The current crisis has led to strange comments from some very unlikely quarters. Bernard Connolly, chief global strategist and head of research at AIG London, recently brought out a report with the superb title “Has the World Gone Mad?”, in which he makes the following disquieting revelation: “We have lost count of how many notes we have, in the past few years, written with some reference to a crisis of capitalism. Tragically, that crisis is now upon us, and the pace of unravelling seems to be accelerating.” Now, Connolly’s views are being echoed by many others.
So far, we were under the impression that what we’re seeing is a cyclical slowdown, or a credit crunch, or a housing bubble or a commodity bubble. We had no doubt that whatever it was, it was a short-term worry, but nothing the system couldn’t handle. A “crisis of capitalism” sounds much more ominous. Joseph Ackermann, head of Deutsche Bank, is much more pessimistic. “I no longer believe in the self-correcting nature of markets,” he said a couple of months ago. He was referring to one of the central beliefs of free-market capitalism that markets, left to themselves, would correct imbalances of their own accord. German president Horst Koehler, a former head of the International Monetary Fund, says that markets are “monsters”. The French have been quick to chime in. President Nicholas Sarkozy earlier this year called for an end to a “capitalism of lies, of frivolity.” George Soros, who made billions out of the financial system and should therefore be one who sings its praises unreservedly, has displayed absolutely no gratitude and the title of one his books is “The Crisis of Global Capitalism”.
Even the Anglo-Saxons have become renegades, with investment guru Warren Buffet being openly contemptuous of the financial engineering that led to the crisis. His description of derivatives as “weapons of financial mass destruction” is now part of folklore. Martin Wolf, well-known economist and chief economics commentator at the Financial Times, wrote after the Bear Stearns collapse, “Remember Friday March 14 2008: it was the day the dream of global free-market capitalism died.”
The crisis has led to a revival of interest in the works of Hyman Minsky, whose seminal work on credit booms and busts had earlier been relegated to the fringes of economics, as he didn’t subscribe to the prevailing orthodoxy of markets tending towards equilibrium. According to Minsky: “the capitalist market mechanism is flawed in the sense that it does not lead to stable price-full employment equilibrium, and the basis of the flaw resides in the financial system.”
Could Minsky’s thesis about financial instability have something to do with the supremacy of finance in the global economy? That finance is at the heart of the global economy may seem a trite truism today, but it’s not how the world economy functioned 30 years ago. Finance used to be a mere handmaiden of production, existing primarily to smoothen the process of manufacturing and trade. Since then, rapid advances in telecommunications and computer technology and the breaking down of barriers to capital flows have led to exponential growth in financial services. The volume of foreign exchange transactions, for example, is far in excess of the volume of international trade. Ditto for transactions in derivatives, which have left trades in the underlying assets far behind. These trends are well-known, identified by British academic Susan Strange as far back as 1986 in her path-breaking book called, appropriately enough, “Casino capitalism”.
In other words, the critics of the current system are worried about the way capitalism has evolved over the last three decades, ever since the Bretton Woods system of managed exchange rates and relatively low capital flows was superseded by a more open system and free capital flows.
Is the current crisis so very different from others in the past? Not at all, say Kenneth Rogoff and Carmen Reinhart of Harvard University and the University of Maryland, respectively, who have jointly authored a paper called “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises”. These economists studied credit crises in 66 countries across the world over several centuries (including crises in India in 1863, 1958, 1969 and 1972) and came to the conclusion that there’s nothing unique about the current crisis. But they too underline the fact that “periods of high international capital mobility have repeatedly produced international banking crises.”
However, the flip side of that international capital mobility and freer markets has been the rise of countries like India and China, which has helped pull millions out of poverty. Crises are capitalism’s way of purging excesses from the system, but the biggest ones have often changed the course of history.
As political economists Sam Gindin and Leo Panitch have pointed out, “Of the three great structural crises of capitalism, the first (post-1870s) accelerated inter-imperialist rivalry and led to World War One and Communist revolution, while the second crisis (the Great Depression) actually reversed capitalism’s internationalizing trajectory. Yet the crisis of the early 1970s was followed by a deepening, acceleration and extension of capitalist globalization.” Simply put, capitalism has shown a remarkable ability to survive crises by reinventing itself, although sowing the seeds of future crises in the process. Reports of its demise have always been greatly exaggerated.
Mint’s resident market expert Manas Chakravarty looks at trends and issues related to investing in general and Indian bourses in particular. Your comments are welcome at firstname.lastname@example.org