ECONOMICS: by Colin TeeseNews Weekly
Can capitalism be rescued?
, November 16, 2002
Peter Warburton published his book Debt and Delusion in 1999. It first came to this writer's attention less than a year ago. The curious thing is that - though it has been part of the language for two years - readers of News Weekly have not so far been exposed to a review of its most compelling and important contents.
|"the large economies of the|
West ...are becoming
the servants of global
rather than its masters."
In this writer's view it is, by far, the most important exposition of the contemporary practices in financial markets and how these have contributed to the undermining of the important Western developed economies. It is worthy of full scale examination in it own right. Perhaps, however, it is now too late for a formal review of Mr Warburton's work: instead, readers are invited to consider this article as an attempt to correct that unfortunate oversight.Fragility
Above all else, the book comes as a timely reminder of the fragility of present day capitalism; and of important and worrying truths which flow from that realisation.
The first truth is that if capitalism is to be rescued from its present troubles, it will be done - as was the case three-quarters of a century ago - against the best efforts of dedicated capitalist to drive the system towards total destruction.
And the second is - again as was the case eighty years ago - that capitalism is threatened by the malfunction of its financial structures, and of the tendency of those malfunctioning structures to corrupt business organisation and operation.
Warburton makes all of this clear to us in almost three hundred pages of well arranged and presented arguments. Not that he wastes any time in getting right down to it.
Before we have passed the first page of preface
he introduces us to a pertinent and telling observation which is certain to strike satisfaction into the hearts of the practising "anti-economic rationalist". He observes, speaking of the present day, "The promise of economic freedom held out by the dismantling of state ownership and control has been subverted by a personal and collective enslavement to debt".
All of this comes about by means of what he calls "an extraordinary reversal of roles ... whereby, the large economies of the West ... are becoming the servants of global financial activity rather than its masters."
This is possibly the most important single point in the book and it enlightens the remainder of the text. We all know instinctively what Warburton spells out for us; that the finance industry has been allowed to drive the productive sector of the economy rather than be its faithful servant.
Warburton is at his most persuasive when he argues that the instrument guiding that important switch in roles has been the rise in both personal and corporate debt.
For this he holds Central Banks of the Western developed economies entirely responsible. By allowing debt addiction to take hold of the major developed economies - financed from outside the traditional banking system - they have put the entire system at risk.
This kind of financial mismanagement could not have happened if the Central Banks had not had their own shoulders so firmly to the wheel of containing inflation, rather than watching over the workings of the entire economies they are supposed to guide.
Inflation is of course a threat not to be dismissed, if only because, once it takes hold, it is fed by future expectations; but the same is true of deflation. In debt-ridden economies, deflation can be even more of a problem.
In inflationary times, the value of money decreases, and debts are therefore easier to repay. In a deflationary environment the value of money rises, and debt servicing is correspondingly more costly.
Since the beginning of the 20th century, capitalist economies have been lubricated by consumer spending. Businesses large and small absolutely depend upon it for their survival, as do economies for their prosperity. Given these facts, in the absence of some measure of inflation, how can consumers be tempted to spend? In a deflationary environment, buyers will hold off buying now in the expectation that goods will be cheaper later.
Because of this effect of price expectations on consumer reasoning, it is very difficult to restart deflated economies. And, for obvious reasons, even more so if businesses and consumers are both overloaded with debt.
This, the world discovered in the 1930s - when debt levels were nothing like present levels. Japan, presently afflicted with deflation, is rediscovering the same point.
Warburton's point about all this is that the Central Banks, by allowing credit creation to be taken out of the hands of traditional banks and the concomitant regulatory framework - as part of their commitment to financial deregulation - have lost the power to control national economies.
Instead, it has passed into the hands of financial institutions unconcerned with prudent lending considerations.
These he judges, properly, to have contributed to the reduction in transparency and the increase in instability which has characterised the finance industry in the past two decades or so. The most damaging aspect of the new complex financial instruments has been to encourage excessive speculation along with the assumption of risk without responsibility.
These weighty condemnations become weightier still when the contradictions they expose in the attitudes of the Central Banks are fully understood.
It will be recalled that Central Banks, without exception extol the virtues of free trade and condemn protectionism precisely because of the need for transparency in economic management tools. Protection is to be condemned because it helps cover up what would otherwise be revealed as fundamental weaknesses in national economic structures.
How curious that they should demand that these virtues be applied to the production side of the economy, while, at the same time, helping to ensure that they are avoided in the financial sector.
But that is not the total extent of the complicity of Central Banks in helping - whether or not consciously - with the destabilisation of the world financial system.
By their single-minded focus on the management of inflation, they have left themselves with no other tool for regulating economic activity than the control over official interest rates.Share prices
Warburton then conducts a kind of autopsy of what has happened to share prices in the Anglo-Saxon countries and how these developments - fostered by financial deregulation - have impacted adversely on the respective economies. Because it is the largest economy, and therefore the most significant, he concentrates on developments in the United States.
Excessively generous and imprudent lending for the purposes of share purchase has corrupted both the stock market and US business.
Borrowing to buy shares creates an excess of demand which, in turn, inflates the value of shares above their "true" level based upon the performance of the company. As a result of this "demand push" the illusion was created in the minds of share purchasers that the prices of shares could and would go on rising indefinitely - independently of the actual the performances of companies.
In the US, prices reached heights that ultimately caused the Chairman of the US Central Bank to characterise the activity as irrational expectations, while at the same time insisting that there was nothing that the Bank could or should do about it.
The end result is that there has already been a market correction writing off some US$9 trillion of value from US stocks (some 20 per cent and with more certainly to come.)
As the debt associated with these downturns is called up, the expectation is that consumer spending - already down - will be further curtailed. The full consequence of this for the US economy is yet to be felt.
And when that time comes the US will not be able to turn to the US Federal Reserve for relief. Its hands will be tied. It won't be able to lower interest rates for fear of creating negative returns on lendings; and it won't be able lift them to stimulate the economy because doing so will put more pressure on those trying to repay debts, and act as a further constraint on consumer spending.
At the business level, pre-occupation with company share price rather than running the business has led to various corrupt practices, including accounting fictions aimed at deceiving shareholders as to the company's true profitability. Various institutional investment companies and superannuation funds have already fallen victim to these practices.
And since the true extent of the setbacks for those agencies is not yet known, we can only speculate as to the harm done and what might have to be done about it.
While it is perfectly clear that much of the damage done may not be able to be mended - at least within any of the orthodox policy frameworks, Warburton is clear about one thing - there will need to be substantial re-regulation of the financial industry to guard against any future recurrences.
Undoubtedly that will be painful, especially for those with financial or intellectual commitments to deregulation. But it must come.
For the Central Banks, the change must be to reverse their blind faith in the virtues of low inflation as a virtue from which all others flow.
Warburton believes that part of the resolution of the present situation will be that much of at least the private debt may have to be forgiven. After all, nothing positive can be expected from pursuing debt from those unable to pay.
As to the re-regulation, it will almost certainly be necessary for the Central Banks to regain control over credit creation and lending.
One of Warburton's further suggestions is that the limited liability privilege which is conferred upon companies under law be withdrawn except for companies offering goods and services to the public.
As to those companies engaging in merely speculative activities and who rack up losses, then the assets of their officials and directors (and families) could be confiscated for repaying debts accumulated.
Other possibilities building on these suggestions can easily be contemplated, and it is to be assumed that the extent to which any or all of them will be taken up depends upon how serious the problem becomes.
We are still some distance from knowing that.
Meanwhile, one or two things can probably said with some confidence. First, the days of unregulated financial markets are drawing to a close. And second, that in future Central Banks, whether they admit it or not, will have to cast their focus wider than mere control over inflation.