You are here

The Global Financial Crisis

Iceland's stock exchange values


Today we are in an global economic crisis. It is an economic crisis not because of the scale, for at worst there has been a recession of a few percent of GDP, but rather because it has been systematically induced. The best strategies that have been proposed so far are essentially neo-Keynesian; because private demand has fallen, government expenditure can alter aggregate demand to provide a stimulus to the economy. At best, this can provide necessary infrastructure for positive externalities through network effects; at worst it will simply serve as a delaying tactic, leading to a greater crisis in the near future.

What Happened?

The start of the current economic problems were evident at the end of 2005 when there was a sudden halt to the rampant increases in real estate prices in the US. In 2006, as estate prices remained flat, the Dow Jones Index actually increased approximately a quarter. In 2007 real-estate prices declined leading to twenty-five subprime mortgage estate lenders went bankrupt, including the largest lenders such as New Century Financial, American Home Mortgage and Ameriquest. The largest U.S. mortgage lender Countrywide Financial narrowly avoided bankruptcy by borrowing $11 billion from other banks and in the UK there was a run on the Northern Rock bank, which was eventually put into public ownership in 2008.

Despite this the 2007 Dow Jones Index increased by 11.5% between January and October although for most of this was due to increases the price of natural commodities, especially oil and food prices The price per barrell of crude oil increased from just over $40USD at the beginning of 2007 to over $130USD in the middle of 2008 (it now below $40). Between the start of 2006 and 2008, the average world price for rice rose by 217%, wheat by 136%, maize by 125% and soybeans by 107% - all of which had a dramatic effect on the poor of developing countries.

In early 2008 all share market gains of the previous year were wiped out. There was a damaging series of arrests for fraud that shook the mortgage industry. The Bear Stearns Companies, which had been one of the largest global investment banks, was caught in this operation and its stock value went from a high of $133.20 to a low of $10 per share when it was purchased by JPMorgan Chase. As investor confidence was wiped out the U.S. government was required to nationalise the Federal National Mortgage Association ("Fannie Mae"), and the Federal Home Loan Mortgage Corporation ("Freddie Mac") in September. Combined, they owned or guaranteed about half of the U.S.'s $12 trillion mortgage market. Soon afterwards, the financial services company Lehman Brothers filed for bankruptcy, despite holding assets approaching $700 billion dollars. Merrill-Lynch despite having a trillion dollars in assets, had such a poor revenue stream (negative $60 billion in 2007), that it was purchased by the Bank of America for a mere $50 billion.

In Europe, the Benelux Fortis bank required half nationalisation to the tune of €11.2 billion (US$16.3 billion). The French-Belgian bank Dexia required a government loan of €9 billion. Russia was twice forced to suspend its trading exchanges in October, due to dramatic falls. The UK government made £25 billion available to major British banks as preference share capital, or permanent interest bearing securities, as form of partial nationalisation; in December it was revealed that the Royal Bank of Scotland and HBOS (Halifax and Bank of Scotland) had been "only hours away from being unable to open for business". By November 20, 2008 the Dow Jones had fallen to approximately half of its value from October 2007. Although not a major economic player on a world scale, the Iceland the stock exchanged fell by more than 90% and with banks there holding 80% of their €50 billion foreign debt during 2008, all of Iceland's major banks were put under public administration.

The World Bank expectations in December 2008 was that the global economy will enter a recession for the first time since 1982 with global GDP growth to decline to 0.9% in 2009. Global trade is expected to decline 2.1% in 2009, the first decline since 1982, on reduced global demand and export credits. Germany contracted by 0.5 percent in the third quarter of 2008, putting it in recession for the first time in five years. Japan's GDP contracted at an annual rate of 0.4 percent from July to September 2008, marking the second consecutive quarter of negative growth. The Eurozone economy. made up of the 15 countries that use the euro contracted by 0.2% in the third quarter of 2008 following a 0.2% fall in GDP in the second quarter. In USA, GDP dropped 0.5% drop in the third quarter of 2008.

In February 2009 U.S. President Barack Obama signs the $787 billion American Recovery and Reinvestment Act of 2009 into law. Also this month the Bank of Antigua is taken over by the Eastern Caribbean Central Bank after Sir Allen Stanford is accused by US financial authorities of involvement in an $8bn (£5.6bn) investment fraud In March, the UK Government took a controlling interest in Lloyds Banking Group by insuring their debt. Also in March, the US Federal Reserve announced that it will purchase $1.15 trillion in US Assets in a bid to prop up liquidity. At the end of April, Chrysler filed for Chapter 11 bankruptcy protection. They have received indications from the White House official indicated that the government would provide debtor-in-possession financing for between $US 3 billion to $US 3.5 billion, and upon a completion of Chrysler bankruptcy restructuring and court proceedings, the company would be eligible to receive up to $US 4.5 billion in financing to resume operations, for total of $US 8 billion of government support. Yesterday the US Office of Management and Budget released a report that Fannie Mae and Fredic Mac will require $92.2 billion more in fiscal aid in 2010, on top of the $78.2 billion they've received since they were taken over by the government in September.

How Did It Happen?

The causes of the global economic crisis are not particularly well understood. Most discussions of how it happened are often a description of what happened. For example, a Marxist analysis would say that there is massive disparity between use-value and exchange-value which has become evident in an economic cycle; and this is correct - but it is descriptive of the symptoms, not the causes. The reason for this lack of understanding boils down to a lack of application of the classic theory of economic classes. This is a field of inquiry largely ignored since the development neoclassical economics in the latter part of the 19th century. The neoclassical economists contributed to the conflation by converting land into capital, and assisted by some rather dogmatic and vulgar Marxists could only see the existence of the worker and capitalist classes. Finally, the conflation was due to the influence of American functional sociology in the 20th century which investigated relationships and activity on the basis of income (which is appropriate for cultural studies), rather than ownership of the means of production (which is appropriate for economics).

In contrast classical economists, including the physiocrats, Adam Smith, David Ricardo, Karl Marx, Léon Walras and John Stuart Mill, all recognised the distinction between the factors of production (land, labour and capital), the respective sources of income derived from each of these factors (rent, wages and interest) and the respective economic classes (landlord, worker and capitalist); it is noted of course that an individual can be a member of multiple classes simultaneously and proportional to the way their income is derived.

Economic Class Factor of Production Receipt of Income
Landlord Land Rent
Capitalist Capital Interest
Worker Labour Wages

These terms are quite specific and carefully defined in economics. "Land" does not refer to just the ground under one's feet; it also includes the oceans, the atmosphere, the electro-magnetic spectrum; it means, natural resources in their unimproved state. "Labour" does not just refer to physical activity, but also all mental activity including entrepreneurship; it is all of human activity. Finally "Capital" refer to all products that result from economic activity, both simple and complex, including both commodities and the tools of production. Money itself is not capital, but rather a representation of the value of capital.

This excursion into political economy has a very real purpose; Abraham Lincoln rightly observed that labours hold a privileged position to capital, for the latter depends on the former. But even more so, labour and capital are both dependent on natural resources. It is from natural resources, as John Locke pointed out, that one can "mix their labour" and provide a justified foundation for property rights. However, economic land is not just unique in this regard; it is also relatively fixed supply and a often a necessity, thus inelastic in demand. For those who seek to extract income without contributing to production, economists have been almost unequivocal in their description of this behaviour: "rent-seeking". Despite constant criticism from positive and normative economists, the politicians of the world have shown an outstanding lack of will in this regard and have actively encourage unproductive and monopolistic investment in the form of the acquisition of economic land to exploit the holders of labour and capital and instead have allowed the burden of providing public income increasingly on those who provide actual goods and services.

The economic (and taxation) system punishes the productive investor and labourer, rewards the unproductive investor, and polices those dependent on social welfare. The productive worker and the productive investor are both fettered by taxes, tariffs, and rents, all onerous on their ability to provide goods, services and create wealth. More and more aggressive wars are fought for the control of natural resources with horrendous civilian casulties - all with the objective of monopolistic control over natural resources. The banks start lending money with cavalier disregard at extremely low rates and lax conditions, with with the assumption that "someone else" will engage in the productive labour and investment that will give a location a good rental price. Fewer and fewer invest in new business, new industry, new goods, and new services; and then the expected returns from "somebody else" do not materialise.

The would-be monopolists find themselves with a debt that they cannot afford to repay. What was once marked as an asset by the banks suddenly becomes written off. Confidence is lost, industry fails, economies shrink, unemployment for masses loom. And like pigs the monopolists come squealing once again before the our governments. They plead for the government, which means us, to prime the printing presses and pay for hundreds of billions of bad assets, under the assumption that "confidence" and "stability" in the credit market will be recovered - and so they can exploit both worker and investor yet again.

This is not a sustainable proposition.

Home Prices in Detroit

How Can We Fix It?

There have been three main strategies to deal with the problem, which I can be described as the Bush administration approach, the European approach which correlates somewhat with the Obama administration approach. The first, constituting roughly $1 trillion for a $14 trillion economy, was a set of deposit guarantees, stock purchases, tax breaks and direct aid. However when Associated Press contacted 21 major banks which received the bailout, none of them could give specific answers on how much has been spent? What it had been spent on? How much was being held in savings and what's the plan for the rest? Thomas Kelly, a spokesperson for JPMorgan Chase, which received $25 billion in emergency bailout money. "We have not disclosed that [information] to the public. We're declining to."

In contrast the European and Obama approach is, in different guises, forms of Keynesian government intervention as social liberalism or social democracy. It involves re-regulation of the financial sector, the purchase of preferential shares or outright nationalisation on one hand and one the other, as expressed by President-elect Barak Obama, a massive government expenditure in public works and infrastructure, on electrical grids, on public transport, on dams and investment in alternative fuels, expected to be valued at another $1 trillion dollars, although the US Federal Reserve chair, Ben Bernanke, has warned Obama that this may not be enough. Nevertheless after several years of significant neglect in this area the intervention will undoubtedly assist those most dependent on improvements in public goods and thus provide positive externalities to the US economy as a whole. Comparison with Franklin Delano Rooselvelt's "New Deal" program have, of course, already been made.

Whilst all these actions will be beneficial, in varying degrees, in relieving the symptoms of the global economic crisis, there is good reason to suggest that they may not be sufficient to cure the cause. As mentioned right at the very beginning of this presentation, this is a crisis primarily because it is systematically induced. It has arisen first and foremost from speculative bubbles in real estate and primary resources for a reason; because natural necessities are relatively fixed in quantity and they have no substitute (except for other natural necessities), they are particularly prone to monopolists. Not a single dollar "invested" in this desire for medieval lordship over land and nature provides goods, services or employment, yet all must pay an ever-increasing rent for what nature provided freely. Is the liquidity crisis and the resultant downtown in productivity a real surprise then?

I would argue there are three related 'fixes' that should be implemented.

Firstly, public financing must change. The Labor Party should re-institute what was a sixty year policy in its platform and which was dropped by administrative oversight in the sixties, at least according to Clyde Cameron. The public sector should receive its finances entirely from the rent of economic land. Nearly every economist in the world, whether liberal, conservative or radical, agrees that public finances should be derived from resource rents in preference to goods and services. The radical capitalist Milton Friedman argues that "In my opinion the least bad tax is the property tax on the unimproved value of land", whereas the neo-Keynesian Paul Sameulson argues that "pure ground rent is in the nature of a 'surplus,' which can be taxed heavily without distorting production incentives or reducing efficiency". The conservative Robert Solow has claimed "For efficiency, for adequate revenue, and for justice, every user of land should be required to make an annual payment to the local government equal to the current rental value of the land he or she prevents others from using", whereas the radical antifascist Jewish refugee and economist Franco Modigliani stated "It is important that the rent of land be retained as a source of government revenue". Finally, the maverick socialist William Vickery claims "While the governments of developed nations with market economies collect some of the rent of land, they do not collect nearly as much as they could, and they therefore make unnecessarily great use of taxes that impede their economies - taxes on such things as incomes, sales, and the value of capital goods." The polymath Herbert Simon said "Assuming that a tax increase is necessary, it is clearly preferable to impose the additional cost on land by increasing the land tax, rather than to increase the wage tax."

Everyone of the people just quoted are winners of the Nobel Prize in Economics. Just maybe the fact this incredibly diverse and competent group of individuals agree on this matter there might be something to it. Why don't we listen to them?

Secondly, public monies must be spent in the right way. It should only be spent in those areas that are actually beneficial for the public as a whole. All the bailouts, all the public propping of unsustainable private enterprise, all the tariffs, every single instance of private expropriation of public funds must come to an end. A general principle can be suggested here; the closer that a good or service is to being a natural monopoly the greater the requirement for a centralised public service, whereas the closer the good or service is to being in accord to a competitive environment, the greater the requirement for government to leave it to its own devices.

Finally, attention must be paid to normative issues such as wealth equality, because these do have positive effects. In a very recent book, "The Spirit Level" (2009) two epidemologists, Richard Wilkinson and Kate Pickett, uses a wealth of data from the World Bank, the United Nations etc to show that that levels of various social ills - e.g., violent crime, mental illness, drug addiction, illiteracy, obesity etc. are almost always higher in more unequal societies and that such levels have deleterious effects on the economy as a whole as well as the individuals who suffer from them. Thus a high Gini co-efficient (a statistical measure of inequality) in wealth and income itself is a negative externality. This confirms the results from The Economist's Quality of Life index published in 2005, which showed a positive correlation between GDP per capita and quality of life, as expected. However it also showed ignificant disparities between the two depending on how that wealth was used.

The nations were the Quality of Life was significantly higher (10 ranks or more) than their GDP per capita in the larger economies included places like Sweden (+14), Italy (+15), Spain (+14) and New Zealand (+10). Places where the QoL index was significantly lower that their GDP per capita included the United States (-11), the United Kingdom (-16), Saudi Arabia (-23), and almost at the bottom of the list (despite being a mid-range economy according to GDP per capita), was Russia (-50). The best places to live, overall, were Ireland, Switzerland, Norway, Luxembourg, Sweden, Australia, Iceland, Italy, Denmark and Spain, Singapore and Finland. If Norway, Sweden, Iceland and Finland seem to be uncomfortable places because of the climate keep in mind that the survey even included a small weighted value for how hospitible the climate was!

Simply put, having income is not enough. How a nation spends it is critically important to the quality of life of its citizens.

Presentation to St Kilda branch of the Australian Labor Party, May 13, 2009


Nearly 11 Percent of US Houses Empty:

Homeownership is falling at an alarming pace, despite the fact that home prices have fallen, affordability is much improved and inventories of new and existing homes are still running quite high.

Ownership is falling whilst eleven percent of houses are empty. That is signs of an impending "correction".

How can you fix and economy that is built on debt. It amuses me when I watch the talking heads on the news always asking how to fix things. You can not fix problems like these. Some broken things are fixable and some are not. An economy can not be stable and productive when it is relying on consumers borrowing more and more in order to buy more stuff they do not need. If this borrowing continues on both the government and consumer side watch the Dow Jones Index and the SP500 plummet like rocks in the coming months and years. The house of cards will eventually fail.

Interesting infotmation, thanks!

Terrificly written description of what has happened and how we might address it - something that people with a wide variety of opinions could appreciate even if they don;t change their minds. Your "functional sociology" hypothesis and how it relates to how mortgages and property ownership has evolved in the states is particularly interesting to me as someone who blogs about that industry.