BEHIND THE GLOBAL MARKETS’ MELTDOWN
Chart 1. Financial profits as a percent of total profits (five-year moving average)
Source: Table B-91. Corporate Profits by Industry, 1959–2007, Economic Report of the President, 2008.
The first principles, we must not forget the financial booms and busts are not a new phenomenon. What is alarming about the current meltdown is that it is in the nature of seismic earth-shaking proportions. AS international financial markets continue to tumble and national economies slip into recession, the fear of a global meltdown has begun to haunt people everywhere. The global financial crisis has its origins in the U.S. subprime mortgage crisis of August 2007. It seemed initially that it would only affect developed countries, but the so-called “decoupling phenomenon,” which predicted that developing countries would remain unaffected, has not occurred. Instead the crisis has become a global phenomenon, as the following measures indicate.
Grounds
Any explanation of the current financial turbulence begins with the housing bubble fuelled by low interest rates, increased global liquidity and predatory lending by the financial giants. According to some estimates, the annual issuance of US sub-prime mortgage backed securities increased from a mere $56 billion in 2000 to a massive $508 billion in 2005, comprising something of the order of 20 percent of total US mortgages. By 2006, the housing bubble was beginning to unravel, as higher interest rates and rising oil and food prices - and a generalized decline in consumer confidence - were starting to take their toll.
In the September 2006 Global Financial Stability Report the IMF executive board directors expressed worries that the rapid growth of hedge funds and credit derivatives could have a systematic impact on financial stability, and that a slowdown of the U.S. economy and a cooling of its housing market could lead to greater “financial turbulence,” which could be “amplified in the event of unexpected shocks.” The whole context is that of a financialization so out of control that unexpected and severe shocks to the system and resulting financial contagions are looked upon as inevitable.
This scenario, which was already beginning to be played out at the time that the above passage was written, of stagnant and falling home prices, a flood of defaults, and a global economic crisis due to financial contagion and a drop in U.S. consumption, has now become a concrete reality. Since the collapse of the subprime mortgage market in July 2007, financial distress and panic have spread uncontrollably not only across countries but also across financial markets themselves, infecting one sector after another: adjustable rate mortgages, commercial paper (unsecured short-term corporate debt), bond insurers, commercial mortgage lending, corporate bonds, auto loans, credit cards, and student loans.
What Paul Sweezy just over a decade ago called “the financialization of the capital accumulation process” has been the main force lifting economic growth since the 1970s.3 The transformation in the system that this has brought about is reflected in the rapid growth since the 1970s of financial profits as a percent of total profits (see chart 1). The fact that such financialization of capital appears to be taking the form of bigger and bigger bubbles that burst more frequently and with more devastating effect, threatening each time a deepening of stagnation—i.e., the condition, endemic to mature capitalism, of slow growth, and rising excess capacity and unemployment/underemployment—is thus a development of major significance.
Growth
Expectations of growth rates for 2008 have fallen in most countries. In October 2007, world growth was predicted to be 4.8 percent. The International Monetary Fund now predicts that it will be 3.7 percent. Expectations for 2008 growth for advanced economies now stand at 1.4 percent, down 0.8 percentage points from predictions made in October 2007. Expectations for emerging and developing country growth in 2008 now stand at 6.6 percent, also down 0.8 points from a year ago.
Growth
Expectations of growth rates for 2008 have fallen in most countries. In October 2007, world growth was predicted to be 4.8 percent. The International Monetary Fund now predicts that it will be 3.7 percent. Expectations for 2008 growth for advanced economies now stand at 1.4 percent, down 0.8 percentage points from predictions made in October 2007. Expectations for emerging and developing country growth in 2008 now stand at 6.6 percent, also down 0.8 points from a year ago.
Expectations of 2009 growth fell everywhere between January and November. Projections of world growth for 2009 slumped from 4.4 percent in January to 2.2 percent today—effectively a global recession. Every G7 country aside from Canada is expected to contract next year and the United States and United Kingdom are already in recession. Every BRIC country (Brazil, Russia, India, and China) has seen growth expectations fall by between 1 and 3 percentage points.
Stock markets
Stock markets
As expectations of growth have fallen and credit has remained frozen, stock markets have been adversely affected. Dramatic drops in developed countries have been well documented, but since reaching highs in 2007 or early 2008, stock markets have fallen in every G20 country—aside from South Africa—with an average fall of 45 percent. The BRIC countries have faced dramatic collapses in their stock markets during 2008 following rapid expansion in the preceding three to four years. Stock markets for these countries are now at or below their 2005 values. Indeed, the Russia Trading System has lost 76 percent of its value so far in 2008.
Policy responses
Policy responses
The global credit crisis combined with collapsing share prices and the looming risk of recession have led to calls for dramatic policy interventions, including coordinated interest rate cuts, bailouts for the banking sector, and large fiscal stimulus packages. The communiqué from the world leaders’ summit on November 15 said that G20 countries would, “Recognize the importance of monetary policy support, as deemed appropriate to domestic conditions [and] use fiscal measures to stimulate domestic demand to rapid effect, as appropriate, while maintaining a policy framework conducive to fiscal sustainability.” These tools, however, have not been available to all countries. Stimulative monetary policy has only been possible in a handful of countries. Interest rate changes across a range of G20 countries in December 2007, June 2008, and December 2008.
The United States undertook the most dramatic interest rate cut from 4.5 percent to 1.0 percent. The United Kingdom and Canada also cut their rates throughout the year. China has adopted an alternative form of simulative monetary policy and cut its reserve requirement ratios in recent months. But other countries, particularly in the developing world, have seen their interest rates rise as capital flight has taken hold and hot money has sought less-risky havens such as Treasury Bills. Brazil, South Africa, and Russia, for example, all have interest rates above 10 percent which continue to rise.
Capital flight has also had a profound impact on exchange rates. In every G20 country aside from China and Japan, exchange rates have depreciated, including falls since January of over 20 percent for Australia, Brazil, Canada, India, South Africa, South Korea, Turkey, and the United Kingdom. Many currencies have faced a particularly dramatic slide in recent weeks. For example, in the month of October alone, the South African rand lost 25 percent of its value.
More countries have been able to announce rescue packages for their domestic financial sectors. Policy measures have included deposit insurance, short-term loan guarantees, the purchase of shares in financial institutions, and the removal of bad assets from bank balance sheets. The $700 billion that Congress has made available to Treasury Secretary Henry Paulson to buy preferred stock in struggling banks has been well documented, but many other countries have provided bailouts. This includes a $100 billion liquidity injection in Russia, $19 billion for emergency bank use in the United Arab Emirates, and $8 billion released into the banking sector in India by cutting the reserve requirement ratio.
In addition to these bailouts, sovereign governments are being encouraged to use fiscal stimulus packages to kick start their domestic economies. China announced a $586 billion package worth 14 percent of gross domestic product on November 8 [although this number has been challenged]. Britain announced on November 24 a package of tax cuts and speeded up investment measures worth 1.1 percent of GDP. The United States is expected to follow suit with a stimulus package worth 2 to 4 percent of GDP by January at the latest. Australia, Chile, Germany, Italy, Japan, South Korea, and Taiwan are other countries that have been able to announce stimulus packages.
Many other countries, without either reserves or the ability to increase borrowing by issuing government bonds, have their hands tied. Iceland, Hungary, Ukraine, and Pakistan have already been forced to rely on the IMF’s lending facility.
Conclusion
Conclusion
The U.S. subprime mortgage crisis, which became a developed country banking crisis, is now a global economic meltdown. Global growth projections have fallen, stock markets have plummeted, and currencies have lost value against the dollar. Meanwhile, the call has increased for coordinated monetary policy interventions, bank bailouts, and fiscal stimulus packages.
As outlined in this briefing paper, these policy interventions are only available to the handful of countries which have the ability to defend themselves from capital flight or can fund their fiscal deficits. With the notable exception of China, most middle-income countries have struggled to make the necessary policy interventions. Least-developed countries look on with concern as necessary expansions in development assistance are threatened. Options for these countries are running out, but the costs of inaction could be even more catastrophic.
