It is a Financial Catastrophe

The current financial crisis, first named as a global financial Tsunami and now being referred to as the financial meltdown, is nothing short of a global catastrophe that has cast serious aspersions on the viability of the capitalist economic system.

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June 23, 2022

The current financial crisis, first named as a global financial Tsunami and now being referred to as the financial meltdown, is nothing short of a global catastrophe that has cast serious aspersions on the viability of the capitalist economic system. It is a case of system failure and it calls for systemic corrections, if not a whole set of new economic philosophy, approach and practices.

A very simplistic approach towards the financial crisis is to consider it a normal phenomenon of trade cycle. Such recessions do happen. “Since the emergence of modern capitalism some three centuries ago, we have seen more than 30 major financial crises – about one every 10 years,” says Andrew Graham, an economist and master of Balliol College, Oxford (“Financial Crisis: Key Role of China,” The Hindu, 16.10.2008).

Amartya Sen, the Nobel laureate, distinguished economist and academic, admitting that recession has crept in, explained that it happened because people lost confidence. He added, “You lose confidence, you cut down your activities and as a result others cut down their activities. It’s the classical Keynesian territory. Regenerate confidence and also support each other through expansion rather than contraction. But the positive side is that just as it can decline by lack of confidence, once confidence comes in it can also dramatically improve” (“Amartya Sen Puts His Faith in Obama,” The Hindu, 19.10.2008).

Amartya Sen has forwarded a simple solution that any change, like a change in US government, may push up the trade cycle. With this logic the win of Barrack Obama may usher in the required faith in economic activity and every thing may come back to the right track.

Other experts do not agree with the Sen analysis, perhaps not considering it to be a sane approach. Serious concerns are being expressed regarding issues like banking system, prime and sub-prime lending methods, size and quality of financial derivatives, speculative market segment and future of capitalist economy. Andrew Graham, referred to above says that the unfettered belief in the US that the banks could largely be left alone in private sector without much state interference stands shattered as it is now obvious that banking systems almost always eventually over-extend themselves and have to be rescued.

He emphasises, “Financial regulation has to be approached with a completely different mindset from that for the rest of the economy. Elsewhere, competition can be a substitute for regulation. In banking, the opposite applies: the greater the competition, the greater the need for regulation and/or supervision.”

This is not a case in isolation about the banking system. This shows the failure of the basic premise of the capitalist system where more reliance confidence is reposed in the corrections by the invisible hands of market forces than the visible hand of the state laws and regulations. It is interesting, rather eye-opening, to note the conclusion drawn by Andrew Graham: “It (is) inevitable that the Anglo-Saxon model of unfettered capitalism that has dominated thinking for half a century will be much diminished. What will replace it is unclear, but it may well look more like a form of state capitalism – perhaps not full-blown, but something much closer to Chinese capitalism than would have seemed conceivable just a month ago.”

Let us at this stage discuss in brief what have happened in the world and what their causes are.

THE EVENTS
Experts have been highlighting for quite a considerable time that the condition of the US economy is unhealthy and it would lead to a catastrophe. However, the debate came to the public only in the year 2007 when sub-prime crisis was reported. The US administration initially tried to give the impression that nothing was abnormally incorrect and that things would shortly come under control. But the consequent event forced them to admit, though belatedly, that they have failed to check the slide down. In February, 2008 tax cuts amounting to 160 billion dollars were announced to bail out Bear Sterns, the investment banking and securities brokerage firm.

Other unsavoury events started unfolding at a fast pace. The US government was forced to take over mortgage giants Freddie Mac and Fennie Mae and subsequently infuse huge funds to save financial companies such as Wa Mu, Lehmen Brothers, Merril Lynch and AIG from collapsing. It is estimated that total funds earmarked and utilised for these government actions exceed one trillion UD dollar. The condition of economy may be understood from the fact that unemployment during this period rose by more than one million. The word at large is facing the disastrous impact of the above mentioned economic recession.

CAUSES
The basic cause reported is the unregulated financial market and unrestricted availability of credit. The practices followed by prime lending institutions and sub-prime lending institutions do not have much difference. Both behaved in irresponsible manners in extending credit to all and sundry in the expectation of earning quick money. It is all well when the goings is smooth. Expectation of fast bucks made their vision blurred, if not blind. Project feasibilities, financial viabilities and credit worthiness became meaningless theoretical issues.

Another very obvious reason is the low savings of the US economy. An economy needs funds both for maintenance and growth that would either come from its savings or borrowings of deficit financing. When an economy with the feature of excessive and unrestricted availability of credit can not save it would resort to both internal and external debts. Further, with the clout that the US has had in the world it resorted to uncontrolled –  if not illegal, unethical and theoretically incorrect and disastrous – mode of printing currencies in the name of deficit financing. Western financial experts are eying with greed the savings available in Asia, particularly China. As a proof of this greed one can read what Andrew Graham, referred to above, has to add on the subject.

“(The) recession (or the shortage of global aggregate demand) is the elephant in the room. Its origins lie in the huge imbalances in the world economy, resulting from our credit-driven consumption in the west having filled the vast hole in demand that would otherwise have been left by high levels of Asian (especially Chinese) saving. As we in the west stop spending, the only way to avoid a global recession is for the Chinese, especially, to spend more. At the global and aggregate demand level, as well as in terms of future global financial stability, the Chinese are an essential part of the solution and it is extraordinary that the G7 or G8 groups do not include them. They should be invited immediately.”

The wars in Afghanistan and Iraq are bleeding the USA, both financially and otherwise. Earlier it was possible for the US administration to bill other countries like the cash rich Arab monarchies and Japan for the cost of any war (as in the case of Kuwait attack). But now it is becoming extremely difficult for the US to export its deficits and costs to others. The world has become cautious; the US administration has not remained as darling as earlier, if ever it was.

Another reason of the US economic recession is the falling importance of its currency in the international market. The US dollar is losing its grip. The highhanded, if not deceitful,  manner in which the US dollar was getting benefit of international trade like OPEC oil related transactions has now an alternative in the form of Euro. Other international conglomerates are also inclined towards their own regional arrangements.

In the present scenario where the US and its currency calls the shots, it was but natural that their recession had a cascading effect and the world economy is facing the economic shockwaves, rightly called financial Tsunami.

THE CASE OF INDIAN ECONOMY
Indian economy is also experiencing the shockwaves. We may pat our own back that we are not affected as badly as we should have had as we opened our economy to international market in the speed in which the trio of Manmohan Singh, Chidambram and Ahluwalia tried. The Indian democratic checks and balances, particularly the speed breakers raised by our Left parties may be thanked for this. But we cannot be immune to the polluted atmosphere. We have already committed many errors and we are continuing in the same path unmindful of the disastrous consequences. Our speculative segment of economy continues unchecked. The Vajpayee administration had played its dismal role in allowing forward and futures trading in commodities. The Manmohan administration further moved further in the same path and it opened the doors for the similar market in currencies.

The panacea lies in learning lessons. If we do not learn we will suffer. There is the need to look everything afresh. A systemic change in favour of interest-free and speculation-free economy is the need of the hour.