Download Economía política de la crisis y la regulación financiera

POLITICAL ECONOMY OF THE FINANCIAL CRISIS AND REGULATION:
FROM BRETTON WOODS TO BASEL II AND THE CURRENT CRISIS
Fernando Sánchez Cuadros
“Only after the speculative collapse does the truth emerge”
A Short History of Financial Euphoria
John Kenneth Galbraith
“This crisis is the fruit of dishonesty on the part of financial institutions,
and incompetence on the part of policymakers”
Joseph Stiglitz
Introduction
The current financial crisis has revealed deep inconsistencies in and the
inappropriateness of financial regulation implemented in the early 1980s, during
what became known as the “conservative revolution.” To the United States, the
“new concept” had a very specific function: shoring up the eroding foundation
on which US hegemony was built.1 Increasing imbalances in foreign trade and
public finance, inflationary pressure, oil shocks and their geopolitical
ramifications, loss of competitiveness in industrial manufacturing, the nationalist
challenge of the Third World, and a never-ending Cold War highlighted the
inability of the United States to remain the backbone of the world order
constructed at the end of World War II and created an unacceptable cost for the
economic adjustment that would be necessary to reverse the trend toward a
weakening of the profit rate and the erroneously labeled “deindustrialization” of
the capitalist economy.
The response was to promote a restructuring of the world economy,
eliminating all vestiges of a “neutral” monetary pattern based on the dynamics
of the dollar and the financial system. Reagan’s goal was to reverse declining
1
While monetarist discourse was spreading since the 1960s, the theoretical transition in the United States
coincided with the outbreak of stagflation in the 1970s and the erosion of the hegemony on which the
United States based the post-war world order.
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profits from the financial portion of capital and turn it into the new international
mainstay of accumulation of capital. That simple fact completely conditioned
thinking about the relationship between the financial system and the economic
system as a whole, leading to growing autonomy of financial activity; in other
words, the financial became separated from the real through a rapid process of
financial internationalization promoted in the Euromarket. This process reached
a turning point with the emergence of petrodollars and the indebtedness of
unbalanced economics, which accompanied that phenomenon in developing
countries,
while
developed
economies
were
engaged
in
accelerated
technological change and were trying to reverse the downturn in terms of trade
that occurred in the second half of the 1970s and wage pressures on profits.
There were additional factors in the United States because of the country’s
hegemony.
Deregulation of the financial system gave economic dynamics the impetus
needed to attain those goals, and the United States became the foremost
promoter of liberalization and opening markets, including financial markets.
The problem of financialization
Accumulation of capital and financial hegemony
Capitalism’s last great cycle of expansion occurred after World War II, in the
1950s and 1960s, as a result of agreements among the world powers at the
time, including those that had opposed each other during the war. The
conviction that the distribution of markets through warfare was no longer
acceptable2 was accompanied by the design of an economic architecture that
The presence of the USSR conditioned the capitalist powers’ willingness to agree to rebuild markets and
reconstitute capitalism’s capacity for growth, increasing investment and job creation.
2
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looked to free trade and cooperation to encourage expansion of investment to
increase employment and income. The liberal utopia of competition and
complementarity appeared to finally have found fertile ground, after its collapse
in World War I and the crisis of the 1930s. That model, however, assumed the
leadership of the United States, which guarded its hegemonic aspirations
closely.
This expansion cycle came to an end in the second half of the 1970s,
because of a steady decrease in the benefits realized by companies due to
excess installed capacity, wage pressure and greater competition for markets
spurred by the decrease in revenues, competition that was addressed through
technological innovation. Conflicts between capitalists, between capital and
labor, and between states representing national capital marked a transition
between 1965 and 1973. 3 The Welfare State’s labor victories meant higher
costs for companies, which encouraged investment in countries where lower
wages or access to cheaper raw materials boosted competitiveness, leading to
intercapitalist competition. Strong labor movements were accompanied by the
rise to power of political parties of workers.4 In the second half of the 1970s, the
increase in prices of raw materials, especially petroleum, put even more
pressure on profit recovery.
From the US standpoint, at the state level the conflict could be solved by
devaluing the currency and abandoning the gold standard, putting an end to the
Bretton Woods accords. The United States was overwhelmed by pressure on its
3
Robert Bremmer. La expansión económica y la burbuja bursátil. Ed. Akal, Spain, 2003.
Arrighi, Giovanni. Adam Smith en Pekín. Orígenes y fundamentos del siglo XXI. Ed. Akal, Spain,
2007, p. 133. In both the institutional and political spheres, workers had reached the peak of their political
capacity: full employment policies, the right to strike, unionize, bargain collectively, have access to loans
and pensions, etc. This strength crumbled in the 1980s under pressure from unemployment and labor
reforms stemming from a new concept of macroeconomic management, the role of economic policy and
the concept of social rights, which conflicted openly with property rights and ideas about the freedom of
homo economicus.
4
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current account and a growing current account deficit; “wracked domestically by
intense social conflicts stemming from the Vietnam War and civil rights, the
political price of subjugating monetary circulation to the discipline of the gold
standard had a clear social component that also included the risk of alienating
workers from the ideologies and practices of the dominant bloc.”5
Capital’s other response to declining profits was foreign investment. In the
quest for lower wages, the ability to sustain workers’ pay rates weakened in
advanced countries. Once the policies promoted by the Reagan and Thatcher
governments undermined the work force as a class, capital was “redirected
from low- and medium-income areas toward the United States.” The choice of
an inflationary (as opposed to deflationary) route to address the crisis of the
1970s was more decisive and effective than international capital mobility in
eroding the labor movement’s gains. 6 This was the greatest achievement of
Ronald Reagan’s monetarism.
Inter-capitalist competition and capital-labor relations alone were not
responsible for economic events of the 1970s and the financialization of
capitalism. The Vietnam War was a key factor because of its impact on
budgeting and the balance of payments. This reflects one factor underlying the
US economy’s loss of industrial power: the fight against communism meant that
besides serving as lender of last resort, liquidity source, capital exporter and
importer of surplus from other countries, the United States became the West’s
military umbrella. The Vietnam War occurred in this context, bloating defense
spending. For the United States, containing communism also meant confronting
5
Arrighi, Giovanni, op. cit., pp. 135-136. Arrighi adds that after May 1968, one of the great supporters of
the gold standard, French President Charles De Gaulle, chose instead to restore domestic tranquility and
“stop dreaming of gold.”
6
Ibid., p. 137. Arrighi argues that workers ultimately depended on anti-inflationary measures to defend
their wages’ purchasing power, which conditioned their willingness to engage in labor battles.
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nationalist movements in the Third World, and many military fronts were
opened. According to Arrighi, it was the cost of the Cold War that finally led to
the devaluation of the dollar, the end of parity and the resulting collapse of
Bretton Woods. And while devaluation of the dollar transferred part of the cost
of the adjustment to other advanced economies, especially the United States’
closest competitors, the main goal of getting out of the agreements was “to free
the US government’s fight for domination of the Third World from monetary
restrictions, [giving it] unprecedented freedom to siphon off resources from the
rest of the world by simply issuing its own currency.” 7 This is the essence of
financialization. The United States saw Bretton Woods as a mechanism for
turning its economic, trade, financial and technological supremacy into
hegemony based on industrial superiority. The end of the Bretton Woods
accords was necessary to reposition that hegemony in its financial system.
During the 1960s, while the system of fixed parity and capital flows regulated
by monetary policy was collapsing, much of the surplus generated by petroleum
exporting countries was concentrated in the international banking system, which
enabled it to serve as intermediary for the “petrodollars.” Inflationary pressures
from excess liquidity accumulated during the rapid expansion of investment and
world trade after World War II, exacerbated by the oil shock and a recessive
trend stemming from overaccumulation of capital during the “golden quartercentury of capitalism,” slowed demand for credit from large conglomerates
traditionally served by the international banking system, which had to look to
new markets. This enabled governments of developing countries, especially
7
Ibid., p. 143.
362
those with serious trade and budget imbalances, to get unconditional, broadly
discretional loans from multilateral financial bodies.
This was the context for the first structural change in international financing,
the privatization of financing, when the private international banking system
became the main intermediary for surplus oil money. Attempts to channel at
least some of the “petrodollars” through a fund managed by the United Nations
to finance development were unsuccessful, leaving the task – and the revenues
that could be generated with this liquidity – entirely in the hands of the
international banking system. If the Bretton Woods accords had remained in
effect and financial intermediation had not been under the control of the private
banking system and subject to its profitability criteria, initiatives to generate
increased development funds probably would have had a greater chance of
implementation. But other urgent factors influenced the redesign of the financial
architecture at that moment.
With the 1944 agreement, the United States won the “right” to go into debt in
its own currency with no adjustments to its economy, in exchange for
supporting, with its dollars, the liquidity that the international economic system
would need to keep trade and investment from stagnating, operating as lender
of last resort and guaranteeing that dollars could be freely converted to gold. It
replaced the European Union as lender of last resort, ignored free convertibility,
and thereby put an end to the system of fixed parity. And while it offered liquidity
through its current account deficit, it was also the source of the greatest
demand.
Capitalism and the competition it spurred between the major powers, once
they returned to the economic scene as competitors and rivals, combined with
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the US strategy of basing its power on military might and the dominance of the
dollar, began to erode the foundations of industrial supremacy and weaken
hegemony. Toward the end of the 1970s, various international crises
accentuated that decline, but did not weaken the United States’ hegemonic
greed. This was the era of the conservative revolution led by Ronald Regan and
the underlying change in monetary policy. The decline over the next 20 years
(1973-1993) was accompanied by efforts to modify North-South relations. The
massive Third World debt would play a key role in this process, channeling
overabundant liquidity and opening market floodgates to flows of goods,
services and capital, expanding the market for a supply that was steadily
increasing because of constant technological innovation.
Although the cutback in financing for developing countries through sovereign
loans was due to the growing risk of accumulating short-term debt with high
interest rates and a marked deterioration of the debtors’ exchange rates, this
process coincided with the shift to a restrictive monetary policy in the United
States, the need to finance increased military spending, and the combined
effect of the drop in petroleum prices and the rapid accumulation of surplus in
Japan’s current account, along with its preference for the bond market over
bank savings, all of which helped reroute sources of liquidity from the Middle
East to Asia and transfer the leading role of commercial banking in capital
markets. The United States had no problem in fighting for the resources used to
manage an increasingly revolving external debt at the worst moment for debtor
countries. At this point, the second structural change in international financing,
the securitization of financing, occurred.
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In the 1980s, the financial dry spell played a decisive role in the adjustment
process and, subsequently, in the nature of the reform implemented in the
1990s. This process occurred within the framework of what became known as
globalization, referring to an accelerated worldwide flow of production, trade and
finance. For developing countries, the reform meant increased integration into
the world economy through:

The opening of their markets via trade liberalization, which usually failed
to consider the need to adapt the productive apparatus to make it
competitive, and which assumed that mere exposure to competition
would be sufficient to make production competitive. This process ignored
the impact of cost differentials, technological know-how, and access to
distribution and supply channels, in which conglomerates clearly had a
competitive advantage, and eliminated the need for an industrial policy.
Production costs have been high, and while exports increased in many
cases, there has not been sufficient diversification in types of goods and
markets. Economies like those of Brazil and Southeast Asia, which took
greater advantage of the trade opening, tended to have a more complex,
more industrialized productive apparatus.

The
second
means
of
integration,
financial
liberalization
and
deregulation, was even more harmful, because it conditioned financial
intermediation on the urgent need to attract capital to complement scant
internal savings. This was aggravated by the production sector’s
tendency of import and the rigidity of its export structure; in most cases,
financial integration has not increased the capacity to retain surplus or
stimulate internal savings. Instead, it has perpetuated the financial
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dependence that tends to accompany technological dependence, which
cannot be eliminated by opening up trade. In the 1990s, the “return” to
capital markets was strongly determined by low US interest rates and the
permissiveness granted to financial capital with liberalization. As a result,
short-term capital predominated.
Financial crisis and architecture of the international financial system
The architecture of the international financial system (IFS) consists of a
series of institutions that regulate and supervise international financial activity,
the norms, regulations and agreements that serve as the basis for this
oversight, and public and private agencies that participate in international
financial transactions.
In recent years, IFS regulators have been convinced that to function
properly, domestic financial systems must not only become part of the IFS,
liberalizing and opening their markets, but must also establish prudent
regulation, balancing the national risks of financial activities with careful,
responsible performance by financial intermediaries.
This conviction has become stronger, and emphasis has shifted from
opening and liberalization to orderly liberalization of the movement of capital.
This shift essentially acknowledges that the rapid opening of capital markets
has weakened, rather than strengthened, national capital markets, increasing
contagion and the vulnerability of financial systems. This increased financial
fragility is occurring in a milieu in which the speed of capital flows has
accelerated markedly because of communications technologies and computer
systems, which reduce the time and cost of capital movement and make it
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possible to profit from short-term market advantages created by price
differentials in financial assets, interest rates and exchange rates.
Internationally, especially since the late 1990s, various measures have
been taken to strengthen the IFS. The International Monetary Fund (IMF),
World Bank (WB), Bank for International Settlements (BIS), financial
supervisory bodies coordinated by the Basel Committee, and the Group of 30
— an international committee of well-known figures in the financial world,
academia and international bureaucracy, which acts as consultant or adviser to
multilateral bodies and the Group of Seven (G7) for multilateral decisions about
the international economic system — have taken on the task of studying,
designing and promoting measures to strengthen the IFS architecture.
Many of these efforts have focused on improving regulation and
supervision of the financial system. This approach emphasizes provisions
aimed at the orderly liberalization of capital flows, reinforcing market
supervision, improving international oversight of national economic policies by
promoting good practices and transparency in monetary policy, providing more
rapid and higher-quality information, expanding collaboration and consultation
at the regional level, and including the private sector in the prevention and
solution of financial crises.
The sequence, depth and scope of the crises that began in 1994
revealed the link between financial fragility and the deep, accelerated
liberalization of capital markets, which allowed capital to move from one market
to another with no regard for the impact of sudden, massive inflows and
outflows on domestic markets. Debate over the new international financial
architecture has therefore emphasized the need to better foresee crises and
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mitigate their impacts, creating an environment that would leverage the positive
effects of capital flows while controlling negative impacts.
Private capital is extremely mobile, partly because of technological
facilities, but also because of the accelerated deregulation and opening up of
financial systems in industrialized countries in the 1970s and 1980s, and in
developing countries since the 1980s. These changes are closely related to the
development of the IFS since the 1970s. The current financial crisis
demonstrates that regulations have been less effective in governing financial
entities’ accounting (there has been a proliferation of off-the-books operations),
leveraging with little capital, the uncontrolled profusion of hedge funds and
structured products, and the creation of a murky financial system in which many
financial institutions could take on banking functions, and in which conditions for
requesting and granting loans were relaxed.
8
This dynamic and the
corresponding regulatory weakness resulted from financial dominance that not
only went unquestioned, but was also encouraged by both regulatory bodies
and monetary policies.
The problem of deregulation
In the strictly financial sphere of reforms, deregulation is probably the factor
with the greatest impact. The collapse of Bretton Woods left a huge vacuum
that was not filled with new regulations, but which led to deregulation as a
response to the distortions that created “financial repression.” In light of the
“Freed by deregulation, the banks found new business by converting consumer debt into tradable
securities and then selling those securities to the funds (or other banks). In order to finance this operation
the banks themselves took on more debt, blithely assuming that the return on the securities would be
comfortably above their cost of borrowing, and that they would anyway soon sell on the securities to
someone else, in what was known as the ‘originate and distribute’ model.” Robin Blackburn, “The
subprime crisis,” New Left Review, No. 50, March-April 2008, p. 57.
8
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series of crises that have occurred since the mid-1990s, it seems clear that this
did not help strengthen the financial system, but did reinforce the predominance
of the financial over the productive. Extreme permissiveness toward innovation
contributed to the rise of agents, products and markets that were not foreseen
by rules designed to maintain stability.
Deregulation focused on the liberalization of interest rates, giving
intermediaries great leeway to set financing costs and the prices of their
products and services. This approach is counterproductive if the goal is a
deeper, more stable financial system. Financial activity complements productive
activity, and consists of intermediation between savings and the financing of
production. Deregulation sped up the collapse of this intermediation and
allowed savings and surpluses to be channeled into capital markets, where tacit
rules for access to financing create a bias in favor of productive units and
individuals with greater financial capacity, leading to a greater concentration of
income. Under these conditions, investment projects that lacked access to
capital markets had no choice but to turn to informal markets with higher costs.
In a context of free trade, this aggravated competitive disadvantages, especially
for small and mid-size companies, which tend to create the most jobs.
Financial liberalization, however, was mainly guided by the need for financial
capital to diversify its opportunities and risks. Not by chance were the crises
faced by developing countries connected with massive capital outflows that
followed inflows of varying duration, which tended to create inflationary pressure
and Dutch disease, exacerbating current account imbalances and increasing
dependence on foreign savings.
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The strongest supporter of financial liberalization was the US government,
especially under former Presidents Ronald Reagan and Bill Clinton, at a time
when many companies’ profits came from their participation in capital markets
through the operations of their treasuries.
9
Many investments involved
purchasing the company’s own stock to raise its stock price. These revenues
helped maintain high-cost, low-profit productive structures and provide access
to leveraging.
Prudent, transparent self-regulation
Financial systems were profoundly transformed in the 1970s and 1980s, and
in the 1990s they took on characteristics that appear to have undergone a crisis
amid recent episodes of instability, volatility and speculation. The floating after
1973 “assumed a real ‘privatization of exchange risk,’ which imposed the need
to create financial instruments to cover it and multiplied currency transactions.”
International financial bodies began promoting economic liberalization among
developing countries, reflecting the new power relationships and their
ideological manifestation. “Increased internationalization of finance made new
regulatory standards necessary,” especially with regard to debate over the role
of international lender of last resort after the banking crisis spread around the
world. This led to the Basel Committee on Banking Supervision and the Bank
for International Settlements (BIS) adopting, in 1975 and 1988, the core
principles for effective banking supervision (Basel I). Because of constant
9
Robert Pollin. Los contornos del declive. Editorial Akal, Spain, 2005, pp 64-72. Analyzing the origin of
the financial bubble of the 1990s, Pollin refers to accounting fraud in companies that artificially inflated
benefits to impress Wall Street; the dot-com boom, which contributed to an increase in investment in new
technologies driven by the promise of hugely expanded markets thanks to the Internet’s transmission
capacity, financial deregulation and the Federal Reserve’s initiatives, the increase in inequality and
business profitability, change in supply and demand in the stock market, etc.
370
modifications to the financial system, driven by the market integration,
innovation and increasingly complex financial transactions, the standards
needed adjustment. The result was rules encompassing a range of issues, set
out in the revised framework for international convergence of capital
measurement and capital standards (Basel II),10 whose purpose was to “secure
international convergence on revisions to supervisory regulations governing the
capital adequacy of internationally active banks.” It also proposed “the adoption
of stronger risk management practices by the banking industry” through “the
three pillars (minimum capital requirements, supervisory review, and market
discipline) approach on which the revised Framework is based.” 11
For Pillar I, minimum capital requirements, the approach should “help create
a culture of risk management, improving the banks’ decision-making process”
through incentives including lower credit risk capital requirements, along with
the development of internal models for risk assessment and management (IRB
approach),
so
“concepts
such
as
economic
capital
and
profitability
measurements for risk-adjusted capital will assume a lower degree of
subjectivity when a loan is made and a more objective comparison of the results
of each operation.” 12 The framework offers a sort of menu of options for
determining the minimum requirements for credit and operational risks, which
can be adapted to the specific characteristics of national financial markets with
a certain degree of discretionality, although the Basel Committee would oversee
and monitor implementation of the framework.
10
ECLAC, Globalización y desarrollo, Santiago, p. 56
BIS, Basel Committee on Banking Supervision, International Convergence of Capital Measurement
and Capital Standards: a Revised Framework, June 2006, pp. 1 and 2.
12
Alicia García-Herrero, “Posible impacto de Basilea II en los países emergentes,” CEMLA, Boletín,
Vol. LII, N° 3, July-September 2006, pp. 105-107.
11
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Pillar I, on supervisory review, establishes four principles: banks should have
a process for assessment of capital adequacy based on a risk profile and on
having a strategy for maintaining capital levels; supervisors should review these
strategies and capital adequacy assessments; supervisors should expect banks
to operate above the minimum regulatory capital ratios; and supervisors should
intervene at an early stage to ensure that capital does not drop below the
regulatory minimum.
Pillar III, on market discipline, is related to transparency, or truthful, complete
information.
The rationale behind Basel II as a regulatory framework is the establishment
of good banking practices that should be observed by lending institutions. If
every institution observed these rules for capital and adopted risk assessment
and management practices, and if supervisors enforced the rules, the stability of
the financial system could be ensured and information and data would be
available to verify the health of the financial system in real time.
The recent crisis, however, has demonstrated that large commercial and
investment banks involved in leveraging operations and structuring of financial
products ignored and avoided the recommendations, resorting to increasingly
sophisticated financial engineering that distorted the risk management process,
often leading to speculative operations.
One factor in the instability of the financial system is the ease with which
capital can move among markets worldwide in a highly integrated financial
system. In the current regulatory framework, however, there has been a
tendency to avoid controls on capital inflow (liberalization of the capital account)
without allowing the recipient to differentiate between short- and long-term
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capital or investment and speculative capital. Recently, however, after the
repeated financial crises of the 1990s, some consideration has been given to
regulating capital inflows, or at least discouraging the inflow of volatile and
speculative short-term capital. These measures are coming slowly and with
difficulty, even though short-term capital tends to create macroeconomic
pressures and distortions in the behavior of economic agents.
Liberalization, innovation, deregulation and globalization
Two factors that explain how the liberalization and deregulation of financial
markets have increased financial fragility are the speed at which contagion
occurs and the volatility of capital.
Volatility highlights the market’s tendency toward cycles of financial boom
and panic, in which capital flows tend first to grow and then to contract, beyond
levels that sound economic principles would advise in either case. Volatility
refers to trend shifts that can take even investors by surprise, rather than
fluctuations within a trend.
Contagion is the market’s inability to distinguish between different
borrowers. It tends to occur when economic agents, swept away by the
euphoria of investing in capital markets, contract debt while underestimating the
risks, trusting in the liquidity characteristic of boom times. Euphoria mixes
perversely with available liquidity, leading to speculative rushes and
overindebtedness. When the financial situation reverses, extreme pessimism
follows, with a loss of confidence as the secondary markets become
disorganized, leading to an overall loss of liquidity.13
13
See José A. Ocampo, La reforma del sistema financiero internacional: un debate en marcha,
Santiago, Fondo de Cultura Económica/Economic Commission for Latin America and the
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Homogeneous criteria tend to be used for investment decisions about
capital from different sources in dissimilar economies, especially in panic
situations when, after experiencing losses in one market, investors sell
profitable assets in another country to cover their positions. Investment banks
and mutual funds tend to do the same thing, to ensure greater liquidity in case
their customers withdraw their deposits. These sales can affect interest rates,
prices of financial assets and exchange rates, undermining macroeconomic
principles even in healthy economies.
The problem is exacerbated when economies undergoing financial
liberalization suddenly receive massive inflows of capital seeking high yields.
Such inflows have generally been followed by episodes of expansion of bank
credit, leading to a decrease in the quality of assets and excessive relaxing of
risk analysis. With so much liquidity available, financial intermediaries lose
discipline and caution in making loans, which the market absorbs avidly,
especially when economic agents operating in the productive sector
simultaneously face the consequences of rapid trade opening and increased
financing costs. The situation is aggravated by the impact on exchange rates,
which tend to become overvalued, making the productive apparatus less
competitive and eroding the balance of payments.
In financial activities, excessive lending generally finances a sudden
increase in asset prices (financial bubble), so rampant speculation, which
follows the bank debt fever, is the result of the arbitration of price differentials by
investors.
Caribbean (ECLAC), 1999. See Charles Kindleberger, Manías, pánicos y cracs, Editorial Ariel,
Barcelona, 1991.
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When the capital sustaining liquidity expansion and overindebtedness
reverts, the liquidity crisis immediately becomes a bank crisis. Contrary to
conventional belief, therefore, the fragility of the financial system is more a
consequence than a cause of the reverting of capital flows. The consequence is
that banks will try to safeguard their assets and speed up loan recovery,
transferring the credit crisis to the real sector of the economy. Debtors stop
repaying loans and bank portfolios deteriorate, while country risk ratings
discourage new investment in the affected economy. The liquidity problem
tends to become a solvency problem, and economic pressure increases, further
reducing the possibility of correcting the crisis in the short term.
Implementing restrictive monetary policies to lower inflation, along with a
fixed exchange rate, creates incentives for capital inflow that further erodes the
current account by overvaluing the local currency, making it necessary to resort
to new inflows of capital increasing real interest rates. This transfers the cost of
financing capital inflows, which are registered in international reserves as a way
of covering a sudden capital outflow, to the real sector of the economy. An
increase in international reserves creates a false appearance of financial
solvency and exchange rate solidity, but loses sight of the implicit cost of
maintaining international reserves that are invested at lower rates than are
being paid to avoid the monetization of capital flows.
Another distortion caused by capital inflows is the tendency for both
financial intermediaries and other economic agents to contract debt in dollars.
Encouraged by the apparent strength of domestic currency and high domestic
interest rates, the demand for leveraging of companies, funding of banks, which
do not capture savings because of low internal savings rates, and speculative
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credit tends to be met with currencies. Under these conditions, the reverting of
capital tends to lead to devaluation and, therefore, a crisis in banks and
businesses. This puts additional pressure on parity. Devaluation therefore is not
the result of excess spending, but the effect of economic agents’ financial
results.
Under these conditions, capital withdrawal sparks a crisis. This withdrawal
may be the result of external decisions that cause capital flows. Monetary
policies in the United States and some other OECD countries have generally
been a trigger. When there are fears that economic policy will be unable to
contain the imbalances caused by capital inflows (overvaluation, high interest
rates, increasing current account imbalances and indebtedness), capital will
always find a safe, though less profitable, refuge in the markets of industrialized
countries. It is not yet clear to what extent the current crisis, which began in the
very heart of the financial system, will affect capital flows.
The role of monetary policy in the outbreak and spread of the crisis
Many analysts are asking why the Federal Reserve kept interest rates so low
since the 1990s. The answer makes it easier to understand how US monetary
policy contributed to financial instability and the outbreak of a major crisis.
After the Cold War, the Fed’s monetary policy was aimed at reducing interest
rates, supposedly to encourage investment in technology and the restructuring
of industrial sectors that lost ground significantly during the “foreign debt crisis.”
Lower interest rates, however, led to a credit boom.

Part of this financed increased consumption, which helped accelerate
growth. Because much of the demand was met with imported goods, the
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cost was the accumulation of current account imbalances financed with
capital inflows.

Another significant part of the debt was contracted by corporations and
institutional investors to obtain high, fast returns in financial markets
(leveraging).

There was also investment in the purchasing of mortgage debt
guaranteed by the anticipated increase in the value of mortgaged real
estate (so-called sub-prime mortgages), originally placed on the market
by the bank that provided the mortgage. Financial alchemy turned these
liabilities into assets, resulting in inflated values in the asset books and
profits in the stock market.14
The greater volatility of financial markets leads to capital movements that
affect interest and exchange rates. Monetary authorities would try to moderate
the impact of these variations on inflation rates, increasing interest rates, but
this would make it more difficult for creditors to recover their debts, causing a
simultaneous reduction of consumption and investment, which tend to feed
each other. At this point conditions are probably ripe for a recession, and the
decision will have been made to leave debtors to their fate.
14
Robin Blackburn, op. cit. Amid this maelstrom of speculation, US household debt reached 120
percent of annual income, with mortgages representing three-quarters of this amount. The
increase in delinquency and foreclosures affects more than 5 million homes. “Por vez primera
en diez años comienzan a bajar los precios, y se disparan los intereses. La crisis ha estallado –
como no podía ser de otro modo— en el segmento subprime del mercado, entre las familias
más pobres con pocos (y en términos reales, descendentes) ingresos. Más de dos millones de
norteamericanos han perdido sus casas, hay más de 500 mil millones de dólares acumulados
en morosidad: un tsunami de hipotecas fallidas arrasa el país. Cuando se hizo evidente que los
fondos creados con base en títulos de deuda subprime estaban quebrados a consecuencia de
la incapacidad de los bancos de recuperar los préstamos hipotecarios las grandes firmas
realizaron compras masivas de acciones con compromiso de recompra para evadir o posponer
el colapso y las que no pudieron llevar a cabo estas operaciones sencillamente quebraban
alimentando un pesimismo transmutado en pánico que se apoderaba de los mercados. Así, en
Inglaterra, cuatro gigantes de las finanzas: Bear Stern, Goldman Sachs, Morgan Stanley y
Merrill Lynch se han quedado con 75 mil millones de dólares en acciones que no logran
revender. En este contexto en Banco de Inglaterra comienza a inyectar recursos tratando de
evitar que se detenga la ruleta.
377
The confluence of financial instability and the petroleum crisis
The US economic situation offers little cause for optimism. The possibility of
making a “correction” by increasing interest rates is limited by the amount of
accumulated debt and the resulting risk of deterioration of bank portfolios.
Meanwhile, petroleum prices will almost certainly exacerbate efforts by US
neoconservatives15 to take control of international oil and gas reserves, not only
aggravating the US current account deficit and making its need for financing
even more urgent, but also undermining the confidence of investors, businesses
and consumers worldwide, leading to a massive flight of dollars that will
ultimately result in collapse.
Because the financial crisis began with mortgages, it has had an enormous
impact on the construction industry. Because of that industry’s close ties with
other manufacturing and industrial sectors, like petroleum, which is a source of
energy and other assorted inputs, this will aggravate recessive pressures and
affect expectations.
Meanwhile, monetary authorities in the United States, United Kingdom and
European Union have injected liquidity into markets and lowered interest rates
by unusual degrees in an effort to limit the crisis to the real estate sector and
avoid systemic contagion. For this to be effective, however, the world
economy’s growth rate must be maintained. This raises certain questions:

Are conditions right for taking the risk of increasing investment?

What will China and other Asian creditors (including South Korea and
Russia) do with their international dollar reserves?
Seer Klare, Michael T., “Sangre por petróleo: la estrategia energética de Bush y Cheney,” in
Leo Panitch and Colin Leys, En nuevo desafío imperial, Socialist Register 2004, Clacso,
Buenos Aires, 2004.
15
378

What price will Iran and other producers set for oil exports?
When the Cold War ended, US power brokers bet on a strategy combining
rapid growth, which led to a consumer-financial bubble, and a military offensive
in Eurasia that would strip real and potential rivals of their response capacity
and give the United States control of strategic resources as part of its command
of international economic cycles. That was why George Bush pursued both the
FTAA and war against Iraq, and why Bill Clinton pursued financial liberalization
while continuing bombing in Iraq, as well as Yugoslavia and East Timor. By
early 2006, however, it was clear that the strategy was not meeting its goals,
both because the economy could not sustain the recovery driven by Clinton 16 —
- the bubble had not led to a solid enough expansion to provide a foundation for
investment in technology drive an increase in productivity that would
subsequently sustain growth — and because the campaign in Eurasia
foundered at its first stop, Afghanistan. Military victory was crucial, because it
would allow the United States to “redefine economic rules on the planet” for
orderly recomposition of financialization.
US economic strategy is at a crossroads: the country must lower its
economy’s debt burden to avoid a generalized suspension of payments that
would lead to recession. This means lowering interest rates even further, which
could further weaken preference for the dollar, reverting capital flows and
leading to a severe restriction of credit, which would make it impossible to do
the debt restructuring necessary to brake the slowdown. Lowering interest rates
could also be counteracted by speculators, who would use the injected liquidity
for new operations unless drastic measures were taken to transform an
16
See Robert Pollin, op. cit; Robert Bremmer, op. cit; G. Arrighi, op. cit; Joseph Stiglitz, Los felices años
90. Editorial Taurus, Spain, 2006.
379
international system that is permissive toward speculation. Once the depression
was fully under way, as in 1929, protectionism and trade warfare would become
exacerbated.
Until now, growing imbalances in the US economy had not conflicted with its
ability to maintain a policy of full employment and low inflation, but that appears
to be changing. As a result, the rest of the world is beginning to doubt that the
United States can maintain its imbalances, pay its debts and encourage
worldwide economic growth, which could lead to unilateral solutions, especially
if there is no noticeable change in US foreign policy and the country’s
hegemonic intentions.
380
The systemic outlook for the crisis: risks of aggressive geopolitics
The subprime crisis, as the current financial crisis has been called, is not an
isolated crisis in a certain market, whose possible impact on other sectors of the
economy can be contained with “good decisions” about monetary policy. Unlike
past crises, this one is occurring in the United States, at the heart of the
capitalist system, and has begun to expand first through developed economies.
This time, the lenders are the so-called emerging economies. Some key
characteristics of the US economic situation shed light on the depth of this
crisis:
1. Unsustainable deficits:
a. Current account: US$850 billion in 2007
b. Budget: US$162 billion in 2007, and an official projection for 2008 of a
public deficit exceeding US$445 billion. This is not surprising, considering
that military spending for this year will exceed US$1 billion for the first time in
history, while new tax cuts for the rich are planned.
2. Excessive indebtedness: The United States has a public debt of
US$10 trillion, equivalent to 40 percent of GDP. It is estimated that the trade
and budget deficits; private debt; and the deficits left by the bubbles that have
already burst (especially the “dot-coms” in 2000), the mortgage bubble, which
is bursting now, and the retirement fund bubble yet to come will amount to
US$10 trillion at the end of 2008 and could exceed US$11 trillion by 2010.
Accumulated debt in the United States is estimated at more than US$37
trillion.17
17
See http://www.indebtwetrust.org/docs/IDWT%2...0sheet.pdf
381
3. Weakness of the dollar: Because of the above points, the dollar has
depreciated, from parity above the euro early in the decade to more than
US$1.50 to the euro.
4. Weakness of macroeconomic indicators. The most optimistic
forecasts are for GDP growth of 1.5 percent for 2008. According to the
Economist Intelligence Unit, this rate could actually be 0.8 percent, reaching
1.4 percent for 2009, while inflationary pressure increases (from 4.5 percent
in 2007 to more than 5.5 percent in 2008) and unemployment rises (from 5.5
percent in 2007 to about 6.5 percent toward the end of 2008).
5. Instability and lack of governance in finance, based on a broad
range of unregulated financial practices (hedge funds and various forms of
securitization of financial transactions, such as those in which banks engage
with their traditional loan operations), whose real extent is hard to gauge.
Financial institutions also engage in shady accounting practices, known as
“creative accounting,” and off-the-books operations, and their corporate
governance is characterized by a collusion of interests in which a single
entity can act as accountant, auditor, risk evaluator, financial agent and
investor, as well as customer (emblematic cases include corporate scandals
early in the decade, such as those involving ENRON, Worldcom, Parmalat,
etc.), which is exacerbated by the extreme concentration of these key
functions in a small number of institutions. For example, there are only a
handful of risk evaluators in the world — Moody’s Investor Services,
Standard & Poors, Duff & Phelps, Fitch Ratings LTD. Arthur Andersen, which
was brought down by the Enron scandal, was emblematic of the mixing of
auditing, consulting and business management.
382
These figures alone could be considered irrelevant, since the US economy
has demonstrated growing imbalances since the 1970s. The United States has
been absorbing huge quantities of goods and services produced in other parts
of the world, creating a trade deficit. This deficit is financed with part of the
surplus created by trading partners that invest in financial instruments
negotiated on Wall Street, especially Treasury bonds. China, Japan, India,
Russia and a few Asian tigers have more than US$3 trillion in accumulated
international reserves, of which a significant part is invested in dollar
instruments. In other words, they are financing US deficits or, more precisely,
subsidizing its “purchasing power,” which is crucial if the United States is to
maintain, without adjustments, an economy that depends on consumption and,
ultimately, debt.
But another condition is also necessary to sustain the dollar: exporters of
high-priced raw materials, especially in the energy sector, must continue to
handle their sales in dollars, although it would not be absurd to modify the
pricing of raw materials considering the dollar’s continuing weakness. In fact, it
would make sense. This alone increases pressure on the price of the dollar,
against which economic arguments are inadequate.
Besides maintaining international reserves invested in dollars and raw
materials pricing in dollars, therefore, the United States needs dissuasive
arguments based on diplomacy, negotiating ability and, as a last resort, military
might. The United States is therefore attempting to maintain its military
advantage over the rest of the world, adding pressure to the budget deficit.
Currently, the US military budget accounts for half the world’s military spending.
383
But although the immense US military might is failing in Iraq and Afghanistan,
the Bush Administration is planning a possible attack on Iran, continues to
exercise decisive influence in the Caspian Sea, and moved the Fourth Fleet
toward the coast of Latin America. The strategy appears aimed at controlling
the world’s petroleum and gas reserves so as to manage the international
economic cycle and the transition to a new energy paradigm that is emerging as
the era of cheap oil comes to an end. The problem is that the equation of trade
imbalance + budget deficit + huge debt + weak dollar does not create an
environment conducive to maintaining a hegemony whose material foundations
are seriously weakened.
Nowadays, corporations also compete in financial markets, where their
investments complement their earnings. The concentration of income gives
them access to a quantity of resources allowing them to realize high profits from
stock market activity. To ensure their survival, companies must merge, which
they do by buying stock. The liquidation of assets required by these mergers
undermines the future ability of capital to reproduce: extreme concentration
could reach the point at which there will inevitably be no more assets to
liquidate/merge.18
Another factor in this process is the exhaustion of resources because of the
race to accumulate (deforestation, exhaustion of freshwater reserves, the end of
cheap oil, the expansion of transgenic crops that compromise future supplies of
fertile land, etc.).
It is possible, therefore, that US geopolitics could complicate the willingness
of China and India to “collaborate” and put other powers, such as Russia, on
18
-See Zygmunt Bauman, Tiempos Líquidos, Editorial Tusquets. Mexico, 2008.
384
alert, causing them to consider it necessary to defend their own interests. The
US neocons’ bellicose strategy is counterproductive in the current crisis, but
they are convinced that if the crisis catches them on unsure economic footing,
they will have to maintain power by force.
Conclusion: What should be done?
Considering that one decisive factor in the instability of the world economy is
the accumulation of imbalances, exacerbated by financialization, the US
economy should increase its internal savings. Maintaining consumption levels
that have driven US savings rates to the Great Depression levels of the 1930s
and created an addiction to foreign financing limits access to resources for other
programs, such as the Millennium Development Goals, which are far more
legitimate than living beyond one’s means. Ultimately, the US model reflects the
financialization of the economy.
It is therefore also crucial to deactivate the mechanisms undergirding the
hegemony of financial capital: banking secrecy; tax havens; lack of taxes on
financial earnings; inadequate regulation of financial engineering; lack of
transparency in the dealings of some financial entities; and conflicts of interest
among entities responsible for accounting, auditing, risk evaluation and fund
management. The international financial system needs a profound reform to
redefine the role of financial activity in the economy, sharply limiting speculation
and imposing the social responsibility inherent to any activity: paying taxes;
ensuring transparency; guaranteeing the accountability of individuals and
corporations that have the power to move markets, because of the amount of
money they can mobilize; and requiring them to commit more of their own
385
funds, to limit leveraging. Ideally, of course, there should be resource
redistribution equitable enough to put an end to extreme wealth and extreme
poverty, but that would change the world.
There is a vital need for a new multilateral framework based on collaboration
rather than competition, to respond to the challenges of financial instability,
global warming and the growing power of international mafias, a framework in
which the key players recognize their mutual interdependence and none tries to
impose conditions on others unilaterally. This can only be possible in a
democratic world order.
386
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