A universe of fantasy finance

The turmoil in the world’s financial and stock markets that erupted at the end of last week prompted a panic release of funds into the system from the leading central banks. But their actions only add to the underlying cause of this crisis. The European Central Bank, the US Federal Reserve and the Banks of Japan and Australia stepped in to try to stem the massive loss of confidence in the share markets and the financial system as a whole. The intention was to loosen the seizure that had cut the flow of funds between banks, which are needed to keep the global economy operating. The hundreds of billions of dollars pumped into the system was the biggest such intervention since the crisis following the 9/11 terror attacks.

Some financial observers, as well as the International Monetary Fund, are claiming that last week’s events, whilst serious, do not greatly damage the fundamentals and will not impede continuing global growth. But this time the problem is not only a liquidity crisis - a sudden shortage of available cash known as a credit crunch. No, this time, the problem is greatly compounded by a crisis of insolvency. People can’t pay their debts. The three decades or so of continuing growth, albeit interrupted by many crises, has been made possible by low interest rates set by central banks, easy and easier credit, and the virtual elimination of control or regulation on the operation of financial institutions.

All of this was necessary to fund the profit-led capital expansion which offered a way out of the political upheavals of the late 1960s, the US defeat in Vietnam, and a wave of action centred on Paris in 1968, which threatened to undermine the capitalist system. A watershed in this process was the decision 36 years ago this week – on 15 August 1971 – to separate the dollar from gold, thus freeing the currency from any nominal connection with real value. Globalising corporations emerged able to optimise opportunities worldwide and dictate terms to national governments. In widening and exploiting inequality they greatly expanded production. Consumers, needed to buy the products, were seduced by marketing and then enslaved by unsustainable debt. To keep the whole thing growing required a universe of fantasy finance - apparently with a life of its own - expanding far faster than the real economy. Every day in the year to April 2006, in the foreign currency markets around 60 times the value of a whole year’s global production changed hands. Hardly a shortage of cash.

In particular, it is the globalisation of unpayable debt in the US housing market as well as other forms of debt, packaged into hedge funds and leveraged buy-out deals which has destabilised the entire system and which sparked the latest crisis. The world’s largest publicly quoted hedge fund manager, Man, lost nearly a quarter of its market value last month, with the worst two-day drop in its history before the weekend. The current crisis began to emerge from the murky depths of unsecured “sub-prime” mortgage lending. Sub-prime simply means borrowers with a poor credit history – usually low-wage earners who have trouble repaying their debts. Wall Street, burnt by its latest bonfire of the vanities, is now describing loans to risky borrowers as “toxic waste”.

The contagion is certain to spread as there are very many over-borrowed, over-stretched corporations - not just financial institutions - as well as the millions upon millions of individuals who find themselves in trouble in every country. The British economy is particularly vulnerable, as it is now dominated by financial services and speculation to the exclusion of manufacture and production. Some observers are comparing the situation to 1929, when the Wall Street crash led to a world-wide slump. But today, the world financial system is far more integrated as a result of globalisation and the consequences will be far more devastating for international capitalism.

Gerry Gold, economics editor