It is commonly argued that the economic crisis, which began in 2008 with the collapse of Lehman Brothers, was the result of the preceding decades of neo-liberal policies. In this article Soteris Vlahos argues that the origin of the crisis lie further back in time, in the crisis of profitability of real production that struck the world in the early 1970s. And furthermore, he claims that neo-liberal policies helped alleviate this. By creating unemployment and attacking the living standards of the working class, it attempted to restore profits. Then it dealt with the subsequent loss of demand by pumping fictitious capital into the system. However, this led the world into today’s even deeper and unsolvable mess.
The Crisis of the 1970s
The roots of the present economic problems should be traced to the early 1970s, when the most spectacular economic growth in the history of humanity ended. It was a growth that begun around 1950 and transformed the developed countries. Although, unfortunately, only them.
This growth was based on Keynesian economic policies. Heavy investment and the consequent full employment was a prerequisite for development. The state played a central role, coordinating and controlling.
In the beginning of the 1970s, these policies stopped having the expected result. By 1974 profitability in the advanced capitalist countries had, on average, fallen by around 50% from its peak around 1965. Although not every economist that has dealt with the matter has the same figure, there is no disagreement on the fact that in the early 1970s world capitalism faced a dramatic collapse of profits. Heavy investment resulted in higher prices, unemployment rose and the world economy took an unexplained and uncontrollable dive.
The answer of the capitalists to this situation was drastic. They entered into a counter-offensive to support their profits, their system, and their very existence.
Under the guidance of the Federal Reserve Bank of the US, money markets used very high interest rates to increase unemployment (you do that by making borrowing and thus investment very expensive). [“From Global Finance to the Nationalization of the Banks”, Prof. Leo Panitch, Prof. Sam Gindin]
Victory over the unions meant that salaries were cut. In the US this policy was combined with the dismantling of investment in the industrial production of the country and investment in countries like China and India where they could pay wages tens of times smaller than in the US.
The law behind the crisis
By attacking salaries and the general benefits of the working class, capitalists indirectly confirmed the Marxian axiom that the only source of profit is labor. Capitalists pay a wage equivalent to the value of a worker’s labor power, the amount of money that a worker needs to sustain himself. The extra value the worker produces over and above the value of his labor power is what Marx calls surplus value. This is appropriated by the capitalist and in part is re-invested leading to an accumulation of capital.
A company can increase profitability not just by decreasing wages, but by saving on everything else. However, when one company increases profitability by saving on energy, the energy company loses. A particular company gains profit, but the national economy as a whole does not gain.
‘The rate of profit’ is the surplus value divided by the total cost of production expressed as a percentage. The higher the surplus value the more likely it is that there will be a high rate of profit. However, there are also factors that act against achieving a higher rate of profit. These factors can deprive the capitalists of a high rate of profit, even if there is a high surplus value.
The main factor behind this was a law that Marx called the tendency for the rate of profit to fall.
This is in every respect the most important law in political economy, and the most essential for understanding the most difficult relations. It is the most important law from the historical standpoint. It is a law which, despite its simplicity, has never before been grasped and, even less, consciously articulated. Grundrisse (p.748) [?Rob Sewell on the tendency of the rate of profit to fall?, Mick Brooks]
With developing technology more machinery is introduced to the production process and less labor is required. The Capitalist has to invest more on this machinery and less on labor, thus making the amount of unpaid labor he can extract from the workers smaller in proportion to his total investment. The Rate of Profit has a tendency to fall.
There are many factors, as Marx showed, which counter-act this tendency, even to the extent of increasing the rate of profit. But these factors can only play a role for a period of time, at the level of a company, of a sector of the economy, of a nation, but they could never change the direction of the falling rate of profit on a world level.
The world capitalist class believed that they could reverse the tendency for the rate of profit to fall through salary reductions and an extension of the working day. They tried to do this during the neoliberal period which began in late 1970s and early 1980s.
However, the extension of the unpaid part of the working day is not synonymous with the creation of profits. The world capitalist class discovered this after their attack on living standards. A historical irony made itself apparent. They thought they could restore the ability of the companies to create profit through cuts in salaries, but by doing so they decreased the purchasing power of society. A new huge problem that needed a solution was created.
Neoliberalism increased profits and reinforced demand
The new reality of decreased demand expressed itself through even greater unemployment. This was the basic problem of world capitalism at the beginning of the 1980s. Unemployment in the main capitalist countries was higher than today (Spring 2013).
However, as often happens in history, accidental events pave the way for totally unplanned solutions.
Up until this point, privatization of strategic industries as well as the whole neoliberal model were solely ideas in the minds of marginalized academics.
Privatization figured only slightly in early Thatherism. It did not appear at all in the 1979 election manifesto and first featured in a Tory administration in 1982, when the lack of funds needed for the modernization of the British telecommunications industry forced the government to consider what was a revolutionary step – the privatization of a major public utility. [John Gray, ?False Dawn?, edition 2002, page 27]
This step gave a practical solution to a problem associated with the assumed failure of Keynes’ model and the public sector. The high inflation made impossible the printing of more money and selling society’s assets provided the cash that made the functioning of the government possible. A first decisive moral victory of the economics of the neoliberal period was achieved.
b. Floating exchange rates
On August 15, 1971, the world international finance was changed forever. On that day President Richard Nixon instructed the US Secretary of the treasury to suspend all sales and purchases of gold. The gold window was closed. It was never re-opened, and the international economy has never been the same. [John Eatwell and Lurence Taylor, ?Global Finance To Risk?, first edition — 2000, page1]
That was the end of the Bretton Woods system which had constituted the pillar upon which all post-war development had rested. A pillar that “meant that the private sector was freed from foreign exchange risk” through fixed exchange rates. Under this system all currencies were tied to the dollar, and the dollar was tied to gold. The USA guaranteed a price of thirty-five dollars per ounce of gold. Thus, exchange risks were taken by states.
Now risks were privatized. International transactions became enormously risky. There was no guarantee whatsoever that what you agreed to buy at a certain price today would have the same price tomorrow. The world entered a period of fluctuating and unpredictable exchange rates.
However, the new risks became a source of profit. The higher the risk, the higher the potential profit. Dollars were exchanged for German marks which were exchanged for Japanese yen and then the circle was closed by exchanging them for dollars again. This could result in huge gains (or loses) because of imbalances in the exchange rates.
c. Free movement of capital
On New Year’s Day 1974, the USA, following a similar move by Canada, Germany and Switzerland in 1973, abolished all restrictions on the movement of capital. A new era opened up where they moved “capital out of the high cost, low profitability lines of material production (production of real goods), especially towards the financial services.” [John Eatwell and Lurence Taylor, ?Global Finance To Risk?, first edition — 2000, page 2]
The free movement of capital found “profitable” investment almost exclusively in world gambling, in betting on the movement of interest rates and exchange rates. Investment in real production was a tiny portion of international transactions. By 2000, this constituted no more than 5% of all transaction, according to many estimates.
The development of securitized financial markets and the internationalization of the American finance allowed for the hedging and spreading of the risks associated with the global integration of investment, production and trade. Without this, capitalist accumulation would otherwise have been significantly restricted. [“From Global Finance to the Nationalization of the Banks: Eight Thesis on the Economic Crisis?, Prof. Leo Panitch and Prof. Sam Gindin, Global Research]
Here lies a central point: ‘capitalist accumulation would otherwise have been significantly restricted’. The world capitalist system would have faced much higher levels of unemployment, and would have provided considerably lower living standards leading to social unrest much earlier.
The final factor that gave neoliberalism an unexpected and unprecedented force in restoring capitalism after the 1970s, was the huge accumulation of excess capital. Capital which could not be invested profitably in real production, capital that had already made itself present in the 1960s [John Eatwell and Lurence Taylor, ?Global Finance To Risk?, first edition — 2000], could now be used worldwide. It was partly used for investment in low labor cost countries like the countries of South East Asia, China, India, where they transferred production from the advanced countries, especially the US. But mostly it went into an explosion of credit.
International bank lending expanded from 265 billion dollars in 1971 to 4.2 trillion dollars in 1994 [John Eatwell and Lurence Taylor, ?Global Finance To Risk?, first edition — 2000, page 5]. Finance capital and financial institutions (banks, hedge funds, etc.) acquired an unprecedented worldwide character. Capital could go anywhere but also leave from everywhere – blackmailing and ruling societies, governments, the whole world. With the push of a button at the headquarters of any multinational, billions of dollars would be removed from an account in one country and reappear in an account in another country; Creating havoc in the country they abandoned, destroying currencies and creating unemployment from one moment to the next. This is what they did in a huge number of countries. This is what they did in Turkey in 2001 when the local currency lost one third of its value in a week.
Despite the devastating effects the finance capital had on individual countries and on the standards of living of the world working class, its role as a whole was beneficent in the sense of providing an extension to the life of world capitalism. It financialized the economy. This financialization affected demand in a positive way.
On one hand, the capitalist class and especially the financial institutions started recording profits again. Nobody cared whether they were real or fake, since it served them well for decades. And on the other hand, households and states made up for their lost income through borrowing. Future generations were given the responsibility of paying for today’s consumption. It was like “colonizing the future” [This is the meaning of the debt without precedent accumulated during the neoliberal period; the term ?Colonizing the future? is borrowed from Professor Photis Lysandrou]. Is there a more perfect social system than capitalism?
Thus the problem that appeared in the 1970s, the collapsed profitability, the inability of the capitalist system to create new real values through the production process, the general stagnation, the rising unemployment – all of these “found a solution”. By the beginning of the 1980s world capitalism was on the rise again. The neoliberal period, through its methods, achieved what investment in real production could not.
The FIRE( finance, insurance, real estate) sector now contributes more to the American GDP than manufacturing, and its foreign exchange operations are an essential component of the sector and hence of the GDP . [John Eatwell and Lurence Taylor, ?Global Finance To Risk?, first edition — 2000, page 49]
The logic of neo-liberalism
The financial system of USA issued bonds ? so called mortgage backed securities . Let us call them “shares” which represented the value of a house (or many houses or many other assets). Shares that were sold at artificially high values to the whole world ? billions and trillions of dollars. The Chinese would buy these mortgage backed securities and give Americans money to buy houses, giving the economy a push and thus allowing the Americans to continue purchasing Chinese products.
The value of houses continued rising and the American people continued to mortgage them to borrow money for the education of their children, to buy Chinese products or go on vacations…
The whole system was a “very unstable system to be able to survive forever, but was a system which for decades contributed to the maintenance of a world tranquility (though unstable) which depended on the continued voluntary flow of capital, something that someone could interpret as ‘gifts of servitude’ (instead of taxes), from the world periphery towards the American metropolis – gifts which the metropolis, in its turn, uses (consumes) in order to keep the periphery flourishing.” [Yanis Varoufakis, ?The World Minotaur?, first published in English in 2011, quoted from the Greek edition published in 2012, page 63]
Larry McDonald, one of the vice presidents of Lehman Brothers, the ‘giant’ that collapsed in 2008 bringing the world financial system to its knees, characterized the building industry of the US as the new ATM machines of the American population. He cried in despair that the whole system was based on “money which was not real money, prices of houses which were not real prices, mortgages which were not based on any definition of reality” [“Colossal Failure of Common Sense?, Larry McDonalds, first published in 2009, page 133]
When the international selling of the “shares” of the houses could not provide to the system the necessary amount of money, they moved into issuing other types of “shares”/bonds, which corresponded to no mortgage, to no real defined value.
Larry McDonald again, speaking about Lehman Brothers, states that they continued to collect/borrow “massive amounts, billions of dollars – always pledging their new toys as collateral… Those toys were time bombs despite their fancy names: CDO (Collateralized Default Obligations), CLO (Collateralized Loan Obligations).” [“Colossal Failure of Common Sense?, Larry McDonalds, first published in 2009, page 134]
In this way economic activity was created. Companies such as Countrywide, New Century and Nova Star (Real Estate Companies), among others, created much more than 1 trillion dollars of economic activity.
The world system appeared to develop and grow. This was the way that companies were making profit. In the year 2006, probably 50% of the growth of the United States was bogus- CDO, CMBSc, CLO and MBSc. [“Colossal Failure of Common Sense?, Larry McDonalds, first published in 2009, page 256]
The US borrowing strategy has become an important element in keeping up demand around the world. If the US strategy were forced to change, it would have serious implications for the future stability and growth of the global economy. [John Eatwell and Lurence Taylor, ?Global Finance To Risk?, first edition — 2000, page 122]
The economic activity was based on continues creation of debt and investment in anything but material production. In 1970, the yearly valuation of financial derivatives ? principally those devoted to interest rates and foreign exchange ? was probably only a few million dollars. The sum swelled to about 100 million to 1980, to nearly 100 billion by 1990, and to nearly 100 trillion by 2000, when about 1500 million derivatives contracts were traded.
Control of the whole game was concentrated in the hands of the ten largest Euro-American institutions. [Edward LiPuma and Benjamine Lee, ‘Financial Derivatives and the Globalization of Risk’, 2004, page 45]
Governments lost control over the money supply. It fell into the hands of financial organizations which ‘recognize no national boundaries, obey to no rule, accept no law except the law of the power of money and inflict severe punishments on those who violate the laws of the market.’ [Gregory Milman, ?Around the world on a trillion dollars a day?, 1995]
The problem of real profitability was unresolved
The absolute prevalence and control of society by a handful of financial institutions, their enormous profits and the provocative salaries of the ‘golden boys’ were the logical consequence of an unconscious process through which they ended up saving the system for a while. But as Robert Brenner explains, the fundamental problem remained unresolved:
In fact, all of these interrelated measures of cost reduction, neo-liberalization, and globalization ? unleashed with ever-increasing intensity from the start of the 1970s by the advanced capitalist economies ? constitute little more or less than an ever more frenzied attempt to cope with the pervasive and persistent problem of reduced profitability. But the overriding fact remains that far from restoring economic dynamism, these measures failed to prevent the performance of the advanced capitalist economies from worsening as time went on. As a consequence, as of 2000, the long downturn remained very far from overcome. [?The Economics of Global Turbulence?, Robert Brenner, edition 2006]
There are numerous estimates of profitability since the 1970s by many Marxist and non-Marxist economists. They show different results. Some of them show a partial restoration of profitability. Some show a full restoration by 1990s and 2000s, etc. None of these estimates however take into account that all economic indicators were probably rendered useless by swollen values, bubbles, and an incredible amount of money and financial instruments circulating in the economy,
How can one compare a profitability of, say, 5% in a national economy without loans, to a 5% profitability of a national economy with state and household debt equal to or many times the GDP of a national economy? How can a measure of 4% unemployment be a sign that an economy can provide employment to its citizens, if this economy is heavily indebted? If profitability in the US in 2008 fell by around 50% from a peak in 2006, how real was the figure of 2006? In 2008, 40 trillion dollars disappeared from global stock markets.” [Yanis Varoufakis, ?The World Minotaur?, first published in English in 2011, quoted from the Greek edition published in 2012] How did the existence of this incredible amount, distort the economic indicators before 2008?
After the 1973-74 crisis capitalists did take measures to restore the profitability of each individual company by extending the unpaid part of the working day. But by this method, they simply decreased the amount of real values in the hands of the working people to be exchanged with produced goods, leading to further increase of unsold goods, to more companies passing the threshold of being unable to stay alive. Thus the high unemployment figures of the early 1980s were created.
This is the essence of what has already been characterized as the historic irony of the 1970s: “by trying to restore the profitability of each individual company they simply decreased the amount of money each worker would take home, they decreased the purchasing power of society, they weakened the demand side.” [?The end of the road??2009, page 14, Soteris Vlahos, published in ?Sosialistiki Efkrasi?]
Restoring the rate of profit by extending the unpaid part of the working day, can have a result when it occurs in an individual company or sector of the economy. It can even have results when it occurs in a number of export oriented countries during a period of general economic expansion. But during periods of a general capitalist crisis, like the one that hit the world in the 1970s and in 2008, it can only lead to further deterioration.
After the 1970s there was space for the neoliberal model to play a role in saving the system. No such space is available now. Everything is at an end.
“2008, to say it in a more simple way, has been proved to be the 1929 of our generation… With an economic ending that may be worse than even the one of 1929.” [Yanis Varoufakis, ?The World Minotaur?, first published in English in 2011, quoted from the Greek edition published in 2012, page 24]