Dr Adrian Pabst, Senior Lecturer in Politics, School of Politics and IR, University of Kent; Visiting Professor, Institut d'Etudes Politiques de Lille (Sciences Po), specially for wpfdc.org
As stock-markets worldwide reach the pre-crisis levels and exceed them, one could be forgiven for believing that the global recovery has taken hold and that a new cycle of expansion and strong growth is commencing. However, there is growing evidence to suggest that the world economy has already entered another bubble cycle of boom and bust. As financialisation proceeds apace, economic growth will continue to be too low in order to reduce mass unemployment and generate sufficient innovation. Only a coordinated policy of re-industrialisation can reconnect finance to the real economy and re-embed both states and markets in the interpersonal, social ties on which trust and cooperation depend.
1. Global imbalances threaten another crash worldwide
Five years after the bankruptcy of Lehman Brothers that triggered the global financial crash and the biggest recession since the Great Depression of 1929-32, politicians and regulators in advanced economies and emerging markets claim that a repeat won’t happen. Banking reforms and new central bank policies, so we are assured, will prevent another bubble cycle of boom, bust and bailout.
Since the Basel III agreement, banks are required to hold much more capital in relation to their lending. In theory, this should prevent the kind of over-leveraging that fuelled the credit bubble in the run-up to the events of October 2008 when inter-bank lending froze and the financial system teetered on the brink of collapse. For the same reason, banks won’t need to be bailed out when they are in trouble because they can draw on their own new capital reserves.
Similarly, central banks have adopted a raft of new policies that should in principle stabilise the world economy – from the printing of electronic money (or ‘quantitative easing’, i.e. asset purchases) in order to inject liquidity in the financial system and drive down long-term interest rates via new banking resolution mechanisms to early warning mechanisms that detect emerging bubbles and prevent a systemic breakdown.
However, all the evidence suggests that the changes are too little too late. First of all, total public and private debt levels (including corporate debts) are on average more than 30 per cent higher than before 2008. Amid sluggish growth, budget deficits and debt will continue to rise as a share of national output, which further reduces investment on which strong growth and debt reduction crucially depend.
Second, subordinate debt, which leaves lenders exposed to big losses, has soared in recent years on both sides of the Atlantic. The share of ‘leveraged loans’ used by some of the weakest borrowers has reached an unprecedented level of 45 per cent, which is 10 per cent higher than even in 2007-08.
Third, a number of emerging markets such as Brazil and China are seeing the rise of bubbles (in credit, real estate and commodities) that foreshadow a vicious cycle of boom and bust. Fourth, interbank lending to the booming economies in the global South and global East has soared to new highs. Moreover, the value of corporate bonds issued by businesses from emerging markets now exceeds such bonds in developed economies, which suggests a huge build-up of debt.
Fifth, the policy of ‘quantitative easing’ has fuelled bubbles without inducing systemic transformation. Banks and corporations have hoarded ‘cheap money’ rather than lending and/or investing funds to cash-strapped businesses. Crucially, no central bank has worked out a proper ‘exit strategy’ that does not either leave the current mechanism of excessive loose money in place or induce a panic among investors which would cause market chaos.
The stock-market mini-crash over the summer when the US Federal Reserve announced the winding down of asset purchase (or ‘taper’) is surely a sign of things to come. And that’s not even to mention higher interest rates that will drive up the costs of borrowing and burst the growing global credit bubble.
William White, the former chief economist of the International Bank of Settlements (one of the few institutions that predicted the crisis), put it as follows: “The ultimate driver for the whole world is the US interest rate and as this goes up there will be a fall-out for everybody. The trigger could be the Fed tapering but there are a lot of things that could go wrong. I am very worried that Abenomics [the economics of the Japanese Abe] could go awry in Japan, and Europe remains excessively vulnerable to outside shocks”.
2. Why current policies exacerbate the financialisation of the world economy
Those who advocate the current policies that fuel financialisation point to below-trend growth of national output and persistently high unemployment. Indeed, politicians, central bankers and regulators are all saying that the an exceptional crisis and jobless, slow-growth recovery justify unorthodox policies. These include, first of all, zero or even negative short-term interest rates; secondly, purchasing of government bonds to reduce long-term interest rates; thirdly, credit expansion (purchasing of private assets aimed at driving down the corporate costs of capital).
However, the main problem is that both banks and businesses have hoarded cash rather than lent or invested the cheap money provided by central banks. Five years after the global ‘credit crunch’, there is an ongoing credit crunch that is depressing cash-strapped businesses and demoralising income-starved households. Banks with insufficient capital (which should be recapitalised either by governments or [new] investors) refuse to lend to borrowers which they see as high-risk, while the fledgling recovery and highly indebted households perpetuate a vicious cycle of debt and demoralisation.
All the cheap money should be used to recapitalise banks permanently and restructure the unsustainable debt of certain states and households so as to help bring about a virtuous cycle of investment, production and consumption. As Nouriel Roubini – the Italian economist who earned the name Dr Doom for predicting the crash – recently argued, “all of this excess liquidity is flowing to the financial sector rather than the real economy. Near-zero policy rates encourage “carry trades” – debt-financed investment in higher-yielding risky assets such as longer-term government and private bonds, equities, commodities and currencies of countries with high interest rates. The result has been frothy financial markets that could eventually turn bubbly” .
Indeed, stock markets around the world have rebounded more than 100 per cent since the trough of 2009 and some have broken through previous records. Speculative financial investment abounds – whether high-yield ‘junk bonds’ or real estate prices or indeed commodities.
But all the reassurances about a safer world economy ignore the underlying trends and rest on policies that are largely untested. Among the underlying trends are bubbles (in credit, real estate and commodities), the hoarding of cash, a lack of investment in productive activities and a lack of long-term commitment to R&D, innovation and other strategies to create genuine new, shared value.
The untested policies include limits on loan-to-value ratios for mortgages (to prevent another subprime disaster), bigger capital reserves for banks and corporations that engage in lending and tighter standards of underwriting loans. Even new instruments procedures for winding up failing cross-border banks without need for taxpayer-funded bailouts are insufficient, as they miss the basic point that the multiple failure of several systemically important institutions will simply overwhelm this resolution mechanism.
The new central bank activism might also create perverse incentives, making the behaviour of banks even riskier since bankers will be safe in the knowledge that the central banks can create domestic money without limit. At the very least, central banks should lend to commercial banks at a penalty rate in order to dissuade excessive risk-taking. It is also imperative to consider strict limits on leverage. Anything in excess of a leverage ratio of 30 to 1 (30 dollars lent against 1 dollar of equity capital) should simply be banned, as Martin Wolf has rightly remarked .
Moreover, forcing banks to convert their debt into equity in the event of a crisis might let the taxpayer off the hook and thereby break the near-deadly embrace between bankrupt banks and bankrupt government who hold each other’s debt. But it would also greatly reduce the ability of banks to lend to businesses. So it is far from a panacea.
3. The Problem with Mass Liquidity Creation
Fundamentally, the problem with mass liquidity creation is twofold. Either much of the cheap money will flow from those parts that need it most to those that lack it least. Or restricting leverage will drive liquidity to the less regulated ‘shadow banking’ system. Either way, the financialisation of the world economy continues to fuel a new bubble cycle.
Crucially – as Roubini points out – everyone is pinning their hopes that interest rates policy will be able boost the recovery and secure financial stability, two goals that are at best at odds and at worst mutually exclusive. Raising interest rates too little too late in order to secure a stronger recovery could fuel another asset bubble and bust from which neither the public nor the private sector would be able to recover. But raising interest rates too far too fast could kill off the recovery and reverse the economic gains of the past few months.
Despite the greatest financial crash and deepest recession since 1929-32, economic thinking has barely changed. The myth that a big financial sector is an asset to an economy endures, but the evidence simply isn’t there to support it. If anything, the opposite is true. The moment the assets of banks exceed the value of gross domestic product by several factors, the ensuing systemic risks create uncertainty and induce volatility.
In the UK, as elsewhere, the financial sector may have become a key source of jobs and income as well as a matter of great national pride and global status – at least from the perspective of the metropolitan elites of London. However, the relentless expansion of the financial services industry has also generated growing income and asset inequality as well as a systemic instability and dependence on global markets that are beyond the control of any national government and parliament.
As Martin Wolf points out, “the biggest question is whether ever increasing financial deepening and cross-border integration are good things. The evidence is against these beliefs. In a recent paper, two economists from the Bank for International Settlements argued that there is a "negative relationship between the rate of growth of finance and the rate of growth of total factor productivity". Part of the reason for this is that finance disproportionately benefits "high collateral/low-productivity projects"” .
Of all the loans outstanding to UK residents, only 1.4 per cent went to manufacturing. This is why Wolf is right to conclude that “UK banking is a highly interconnected machine whose principal activity is leveraging up existing property assets”. This is largely unproductive, speculative growth whose proceeds neither trickle down to the general population nor fill the coffers of the state who could redistribute a share. So the continual expansion of the financial sector will benefit big finance, not the rest of the economy of society.
4. Rescuing the market economy from capitalism
As I have argued, global finance capitalism pervades the entire real economy. Here it is crucial to distinguish market economies from capitalism. Since its inception following the dissolution of the monasteries and the ‘enclosure’ movement in the 16th century, capitalism can be described in terms of a series of layers built on top of the everyday market economy composed of agriculture, manufacturing and light industry. These layers – local, regional, national and global – are marked by ever-greater abstraction. At the top sits disembodied finance, seeking returns anywhere, uncommitted to any particular place or industry, and subjecting anything and everything to commodification. That’s why an alternative political economy must reconnect finance to the real economy.
Crucially, the unprecedented penetration of finance that henceforth pervaded virtually the entire economy, including agriculture, industry and trade. As Polanyi and Braudel have convincingly shown, the difference between traditional economies and global capitalism can be described in terms of a series of layers built on top of the everyday market economy composed of agriculture, local manufacturing and industry. These layers – local, regional, national and global – are marked by ever-greater abstraction. At the top sits disembodied global finance, seeking returns anywhere, uncommitted to any particular place or industry, and subjecting anything and everything to market valuation and commodification. As the financial crisis of 1873 and the subsequent First Great Depression (1873-96) demonstrated, the German and Austrian stock market crash spread to the Americas by triggering a collapse in trade and in capital flows, thereby causing a wave of debt defaults through reduced tax and export revenues. In turn, debt defaults in Central America in 1873 depressed bond prices and the crisis returned to Europe shortly thereafter to engulf England, France and Russia. By 1876, a variety of countries at the center and in the periphery had defaulted, and the world economy entered a protracted recession that in some countries lasted until 1896 . This underscores the dependency of vast swathes of economic activity on global finance already at the end of the nineteenth century.
But given that the nominal value of capital must be reinvested in real material processes, the living universe is almost supplanted by a virtual reality that operates on the basis of a vacuous generality. This is reflected by the capitalist fetishization of idealized commodities – the belief that the value of material objects lies in their status as commodities instead of being somehow both intrinsic to things and added to them by human labour. In conjunction with the formalism of the rule of law that displaces organic cultures, capitalism and democracy weaken real relations among actually existing things . For both privilege the abstract individuality of commodities or persons at the expense of the social, cultural and religions structures or arrangements that bind them together and provide the civic culture upon which a vibrant democratic polity and market economy depend.
 Nouriel Roubini, ‘Bubbles in the Broth’, Project Syndicate, 31st October 2013, available online at http://www.project-syndicate.org/commentary/on-the-ugly-policy-tradeoff-facing-advanced-country-central-bankers-by-nouriel-roubini
 Martin Wolf, ‘Bank of England’s Mark Carney places a bet on big finance’, The Financial Times, 29th October 2013, available (subject to registration) online at http://www.ft.com/cms/s/0/08dea9d4-4002-11e3-8882-00144feabdc0.html?siteedition=uk#axzz2jJvwt9UJ
 Ibid. The reference is to Stephen .G Cecchetti and Enisse Kharroubi, ‘Why does financial sector growth crowd out real economic growth’, Bank for International Settlements, September 2013, available online at https://evbdn.eventbrite.com/s3-s3/eventlogos/67785745/cecchetti.pdf
 Charles P. Kindleberger, Manias, Panics and Crashes: A History of Financial Crises, 5th ed. (New York: Basic Books, 2005); Barry Eichengreen, Globalizing Capital: A History of the International Monetary System (Princeton, NJ: Princeton UP, 2008).
 Zygmunt Bauman, Liquid Love. On the Frailty of Human Bonds (Cambridge: Polity Press, 2003).