The gravity of the present world economic crisis comes in part from the spectacular imbalances and crazy capital flows that occurred in the years of the boom that finally juddered to a halt last year. Martin Wolf, an eminent spokesperson for big capital, warns in the Financial Times (02.12.08), “The world has run out of willing and creditworthy private borrowers. The spectacular collapse of the western financial system is a symptom of this big fact... In the long run, the global economy will have to rebalance.” If it doesn’t work out, “The open world economy may even break down. As in the 1930s, this is now a real danger.”

He goes on, “In 2008, according to forecasts from the International Monetary Fund, the aggregate excess of savings over investment in surplus countries will be just over $2,000bn...In 2008 the big deficit countries are, in order, the US, Spain, the UK, France, Italy and Australia. The US is far and away the biggest borrower of them all. These six countries are expected to run almost 70 per cent of the world’s deficits.”

Global imbalances

This is not supposed to happen. The countries mentioned are the heartlands of world imperialism. Imperialism, according to Lenin’s classic account, is characterised by the export of capital. That means the imperialist powers are supposed to lend to the poor countries. But in the twenty-first century they have been running huge deficits in trade with the rest of the world. They have become the borrowers!

Who has been lending them the money to live beyond their means? According to Wolf it is the oil exporting countries, then China, Germany and Japan. China alone has a surplus of $399bn. Yet compared with the USA, China is a poor country. But for years past the bilateral surplus China runs with the USA on trade is closely mirrored by the capital flows from China to the USA, in the form of huge acquisitions of mountains of American government securities. In effect China has been lending the USA the money to buy Chinese imports!

The very same countries that have huge current account deficits with the rest of the world have exhibited similar financial recklessness at home. US household debt stood at 128% of income. But the champion was the UK, with consumer debt at 175% of earnings. Consumers in both countries have been spending like there’s no tomorrow. And they haven’t been spending their own money. They’ve been buying on the ‘never never’.

Their governments have been doing the same. The US under Bush has amassed a public debt of $10.6trn. Though New Labour showed greater ‘prudence’ till recently, the government spending splurge intended to get Britain out of the recessionary mire will definitely see the government running a deficit so big that they will be spending 8% more than the nation produces – which will send our debt rocketing. Marx once said that under capitalism the only part of the national wealth common people really own is the national debt.

So both the private sector and the government have been spending money they haven’t got. And both countries have been living at the expense of the rest of the world. That sounds just like imperialism! All this has only been made possible by huge capital flows. In effect these flows have created these global imbalances which now come crashing down around our ears.

Imperialism and the export of capital

It should have been clear for years that the situation described could not go on. But that is not the end of the tale of the money-go-round. For those imperialist countries have also been lending their money back out. In particular their targets have been a selected few of the poor countries, and also the former Stalinist states. This does not include countries in Africa south of the Sahara, the whole of which is cynically written off by capitalists with an eye to the main chance as a ‘basket case’.

The countries that have been the lucky recipients of western investment and western loans are described as ‘emerging markets.’ This phrase displays a touching optimism as to the ability of capitalism to raise the living standards of all the people, as their countries are progressively integrated into the world market. As we see, this optimism is misplaced. Instead these unhappy lands have been integrated into a world of crisis and declining living standards. The imperialist powers are determined to make them the principal victims of the present crisis. The harsh medicine to be meted out by imperialism amounts to holding their heads beneath the waters till bubbles cease to rise to the surface.

The gross imbalances in the world economic system are stacked on top of one another like a house of cards. The slightest breath of wind could cause the whole elaborate edifice to collapse. The nodes or junctions between the different units of this structure are the currency exchange rates. The stresses and imbalances in the world economy express themselves in monetary crisis and exchange rate instability. The economic crisis calls out international monetary system into question. But, as Martin Wolf warned, if the world economy breaks down, the present crisis could become as grave as that of the 1930s.

Fixed exchange rates

The system of fixed exchange rates established by the post-War settlement in 1944 broke down in 1971 when the USA refused to exchange dollars for gold – which was the foundation stone of the original deal. The Bretton Woods agreement collapsed, not because of a failure by its founders to adequately grasp the concepts of monetary economics, but because the world had changed in the meantime. At the end of the Second World War the USA dominated world trade, it was the hegemonic capitalist power, and the only capitalist creditor nation. The dollar really was as good as gold. Naturally it was the basic unit of world trade, and most countries held their reserves in dollars. The post-War boom led to the revival of rival capitalist economies, most notably in Germany and Japan. Ironically, these countries began to export more and more effectively to the USA, and dollars flowed out of America to pay for them. Over the course of the long boom the USA moved from the status of creditor to debtor nation. In 1971 the USA effectively devalued the dollar and reneged on the system that had served its interests so well in the past.

Under a system of fixed exchange rates the authorities have to meet any demand for the national currency with the equivalent in foreign exchange. This means that they have to keep trade with the rest of the world roughly in balance. If the country is running a big deficit, it will run out of foreign exchange to pay for all the imports. Under a regime of fixed exchange rates, capital movements are subordinate to the movement of money to pay for goods. All the big countries maintained systems of capital controls in order to keep the exchange rate stable. Big capital movements against a currency could destroy this stability and cause a devaluation.

Floating exchange rates

After 1971 the world moved to a system of floating exchange rates. Here the rate of exchange is not fixed by the government, but is set by supply and demand according to market forces. The exchange rate is determined by monetary flows in and out of the country conducted by speculators. Since the government is not trying to maintain a fixed rate of exchange, there is no need to keep capital movements in a tight corset. Monetary movements are no longer the counterpart of goods transfers, but became increasingly dominated by capital flows, which take on a life of their own.

Vast capital movements are a feature of the modern era. In the new millennium capital flows overwhelm trade payments in the formation of exchange rates by a factor of 100:1. Speculation in foreign exchange becomes a major motive for monetary flows. Yet 90% of this speculation is in half a dozen major currencies. Among the ‘emerging economies’ most governments fix their national money against one of the global currencies, such as the US dollar or the Euro. In doing so, they expose their currency to speculation by the ocean of money that these global capital flows represent. When the balance of payments looks precarious, the speculative sharks gather round. They bet on a devaluation. A fixed exchange rate under siege offers a one way bet. If the currency doesn’t devalue, the speculators have lost nothing. If it does, they can make 10% or 20% (whatever the devaluation is) in a day. So they wait. In doing so, they make devaluation a certainty. This is the process we are watching now in one country after another. It is brutal and inexorable, and it leads to the impoverishment of already poor countries.

Borrowers and lenders

Another feature of the modern era is the fact that some countries can maintain a position as borrower nations for years, as long as they are prepared to pay the interest on their loans, and the markets have confidence the situation can continue. In 1967 a balance of payments crisis forced the Labour government of the time to devalue. The International Monetary Fund intervened, demanding that the Labour government of the time stop its profligacy. The supposedly sovereign government was humiliatingly forced to tear up the reform programme the British people had voted it into office to carry out, and to move to counter-reforms in order to reassure the foreign speculators.

Yet the deficit Britain was running amounted to less than 2% of GDP. In recent years Britain, like the USA has been running deficits of 5-6% year after year without anyone calling the British government to order.  How can this be? Capital can on no account be allowed to lie idle. It must be given things to do, whatever mischief it causes. A function of these huge capital flows, anxious to go anywhere in search of a return, is that imbalances can be created, balloon and be allowed to fester, apparently oblivious to elementary principles of accounting known to all. Even Mr Micawber, in Charles Dickens’ Pickwick Papers could recite, "Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery." (In modern currency this translates as £19.99 and £20.01 respectively.)

Fictitious capital

This capital that caused so much damage is fictitious. It consists entirely on pieces of paper that represent claims on the unpaid labour of workers somewhere. The ‘GDP’ of the planet, the amount of new values we collectively produced each year, increased by 4% or 5% p.a. in the early years of the new century through prodigious efforts on the part of earth’s 6 billion inhabitants. This credit mountain of fictitious capital built itself up with perfect ease over the same period like an enormous parasitic growth. It now comes to about $600trn, compared with a world GDP of $50trn in 2007.

 This capital may be fictitious, but it has real effects. It demands imperatively to be paid and, in the process, it can cause bubbles, panics, crashes and manias that can devastate real productive capacity. Actually all this shows is that ,with big capital flows, you can get yourself in a much bigger mess with much more massive debt than was possible forty years ago. As Joe Louis used to say, “The bigger they come, the harder they fall.”

The ‘carry trade’

Usually investment in poor countries by rich countries, or loans to the poor countries, is seen as some sort of assistance for them. Surely that is better than leaving them to pull themselves up by their own bootstraps! Actually one reason for these capital flows was the ‘carry trade,’ discussed in our recent article on Iceland. The importance of the carry trade is that it shows capital movements are purely in search for a fast buck. They do not represent a rational transfer of resources to countries that most need them. Capital involved in the carry trade moves purely to take advantage of interest rate differentials.

In the case of Iceland Western capitalism poured money into a country with a population the size of Coventry not to help the Icelanders but to take advantage of their relatively high interest rates. This was sheer speculation. Jack Smart explained, “This is a way for capitalist speculators and swindlers to borrow money outside Iceland, e.g. in the Eurozone, at low interest rates, exchange it into Icelandic Krona, and to lend it to banks, companies and individuals in Iceland at higher interest rates. The difference between the two interest rates was pocketed by the capitalist as profit...The FT reported on 8 October 2008 that according to the central bank of Iceland, the money owed by the country's banks to foreigners amounted in the second quarter of 2008 to six times Iceland's GDP (annual national income). Iceland had become in capitalist eyes a ‘reasonably large banking system with a small country attached’ (FT 8 October 2008), but the banking system itself was in crisis.” (http://www.socialist.net/iceland-what-happened.htm)

Any sane person could have predicted that national bankruptcy would be the inevitable result of loading up the Icelandic economy with debts equal to six times its productive capacity. But the speculators roam in packs. Their motto is, ‘the devil take the hindmost.’

So the carry trade has led to perverse investment flows. So long as interest rates varied between different countries, then speculators could exploit those interest rate differentials to make money. This activity was completely risk free – as long as the money kept flowing. The collapse of Lehman Brothers in September 2008 meant that the money fountain suddenly stopped. As a result the whole spider’s web of global transactions was rent asunder, and capitalists and whole nations left hanging in mid air.

Emerging into what?

Growth in Eastern Europe has been quite impressive over the past five years or so. This has fed the illusion that these economies are indeed emerging on to the world market as equal partners with the classic imperialist countries. But, throughout this period of growth, they were carrying massive levels of debt and running big deficits with the West. As we now see, this was like riding a high geared bike. The rider has to pedal furiously to avoid falling off – as has now happened. Their growth was at every stage limited and determined by the great capitalist powers. And when things get sticky, the little countries are the ones that get it in the neck. They are all about to share, to a greater or lesser degree, the fate of Iceland, known in stockbrokers’ newsletters as ‘the canary in the coal mine.’

The banking collapse has brought the free flow of funds, and with it the carry trade, to an abrupt halt. Economist Paul Krugman explains the consequences for Japan of the credit crunch. Japan is a much bigger player in the world economy than Iceland, the second largest national economy in the world. “The conduit of funds from Japan and other low-interest nations was cut off, leading to a round of self-reinforcing effects. Because capital was no longer flowing out of Japan, the value of the yen soared: because capital was no longer flowing into emerging markets, the value of emerging-market currencies plunged. This led to large capital losses for whoever had borrowed in one currency and lent in another. In some cases, that meant hedge funds...began shrinking rapidly. In other cases, it meant it meant firms in emerging markets, which had borrowed cheaply abroad, suddenly faced big losses.”

The collapse

So the credit crunch impacted on the ‘emerging markets’ through a drying up of funds from the West, after it had lumbered them with monster foreign debts they could only finance through exports.  As the crisis took hold in the West, these export markets also dried up. This in turn caused a crisis in the world market for the commodities supplied by the poor countries, and a collapse in the price of commodities by which they hoped to make a living in the world. The West was then forced to contemplate a serious prospect of default on their debts in the ‘emerging markets’. This provoked a flight of capital from the dependent countries and put extreme pressure on their currency to take the strain. This is why we live in a period of extreme exchange rate volatility. They are the transmission mechanism that reflects the pressures upon the unbalanced world economy. Exchange rates take the strain, and if it is too great they break.

Ukraine

A classic example is Ukraine, now undergoing treatment from the IMF. As the Financial Times pointed out (Kiev crunch 03.12.08), the impressive growth seen in the country over the past five years is all based on foreign investment. “Foreign banks bought local subsidiaries and foreign lenders piled in, raising the ratio of external debt to gross domestic product from 45 per cent in 2005 to nearly 60 per cent at the end of last year and a forecast 78 per cent next year, according to the IMF... With the current account deficit widening to an estimated 10 per cent this year, external funding evaporating and the currency falling fast, Kiev turned to the IMF to help fund its external financing needs of about $50bn a year.”

The article continues, “The authorities expect about a third of the country’s 170 banks to close or merge. Other industries with opportunities for bottom-fishing investors include property, manufacturing and metals.” Of course a tragedy for a country such as Ukraine is a profit opportunity for the sharks. That’s all on top of the country being under the cosh of the International Monetary Fund, the financial sheriff.

“The impact of the crisis on the real economy is only beginning to emerge, with a 20 per cent drop in industrial production in October. As well as steel workers and coal miners, employees in every sector from banking to bars fear for their jobs.” A 20% drop in output in a single month. Welcome to capitalism!

Ukraine was heavily dependent on exporting iron and steel to Western Europe. Now, because of the economic crisis, the bottom has dropped out of their main market. Not only that. The price of the iron and steel they do manage to sell abroad is falling precipitously.

But the debts they hoped to pay off with steel exports remain. In fact they will get more onerous for most ‘emerging economies’ as their currencies collapse as a result of the devaluation. They will have to pay out more and more Ukrainian Hryvnia for each dollar of debt. Trouble piles on trouble.

Russia

Ukraine’s bigger neighbour Russia is struggling from the same disease. Here’s Paul Krugman on their plight. “In Russia, for example, banks and corporations rushed to borrow abroad because foreign interest rates were lower than rouble rates. So while the Russian government was accumulating an impressive $560bn hoard of foreign exchange, Russian corporations and banks were running up an almost equally impressive $460bn foreign debt. Then suddenly, these corporations and banks found their credit lines cut off and the rouble value of their debts surging. This, truly, is the mother of all currency crises, and it represents a fresh disaster for the world’s financial system.” Political forecasting agency Stratfor says that Russia is experiencing “a comprehensive flight of foreign capital.”It seems the prudent (and ultimately pointless) stockpiling of foreign exchange affords no protection against predatory capital flows. No country is big enough to take on global finance capital. Not only are the rouble and foreign exchange reserves at risk. $230bn has been wiped off the value of oligarchs’ shares on the stock exchanges. As panic struck in September, the authorities had no alternative but to suspend trading.

National defaults?

As we now know, speculators will bet on two flies crawling up a wall. They have evolved elaborate instruments to wrap up their bets. Credit Default Swaps can be made up not just to measure corporate risk, but also against government securities. In effect you can bet on the chances of a country defaulting. Let’s check out what odds the bookies are offering. Here are the current odds.

• Pakistan is reckoned to have a 90% chance of defaulting.
• Argentina’s chances are 85% of blowing it.
• Ukraine and Iceland have a 60% probability of going down the pan.

Other countries are in the firing line – Kazakhstan (60%) and Turkey (35%) are two.

The first country to crash out of the financial whirligig apart from Iceland has been Hungary. Hungarian capitalists borrowed extensively from abroad. As the credit crunch dried up international capital flows, international financiers bet against Hungary’s survival. In doing so, they made the collapse happen. The Hungarian forint lost 20% of its value. The central bank raised interest rates from 3% to 11½% to prop up the currency, to no avail. The IMF beat a path to their door, offering a substantial loan of $25bn, equal to one fifth of the country’s GDP. The downside was that, as ever, conditions were attached. The Hungarian working class are expected to put up with cuts of more than 300bn forint (more than $1bn). They have already indicated that they have no intention of doing so. http://www.marxist.com/hungarys-growing-strike-wave.htm)

The Rumanian authorities resorted to even more desperate measures to preserve the value of their currency, the leu. At one point they were charging overnight interest rates of 900% to keep money in the country. Imagine the effect on domestic industry. No capitalist economy can survive 900% interest rates for any period of time. The Polish zloty and Czech koruna have also been having a torrid time on the foreign currency exchanges. It seems that Eastern Europe and the other ‘emerging economies’ are being set up to take the rap for the economic crisis.

Latvia

Latvia’s national income has fallen by 4.2% in the third quarter of 2008 alone. Tiny Latvia has been running a current account deficit of 22.9% of national income with the rest of the world. That was obviously a disaster waiting to happen. Money that poured in from the West to create a classic housing bubble has suddenly stopped and turned about, and house prices have fallen by 21% this year as a result. Latvian banks employed such ‘innovative’ techniques as setting mortgage terms in Japanese yen. Now they’ve been caught out.

"If the situation were to worsen, Latvia could be forced to seek balance-of-payments support from the EU or the International Monetary Fund," said Kenneth Orchard, senior analyst at Moody's. "The global liquidity crisis will probably cause a shock to the Latvian banking system, which will reverberate throughout the rest of the economy. Unless there are major improvements in the European syndicated loan market by early 2009, the government will be forced to take remedial action."

Oskars Firmanus, head of the Latvian consultancy Paus Konsults, said the Parex rescue had badly shaken depositors in Riga. "It has come as a big surprise. The bank has been very secretive and did not tell anybody there was a problem. People have been lining on the streets over the weekends trying to get their money out of ATM machines," he said. This story is replicated in all the Baltic states.

What happened last time

This has happened before. In 1997 all the East Asian economies struck a reef and foundered. Like the East European economies, they had been growing fast. Like them they were highly geared with debt, and had to grow fast just to keep the wolf from the door. There was the same lack of caution and lack of regulation. Finance in East Asia was treated like the wild west, where fortunes were quickly to be made, in the run-up to the shipwreck. When the collapse came, East Asian growth was seen as haplessly dependent on financial flows from the imperialist powers.

As with Eastern Europe, a myth had grown up around the Asian economies. Nations like Korea were at one time growing faster than any other capitalist country had ever grown before. They were described as ‘miracle economies’, as ‘Asian tigers’. Those myths were laid to rest by the 1997 crisis. These countries were permanently scarred by the process and some have never fully recovered from the experience. The era of the ‘East Asian miracle’ was definitively at an end.

There were important differences as well. The East Asian economies were typically lumbered with a 6% deficit with the rest of the world. In Eastern Europe the average was 10%, with some countries running crazy 20% and more deficits. In other words finance capital was even more liquid, even more irresponsible, more footloose and fancy free than in 1997.

As today, the crisis took the form of ballooning balance of payments deficits and runs on the local currencies. It is not quite true to say that the 1997 East Asian crisis came out of a clear blue sky. Never the less, the contrast with the present crisis is stark. The crash that is in process among the ‘emerging economies’ is the direct result of the crisis in the West. The capitalist world as a whole is facing the most serious crisis since the Second World War. In 1997 the big capitalist countries were able to quarantine the infection in East Asia. Workers in the region bore the brunt of the crisis. This time there is no doubt that the crisis of the emerging economies, produced by the crisis in the capitalist heartlands, will spread back to the major capitalist economies in Western Europe and North America.

Backlash

Eastern Europe and Russia borrowed $1,600bn in five years, and now the West has suddenly stopped lending. It wants it all back. These nations like Ukraine, and the region as a whole, have been running deficits of more than 10% with the rest of the world, mainly with the imperialist countries. This is like a person earning £100 a week and spending £110. They have made up the difference by borrowing. Now the loans are being called in, just as the markets in the West where they hoped to pay their way are drying up. This puts pressure on the local currency, as outgoings massively exceed money coming in. Sighting easy pickings, speculators start to bet against the beleaguered national money. A wall of money makes it impossible to defend the exchange rate when the balance of payments is in crisis.

The catastrophic economic situation faced by these ‘emerging economies’ is not good news for the Western nations that have lent so much, so recklessly. Austria is particularly dangerously exposed. We have been warning about the dangers for months past, as Matthias Schnetzer did. (http://www.marxist.com/go-east-where-skies-are-blue.htm) Austria has loans outstanding equivalent to 85% of its GDP (about $300bn). It has more loans in East and Central Europe than Germany, a capitalist powerhouse with ten times the population of Austria. If these loans are defaulted on then the crisis, begun in the West and exported to the East, could reverberate back on to Western nations with redoubled force.

Another dangerously exposed country is Sweden. The three tiny Baltic countries owe an incredible $123bn. $83bn is outstanding to Swedish banks. Default is a near-certainty.  We wish Swedish bankers a heart attack-free future, but a Baltic default is likely to have wider effects on the whole Swedish economy through the mechanism of bank failure spreading misery to jobs, production and housing.

We wish all our readers a happy New Year – but you’re going to have to fight for it.