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December 2, 2010 / Lukasz Cerazy

A Crisis of American Capitalism

Image: renjith krishnan / FreeDigitalPhotos.net

The 2008 crisis was first dubbed: “the Credit Crunch” because of its squeeze on lending – initially a housing bubble burst in the USA releasing concerns about the amounts of debt in other markets. The London Interbank Offered Rate (LIBOR), which is the rate set for financial institutions in the interbank market, spiked in October 2008, meaning that lending ceased causing outright panic. After years of leveraging and excessive indebtedness a sharp deleveraging shock incurred that would become more than just a financial bubble. Northern Rock, a UK bank, was the first victim of this crisis and was hit by a bank-run, which forced it to require loan facilities from the Bank of England and later the bank had to be privatised. This was the first warning of things to come. At the peak of the crisis it claimed the heads of several financial institutions that either failed, were acquired or were privatised. By then it became clear that the crisis would not be contained within the financial markets and that it would affect other parts of the economy, as it turned out, it became a global crisis that severely dampened economic activity.

Image: renjith krishnan / FreeDigitalPhotos.net

At that point governments threw in the ‘neo-liberal’ towel and sought Keynesian fiscal stimulus to try and pick up demand. Because it spread to most part of the economy I argue that it is a true crisis of capitalism in a sense that institutions, governance and regulation will irreversibly change. I am confident, however, that economies will eventually emerge from this crisis but I am also confident that a new order will be established. This order will shift economic, political and social perceptions, which will again change the face of capitalism. The reason why capitalism has been the main economic paradigm is that it has previously survived two severe crises and emerged stronger: first the great depression of the 1930s and then the stagflation of the 1970s. The previous crisis, the dot-com bubble, was different in both its scale and scope and it was confined to a narrower part of the economy. It was no more than a ‘bump’ on the road and was not a capitalist crisis. It is, however, important to note that every crisis is unique and arguable more complex over time.

Certain observers, particularly Gordon Brown, proclaimed that the boom and bust cycles were a thing of the past and that the economy was quick enough to adjust itself to any changes in the economy. However, a financial crisis is neither a supply-driven nor a demand-driven crisis. Fundamentally it is a result of too much debt that was encouraged by financial institutions, which by securitization were able to spread the risk to others but it simply resulted in severe systemic risk. The accumulation of debt was made possible by huge deregulations in the financial sector in the late 1970s, mainly in the USA and UK under Ronald Reagan and Margret Thatcher respectively. The other powers at the time, Germany and Japan, did not seem to have the answers – experiencing economic difficulties they were left behind a powerful American economy. However, it appears now that these other countries could be in for a revival and become a counterweight to total American dominance along with China, Brazil and possibly Russia and India. In the long run it would appear that the booms and busts of the countries that did not go down the route of comprehensive financial deregulation experience a smoother cycle, which is more stable for long run growth.

In many ways the economy has become more efficient and transparent, which means that it is quicker to react to changes, however, as we have all seen, effective financial regulation is necessary and cannot be left to its own device. These events have therefore brought new thinking into practice and prompted the introduction of Basel III in the near future, which is a set of international regulations for the financial sector.

Image: Salvatore Vuono / FreeDigitalPhotos.net

What is different about the 2008 crisis is that it is a first real global recession, which was made possible by certain international imbalances. Alan Greenspan, chairman of the Federal Reserve, was able to pursue expansive policies that were targeted at stimulating the economy because of cheap imports mainly from China, which kept American inflation low. Following the dot-com crisis American interest rates were kept very low and the George Bush administration moved the federal budget from surplus into deficit letting the economy race on. The loose money conditions in turn fuelled the housing bubble and raised demand for construction and equity. It seems that the policies adopted by America over more than a decade made the economy come crashing down even harder. As other international imbalances persist, like the huge American debt, sovereign debt of Euro countries and global current account balance of payments imbalances, it is not unrealistic to think that these disparities will have to be smoothened out and indeed this is already happening as part of automated mechanisms, however, international cooperation is necessary to synchronise a joint recovery. The dominant position of America has already taken a serious hit and there appears to be other political, social and economic ideas that can challenge the State for the first time since the end of the Cold War. Undoubtedly the USA will still be a leader on many areas, however, the gap has been significantly narrowed and it will no longer dominate single-handedly.



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3 Comments

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  1. Black Flag / Dec 6 2010 00:01

    If you’re ok with it, I’d like to post a comment or two (I’ve hopped over from “Futile Democracy”)

    Regards.

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