THE GLOBAL FINANCIAL CRISIS
by Michel Chossudovsky
Professor of Economics at the University of Ottawa, author of "The
Globalization of Poverty, Impacts of IMF and World Bank Reforms", Third
World Network, Penang and Zed Books, London, 1997.
Black Monday October 19, 1987 will be remembered as the largest one day
drop in the history of the New York Stock Exchange overshooting the
collapse of October 28, 1929, which prompted the Wall Street crash and
the beginning of the Great Depression. In the 1987 meltdown, 22.6
percent of the value of US stocks was wiped out largely during the first
hour of trading on Monday morning... The plunge on Wall Street sent a
cold shiver through the entire financial system leading to the tumble of
the European and Asian stock markets...
Almost day to day, ten years later on Monday October 27th, 1997, stock
markets around the World plummeted in turbulent trading. The Dow Jones
average nose-dived by 554 points, a 7.2 percent decline of its value,
its 12th-worst one day fall in the history of the New York Stock
Exchange. European stock markets were in disarray with heavy losses
recorded on the Frankfurt, Paris and London exchanges. The Hang Seng
index had crashed by 10.41 percent on the previous Thursday ("Black
Thursday" October 24th) as mutual fund managers and pension funds
swiftly dumped large amounts of Hong Kong blue chip stocks. The slide at
Hong Kong's Exchange Square continued unabated at the opening of trade
on Monday morning: a 6.7 percent drop on Monday the 27th followed by a
13.7 percent fall on Tuesday (Hong Kong's biggest point loss ever)...
Table 1:
New York Stock Exchange: Worst Single-Day Declines
(Dow Jones Industrial Average, percentage change)
Percentage
Date Decline
__________________________________________
October 19, 1987 -22.6%
October 28, 1929 -12.8%
October 29, 1929 -11.7%
November 6, 1929 -9.9%
August 12, 1932 -8.4%
October 26, 1987 -8.0%
July 21, 1933 -7.84%
October 18, 1937 -7.75%
October 27, 1997 -7.16%
October 5, 1932 -7.15%
September 24, 1931 -7.07%
The danger signals of an impending financial disaster were visible in
mid-Summer 1997 with the collapse of the Southeast Asian currency
markets under the brunt of speculative trading. A critical turning point
was reached on Wall Street on Friday August 15: in panic trading, the
New York Stock Exchange experienced its largest one day decline since
the 1987 meltdown with the Dow Jones plummeting by 247 points. The
symptoms were similar to those of the 1987 crash: "institutional
speculators" had sold large amounts of stock with the goal of
repurchasing them later but with the immediate impact of provoking a
plunge in prices. Various speculative instruments including futures' and
options' trading played a key role in precipitating the collapse of
market values.
The Asian Foreign Currency Crisis
When viewed historically, the present financial crisis is potentially
far more devastating and destructive. In 1987 national currencies
remained relatively stable; in contrast to the crashes of 1987 and 1929,
the present financial crisis is characterised by the concurrent collapse
of national currencies under the brunt of large scale speculative
activity. An almost symbiotic relationship between the stock exchange
and the foreign currency market has unfolded: "institutional
speculators" are not only involved in manipulating stock prices, they
also have the ability to plunder central banks' foreign exchange
reserves, undermining sovereign governments and destabilising entire
national economies. In the words of Malaysia's Prime Minister Mahathir
Mohamad: "This deliberate devaluation of the currency of a country by
currency traders purely for profit is a serious denial of the rights of
independent nations".(Statement at the Meeting of the Group of 15,
Malacca, Malaysia, 3 November 1997, quoted in the South China Morning
Post, Hong Kong, 3 November 1997)
In the last five months, currency speculation in Thailand, Indonesia,
Malaysia and the Philippines has been conducive to the transfer of
billions of dollars of central bank reserves into private financial
hands. Several observers have pointed to the deliberate "manipulation"
of equity and currency markets by investment banks and brokerage firms.
(Philip Wong, member of the Beijing appointed Legislative Assembly
accused the Manhattan Brokerage firm Morgan Stanley of "short-selling
the market". See "Broker Cleared of Manipulation", Hong Kong Standard, 1
November 1997). Ironically, the same Western financial institutions
which looted developing countries' central banks, have also offered "to
come to the rescue" of Southeast Asia's monetary authorities. ING
Baring, for instance, well known for its speculative undertakings,
generously offered to underwrite a one billion dollars loan to the
Central Bank of the Philippines (CBP) in July 1997. In the months which
followed, most of these borrowed foreign currency reserves were
reappropriated by international speculators when the CBP sold large
amounts of dollars on the forward market in a desperate attempt to prop
up the Peso.
Economic Falsehoods
Business forecasters and academic economists alike have casually
disregarded the dangers of the present financial crisis alluding to
"strong economic fundamentals"; G7 leaders are afraid to say anything or
act in a way which might give the "wrong signals"... Wall Street
analysts continue to bungle on issues of "market correction" with little
understanding of the broader economic picture.
In turn, public opinion is bombarded in the media with glowing images of
global growth and prosperity. The economy is said to be booming under
the impetus of the free market reforms. Without debate or discussion,
so-called "sound macro-economic policies" (meaning the gamut of
budgetary austerity, deregulation, downsizing and privatisation) are
heralded as the key to economic success.
The realities are concealed, economic statistics are manipulated,
economic concepts are turned upside down. Unemployment in the US is said
to be falling yet the number of people on low wage part-time jobs has
spiralled. The stock market frenzy has taken place against a background
of global economic decline and social dislocation. The structural causes
of the stock market crisis are not mentioned.
The plunge on the New York Stock Exchange on October 27th was casually
blamed on the "structurally weak economies" of Southeast Asia, until
recently heralded as upcoming tigers, now depicted as "lame ducks". The
seriousness of the financial crisis is trivialised: Alan Greenspan,
Chairman of the Federal Reserve Board reassured Wall Street pointing
authoritatively to "the contagious character of national economies,
spreading weaknesses from country to country". Following Greenspan's
verdict (October 28th), the "consensus" among Manhattan brokers was that
"Wall Street had caught the Hong Kong flu"...
A New Financial Environment
A new global financial environment has unfolded in several stages since
the collapse of the Bretton Woods system of fixed exchange rates in
1971. The debt crisis of the early 1980s (broadly coinciding with the
Reagan-Thatcher era) had unleashed a wave of corporate mergers, buy-outs
and bankruptcies. These changes in turn paved the way for the
consolidation of a new generation of financiers clustered around the
merchant banks, the institutional investors, stock brokerage firms,
large insurance companies, etc.
The 1987 Wall Street crash served to exacerbate these changes by
"clearing the decks" so that only the "fittest" survive. A massive
concentration of financial power has taken place in the last ten years:
from these transformations, the "institutional speculator" has emerged
as a powerful actor overshadowing and often undermining bona fide
business interests. Using a variety of instruments, these institutional
actors appropriate wealth from the real economy. They often dictate the
fate of companies listed on the New York Stock Exchange. Totally removed
from entrepreneurial functions in the real economy, they have the power
of precipitating large industrial corporations in bankruptcy.
By 1995, the daily turnover of foreign exchange transactions (US$ 1300
billion) had exceeded the World's official foreign exchange reserves
estimated at US$ 1202 billion. (Martin Khor, SEA Currency Turmoil Renews
Concern on Financial Speculation, Third World Resurgence, No. 86,
October 1997, p. 14-15). In other words, the command over privately held
foreign exchange reserves in the hands of "institutional speculators"
far exceeds the limited capabilities of central banks, --ie. the latter
acting individually or collectively are unable to fight the tide
speculative activity.
In the currency crisis of the last few months, billions of dollars of
official reserves have been plundered by institutional speculators.
These reserves have been transferred out of the coffers of the central
banks into private hands. This depletion of official reserves is part
and parcel of the financial crisis. As speculators assault the fragile
vaults of central banks, there is a danger that the Southeast Asian
currency crisis will spill over into other regions of the developing
World triggering a ruinous chain of "Mexican style" currency
devaluations and the concurrent impoverishment of millions of people.
Already in early November, following the spectacular nose-dive of the
Sao Paulo and Buenos Aires stock markets (on the 27th and 28th of
October), Latin American currencies (including the Brazilian real which
is pegged to the US dollar) were under pressure in a renewed wave of
speculative activity...
The Concentration of Wealth
This restructuring of global financial markets and institutions has
enabled the accumulation of vast amounts of private wealth, a large
portion of which has been amassed as a result of strictly speculative
transactions. The number of billionaires in the US alone increased from
13 in 1982 to 149 in 1996. The "Global Billionaires Club" (with some 450
members) has a total Worldwide wealth well in excess of the combined GDP
of the group of low income countries with 56 percent of the World's
population (Forbes Magazine, International Billionaires, the World's
Richest People, 1997. The data is based on recorded wealth. It tends to
grossly underestimate the concentration of global wealth). Family
fortunes are in some case in excess of the GDP of countries (for
instance, the private wealth of the Walton Family owners of Walmart (27
billion), is of the same order of magnitude as the GDP of Bangladesh
with a population of 120 million people...
No need to produce commodities: enrichment is increasingly taking place
outside the real economy divorced from bona fide productive and
commercial activities. According to Forbes: "Successes on the Wall
Street stock market [meaning speculative trade] produced most of last
year's [1996] surge in billionaires". (Charles Laurence, "Wall Street
Warriors force their way into the Billionaires Club", Daily Telegraph,
London, 30 September 1997). In turn, part of the money accumulated from
speculative transactions is funnelled towards confidential numbered
accounts in the numerous offshore banking havens. This critical drain of
billions of dollars in capital flight dramatically reduces state tax
revenues, paralyzes social programmes, drives up budget deficits and
spurs the accumulation of large public debts.
In contrast, the earnings of the direct producers of goods and services
are compressed; the standard of living of large sectors of the World
population including the middle classes has tumbled. Health and
education programmes are downsized; wage inequality has risen in the
OECD countries. In both the developing and developed countries, poverty
has become rampant; according to the International Labour Organisation
(ILO), Worldwide unemployment affects one billion people or nearly a
third of the global workforce (ILO, Second World Employment Report,
Geneva, November 1996). The accumulation of financial wealth resulting
from speculative transactions feeds on poverty and low wages.
Replicating the Policy Failures of the late 1920s
Wall Street was swerving dangerously in volatile trading in the months
which preceded the crash of October 29, 1929. Laissez faire under the
Coolidge and Hoover administrations was the order of the day: in early
1929 the Federal Reserve Board declared that it "neither assumes the
right nor has it any disposition to set itself up as an arbiter of
security speculation or values." The Economics establishment largely
upheld this verdict. The possibility of a financial meltdown had never
been seriously contemplated. Professor Irving Fisher of Yale University
had stated authoritatively in 1928 that "nothing resembling a crash can
occur". The illusion of economic prosperity persisted several years
after the Wall Street crash of October 1929. In 1930, Irving Fisher
stated confidently that "for the immediate future, at least, the
perspective is brilliant". According to the prestigious Harvard Economic
Society: "manufacturing activity [in 1930]... was definitely on the road
to recovery" (quoted in John Kenneth Galbraith, The Great Crash, 1929,
Penguin, London).
Mainstream Economics Upholds Financial Deregulation
The same complacency prevails today as during the frenzy of the late
1920s. The broad economic causes of the crisis are not addressed.
Echoing almost verbatim the economic slogans of Irving Fisher, today's
economics orthodoxy not only refutes the existence of an economic
recession, it also denies outright the possibility of a financial
meltdown. According to Nobel Laureate Robert Lucas of Chicago
University, the decisions of economic agents are based on so-called
"rational expectations", ruling out the possibility of systematic errors
which might lead the stock market in the wrong direction... It is ironic
to say the least that precisely at a time when financial markets were in
turmoil, the Royal Swedish Academy announced the granting of the 1997
Nobel Prize in Economics to two American economists for their
"pioneering formula for the valuation of stock options [and derivatives]
used by thousands of traders and investors" (meaning an "algebraic
formula" which is routinely used by stock market speculators). (See Greg
Burns, "Two Americans Share Nobel in Economics, Chicago Tribune,
October 15, 1997).
In the aftermath of the 1987 crisis, the regulatory policy issues were
never resolved. According to the various commissions set up by the US
Congress, the White House and the New York and Chicago exchanges, the
1987 crash had been triggered by specific events leading to "reactive
responses" by major financial players including institutional traders
and dealers in mutual funds. No other reason was given. "Sound
macro-economic policies" combined with financial deregulation were the
irrevocable answers. The term "speculation" does not appear in Wall
Street's financial glossary.
A presidential task-force had been formed under the chairmanship of
Nicholas Brady (later to become Treasury Secretary in the Bush
Administration). The institutional speculators overshadowing bona fide
corporate interests, represented a powerful lobby capable of influencing
the scope and direction of regulatory policy. The task-force took on a
detached attitude pointing to the "adequacy" of existing regulations.
In the aftermath of the 1987 crisis, the policy errors of the 1920s were
repeated. Government should not intervene; the New York and Chicago
exchanges were invited to fine-tune their own regulatory procedures
which largely consisted in "freezing" computerised programme trading.
("Five Years On, the Crash Still Echoes, The Financial Times, October
19, 1992). These so-called "circuit-breakers" proved to be totally
ineffective in averting a meltdown. On Monday the 27th of October 1997,
a first circuit breaker halted trading for 30 minutes after a 350 point
plunge of of the Dow Jones. After the 30 minute trading halt, an aura of
panic and confusion was installed: brokers started dumping large
quantitites of stocks which contributed to accelerating the collapse in
market values. In the course of the next 25 minutes, the Dow plunged by
a further 200 point triggering a second "circuit breaker" which served
to end the trading day on Wall Street...
Computerised Trading Exacerbates Stock Market Instability
In contrast to the 1920s, major exchanges around the World are
interconnected "around the clock" through instant computer link-up:
volatile trading on Wall Street, "spills over" into the European and
Asian stock markets thereby rapidly permeating the entire financial
system.
Recent experience has amply demonstrated the destablising role of
computerised programme trading: the Dow Jones can swing back and forth
by several percentage points in a matter of minutes facilitated by the
NYSE's Superdot electronic order-routing system. Superdot can now handle
(without queuing) more than 300,000 orders per day (an average of 375
orders per second) representing a daily capacity of more than two
billion shares. While its speed and volume have increased tenfold since
1987, the risks of financial instability are significantly greater.
The Fate of National Economies
The social consequences and geo-political implications of the global
financial crisis are far-reaching particularly in the uncertain
aftermath of the Cold War. Because national economies are interlocked in
a system of global trade and finance, the potential impact of the stock
market meltdown is potentially far more devastating.
Moreover, macro-economic policies are internationalised: the same
austerity measures are applied all over the World under the survellance
of creditors and international financial institutions. In the developing
World and in the former Soviet block, entire national economies have
been destabilised by currency devaluations often resulting in the
outbreak of social strife, ethnic conflicts and civil war...
Economic stagnation in all major regions of the World largely marks the
ten year period since the 1987 financial crash. In the OECD countries as
a whole, GDP growth has hovered between 1.5 % and 3.0 %. These figures,
however, do not in any meaningful way assess the depth of the economic
crisis. In the developing World, economic decline exceeds that
experienced in the USA during the Great Slump of the 1930s: many
countries in Sub-Saharan Africa and Latin America have experienced
negative economic growth rates.
In turn, in the former Soviet Union, economic decline has surpassed the
plunge in production experienced in the USSR at the height of the Second
World War following the German occupation of Bielorussia and parts of
the Ukraine in 1941, and the extensive bombing of its industrial
infrastructure. The Soviet GDP had by 1942 declined by 22 percent in
relation to pre-War levels (World Development Report, 1997, fig 2.1, p.
26). In contrast in the former Soviet Union as a whole, GDP plummeted by
44.0 percent over the 1989-1995 period. (According to data compiled by
the United Nations Economic Commission for Europe, Independent estimates
indicate a substantially greater drop and there is firm evidence that
official figures have been manipulated).
Dangerous Cross-Roads
A massive contraction in global purchasing power has occurred. With the
exception of a buoyant luxury goods' economy for a privileged upper
income stratum, markets for basic consumer goods have dwindled. In other
words, the surge of stock values observed in recent years is totally at
variance with the movement of the real economy. Stock markets "cannot
lead their own life" indefinitely. Business confidence cannot be
"sustained by recession". The price to earnings ratio (P/E) on the
Standard and Poor 500 index (S&P 500) has risen dangerously to 25.8,
well above the P/E level of 22.4 prevailing in the months prior to the
October 1987 crash.
In many regards, the stock market frenzy is analogous to the Albanian
"ponzi" pyramid schemes. People who have invested their private savings
will "get rich" while the market rises and as long as they leave their
money in the stock market. As soon as financial markets crumble,
life-long savings in stocks, mutual funds, pension and insurance funds
are wiped out. More than forty percent of the American adult population
has investments in the stock market. A financial meltdown could lead to
massive loan default sending a cold shiver through the entire banking
system; it could also result in bank failures as well as a tumble of
pension and retirement savings funds.
Financial Disarmament
Market forces left to their own devices lead to financial upheaval.
Close scrutiny of the role of major speculative instruments (including
option trading, short sales, non-trading derivatives, hedge funds, non
deliverable currency transactions, index futures, etc.) should be
undertaken.
A report published by the Bundesbank had already warned in 1993 that
trade in derivatives could potentially "trigger chain reactions and
endanger the financial system as a whole". (Martin Khor, " Baring and
the Search for a Rogue Culprit, Third World Economics, No. 108, 1-15
March 1995, p. 10). Regulation, however, cannot be limited to the
disclosure and reporting of trade in derivatives as recommended by the
Bank for International Settlements (BIS); concrete measures applied
globally and agreed by governments of both developed and developing
countries are required to prohibit the use of specific speculative
instruments.
The risks associated with the electronic order routing systems should
also be the subject of careful examination. Alan Greenspan, Chairman of
the Federal Reserve Board admits that "the efficiency of global
financial markets, has the capability of transmitting mistakes at a far
faster pace throughout the financial system in ways which were unknown a
generation ago..."(Bank for International Settlements Review, No. 46,
1997).
It is essential that the World community acknowledge an increasingly
dangerous situation and adopt without delay a coherent structure of
financial regulation (and inter-governmental cooperation).
This is a broad and complex political issue requiring substantial
changes in the balance of political power within national societies.
Those in the seat of political authority (including Conservatives,
Social Democrats and Socialists) often have a vested interest in
upholding dominant financial interests. At the June 1997 Denver Summit
(which coincided with the onslaught of the Asian currency crisis) G7
leaders in a muddled and confusing statement called for "stronger risk
management", "improved transparency" and "strong prudential standards"
(see Final Report to the G-7 heads of state and government: "On
promoting financial stability", Denver, June 21, 1997). The
destabilising role of speculative activity on major bourses was never
mentioned. In contrast, the G7 statements by political leaders profusely
heralding the benefits of the free market have generated an atmosphere
of deceit and economic falsehood. "Business confidence" has been
artificially boosted by G7 rhetoric largely to the advantage of the
institutional speculator.
A form of "financial disarmament" is required directed towards curbing
the tide of speculative activity. (The term "financial disarmament" was
coined by the Ecumenical Coalition for Social Justice; see "The Power of
Global Finance", Third World Resurgence, No. 56, March 1995, p.21.). In
turn, "financial disarmament" would require dismantling the entire
structure of offshore banking including the movement of dirty and black
money.
The evolution of international institutions (including the World Trade
Organization and the Bretton Woods twins) is also crucial inasmuch as
these international bodies play an important role in overseeing and
regulating macro-economic and trade policies invariably to the detriment
of national societies.
The World community should recognize the failure of the dominant
neoliberal system inherited from the Reagan-Thatcher era. Slashing
budgets combined with lay-offs, corporate downsizing and deregulation
cannot constitute "the key to economic success". These measures
demobilise human resources and physical capital; they trigger
bankruptcies and create mass unemployment. Ultimately, they stifle the
growth of consumer spending: "recession can not be a solution to
recession".
Regulating the stock market per se is a necessary but not a sufficient
condition. Financial markets will not survive under conditions of global
economic depression. An expanding real economy will not occur unless
there is a major revamping of economic institutions and a rethinking of
macro-economic reform...
There are, however, no "technical solutions" to this crisis. Meaningful
reforms are not likely to be implemented without an enduring social
struggle. What is at stake is the massive concentration of financial
wealth and the command over real resources by a social minority. The
latter also controls the "creation of money" within the international
banking system overshadowing the functions of central banks.
The first crucial stage of this Worldwide struggle is to break the
legitimacy of the neoliberal agenda as well as disarm the so-called
"Washington consensus". The latter is endorsed by national governments
around the World. In other words, "financial disarmament" is not
tantamount to State "regulation" narrowly defined; it requires
democratic forms of "social control" of financial markets as well as
radical changes in the structures of political power.
Social action cannot limit itself to the mere indictment of national
governments and of the Washington based bureaucracy. Banks,
transnational corporations, currency speculators, etc. must be
pinpointed. This struggle must be broad-based and democratic
encompassing all sectors of society at all levels, in all countries.
Social movements and people's organisations acting in solidarity at
national and international levels, must target not only their respective
governments but also the various financial actors which feed upon this
destructive economic model.
** End of text from cdp:econ.saps **
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