymen but by woeful oversight of domestic finance, private, public and quasi- public."

In other words, there is nothing wrong in speculators - i.e. capitalists in general, since speculation is a built-in feature of capitalist finance - trying to rip profits out of weaker economies, even if this means pushing them into crisis and recession in the process! From a capitalist point of view - which is obviously that of The Economist - the reasoning behind this cannot be faulted : if the free flow of capital across the world is considered as an integral component of capitalism, then the speculators can never be blamed for the consequences of their actions; it is up to everybody else to take the hazard of speculation into account and learn to live with it by pre-empting its destructive impact! This is certainly showing the true face of capitalism - the law of the jungle. This amounts to stating that, since theft is also an integral part of any society based on private property, thieves should never be jailed and their victims should be blamed for having been caught out...

Blaming the victims for their own ills and for the consequences to the world economy does not sound very credible, however, even less so when it comes to Russia. After all, as a leader article of the French daily Le Monde points out, "very fortunately, since Russia had made us the favour of refusing to insert itself into the world market, it cannot generate strong economic disturbances in the West" - which is undoubtedly a fair assessment of the situation, given the comparatively low volume of trade and financial exchange between Russia and the West. So the danger for the future, and the cause of the recent shockwave, must come from elsewhere. And since for the writer, a former member of the French Communist Party turned staunch anti- communist and supporter of capitalism, it cannot come from the capitalist system itself, it must come from... Japan.

This alternative "bad guys theory" has, in fact, many supporters. In an interview to a Japanese paper published in the first week of September, Henry Kaufman, a former chief economist with the investment bank Salomon Brothers (one of the big players in the worldwide speculation game) explained the Russian debacle and the subsequent worldwide financial turmoil, particularly the sharp fall of the yen against the dollar, in the following way: "Behind the Russian crisis, the major reason was the situation in Japan. The bad debt of the Japanese financial institutions seems to have reached $1 trillion (..) Investors around the world were purchasing Russian bonds by borrowing yen since the interest rates in Japan are so low. Faced with the Russian crisis, they sold them and cashed them in. They made repayment in yen and this pushed the value of the yen down." The culprit, therefore, is the Japanese government for setting its interest rate at such a low level (currently 0.5% compared to 7.5% in Britain). But while Kaufman's reasoning stops conveniently at this point, he could have taken it one step further by explaining where Japan's extremely low interest rates and huge "bad debts" originated from - on the one hand, the on-going currency speculation which plagues Japan's finance and, on the other hand, the banking crisis inherited from the explosion of a speculative bubble back in 1990.

No-one of course would deny that a meltdown in Japan would certainly represent a much greater threat for the world economy than one in Russia. But, whichever way one looks at the problem and regardless of the policy of its government, Japan proves to be no less subjected (and vulnerable) to having its economy preyed upon by international fund managers and other capitalist speculators - that is to the havoc that capitalism itself creates in its trail.

Another link in a chain of crises

Even The Economist had to admit, after the Russian crisis, that "the sickness that started in Asia is spreading still, claiming victims far beyond its source. Investors cannot find time to count their money losses, so busy are they trying to guess where the plague will strike next." As usual, "investors" - that is capitalists, since few small investors would be able to gamble on the so-called "emerging markets" - are given the best role by The Economist. Never mind the fact that for instance, a "big loser" in the Russian crisis, the famous fund manager George Soros, made hefty profits from his other investment representing nearly twice his losses in Russia; or that although the owners of shares quoted in New York have lost almost all their gains since last January, they can still rest comfortably on those made over the previous three years, in which share prices more than doubled. "Investors" seem to be doing quite well after all!

But at least The Economist does admit that the turmoil that followed the Russian crisis and that in south-east Asia are part of the same protracted financial crisis and that there is every reason to think that there will be other explosions in this chain of crises.

In fact, the thread that links the south east Asian and Russian crises can be traced back to the 1980s. At the time capitalists were seeking new ways of making fast profits in a context where the general crisis of the capitalist system was making productive investment more uncertain and less profitable. The financial deregulation introduced during this decade in the main western countries increased the speed at which financial transactions were made, cut cost overheads by ending the role of intermediaries and created new ways of channelling a larger share of the populations' savings into speculative operations. Out of these changes came today's huge investment and pension funds, which make up the bulk of the floating capital which is constantly roaming around the world in search of short-term high-yield investment, in order to make a quick buck.

The size of these funds is sometimes comparable to that of the budget of major countries. For instance, the world's largest investment fund, the US company Fidelity Investment, has over £350bn under management, more than the total British budget. And the world's ten largest funds manage a total representing more than three times the value of the annual production of Britain. With such enormous amounts of capital at hand, which can be moved instantly from one side of the planet to the other via computer links, the large fund managers can indeed upset the financial balance of most small countries and even sometimes of the richest, as was shown by the speculative wave which forced the pound out of the European monetary system in 1992.

The collapse of the financial bubble in Japan, in 1990, seems to be the first link in the present chain of crises. Unlike the more recent crises, this collapse did not take the form of a currency meltdown (although the yen took a serious beating) nor did it create significant turmoil in financial markets outside Japan. But it resulted in an enormous outflow of floating capital toward the rest of the world, and in particular toward the rest of south-east Asia. This flow of capital then kickstarted the speculative bubble which eventually burst last year in the region. And in that sense, the 1990 crisis in Japan can be said to have primed the 1997 south- east Asian crisis.

The next link came in December 1994, with the collapse of the Mexican peso. When the Mexican government was forced by speculative pressure to devalue the peso by 15%, fund managers - in particular those of US pension and mutual funds - who had made vast profits by lending money at high interest rates to the Mexican government, pulled out in a panic, accelerating the fall of the peso far below the 15% planned, down by 30%. At the same time, a number of Third World currencies experienced large falls. As Mexico's public and private debt was mostly in US dollars, in a matter of a few days it was faced with an enormously inflated debt mountain compared to the country's wealth. Mexico was only prevented from going bankrupt by an emergency loan package worth $50bn put together by Clinton and the IMF in order to protect American lenders.

The floating capital which had precipitated the Mexican crisis and brought it to the verge of bankruptcy went elsewhere - to south- east Asia, Russia and other Latin American countries. By 1996, in the five south-east Asian countries worst hit by last year's crisis, new bank loans (short-term as well as long-term) had increased by 138% compared to 1994, investment in shares by 50% and investment in bonds (i.e. mostly short-term debt) by 845%!

Fed by the outflow of floating capital from the Japanese and Mexican crises, a new financial bubble was beginning to reach alarming proportions in south-east Asia, before bursting two years later and devastating the whole region. Meanwhile other fund managers, or the same ones, were flocking to Russia, offering to supplement the long-term loans and investment parsimoniously provided by western powers, with a massive amount of much more costly short-term loans. Three years later this invasion of speculative capital finally proved inadequate to paper over the growing deficit of the state and precipitated the collapse of the rouble.

This crisis chain can only keep generating new crises elsewhere, since its main mechanism involves propelling the cause of the disease, floating capital, from the crisis-ridden areas to the (relatively) less affected ones. Therefore, the plague can only spread always further, and as the "healthy" areas become both more limited and less healthy, the disease can only become more destructive.

The question of capital controls

The days - recent, only a few months ago - when Camdessus, the IMF managing director, referred to the south-east Asian crisis as a "blessing in disguise", because it forced the crisis- stricken countries to implement the liberal measures demanded by the IMF, are over. In an interview to the French business paper Les Echos published on September 14, Camdessus had a very different tone: "I am going to ring the alarm: we must prepare without delay for the next crisis."

A few days earlier, in California, Alan Greenspan, the chairman of the US Federal Reserve Bank, was also ringing the alarm in his own way: "It is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress (..) As dislocation mounts, feeding back to our markets, restraint is likely to intensify." Meanwhile, another US financial leader explained with visible apprehension that only half of the funds withdrawn from the US stock markets since the end of August had been reinvested in government bonds - meaning that the other half was probably invested in short term speculation on the currency markets, spelling possible currency havoc in the weeks or months to come. Again, the days when US economic leaders praised the healthy "fundamentals" of the US economy as an impregnable barrier against the financial turmoil in Asia, seem to be gone for good.

In fact, the situation is seen as so alarming that business papers are now full of articles about capital controls - for or against. Even the Financial Times, an unconditional advocate of liberalism, explains about the capital controls announced by the Malaysian government on 1 September, that although these are "dirty words in today's financial orthodoxy", such controls must be considered an option in some countries where "unfettered movements of capital can have devastating effects".

However, the obviously legitimate need of a small devastated Third World country (or even of Russia, with its collapsing economy) to take protective measures against speculation, may be one thing. Disciplining the worldwide flow of speculative capital is quite another. Indeed, given the internationalisation of profit- making for the capitalist classes of the rich countries in particular, taming the merry-go-round of floating capital would effectively mean curbing financial profits - an item which had become prominent in the balance-sheets of all major companies, including those which are dealing exclusively in production and trade. These bourgeoisies and their governments would certainly never agree in the present context to such a step. At most they may tolerate a return to limited state controls, but only provided it did not impinge on their freedom to make profits, that is, provided it was largely ineffective.

Those who are arguing in favour of capital controls and similar devices to make capitalism more "civilised" - i.e. less crisis-ridden - are thus caught in a catch 22 situation. What they advocate is to paper over the gaping cracks of the system, when it is the system itself, and not just its cracks, which is the problem.

The IMF, fire-fighter or incendiary?

This discussion of capital controls is obviously connected to that of the IMF's intervention which, in the case of Russia, has proved utterly useless, despite the IMF's very unusual attempt at pre-empting a possible collapse of the rouble rather than intervening once the damage is done.

The impotence of the IMF was highlighted in the almost naïve admission made by its deputy managing director, Fisher, in an interview published on 7 September: "International speculators, namely financial mafia speculators, turned to selling off Russian roubles, seeking only their own profits (..) They were concerned only about their own profits, knowing that their sell-off could cause a chain reaction on world financial markets (..) The IMF will not claim that these speculators were the cause of this evil, since the IMF is advocating a free economy". Then turning against George Soros, Fisher adds bitterly: "Soros did not anticipate the crisis and worldwide plunge of the stock markets. Mr Soros reportedly has lost $2bn in this crisis. It is his fault. He has set fire to Russia and made the financial aid of the free world a failure. Without his intervention, our aid to Russia would have worked effectively."

Whether Soros is really personally responsible for the failure of the IMF rescue package (because he was the first to advocate publicly a devaluation of the rouble) is obviously questionable. But that a top functionary of the IMF should recognise publicly, with such an obvious frustration, the paralysis of this powerful institution in front of speculators, certainly shows that the IMF's intervention cannot in the least stop or pre-empt further outbreaks of financial crisis generated by international floating capital.

In fact the only thing that the IMF has managed to achieve so far, has been primarily to protect the richest countries from any major damage. But as to the poor countries which happened to be near the centre of the storm, they have been made to pay a terrible price as was shown for instance by the recent hunger riots in Indonesia.

Not only is the IMF paralysed in front of speculation, but its interventions have actually bolstered the taste for profitable risk- taking among speculators. Indeed, if fund managers have learnt a lesson from the 1994-95 Mexican crisis, it is not that they should be more cautious in future as to the damage their actions could cause in host countries. On the contrary, the IMF's $50bn bail- out package showed them that no matter how reckless their behaviour, the international financial agencies of imperialism would always be there to bail out their victims among the financial institutions and themselves into the bargain, if necessary. With such a backing, why would speculators stop at making a few more billions by betting on a currency's fall? Since they have no concern whatsoever for the human and social consequences of their gambling, all they need to know is that the targeted country's financial skeleton will be preserved by the IMF, long enough in any case to pay its debts.

Moreover bailing out investment funds, banks, etc... after the collapse of a speculative bubble, by injecting tens of billions of dollars into the financial sphere, amounts to replacing permanently part of the artificially inflated paper value which has disappeared in the collapse. Yet this value only existed in the illusion created by the speculative bubble: it never had any counterpart in the real world. For the states who fund the IMF, to recreate this value permanently amounts to subsidising speculators and printing false money, therefore boosting both inflation and speculation and stoking up even more trouble for the next crisis.

Where next?

This next crisis is no longer considered as a remote possibility by economic experts. According to the IMF itself, it is already there in the making, in South America, only weeks after the meltdown in Russia. Brazil, says the IMF, already shows signs of wearing out. Its stock market is sliding down rapidly; high interest rates, at almost 50%, have failed to stop the flight of capital out of the country, with $1bn leaving the country everyday since the beginning of September; its currency, which is pegged to the dollar, only manages to maintain itself thanks to enormously expensive short-term borrowing. All the ingredients for a currency meltdown are there, in a country which is by far the largest in South America and, what is more, closely dependent on US banks. Hence, no doubt, the alarmed urgency expressed by the IMF leaders.

No-one can say what will come out of the Russian crisis, nor if Brazil (and therefore probably the whole of South America) will be the next link in the financial crisis chain, and if it is, what the impact of this new crisis will be, so soon after the last one.

But even if this new crisis does not materialise in the short term, the past crises have already taken their toll much beyond the abstract world of finance. In south-east Asia particularly, the human cost of the crisis, in terms of unemployment, impoverishment and even famine, is already enormous. The real economy itself has been drastically damaged. In the whole region, large numbers of factories, offices, etc.. have been closed down and often dismantled, because the fall of the national currency and the credit squeeze produced by the crisis made it impossible to buy parts and raw material, renew machinery or simply find customers. And as conditions are not likely to improve in the foreseeable future, most of these factories and office towers will probably be left to fall apart irreversibly, next to the unfinished motorways, hospitals, sewage systems and power plants which the state can no longer afford to finance or even run. It may well be, in fact, that in some of these countries - in the poorest like Indonesia or Thailand - this destruction of productive forces will push the economy back to levels lower than those which pertained before anyone dreamt up the phrase "emerging markets".

Brazil itself may well manage, with or without the help of the IMF, to avoid a meltdown by finding ways of luring speculative capital into staying - at an exorbitant cost - while making do with a drastic shortage of credit. The consequences of this would be less brutal than that of an open crisis, but it would nevertheless mean a drastic slowdown of the economy which would also seriously affect Brazil's main trading partners in South America, particularly Argentina. Moreover, in a country as poor as Brazil, such a slowdown would not only destroy part of the stock of productive forces, it would also spell utter deprivation, possibly starvation, for large layers of the poor population. In that case, an open crisis would be avoided, but at what cost!

Besides, even assuming that the world financial system is more or less preserved without too much damage, there is a possibility that the shrinkage of the world market due to the impoverishment of south-east Asia and possibly now South America will result in a serious recession for the industrialised countries. Not to mention the compounding effect of the ongoing "crisis within the crisis" of the Japanese banking system and the resulting possible complications for the Japanese market.

The threat of a generalised worldwide meltdown may still be far away. But the facts, as well as the warnings of the international troubleshooters of the capitalist system, seem to indicate that it is closer than it was last year, after the south-east Asian crisis broke out. In any case the mechanisms to bring this crisis even closer are there, operating fully, as an integral part of the capitalist organisation of the world economy and of its long death agony.