The Greek Debt Crisis in its global context

Abstract

The purpose of this essay is to give an overview of the global economic and financial crisis. I have attempted to cover most of the relevant issues, in a way which should be comprehensible to anyone without specialist knowledge in either economics or finance. Although the initial focus is on the crisis in Greece, I hope to show that while some of problems there derive from circumstances and events unique to that country, most of them do not. The financial crisis which has hit Greece can strike again in many other countries, because of the global nature of the economic and financial system which is its primary cause.

I begin by looking at the specific problems of Greece concerning government taxes and expenditure, and examine the part played by its unusual history, and the corruption and illegality of corporations and rich individuals. Then the role of Greece’s trade imbalance and membership of the eurozone. But the major factor which has tipped government debt into crisis is its bailout of the banks which, in turn, and in common with banks around the world, have been responsible for their own chronic debt problems.

These problems are the result of deeper structural flaws in the banking system originating, in large part, in the USA. But while the banks have precipitated the current crisis, their reckless behaviour can also be understood as a response to rapidly falling levels of profitability within the global capitalist system, from the late 1960s, which have threatened the viability of the more conventional activities of banks and other financial institutions.

The responses to the global financial crisis range from catastrophic bail-outs of the financial system to the recent emergence of central banks as key players in keeping the whole economic edifice alive and functioning. I look at the differing responses of financial commentators to this entirely new process of ‘quantitative easing’ and at some of the alternatives which have been proposed.

Many people have been appalled at the way the banks have rewarded their executives with huge bonuses, even while these institutions have experienced massive losses. So in this essay I have attempted to address specifically the question of whether, and to what extent, the global financial crisis can be explained by the underlying economic structure of global capitalism, and how much to the corruption and greed of the financial elites.

Throughout this essay I have used many of the technical terms – like collateralised debt obligations, and credit default swaps – which have now become an integral part of our daily news bulletins, indeed of our daily lives. Unfortunately I believe that this is necessary: but I hope that in doing so in a historical and contextual way, such concepts will be demystified, and become entirely comprehensible.   

Introduction

The Government of Greece is so deeply in debt that there appears to be no possibility that it will be able to meet its obligations by increasing its income from a mixture of exports, foreign investment and domestic taxation. Under these circumstances investors are reluctant to lend their money to the government, for fear that they may not be able to get it back. But the possible consequences of a loan default are so serious that the government’s creditors have been asked to cancel some of the debt, and a range of international public bodies pressured into extending further loans. There is no general agreement that the arrangements put in place will work.

European politicians, financial institutions and media almost exclusively blame the Greek government for irresponsible spending, with the ‘bloated public sector’ a favourite target. Greece was accused on 8^th February 2012, for example, by an ‘economic analyst’ on RT (formerly Russia Today) of having a minimum wage 20 percent higher than that of Spain, and it was stated unambiguously that this was the cause of the enormous national debt. A prominent official of the European Central Bank (ECB), at an academic meeting where, incredibly, the Chatham House Rule applied, used similar reasoning to conclude that ‘there is plenty of fat’ in the Greek economy which can be cut out.

We have seen that these criticisms of the government easily elide into demonisation of the Greek personality as ‘feckless’ and lazy. From the perspective of the Greek people, whose standard of living is falling at an alarming rate, such criticisms have caused deep resentment. German criticism in particular has revived old memories of the occupation of Greece by Nazi forces in the Second World War: one form of oppression, some Greeks argue, has been replaced by another. The use of such absurd caricatures on both sides, to inflame national hostility, adds an insidious cultural dimension to the current crisis, one which must be eradicated through a careful analysis of its real causes.

(1)      Real causes of the Greek debt

There are several causes of the Greek Crisis which are too often overlooked. First we should put taxation and expenditure in their proper historical context. In this section we start by looking at Greek taxation and expenditure, followed by a brief look at the global banking crisis which has affected most of the Western countries, including Greece.

Taxation and Expenditure

To understand why Greece has an exceptionally high budget deficit it is necessary to put both its revenue and its expenditure into historical context, a context wholly different from the remainder of Europe. Greece, it must always be remembered,  was a military dictatorship for much of the first few decades after the Second World War, and this had major consequences for the class structure, and for fiscal (tax and spend) policies. It is also relevant to understand how this came about. From May 1941 Greece was occupied by the German Nazi army. With huge loss of life, the Greek resistance movements recaptured most of the country by 1944. But despite this it was the Greek government in exile, formed under Western Allied auspices in Cairo, rather than the Resistance itself, that became the official government (Wikipedia: the politics of Greece). After the Nazi occupation of the country the communist forces, which were in control of most of Greece, confronted the externally-imposed official government which was, in turn, supported by the British Army. In 1947 economic hardship, exacerbated by a very cold winter, forced the UK to cede power in Greece to the USA, which continued to fight a military campaign until their ultimate victory in 1949. This period, 1944-1949, is called the Greek Civil War.

After the defeat of the communist army the Right ‘governed via rigged elections through the 1950s and early 1960s. Then, in 1967, the fascist sympathisers and former collaborators in the army seized power through a military coup rather than risk an electoral victory by left of centre politicians. Not until after the military regime collapsed in the mid-1970s did anything like a normal capitalist democracy exist in Greece’ (Harman 2008:539).

The military government finally relinquished power in 1974, and the former conservative leader was reinstalled as a compromise. In 1981 the socialist party (PASOK) won the elections, led by Andreas Papandreou (the father of George Papandreou, the prime minister until his resignation in November 2011).

This history has important implications for the genesis of Greece’s national debt. Before the installation of the PASOK government in 1981 independent trade unions were illegal, wages were very low and there was no welfare state, unlike in the rest of Europe. All this changed in 1981, and while the rest of Europe was beginning its neoliberal journey, Greece was moving for the first time in the direction of social democracy. Greece and the rest of Europe were now moving in opposite directions.

But the new socialist PASOK government ensured that big capital and the ‘moderately wealthy and middle layers remained unburdened by taxes’ (Kouvelakis 2011:21), as in the previous regimes.  A combination of numerous tax exemptions for the ruling classes and rampant tax evasion ensured that between 1991 and 2006 ‘total revenues to the government averaged 37.9 percent of GDP compared with 45.3 percent within the Eurozone as a whole’. This difference is highly significant, as Albo and Evans (2011) claim that bringing tax revenues in line with the EU average would largely resolve the Greek budgetary crisis.

The tax system continues to be highly regressive. This was originally the result of a social compromise with the wealthy and powerful to ensure their acceptance of a social democratic system in which the remainder of the population gained social services and extended human rights. And given the severity of its contemporary economic and financial consequences it seems extremely unlikely that such policies continue to be freely chosen by government. Instead it is plausibly a result of various kinds of ‘government capture’ by powerful forces within the Greek political economy.

The existence of such forces becomes apparent when one looks at the recent revelations of the success of wealthy people in Greece in avoiding even the meagre taxes required of them. Thus in November 2009 Diomodis Spinellis, professor of Software Engineering at the Athens University of Economics, was appointed by the Greek government to lead the General Secretariat of Information Systems in the Ministry of Finance, and given the task of detecting tax evasion, through the examination of various databases. He designed two programmes, one to look for tax evaders, but also another to look at tax collectors (BBC 2012, Papachlimintzos 2012).

What he discovered was that ‘tax collectors routinely pocket 40 per cent of fines imposed in disputed tax cases in return for lowering the penalties paid by miscreants’ (Financial Times 2011). In this way Greece loses revenues of €5bn-€6bn annually because of tax evasion, equivalent to 2.5 to 3 percent of GDP. Spinellis’s report was ignored by the government, and he resigned after receiving threats, not from the tax evaders themselves, but from the union of senior tax collectors. He concluded, in an interview with the BBC’s John Humphrys, that the entire system was corrupted, and that only through a completely new system of taxation could evasion be tackled (BBC 2012).

Greece suffers then from a combination of fundamentally regressive taxation and systematic tax evasion. And this situation is getting worse, not better, under external pressures. The €110bn EU/IMF Stabilisation Programme for Greece, and the €440bn from the EU’s European Financial Stability Facility (EFSF) (see later), come with conditions from the creditors. These include widespread job losses, pay and pension cuts in the public sector, privatisation of several state-owned enterprises (SOEs), and increase in indirect taxes. But it should be stressed that all this is combined with a planned continuation of reductions in corporate taxation up to 2014 (Albo and Evans 2011:301).

These policies will severely reduce the incomes of those who pay taxes while cutting taxes for many of those who can better afford them, and extensively avoid paying them anyway. The implications for the Greek national debt need hardly be spelled out.

The other half of fiscal policy is government expenditure. Here military expenditure is a major problem. In 2005 the government directed 4.3% of its GDP to military expenditures, the second highest percentage in Europe, behind Macedonia (Wikipedia: Politics of Greece). Between 2004 and 2008 Greece was the world’s fifth highest importer of arms: in absolute terms, not merely relative to GDP. These imports come largely from Germany (31%), the USA (24%) and France (24%) (Economist 2009).

Although more recent estimates of arms imports are somewhat lower than this, it seems that the Greek government is reluctant to reveal its true size. According to Chris Pryce, Fitch’s [one of the three big ratings agencies] director of sovereign ratings, “Greek military accounts seem to be regarded as a state secret … In every other EU country we can find out how much they spend on defence, but we don’t know for Greece. All we know is that their military spending is very large, around 5pc of GDP.” (Evans-Pritchard 2009).

The putative reason for tiny Greece being armed to the teeth is the threat from its traditional enemy Turkey. But this is unlikely to be the whole explanation given that both countries are members of NATO, which would militate strongly against a mutual confrontation. Furthermore Turkey has offered Greece to engage in substantial mutual military cuts, an offer that was rejected.

It is tempting to suspect the role of pressure from international armaments corporations and their host governments in Greece’s apparent obsession with ‘defence’ spending. The reduction of military spending has long been an issue in Greek politics. The parties of the Left have been vocal in condemning military spending and argue that it is ‘carried out according to NATO planning and to serve weapon manufacturers and the countries that host them’ (Wikipedia: Politics of Greece).

Thus in 2010 Papandreou travelled to Paris to seek support in the financial crisis. On the very same day the Greek government announced that they would go ahead with buying six Fremm frigates from French companies, worth 2.5 billion euros ($3.38 billion), despite their budget woes (Taylor and Mantezou 2010). "No one is saying 'Buy our warships or we won't bail you out', but the clear implication is that they will be more supportive if we do what they want on the armaments front," said an adviser to Prime Minister George Papandreou, speaking on condition of anonymity because of the diplomatic sensitivity. "The Germans and the French have them over a barrel now," said Nick Witney, a former head of the European Defence Agency.

So there are surely ample grounds for suspicion that Greek fiscal imbalances [taxation too low, spending too high] have their roots at least partially in some combination of internal and external pressure on the Greek Government. But, as we have seen, there is also pressure of a more direct and transparent kind. Thus while EU and IMF loan conditions include reduced public expenditure, increased taxes and privatisation, the government pledges to leave corporate taxation untouched.

The Stability and Growth Pact

A further cause of excessive debt among some Eurozone countries was the criteria originally set down for countries to become members of the EU. The 1992 Maastricht Treaty created the European Union and made plans for introducing a single currency by 2000. Underpinning the single currency were five criteria to be met by all states which wanted to join. These included low inflation and stable interest and exchange rates, as well as reduced government spending and borrowing such that (annual) budget deficits should not exceed 3 percent and (cumulated) national debt 60 percent of GDP.

The Stability and Growth Pact which institutionalised these targets led to a ‘wave of austerity measures being implemented across Europe’ (Georgiou 2010:86). These measures were necessarily contractionary and arguably made for an eventual build-up of debt. It is frequently argued, in the media and elsewhere, that it wasn’t deficit reductions in the build-up to joining the Eurozone which exacerbated problems of Greek national debt (through falling government revenues) but the fact that the government fraudulently manipulated its national figures to understate its real deficits. Here the tendency to extend criticism towards Greece, to the exclusion of other countries, is again in evidence. Thus it is less often remarked that France and Germany, both much stronger countries economically, exceeded the Eurozone-prescribed budget deficits in 2003 and instead of paying fines argued instead for ‘greater budget flexibility’! Some have argued that this complacent response set a precedent for weaker countries, including Greece (Georgiou 2010:100).

The Global Banking Crisis

So we have already seen some good reasons why Greece may have developed a large national debt and why they may have found it difficult to reduce it to a manageable level. Perhaps it does not require the explanation often given  by the media, and reinforced by politicians and bankers, that the Greek government has been irresponsible in its borrowing and spending. But one should go much further with this argument. The national debt was only 96 percent of GDP in 2007, but then grew rapidly to an estimated 153 percent by 2011 (IMF 2011). The reason for this is well known and incontrovertible, as it has been the cause of similar public debt escalations in many other countries besides Greece.

In the years leading up to 2007 banks and other financial institutions throughout the world lent money with a reckless disregard for the creditworthiness of their borrowers. And they also borrowed money with a similar disregard for their own creditworthiness. And such creditworthiness was often non-existent. Loans were not repaid, and this led ultimately to the massive crash of 2007. This is often called a ‘Bank Crisis’.    

Banks by then had three interrelated problems: shortage of money (reserves); uncertainty about the value of many of their assets (including mortgage-backed securities: more later), which made other banks reluctant to lend to them; and uncertainty about the value of the assets of other banks, which in turn made them reluctant to lend to other banks. So inter-bank lending declined sharply, with the result that banks were increasingly unable and unwilling to lend to businesses and individuals. This was the ‘Credit Crunch’.

Of these three problems the most fundamental cause of the crisis was the uncertainty relating to the banks’ assets. The best known of these ‘toxic’ assets were of course, mortgage-backed securities (MBSs). In the USA in particular (but not exclusively) financial institutions had been borrowing money at very low rates of interest and lending it to people to buy houses. Many of these people were relatively poor (‘sub-prime’). The financial institutions had made little effort to establish the creditworthiness of the borrowers, and in many cases had even encouraged them to lie about their financial circumstances. This was naked fraud. The loans were then sold on (as ‘securities’) to investors all around the world yielding for the banks an instant profit, through fees. But to demonstrate to investors their own confidence in these highly risky loans they held on to a large number of them.  It was these loans which banks held as ‘assets’. Investors throughout the world had also borrowed from these same banks to buy these securities. When houseowners began to default on the mortgages it became increasingly clear that the securities constructed around them (MBSs) were of dubious worth. This created the uncertainties which caused the Credit Crunch.

There was no obvious solution to this financial gridlock and the economic stagnation which inevitably followed. After a few months it became established practice for governments to ‘bail out’ these banks: that is, to lend money to them, to increase the size of their reserves to make it easier for them to make loans. The governments found this money by borrowing money themselves, normally through selling bonds: that is, borrowing from businesses (financial and otherwise), individuals, and even central banks (about which more later). Quite apart from the fact that it didn’t work well – it didn’t promote economic growth - the consequence was that governments everywhere became hugely indebted. And this is the cause of the massive increase in Greek government debt between 2007 and 2011 mentioned above.

So we now have three major causes of Greek national debt: low taxation of the middle and upper classes, and excessive military expenditure; the economic contraction encouraged by the formation of the Eurozone; and the recklessness of financial institutions everywhere, but especially in the USA through the sub-prime mortgage scam.

(2)      The role of the post-war German economy

Greece’s national debt can also be explained by its trade deficit within the Eurozone. It consistently imports more from other Eurozone countries than it exports to them. In the absence of other ways of attracting large quantities of capital from outside the country such a trade balance can only be paid for through borrowing. The direct solution to this trade imbalance and consequent national debt is to reduce the quantity of goods and services it imports, to a level for which it can afford to pay. But of course the policy of import controls, often called ‘protectionism’, is strictly forbidden in a world in which ‘free trade’ is sacrosanct.

Logically, for Greece to progressively reduce its national debt it must develop a long term trade surplus. But there are logical and practical difficulties in doing so. First the logical difficulty. As every item traded adds to the value of one country’s trade surplus and adds equally to another’s trade deficit, then the aggregate of all global trade surpluses must equal the aggregate of all trade deficits. So Greece can only develop a trade surplus by increasing the trade deficits of other countries, with associated debts. In other words trade as currently organised is a ‘zero-sum game’, in which countries can only succeed at the expense (indebtedness) of others. So any success which Greece may achieve may be at the expense, say, of Portugal, thereby transforming the Greek Debt Crisis into a Portuguese Debt Crisis.  

The other difficulty – the practical one - is that some of the countries in the Eurozone are much more developed than others, and are more able to produce goods and services more efficiently and export them more cheaply. Greece’s unfortunate post-war history has led to the neglect of both industry and agriculture, which makes efficiency gains very problematic. By contrast, wealthier countries of the Eurozone like the Netherlands, France, and especially Germany, are at the forefront of global technological development. Just as it is important to understand the political reasons why Greece is relatively underdeveloped, so too should we understand the political, ideological and economic roots of German efficiency. In this way the cultural caricatures of Greeks and Germans – feckless and hard-working respectively – begin to lose their credibility.

After the Second World War West Germany – like Japan - was able to develop rapidly due to a combination of a cheap and skilled labour force, and the ability to adopt new technologies which were more efficient than the existing, inevitably older, technologies being used by its major competitors, in particular the USA. But also the system of fixed exchange rates established at Bretton Woods (USA) in 1944, ensured that its economic success did not translate into currency appreciation, as the values of currencies were largely fixed. In other words the success of the West German economy did not lead to an appreciation of its currency, because it was fixed by the Bretton Woods agreement. Consequently the currency became, in effect, increasingly undervalued, which helped promote a highly successful export-led strategy. In this way both West Germany and Japan had caught up with the USA by the 1970s and were able to out-compete them in many products in both US (it was easier to sell Japanese than American cars in the USA) and world markets. There were also clear policy ramifications in that West Germany became, and still remains, wedded to the identification of economic success with an effective export-oriented strategy.

But after the abandonment of the fixed exchange rate system in 1971 the USA used a policy of devaluation to make their products more competitive, and thereby boost its exports. It did this by running current account deficits (importing more than it exported) to keep down the value of the dollar. The USA was the only country which was able to maintain current account deficits over an extended period of time because, as the US dollar was, and remains, the global reserve currency (again, on the basis of the 1944 Bretton Woods Agreement), they had the unique privilege of being able to print dollars to pay for their imports.

Germany did not have this option, and they could only compete with the USA by lowering labour costs, improving technology, and moving production to lower-cost locations. This strategy helped Germany to maintain a current account surplus. Other European countries were forced to lower their labour costs as well, to remain competitive. Consequently the wage share of the GDP in the European Union fell nearly continuously from 67 percent (1976) to 58 percent (2005) (Georgiou 2010:95).  

(3)      The Eurozone structure

But of course, as we have seen, not every country can have a current account surplus. At the global level surpluses and deficits cancel out: every item exported by one country is imported by another. So Germany’s surpluses engendered deficits amongst many of its major trading partners, in particular the so-called ‘PIIGS’ countries of Portugal, Italy, Ireland, Greece and Spain. Long-term and persistent current account deficits have to be paid for, and it can only be done through borrowing, and borrowing increases debt. The Eurozone is primarily a bloc of countries within which trade is both facilitated (through a common currency) and unrestricted (through the eradication of trade barriers). Given that its raison d’etre is to enhance trade it makes little sense if the net importers are unable to pay for those imports. The logical solution would be to greatly reduce trade imbalances by increasing the imports of net exporters rather than reducing the imports of net importers, which would be contractionary: it would reduce the level of trade. So Germany should increase its imports, by raising demand, primarily through increasing the proportion of German production which goes to wages.

While this strategy is logically possible, it is difficult for a successful country which has achieved substantial growth to willingly reduce its competitiveness by raising wages. Germany also has a ‘mercantilist’ way of thinking in which economic growth generates national power and wealth, which are desirable in their own right, for their own sake (Lapavitsas 2012a:57-58). But by maintaining current account surpluses in the name of ‘national interest’ economic success is not sustainable: short-term interests clearly contradict longer-term interests. The German economy cannot continue to grow unless those of its trading partners do as well.

Indeed Germany’s interests are not even being met at the present time, let alone in the long term. Thus between 1998 and 2011 German exports grew by 115% but its economy only grew at 1.4% a year compared with the EU average of 1.7% over that period (Beck 2013). This is because the revenues earned by German exports to other parts of the Eurozone are held as a claim by the Bundesbank (Germany’s central bank) against other Eurozone central banks. This means, in effect, that the Bundesbank, rather than the importer, pays the German exporter. The importers are not able to pay and, in consequence, this claim at present amounts to a staggering €715 billion. This means that instead of the German economy earning export revenues it mostly gains unpayable debt obligations from its trading partners.     

Impossibility of devaluation

But another major cause of national debt in the Eurozone arises from the nature of the single currency itself. An important economic reason for the Eurozone was to make financial dealings, especially in trade, easier and more efficient within the zone, by reducing transaction costs. It was hoped that countries within the Eurozone would thereby benefit from easier trading between individual countries inside it.

But it is logically inevitable that some countries would produce export goods more efficiently than others and would therefore develop a positive trade balance within the Eurozone. In the absence of such a monetary union those countries with negative trade balances could attempt to reduce them by devaluing their currencies, or alternatively in a floating exchange rate system they may automatically lose value anyway. Meanwhile the currencies of those countries with a positive balance would become revalued (have a higher exchange rate) and they would consequently find it more difficult to export their goods.

But within a monetary union like the Euro, this of course cannot happen. Thus for Germany the value of its currency (the euro) remains lower (relative to others in the eurozone) than it would otherwise have been: for Greece it is higher than it would have been. So German trade gains from the single currency, while that of Greece loses. There are obvious parallels here with the ability of Germany and Japan to catch up with the USA after the Second World War because of the system of global fixed exchange rates, whereby German and Japanese export surpluses couldn’t translate into a revaluation of their currencies.

This explains, to some extent at least, why the poorer countries in the Eurozone – the PIIGS – easily develop negative current account imbalances (primarily trade imbalances), and why it is difficult to resolve them through trading within the Eurozone.

Trade deficits, and therefore national debt, may of course be overcome by the alternative of developing surpluses with trading partners outside the Eurozone. But this is problematic partly because most of the trade of individual countries within the Eurozone is with other countries inside it: in 2010 the internal market share of total EU-27 trade in goods was 63.7 percent (EUROSTAT 2012), and in services around 57%.

And also partly because of the high exchange rate of the Euro, which makes exports too expensive. Thus Jean-Claude Juncker, until recently head of the eurozone finance ministers, warned in February 2013 that the exchange rate of the euro is ‘dangerously high’ after reports that the Japanese yen has lost 15% of its value following central bank financial intervention (about which more later).  

(4)      Central Bank bail-outs

It has been argued so far that the mainstream analyses of the cause of the Greek debt crisis have tended to downplay, or ignore altogether, a number of crucial factors related to Greek history and politics. They have also too often proposed solutions which are impractical. We started with the difficulties of improving its trade balance within the Eurozone, and look next at the current strategy of bailing out the Greek government.

From late 2009 there were rising concerns about government debt levels around the world. Governments of course borrow money largely through the issuance of bonds: they borrow on the ‘bond market’. The interest rates which they pay on these loans is determined by how risky the loans are considered to be by the lenders: in other words, on the perceived likelihood of default. In 2009 the debt of some European states was ‘downgraded’: they were required to offer higher interest rates to compensate for perceived risk. Europe's finance ministers responded to this threat on 9 May 2010 and approved a rescue package worth €750 billion aimed at ensuring financial stability across Europe by creating the European Financial Stability Facility (EFSF). This is based on guarantees from all of the Eurozone countries approximately in proportion to their respective population sizes.

The Greek economy, and consequently its debt, was especially badly affected by falling demand for the products of its main industries, shipping and tourism. As we have seen, in May 2010 the Greek government announced a series of austerity measures to secure a three year €110 billion loan from the EU and the IMF. But this didn’t solve the problem, and in October 2011 the ‘Troika’  (EU, ECB and IMF) agreed a second Greek bailout loan worth €130 billion, this time from the EFSF. The IMF agreed to contribute €28bn towards this fund.

The loan was conditional on the implementation of further austerity measures which would be ensured by permanent monitors from the EU, the IMF and the ECB based in Athens, a humiliating intrusion into the country’s sovereignty (Hewitt 2012). The government has to establish a separate account to ensure the servicing of debts is prioritised above funding government services.

In addition to these austerity measures – including privatisations (whose sale provides money for the government to pay its debts) and major cuts in the minimum wage (Bretton Woods Update 2012) - Greece’s debt was restructured through a ‘debt swap’ in which banks and other financial institutions exchanged their €172bn of existing Greek government bonds for new ones, with a total loss for ‘investors’ of up to 74 percent. This deal with banks and other lenders was the largest restructuring of government debt in history, and cleared the way for the bailout.

Further, ostensibly to inject liquidity into European banks, the ECB announced the Long Term Refinancing Operation (LTRO) towards the end of 2011 in which it loaned €489 billion to 523 European banks for an (exceptionally) long period of three years at a rate of just one percent. The biggest amount by far of €325 billion was tapped by banks in Greece, Ireland, Italy and Spain.

 
Round one was carried out on 21 December 2011, when banks took the €489 billion from the ECB. On 29 February 2012, the ECB held a second auction for three-year loans - LTRO2 - providing eurozone banks with a further €529.5 billion in low-interest loans. This second long term refinancing operation auction saw 800 banks take part.
 
So the past few years have seen a variety of responses to the string of sovereign debt crises plaguing Europe. Schemes have been developed by European governments, the ECB and the IMF, to lend money directly to severely indebted countries, and to provide liquidity in the form of loans to struggling European banks.
But these banks have then used these low interest funds to lend, in turn, to indebted governments at much higher interest rates, and kept the very considerable profits for themselves. In other words, the banks which have been directly responsible for the Financial Crisis have been enabled to make huge profits from the very governments which had been forced to bailed them out due to their recklessness.
 
Perhaps more important still, the strategy does not work. Neither direct lending to indebted governments nor indirect lending through commercial banks solve the essential problems of: high levels of debt; and the inability to raise growth and thereby generate the taxes necessary to pay off these debts.
LTRO has its equivalents in both the USA and the UK, where it is referred to as ‘quantitative easing’ (QE) (Lynn 2012). When an economy is stagnant or contracting, the government may attempt to stimulate it through central banks buying short-term government bonds. In this way it reduces the interest rate and hopes to raise the amount of borrowing/lending in the economy at large, and subsequent economic activity. But when interest rates can go no lower, all that a central bank can do is to pump money into the economy directly, by buying long-term government bonds. This is quantitative easing.
 
This system was used by the Bank of Japan in the early 2000s to fight domestic deflation, without success (Wikipedia). Both the USA and the UK began QE at the start of the Financial Crisis in 2008. In the USA there have been three rounds of quantitative easing amounting to $2300 bn, and on 14 September 2012 the Fed said it would continue to spend a further $40bn per month. In the UK quantitative easing had never been tried before 2008, but as of September 2012, the Bank of England had already committed a total of £375bn to the process (BBC News online 2012).
 
The size of the financial flows in quantitative easing is clearly enormous. And there appears to be little doubt that governments plan to continue to use QE for a long time to come. So it is important to understand more clearly what these flows involve. In most developed countries central banks are forbidden by law to buy government debt directly from the government: they are not allowed to finance their public deficits directly by printing money. Instead they must buy government debt (that is, buy government bonds) from the secondary market. They buy these bonds from private sector companies or institutions, typically insurance companies, pension funds and High Street banks (BBC News 2012). The money received from the central banks is then used by these agencies in a variety of ways in order to maximise their financial yields. It can be used to buy shares, other bonds, currency or commodities. In all these cases there is a rise in asset values (see online video by Ciovacco Capital Management). Given the amount of money involved, the rise in asset prices will be enormous. This is the effect of QE.
 
What then comes out of all these financial flows? The immediate and direct effect is on the value of government bonds themselves. As the Central Bank buys government bonds this pushes up their value. They therefore become more expensive to buy, and they become a less attractive investment. This means that yields on government bonds fall (as they are more expensive to buy) and institutions, like pension funds, which hold them, lose income. Thus in May 2012 UK company pension scheme deficits ‘reached a record high of £312bn. If this persists then it will have to be paid off by employers, presenting them with a very large bill’ (BBC 2012).
 
As for asset price inflation it is clear that QE, as the Bank of England said in 2012, had benefitted households differently, according to the assets they hold: richer households have more assets (Wikipedia). Aside from the pronounced effect on inequality then, what has been the effect on the economy in general? Those institutions which have received money from the QE process will use it to maximise their gains. Thus they are less likely to lend to struggling businesses than to invest in emerging markets, commodity-based economies, and commodities themselves, thereby raising prices. And as Lynn (2012) puts it, ‘central banks are fast getting locked into a destructive cycle. They print money to try and pump up demand. Commodity prices rise, which then takes demand out of the economy again’. He goes on to explain further: ‘take a country like Italy. It imports 2.2 million barrels of oil a day. Thirty euros on the oil price adds 24 billion euros to the annual Italian energy bill — and takes out 24 billion euros from the Italian economy. For every euro you pump in, another goes out’.
 
What comes out of these various impressions of how QE initiates financial flows, and of how they develop from there, is that it has the undoubted effect of intensifying inequality, undermining savers, and raising the spectre of inflation. And it is doubtful whether it has any positive effect on economic growth.
It was hoped that the government bond holders which received the central bank money may lend it out to others in the economy and thereby boost economic growth. Some analysts have complained that since QE started in the UK in 2008 lending to businesses and individuals has remained sluggish. Others, such as Michael Nevin (2012: cited in Wikipedia), argued that ‘QE failed to stimulate recovery in the UK and instead prolonged the recession between 2009 and 2012 as it caused a collapse in the velocity of circulation, or rate at which money circulates around the economy. This happened because QE drove down gilt yields and annuity rates and forced pensioners, savers and companies to hoard cash to counter the negative impact of QE on their investment income’.
 
Still others argue that no-one knows how economic growth may have fared in the absence of QE, and BBC economics editor Stephanie Flanders said: "Quantitative easing may well have saved the economy from a credit-led depression. We will never know." What is very clear, however, is how opaque the workings, and how very unclear the consequences of QE are. It has injected enormous uncertainty into the entire financial and economic system.

There are however alternative approaches. Steve Keen, an Australian economist, argues that instead of bailing out banks central governments ‘should give the public a big dollop of cash. Those that had debts should be obliged to use the money to pay them down; those that didn’t would be able to spend the money however they wished. The result would be lower debt levels and greater spending power .... rising household incomes would spur consumption – the biggest component of GDP – and would encourage those companies sitting on big cash piles to invest rather than hoard.’ (Elliott 2011).

Similarly Mehdi Hasan, senior editor at the New Statesman, supports a related approach in the UK  whereby employment is generated directly from the funds created by central banks. It would take £26bn to generate the median wage for a million British workers, around half of the £50bn of quantitative easing (QE) released by the Bank of England in February 2012 (Hasan 2012), and which contributed to the cumulated total of £375bn by September 2012. This would in turn stimulate the economy through increased demand.

(5)      Ratings Agencies

Let us then reiterate the order of events in Europe which led to the current financial crisis in Greece. For a number of years from the late 1990s private banks around the world had lent money to borrowers (‘investors’) who wished to buy highly risky securities for which there were potentially enormous profits to be made. The profits of these investors translated, of course, into profits for the banks. Banks too bought these securities in their own right, and also made enormous profits directly. It was the size of these profits which motivated the irresponsibility of the banks, and made them ignore the obvious risks. So when the income from these securities slumped the investors lost out and so did the banks. The result was a very serious banking crisis, starting in around 2007.

At this stage the debts of European governments had been manageable, and were generally declining. EUROSTAT data show that in 2007 several of the Eurozone countries had levels of debt around the maximum specified by the Maastricht Treaty for Monetary Union, which was 60 percent of GDP (EUROSTAT 2012). Some however exceeded this limit. Not only poor countries, but even Germany and France, did so. The highest were Italy (104%), Greece (95%) and Belgium (85%). So at this stage Greece was indeed heavily indebted, but was not wildly out of line with the rest of the Eurozone countries.

In Europe the governments reacted to the banking crisis by bailing out their private banks. The debts of the banks were transferred to the governments which bailed them out. Private debts became public debts: as some people put it, the private debts became ‘socialised’. The sums of money involved were so large that the banking crisis became a ‘sovereign debt crisis’

Of course all governments borrow money in order to cover the gap between their income and their expenditure. The usual way to do this is to sell bonds, to private investors, most of which are banks. The government financial crisis led to the loaning of vast sums of money to indebted governments over the next few years. Poorer Eurozone countries like Greece borrowed mainly from the banks of the richer Northern European countries.

The terms of these loans are crucial for the financial health of borrowers. In 2007 all governments paid approximately the same interest rate, between 4 and 5 percent, on their loans (called ‘bond yields’). But then the three big US Ratings Agencies began to rate the riskiness of government bonds differently and the interest rates began to diverge wildly between rich and poor countries. By June 2012 the bond yields of most Eurozone countries were below 4%, sometimes well below (Statistics Denmark 2013). But for the PIIGS bond yields had increased sharply: Italy 6%, Spain 7%, Ireland 8%, Portugal 10% and Greece 27%. In general the bond yields were positively associated with the relative size of the debt, but with some notable exceptions. Thus, for example, Germany, with a debt-GDP ratio of 65% in 2007 paid interest rates of only around 1% while Portugal, whose ratio was much the same, at 64%, paid interest of as high as 10%.

These interest rates were bound to contribute substantially to increasing differentials in debt between Eurozone countries. Thus by 2011 the debt-GDP ratios of the PIIGS countries had surged ahead of other governments. The highest ratios in 2011 were Greece (165%), Italy 120%, Portugal and Ireland 108%. But despite lower interest rate payments on their bonds, some other governments were not far behind: Belgium 98% France 86%, Germany 81%. Note also that the ratios for the USA and UK were (again despite interest rates of only 2%), 103% and 86% respectively. These data suggest that bond yields had a substantial impact on debt levels and that there were factors other than debt levels influencing the interest rates paid.

While the interest rate differentials on these loans generally increased the polarisation between richer and poorer countries, so too did the nature of the loans themselves: most of them were made by private banks of the richer European countries. So again this constitutes a massive transfer of money from poorer to richer countries and, yet again, from the relatively blameless governments to the irresponsible banks.  

Further, investors who buy bonds have to insure them against the risk of default, by buying ‘Credit Default Swaps’. The price of these CDSs is again directly related to perceived risk. So yet again the government bond issuer is punished the more precarious the finances of the country it governs. So from around 2007 there was a massive divergence in the interest rates which governments paid for their bonds, as well as for the insurance on them. Clearly then there are specific financial mechanisms – borrowing and insurance – which increases the differentials in debt between countries, with the richer country governments benefitting and the poorer country governments losing out.

And there are also financial mechanisms which operate to weaken government finances vis a vis the banks. We have already seen that steeply rising bond yields for most of the PIIGS governments generate a lucrative trade for the banks. Another mechanism is the differential rating of bank and government borrowing such that banks pay less than governments for the CDSs needed to secure their loans. Again, ratings agencies strongly influence the fact that the ECB which, by the Maastricht treaty is not permitted to lend directly to governments (Altvater 2012:280), gives money to private banks at 1.25% (in June 2011), for them to lend at the market rate of 5% or more to governments, generating yet more strife for government to the advantage of banks. All this leads to greater profits for banks and more debt for governments.

But quite apart from the injustice of such an outcome when it was primarily the behaviour of the banks (admittedly with the compliance of governments) which precipitated the current crisis, there are serious adverse consequences of such financial mechanisms for both the governments and the banks themselves. After all the banks now have an increasing amount of their assets in the form of government debt, debt which is consequently in ever greater danger of being defaulted on. So bank assets are becoming increasingly precarious, even while they pay handsome bonuses to their managers and (less so) payments to their shareholders, and another major banking crisis looms. Further, it becomes increasingly unlikely that this next crisis will be resolvable through bail-outs by ever more indebted governments.     

This unequal financial relationship between banks and governments illustrates a fundamental principle – both pragmatic and ethical – about the relationship between bankers and their clients, respectively. Banks are dependent as creditors for their very survival on the repayment of the loans they make to debtors. So for pragmatic reasons they have to ensure, as far as possible,  that their debtors are able to repay their loans. This is what old-fashioned bankers did. No longer. Now instead they insure their loans by a variety of means. But this does not solve the problem that creditors ultimately derive their incomes from the profits made in the real productive economy. If these fail then no amount of insurance can compensate, as insurance is merely a form of transfer payment within the economy, and it produces no new value as such.

Creditors also need to ensure that there are mechanisms in place which enable debtors to repay their loans when they experience financial difficulties due to a wide variety of potential causes. There must be both effective debt rescheduling mechanisms and bankruptcy arrangements. Debtors must not be treated as criminals from whom the creditors have a right always to gain.

But of course when the debtor is the government, an institution which considers itself to be the guarantor of bank survival, the relationship between creditor and debtor is now a part of the very  basis of bank profits, its very survival. To maintain a tough inflexible stance with a customer which guarantees your very survival is very poor business indeed, and somewhat bizarre.  

(6)      Trade deficits and global imbalances

We have seen that a major cause of Greece’s burgeoning debt is its trade deficit within the Eurozone, the inevitable counterpart of the huge surpluses enjoyed by Germany. These in turn derive from Germany’s exchange rate advantages after the Second World War, and more recently within the Eurozone, together with the German ‘neomercantilist’ policy, resembling that of China, which emphasises export surplus at the cost of its labour force and therefore of the demand which they could potentially generate.

So the problem of trade imbalances, and the resulting growth of international debt, is a global one, and not one confined to Greece.  And it is not at all clear what, if anything, can be done about this problem of ‘global imbalances’, without a fundamental shift in global trade rules, coordinated through an international agency embodying, in turn, international agreements. Unfortunately the World Trade Organisation (WTO) only exists to make trade ever ‘freer’ by reducing all controls, such as tariff barriers. The United Nations Conference on Trade and Development (UNCTAD) has a fundamentally different philosophy, but very little power.

It has been demonstrated by the enormous trade surpluses built up by China and Germany in the past decade, and the even larger trade deficits of the USA, that there is no mechanism operating to limit the size of trade imbalances, and therefore to limit the size of corresponding international debt. It was hoped by some that foreign exchange markets would, through floating (liberalised) exchange rates, work to lower the exchange rates of debtor countries and thereby improve their trading performance, and so correct their trade deficits. In other words, that the ‘free market’ would automatically correct trade imbalances (see The Economist 1999).

But this has clearly not happened, and there appears to be no solution to this huge problem other than that proposed by John Maynard Keynes during the Second World War. At the 1944 Bretton Woods Conference he proposed the establishment of a set of global rules and institutions which would ensure that both countries with trade deficits, and trade surpluses, would be required to eradicate their trade imbalances (D’Arista 2009). As the USA was certain to have large trade surpluses once the war was over, this seemed contrary to their interests, and consequently the opposing ideas of the US delegation led by Harry Dexter White prevailed, with the IMF set up to ensure that only deficit countries would have to ‘adjust’ their economies (Buckman 2005:37-40; Rowbotham 2000:35-47).

The same principles have played themselves out again in the context of increasingly enormous trade imbalances since the early 2000s. It is generally held that China’s trade surplus with the USA, and Germany’s with the PIIGS countries of the Eurozone, can only be resolved through the repayment of the debts of the deficit countries (Aglietta 2012:34). An alternative, of course, is for both China and Germany to raise wages within their own countries in order to stimulate demand and help rebalance the global economy. This would raise overall demand and be expansionary, while the current strategy of reducing expenditure in the deficit countries, on the contrary, leads to global economic contraction. While the expansionary route would be better for the global economy the surplus countries clearly see it as undermining their superior competitive position.

If surplus countries cannot be persuaded to make such adjustments for the very survival of the system which, ultimately, sustains them, they should be encouraged to do so through the development of international legal agreements. No effective alternative to the original proposals of Keynes have ever been put forward, and these must now be resurrected.

(7)      Capitalism, profits and wages

So far we have examined a number of causes of the Greek debt crisis: regressive taxation and tax evasion; excessive and inappropriate government expenditure; contractionary policies of the Stability and Growth Pact; government assumption of private bank debts; the impossibility of devaluation as a response within the Eurozone; the flawed nature of official bail-out strategies; the innately unfair and counterproductive terms of bond markets; and the structural entrapment of the Greek economy as a weak exporter. We have also seen that none of these problems are easily addressed, given the powerful international state and corporate forces involved.

But there may be even more fundamental difficulties which cannot be addressed at all because of the very nature of capitalism itself. Thus many Marxist accounts of the continuing Global Financial Crisis of 2007 begin with the question of profitability.

There are many schools of thought within the Marxist tradition concerning the question of whether there is a general tendency for profitability to fall in a capitalist system. During Marx’s lifetime (1818-1883) there was a far greater degree of competition between firms than there is today in terms, at least, of prices for the final products. And it was this price competition which was the basis of Marx’s idea that profits are bound to fall as capitalists try to gain markets by lowering their product prices against one another. Even the introduction of new productive technology will only give a temporary advantage over other capitalists. But Marx made it clear that this ‘tendency for the rate of profit to fall’ (TRPF) was no more than a tendency. There were also, according to Marx, several ‘counteracting factors’.

To reiterate then, ‘Marx’s Capital, like the work of the other classical political economists, had assumed that the market system was characterized by conditions of free competition, in which capitalist enterprises were small, mainly family-run firms’ (Foster 2002). But even during Marx’s lifetime there was also a powerful tendency for capitalism’s form to change fundamentally through the increase in what he called the ‘concentration and centralisation’ of capital, generating conditions of monopoly. And in the current period too, because of the domination of the global economy by a shrinking number of giant multinational companies, some Marxists concentrate less on TRPF, and instead examine the implications of monopoly or, more accurately, oligopoly (in which a market is dominated by a small number of sellers).

Thus Foster and Magdoff (2009), who derive their ideas on ‘monopoly capital’ from a range of outstanding economists from Schumpeter (1883-1950) and Keynes (1883-1946), to Joan Robinson (1903-1983), Baran (1926-2011) and Sweezy (1910-2004), argue that monopolies are indeed competitive, but in an entirely different way. Whereas monopoly capitalists collude to manipulate the prices of their products (that is, they do not generally compete over final prices), they undertake other forms of competition, such as lowering costs (including labour costs) and a range of other strategies like ‘product differentiation’ (developing minor differences from the products of their competitors, and expending huge resources in exaggerating their advantages), to make large profits.

So this process increases profits partly by reducing labour costs. But this results in a lack of consumer demand. Things can’t be sold, and overcapacity becomes endemic to the system. The consequent lack of incentive to invest causes a tendency towards economic stagnation. This is a theory of ‘underconsumption’, and in this it draws from both Marxists (like Michal Kalecki (1899-1970)) and leftist Keynesians.  

This general tendency towards stagnation is sometimes countered, as in Marx (‘counteracting factors’), by ‘specific development factors’. Foster and Magdoff (2009:65-66), following Baran and Sweezy, conclude that ‘while the stagnation tendency was deeply rooted, powerful and persistent, the countervailing tendencies were more superficial, weak and self-limiting’.

Whether we use the TRPF under price-competitive capitalism, or else the tendency towards stagnation under oligopolistic capitalism, there is agreement among Marxists and non-Marxists alike that the profitability of capital (the ratio of profits to investment) fell steadily in the USA from the end of the Second World War up to around 1980. A paper by Goldman Sachs (which isn’t Marxist!) calculates trends in a similar measure, the ‘yield on physical capital’, and reveals an almost identical pattern (Choonara 2009a:181). So the claim that the profitability of capital in the USA suffered a long-term downward trend after the Second World War is not just a Marxist one. The Goldman Sachs data also show that global trends in this latter measure closely follow those of the USA (ibid:182). So profitability declined for over thirty years all over the world, and not just in the USA.

Some Marxists, like Kliman (2011), claim that once the value of investment, at the time of that investment (that is, in the past), is taken into account, profit rates are still falling (Piazza 2012). Most, however, argue that from the early 1980s the rates have remained at around this low level up to the present time, without falling further.        

This low rate of profitability acts as a powerful disincentive to capitalists to invest in productive capital: to set up or expand factories, mines or farming enterprises. Many agree that one major response to this critical problem has been the attempt to reduce the cost of labour, by laying people off, reducing/limiting wages, reducing the cost of social security, and so on. In the USA for example the proportion of GDP going to wages and salaries fell from a peak of 53.6% in 1969 to 45.9% in 2008 (Harvey 2010:13). In itself this increased ‘rate of exploitation’ (a term used by Marx which, in effect, is the value of the profit net of the cost of labour) has the effect of increasing the profit rate and hence the incentive to invest. But of course this comes at a cost. A reduction in labour income translates into a decline in demand for goods and services in the economy. So this, again ‘in itself’ has the effect of reducing profits.

So here we have a clear paradox. In order to increase the rate of profit, which is essential to ‘capital accumulation’ (the long-term increase in the overall ‘volume’ of capital, in the form of factories, mines, farms, infrastructure and money), the cost of labour needs to be reduced. But on the other hand, in order to increase the rate of profit it is necessary to increase demand, by increasing labour income, through increased employment and rates of pay. While some Marxists emphasise that the capitalist system can only flourish through a reduction in the costs of labour, others, along with some leftist Keynesians – together called ‘underconsumptionists’ -  emphasise instead the need to increase income to labour (Piazza 2012). Yet a third group of Marxists argue instead that this is an insoluble conundrum, the essential inherent contradiction of a profits-driven form of capitalism. The only solution, they argue, is socialism.

(8)      Capitalism, profitability and debt

So data show very clearly and unambiguously that the past thirty years has seen both a persistently low level of profitability world-wide, and a stagnation of wages among all sections of society except the very richest (for US income data 1960-2000 see Harvey 2005:25). The latter – low wages - can be seen as a direct result of the former – economic stagnation - and this relationship can be seen as the essential feature of ‘neoliberalism’. But the increased exploitation of labour is not the only key feature of this neoliberal period. Another is the explosive growth of.

The history of this growth in debt is a complex one, and it is possible to write it in any number of ways (see section (9) for a brief account). But there is no doubt that it can be understood as another response to the crisis of profitability from the 1970s onwards debt (Radice 2011). If increased wages reduced profitability, but stagnating wages killed demand, a solution could be to increase lending. In this way people would have both: low wages, keeping profitability up; and sufficient money to generate demand. Consumers would have both insufficient money and sufficient money at the same time. This is of course a fiction, a form of make-believe.

From the 1980s onward personal borrowing, including mortgages, became much easier. Different kinds of loans proliferated, and the terms became easier. Throughout the 2000s the response of many Western governments to economic crises and stagnation has been for central banks, and hence ordinary commercial banks to lower interest rates to stimulate borrowing. In the USA, as a result, the average household debt increased between 1980 and 2010 from $40,000 to $130,000, in constant dollars (Harvey 2010:17). But loans have to be paid back and the combination of sky-rocketing debt and stagnating wages makes this impossible. So the rise of easy credit failed to solve the problem of falling profit rates and demand. Instead all it did was push the crisis – the point where indebtedness undermines both the borrowers and their creditors – into the future. A future at which we have now arrived.         

(9)      Capitalism and financial liberalisation

We have seen then that the rate of profit around the world declined steadily from the late 1940s through to the late 1960s. Some (but not all) Marxists see the inherent tendency for profits to decline under capitalism as a basic tenet of Marxist theory. Whether this is the case or not, there is no doubt whatever that this has occurred: economists, from Marxists to Goldman Sachs, are agreed on this. In other words businesses were finding it harder to make adequate profits, while financial capitalists were struggling to find ways of investing their money profitably.

We have further seen that the low levels of profitability from around 1970 led to successful attempts to limit wages (to increase the proportion of profits which accrue to capital), together with an explosion in lending, and consequent debt. But in order to understand how debt is at the heart of the Global Economic and Financial Crisis, and is not just a contingent and specific problem for the government of Greece, we need to look in much more detail at both the debt mechanisms, and the associated institutions, which have been increasingly at work over the past 30-40 years, since the early 1970s.

We start with the search for increased profits from around 1970, under the circumstances of low profitability. One way to do this, where possible, is to reduce borrowing costs. The cost of borrowing from banks is always necessarily elevated by banking administrative costs and the need to cover bank losses from the defaults of other borrowers. Consequently from around 1970 attempts were made to by-pass the banks and find other cheaper ways of borrowing funds (Shutt 1998:76-82). As a result there began a secular decline in the proportion of the borrowing requirements of corporations which came from banks. This trend occurred at different speeds around the world: in the USA for example corporations which had made 65% of their loans from banks in 1970 were only borrowing 17% of their funds from banks by 2010  (Rethel and Sinclair 2010:58-59). This same trend towards the purchase of bonds and equities, and away from borrowing from banks, also accelerated sharply in East Asia between 2001 and 2010.

This meant a huge loss of business for banks. And in order to compensate for this they worked hard to find new profitable banking activities, and these in time would have serious implications for the stability of the global financial system, and the associated crises of the late 2000s, as we will see.          

The attempts of corporations and households to by-pass the banks were strongly influenced, then, by the falling rate of profit. But the events of 1971 added impetus to this trend. In 1944 a new global system had been established, primarily by the US government, at Bretton Woods. One of the main pillars of this system was the fixing of exchange rates to the US dollar which was, in turn, worth a specific quantity of gold. The subsequent ability of the Viet Cong to resist the US invasion of Vietnam over twenty years (1955-1975, but most intensively between 1965 and 1973) was a major factor in the USA developing an enormous national debt. This debt was so large that it could not be covered by US gold reserves. So in 1971 President Nixon abandoned the link between the dollar and gold and, as a result, the global system of fixed exchange rates collapsed.

The fixed exchange rate system was replaced by a range of different national systems but the most important was the system of ‘floating exchange rates’. This gave the opportunity for speculators to buy, for instance, foreign currency in the expectation that it would increase in price relative to the home currency, and sell it at a profit if their expectations proved correct. In short, the opportunities for currency speculation increased greatly as a result of the new financial system.

And because currencies were no longer fixed against one another, currency trading increased rapidly and continued to do so throughout the 1980s, leading to extreme fluctuations in exchange rates. In the 1980s too several governments – and especially the USA and UK – relaxed exchange controls, making it easier for the currency of one country to be used in another (Shutt 1998). This had very important repercussions. First of all it made it easier to move capital between countries, in the form of borrowing and investment.  In order to prevent the resulting instability in exchange rates, governments manipulated their interest rates (if exchange rates were falling too quickly the government could buy their own currency to arrest the decline). So the result was a world in which both exchange rate and interest rates became increasingly unpredictable.

Many financial transactions are agreements to sell or buy (commodities, goods, shares) or to lend or borrow (such as bond trading), at some agreed time in the future. Some of these (like buying grain or iron ore) may be affected by a wide range of contingencies, like the weather, or labour relations. And it is possible to buy insurance to reduce the consequent risks of financial loss. The level of insurance is ‘derived’ from the prices of these purchases, and for this reason they are called ‘derivatives’.

And due to the new volatility of exchange rates and interest rates, financial transactions have now became much more precarious. They have acquired a range of associated financial risks: interest rate risk, foreign exchange risk and default risk. Consequently there have developed a range of derivatives to insure buyers, sellers, lenders and borrowers – collectively called ‘traders’ – against this increased risk. Through the purchase of derivatives each of these risks can be priced and traded. The decomposition of loans into commodified risk attributes is a new invention (Bryan and Rafferty 2011).

So these derivatives have developed as a means of reducing (‘hedging against’) financial risk. They have increased in importance because of the growing risks associated with planned future financial transactions. But from the 1980s the world became increasingly awash with credit. This was largely because of a rapidly increasing US current account deficit (imports larger than exports) and a corresponding ocean of dollars in central banks around the world (Duncan 2012). This new money could now be used to invest in the growing array of different kinds of derivatives. So as well as acting as a form of insurance against rapidly escalating risk, derivatives provided an outlet for speculation/gambling, for which there was a growing demand.

So the dual function of derivatives – as risk insurance and for speculation – led to a massive increase in the trading of currency derivatives, especially from around 1990, from which time they increased in value to around $420,000 bn ($420 trillions) by 2009 (Bryan and Rafferty 2011).

The relaxation of exchange controls in the 1980s - mentioned above – meant that it became much easier to borrow money from a range of sources. So, banks found their primary business, of lending money, yet further undermined. This added impetus to their search for new business opportunities, new ways of making money (Shutt 1998). One of the traditional constraints on bank profits was – and still is – the requirement for them to hold reserves to ensure that they wouldn’t become bankrupt in the event of bank runs, or an increase in loan defaults. This is expressed as a legal requirement that reserves are set at a fixed proportion of their lending (or, strictly, of the value of their assets). Of course these reserves cannot be lent, and therefore cannot be used to make profit. Because of the reduction in their business brought about by various government policies (like lowering exchange controls) they demanded that reserve requirements be reduced. The controlling body of all central banks, the Bank for International Settlements (BIS), agreed to this change in 1988 by broadening the definition of capital assets (Shutt 1998:78). This naturally had the effect of making bank lending activities more precarious, and further undermined the stability of the international financial system.       

From the 1980s then there was a strong secular increase in the amount of credit in the world. People were now buying cars, houses and higher education on credit. And more generally credit cards were used to purchase a range of goods and services. These growing debts provided a stream of income for the corresponding creditors. Put differently, they represented ‘assets’ – sources of profit - for various financial institutions (banks, building societies). At the same time, at a global level, as we have seen, there were growing mountains of money derived from trade surpluses, especially in China, and oil-exporting countries. This was placed into ‘sovereign wealth funds’. Money was also piling up in pension funds and hedge funds. All of these funds were searching for ways to invest their money in order to make a good profit. Traditionally the place to deposit such funds would be through US treasury bonds (lending to the US government), but with the global decline in the rate of profit, such investments now yielded only very low rates of return (low interest rates).    

So there was a juxtaposition in the 1980s, and increasingly so in the 1990s, of a growing demand for profitable outlets for capital (pension and sovereign wealth funds) and a supply of such profit from repayment of debt (mortgages, student loans, car loans). This supply and demand were brought together (‘structured finance’) by converting loan repayments into securities (such as packaging mortgages into securities to sell on to ‘investors’): so-called ‘asset-backed securities’ (ABSs). These were another kind of derivative whose popularity mushroomed in the following years. So in effect, in the absence of profitability in the productive economy, millions of debtors (borrowers), many of whose debts were highly precarious, were enabling trade surplus governments and pensioners to effect a decent revenue from their savings. The whole edifice was obviously extremely unstable, as ultimately the ability of borrowers to repay their debts depended on their incomes which, in turn, depended on the profitability of the capitalist system of production.

This sharp increase in the availability of these new kinds of securities (through the securitisation of loans) also provided a further opportunity for banks to make yet bigger profits. By making loans (such as student loans) and then immediately securitising them and then  selling these ABSs to ‘investors’ they made immediate profits, rather than having a steady profit (from the loans) over a long period of time. This activity didn’t require them to have corresponding inactive reserves, and it thereby increased the ratio of profit to reserves. It was, in effect, another way of getting round the profit-constraining effect of having, legally, to maintain the ratio of reserves to lending (or assets). Securitisation, that is, lowered reserve requirements and increased profits.

This process of creating ABSs through the securitisation of pre-existing loans had two very important effects. The first was the enormous positive effect on bank profits, as much of their activity now took place off-balance sheet, with no need for reserves. The second results from the fact that these securities had to be sold to ‘investors’ who needed to be confident that they would generate a reliable stream of income. But it was impossible to know whether they would do so, because each security was based on thousands of separate loans (mortgages, student loans etc), and the reliability of each individual mass of borrowers was necessarily unknown. So to reassure the investors that they were, indeed, reliable, the banks employed Ratings Agencies to rate each of these complex securities. They had an incentive to rate them highly, as otherwise they may not be asked (by the banks) to take on the rating assessment for future securities. There was, in other words, ‘moral hazard’, which means a positive incentive to behave badly. And they did indeed behave badly by rating these ABSs as ‘AAA’, which means that they were as reliable as any security could possibly be. They hence conned millions of investors into buying them until, of course, the individual borrowers (house owners, students) defaulted in large numbers and the investors lost huge sums of money, from 2007 onwards.  

While banks were finding such new ways to make profit, their traditional business continued to be eroded. We’ve seen that borrowers increasingly shunned banks in an attempt to counter the long-term decline in return on capital. But depositors/lenders were doing the same. The trend away from lending to banks, towards mutual funds (the pooling of money from many investors to purchase securities) in the USA gathered pace in the 1990s and 2000s. Thus by 2010 mutual funds in the USA were worth $11,800 bn compared with $7,900 bn in US bank deposits. Now 44% of US households own mutual funds compared with only 6% in 1980 (Rethel and Sinclair 2010:58-59)

These new opportunities to make highly profitable, but highly risky investments, were seized on by the banks out of a combination of necessity – to compensate for the erosion of its traditional business – and greed. The outcome was very dangerous: banks, with their enormous resources, and the implicit backing of governments, invested heavily in financial markets. The repeal of the Glass-Steagall Act in 1999 removed the barriers between retail, commercial and investment banking activities, which drove commercial banks into the financial markets with renewed speed. Compared with other investors the banking sector was immensely wealthy, and also secure in the knowledge that governments wouldn’t allow them to fail. This was like letting an immensely powerful car free onto the public road system with the unique right to drive without a speed limit.

Remember again that from around 1970 the banks began to lose their essential business as intermediaries between lenders and borrowers. That business, in theory at least, implied an important role in promoting the stability and success of the economy within which it operated. This involved a responsibility as lender in assessing both the profitability of businesses it supported, and the related creditworthiness of borrowers in general. Thus Rethel and Sinclair (2010:62) describe the role of banks as ‘authorities or gatekeepers, operating as hybrid institutions of collective action, between state and market’. Their invaluable stabilising function was rapidly undermined with the relentless growth in their new activities as market participants.

The instability of the global financial system has been ratcheted up since 2000 by the increasing activities of the ‘shadow banks’. These are non-bank financial institutions which typically do not have banking licences, don't take deposits like a depository bank, and therefore are not subject to the same regulations. They first came to prominence from the mid 1980s to the mid 1990s in the context of declining net interest margins, in which they offered a way to increase investment returns by avoiding reserve requirements.
 
Then, after the bursting of the dot.com bubble in 2000 interest rates were brought down savagely, supposedly to stimulate economic growth. As a result investment yields became very low, and investors looked for better ways to make money. Depository banks and investment banks did this by creating these new financial institutions – shadow banks - which would not require regulation. They made money in many different ways. One was by the securitisation of loans (ABSs) which were then sold on to ‘investors’ such as pension funds. Uncertainty about the value of these securities, which led directly to the Financial Crisis from 2007, have already been mentioned. But, more typically, shadow banks act as intermediaries between investors (eg pension funds) and borrowers (eg corporations). The borrowers (in this case corporations) are often not creditworthy. If they default on their loans the shadow banks may lose heavily. Unfortunately they will then, in turn, default on their own loans, to creditors, which may be deposit-taking banks. This affects the latter banks’ creditors - ordinary individuals and businesses - and may lead to government bail-outs which will be paid for by tax-payers.
 
So this deep integration of shadow banks into the mainstream financial system, and hence the mainstream economy, makes the irresponsibility of their lending practices very dangerous. Max Keiser (2012) makes the point that the very term ‘shadow banking’ is dangerous in itself. While ‘shadow’ correctly implies ‘shady’, improper practices, it incorrectly gives the impression of operating in the shadows, unconnected with the real world, and therefore essentially unimportant. In fact however, regulated banks and shadow banks have profound mutual obligations and their fates are deeply entwined.
 
The largely unregulated shadow banking sector has grown from $27,000 bn in 2002 to $60,000 bn in 2010 according to the Financial Stability Board (FSB), a regulatory task force for the world's group of top 20 economies (G20). It now makes up 25 to 30 percent of the total financial system, and there are concerns that more business may move into the shadow banking system as regulators seek, hopefully, to bolster the financial system by making bank rules stricter.

(10)   Capitalism, financial liberalisation and fraud

We have seen that the origins of the debt crisis in Greece are broadly comparable to those of many other Developed Countries. And they can all be understood as evolving out of the need for capitalism to solve the problem of economic stagnation, or declining profitability, through the easing of restrictions on credit. This process of liberalisation of lending and borrowing was described in the previous section, again in broad outline (see also Radice 2011).

If this line of reasoning is accepted, then we can conclude that the ever-growing debt crisis is a structural crisis firmly rooted in capitalism’s crisis of profitability. The emphasis is placed firmly on structure, while human agency is seen as trapped within that structure. Human beings are, in a sense, not to blame. But the tone of so much of the analysis of the crisis, especially in the media, revolves around malfeasance: the greed and immorality of ‘the bankers’. So in this section an attempt is made to address some of the mechanisms leading to the crisis and ask whether these are structural, or else derived from freely chosen human behaviour.

To address this question a brief historical recap is necessary. We have seen that financial liberalisation received a boost from the abandonment of the Bretton Woods regime in 1971. It accelerated in the 1980s with the spread of disintermediation, the rapid replacement of borrowing and lending through banks. Banks responded to this loss of business by trying to limit their reserve requirements, to regain lost profitability, and were frustrated by the decision taken by the Bank for International Settlements (international organisation of central banks) at Basel, in Switzerland in 1988 (the ‘Basel I accords’) which stipulated the holding of specified levels of reserves.

In the 1980s commercial banks also tried to reinvent themselves as traders in securities,   trading for their own gains, and not for those of their customers. Despite the Glass-Steagall Act of 1933, which specifically forbade this trading, US banks were permitted to do so by the US Central Bank (the Federal Reserve, or ’Fed’), and the legal limits were raised further in 1996. Finally, in 1999, after intense lobbying, Congress repealed the remnants of Glass-Steagall via the Financial Services Modernisation Act (Roubini and Mihm 2010:74). But why did this happen? According to Lanchester (2010:160-162) this calamitous policy derived from ‘the received wisdom of the people in charge’, right across the political spectrum: the ‘entire climate of opinion, in the world of power, was in favour of laissez-faire, and deregulation and ‘innovation’’. Again, ‘this was the system’. So the ability of the commercial banks to move strongly into the trading of securities as their core activity was facilitated  by the power of neoliberal ideology, and of the political and financial Establishment which had embraced it .

But other attempts by the banks to find new ways to increase profits and compensate for their loss of business, are more grounded in opportunism than ideology. Again in the 1990s some of the big banks argued that instead of holding large reserves to insure themselves against the risk of default, they could simply take out insurance against such a risk. Matthias Chang, former Political Secretary to the Prime Minister of Malaysia, describes how they bought CDSs (see section 5, on Ratings Agencies) from insurance companies and were delighted when in 1996 the Fed responded by allowing them to lower their reserves as a result (Chang 2010).

The next stage in the attempt by banks to get round reserve requirements was to reduce the size of their assets: the fewer the assets the lower the reserve requirements which had, legally, to be held against them. As we saw earlier, they did this by converting their assets into securities which they then sold on (to ‘investors’). These securities would include mortgage loans, and were called ‘mortgage-backed securities’ (MBSs: see section one, sub-section ‘The Global banking Crisis’). This enabled the banks to make instant profits rather than accrue incomes from the assets over an extended period of time. In itself this process was driven by greed, and by a rapidly evolving conception of the nature of banking. But the consequences of this process, which accelerated in the 2000s, have been disastrous, for all but bankers. In these deals the banks no longer depended on the borrowers for their income, but derived instead from one-off fees. Any risk of default by the original mortgage holders was borne by the investors, and had no effect on the banks involved in the deals.

So banks had a financial incentive to make loans without any consideration of the creditworthiness of borrowers. The result was a bonanza of irresponsible lending, and the conditions for a massive future default. Again, in order to persuade investors that the assets they were buying from them were safe they employed Ratings Agencies which gave them low-risk ratings, despite a lack of information about the likelihood of default. Many of the initial bank loans, and the behaviour of ratings agencies, are clearly fraudulent (Rickards 2011:117), while Chang (2010) argues convincingly that so too is the absence of regulation. There appears to be little if any disagreement about this. And the subsequent mass default triggered the 2008 Crisis in which the world is still trapped. While the whole banking industry will have been aware that widespread default was inevitable, it is less clear how many bankers, let alone government officials, understood that this could also trigger a global systemic crisis.

But, incredibly, the banks then found yet another way to reduce costs. The insurers were making money from banks by selling them CDSs. The banks decided to eliminate these costs by establishing their own institutions (called ‘special purpose vehicles’: SPVs) which would issue CDSs and sell them to themselves. In effect banks were now buying insurance against the risks of asset defaults, from themselves. Yet more incredibly, as they were now in the business of selling insurance they began to sell CDSs to investors, hedge funds and pension funds as well, increasing their profits still further (Chang 2010). But it was all too clear to them, in fact, that CDSs could not possibly pay out enough compensation in the event of such huge potential defaults. So – now almost beyond belief - they began to buy CDSs from other issuers, in effect betting on default, and betting against the very products (insurance) they were selling. Whether one regards selling insurance to oneself, and betting against the very viability of this insurance, as wrong or not, it is surely clear that the banks were becoming increasingly preoccupied with gaining profits by whatever means, and neglecting the social purpose for which they were established. After all, the profits they were now making accrued exclusively to themselves, and not to their customers.  

The absence of government in the control of financial activities involving collateral debt obligations (including MBSs) and CDSs seems puzzling, until one realises that the US Congress passed the Commodity Futures Modernisation Act in 2000 specifically to place such derivatives off-limits to regulation (Roubini and Mihm 2010:75). The US government was not in fact absent in all these dangerous banking activities, but actually created the legal framework which allowed them free reign.

And just as the banks could create SPVs without breaking laws, financial institutions were able to establish themselves without calling themselves ‘banks’ and therefore without having to hold adequate reserves to limit the dangers (to everyone) of default. These shadow banks became more wealthy than mainstream banks in the 2000s and their very function was to by-pass regulations designed to improve the stability of the financial system. They further undermined the ethical standards of the banking industry by selling to untrustworthy borrowers with the sole purpose of maximising gain, in the knowledge that they are, in effect, not answerable to any form of government, but that government could be relied on to bail out the mainstream banks with which they were enmeshed, in the event of failure.

The financial crisis which started in 2007 with the ‘credit crunch’ and exploded with the bankruptcy of Lehman Brothers in 2008, has drawn the critical attention of national and international regulators, and the public, to bank malfeasance. But this attention seems to have done little if anything to discourage banks from unethical, and even illegal behaviour, as the unresolved crisis drags on. As for morality, the media continue to report the huge bonuses which banks pay to their staff, indifferent to the righteous hostility this generates. But recently, more than four years after the breaking of the crisis, there have been stunning revelations of straightforward fraud as well.

Thus in December 2012 a US Senate investigation into the international activities of HSBC bank found that it had been involved in the laundering of money for Mexican and Colombian drug cartels, tax evadors and organised crime groups. The Senate Permanent Subcommittee in their report concluded that HSBC had become a major conduit for illicit money flows.

But this disgraceful criminal activity raises another important point about the global economic context in which it takes place. Antonio Maria Costa, former director of the United Nations Office of Drugs and Crime, told the Observer in 2009 that for some banks on the brink of collapse “the money from drugs was the only liquid investment capital. In the second half of 2008, liquidity was the banking system’s main problem and hence liquid capital became an important factor.” Costa said that “a majority of the $352bn of drugs profits was absorbed into the economic system as a result.” (Syal 2009). This claim, rejected by the British Bankers’ Association, suggests that the world’s economy, mired in stagnation and crisis, may ironically be dependent on finance from illegal activities, like drug trafficking and tax evasion, for its very survival.

We’ve seen that government has played a key role in the processes of liberalisation and deregulation. But even its derisory role in punishing illegal activity is well illustrated in this case.  Even though the US Department of Justice (DOJ) accepted the Senate findings that HSBC had failed to maintain an effective anti-money laundering programme - they had, for example, failed to monitor more than $670 billion in wire transfers from HSBC Mexico between 2006 and 2009 (Burghardt 2012) - it nonetheless only imposed a Deferred Prosecution Agreement (DPA), and fines totalling $1.92 billion, less than 10 percent of its profits for 2011 and a fraction of the money it made laundering the drug bosses’ blood money.

Furthermore, those fines will not be paid by bank managers and officials, but by its shareholders which include municipal investors, pension funds and the public at large. According to Assistant Attorney General Lanny A. Breuer, HSBC “has agreed to partially defer bonus compensation for its most senior executives – its group general managers and group managing directors – during the period of the five-year DPA.” So despite the severity of their crimes, senior managers have “agreed” to “partially defer” bonus compensation! This is surely an eloquent illustration, if one is needed, of the inability, or unwillingness of government to exercise it law-enforcement role.

And we must ask why this is. An answer is provided by Ben Protess and Jessica Silver-Greenberg (2012) of the New York Times, who argue that state and federal officials decided against indicting HSBC “over concerns that criminal charges could jeopardize one of the world’s largest banks and ultimately destabilize the global financial system.” They go on to say that “four years after the failure of Lehman Brothers nearly toppled the financial system, regulators are still wary that a single institution could undermine the recovery of the industry and the economy.” So not only are governments reluctant to allow huge and powerful corporations to fail through their inefficiencies and reckless financial decisions, they are also prepared to allow the most heinous of criminal activity to go unpunished, because of the potential economic and financial consequences.

Many of the issues raised by the HSBC revelations are also in evidence in the recent ‘LIBOR rigging scandal’ which many have described as the greatest financial fraud in history. This has to be set in the context of the fundamental changes made to the global financial system resulting initially from the abandonment of fixed exchange rates in 1971. This led, of course, to currency trading and thence to fluctuating exchange rates. As we saw earlier,the relaxation of exchange controls in the 1980s increased capital movements, which governments tried to control by manipulating interest rates. In turn the unpredictability of interest rates cleared the way for a growing demand for interest rate derivatives.

These derivatives were used both to hedge against risk and as an instrument of speculation.  Will Hutton points out that the world’s GDP is currently around $70,000 bn, while the market in interest rate derivatives is worth $310,000 bn. He concludes that this trade cannot possibly reflect the demands (for insurance) of the real economy (Hutton 2012). Instead it is a hugely lucrative speculative bonanza. He then points out that ‘none of the banks that constitute [this] market ever loses money. All their divisions that trade interest rate derivatives on their own account report huge profits running into billions’.

So if all the banks are gaining from their speculative trade in these derivatives, who then is losing out: where does that profit come from? The answer, says Hutton is that ‘it comes largely from you and me’. Let’s consider, for example, the role of LIBOR in all of this. LIBOR (the London Interbank Offered Rate) is the rate at which banks are able to borrow from other banks. There have been accusations going back at least to 2007 that individual banks are deliberately under-stating this rate to give the impression that they are more creditworthy than they really are. But LIBOR underpins $3,500 billion of interest rate derivatives trading, and over time banks became accused of LIBOR manipulation, not just to appear healthier than they were, but also in order to make greater profits from this.  

The rationale and consequences of LIBOR manipulation can be understood by looking, for example, at the finances of US municipalities. From the late 1990s they were advised by investment bankers to borrow money by issuing bonds at a variable rate of interest, instead of the previous fixed rate. In this way they could make lower interest payments. But to do this they had to hedge their loans through the purchase of interest rate swaps (a kind of derivative). This mechanism generally works well, but if interest rates are artificially manipulated the buyer can end up making excessive payments to the derivatives traders. Thus ‘before the financial crisis, states and localities bought $500 billion in interest rate swaps to hedge their municipal bond sales. It is estimated that the manipulation of Libor cost municipalities at least $6 billion’ (Wikipedia entry on the ‘Libor Scandal’).

This is just one example of how Libor manipulation has been used to divert money from public funds to private ‘traders’. These funds are taken from the investment portfolios of large insurance companies, pension funds and even from the portfolios of the banks' own clients (Hutton 2012). It needs to be stressed that the activities of these traders has no social value whatever:  ‘this was about making money from money for vast personal gain’.

Hutton further rejects the argument often heard that the banks are in truth innocents in these fraudulent activities, and that ignorant bank managements are being fooled by rogue traders.  ‘They were no such thing’ says Hutton, ‘the interest rate derivative market is many times the scale than is warranted by genuine demand precisely because it represented such an effective way of looting the rest of us’. The traders are, in fact, the banks’ own employees: these are banks ‘trading in derivatives on their own account’ (see the lucid ‘The trader’s job, as described by a trader’, on the net).

These fraudulent activities do not create wealth, these institutions are not wealth creators, and the financial system through which we all work and survive, is not one which supports wealth creation. Quite the reverse: the financial system destroys wealth, enterprise and economic security. Hutton concludes that ‘global banking, intertwined with the global financial services and asset-management industry, has emerged as a tax on the world economy’,

We saw in the HSBC scandal how governments have failed to punish the perpetrators of fraud. We also saw that fears were expressed by those in authority that to do so would threaten the very survival of the global financial system. What, then, was the official reaction to the LIBOR rigging revelations, which is arguably an even bigger structural distortion of the workings of the financial system, of capitalism itself? Well it seems that even though the story broke in mid 2012 the New York Federal Reserve had revealed that they were aware that banks were lying about their borrowing costs when setting Libor as long ago as 2007.

The NYFR boss, Timothy Geithner, learned of how interest rates were being fixed in London, informed top British authorities, and suggested reforms (Wolf 2012).  But Barclays Bank continued reporting false rates, seeking to boost its profits. This manipulation is now alleged in numerous lawsuits to have defrauded thousands of bank clients. Geithner’s warnings were ignored. He was later promoted to the key position of US Treasury Secretary, but he didn’t use his new authority to act. Instead he did nothing, and Wolf speculates that the willingness to keep quiet is well rewarded within our financial and political establishment.

In the UK the decision by Barclays Bank to lower its LIBOR rate in 2008 was based on a discussion between its CEO Bob Diamond, and Paul Tucker, Deputy Governor of the Bank of England (Scott 2012). Tucker expressed concern, as he admitted to the UK parliament, that Barclays having a higher interest rate than other banks could undermine public confidence in it. Barclays took this as a sign to lower its LIBOR. In other words it is difficult for a bank to remain honest in an environment where all others are committing systemic crime.

The relative silence and implicit consent to massive fraud, by the US Treasury Secretary Timothy Geithner, and the alleged encouragment for it by the Deputy Governor of the UK’s central bank, are just two indications of the official approach to systemic fraud within the banking system, by Western governments. Although Barclays and the Swiss bank UBS have been fined a total of nearly $2 billion by the regulators, this is a paltry sum, and it has become clear that all the major banks have been involved. According to Will Hutton again, the UK government ‘fears that more upheaval will unsettle banking and business confidence’. This is the same attitude which pervaded official reaction to the HSBC fraud: to punish the banks would damage the global financial system, and its economy with it.

The financial crisis of 2008 revealed the extent of irresponsibility displayed by the banks. It was widely expected that the subsequent bail-out of the banks with tax payers’ money would have inspired some humility, and a determination to repay this trust, generosity and forgiveness. But instead there has been a torrent of financial scandal over the susequent five years, the most stunning example of which were the drug-laundering and inter-bank landing rates revelations discussed above.

Governments could have chosen to impose widespread criminal prosecutions against what Max Keiser calls ‘banking terrorists’, to ensure strong disincentives against a continuation of such behaviour. But they have rejected this option, and merely tried to ensure instead that banks can cope with the consequences of their inevitable crises. To do this they have gone back again to the same old question of capital reserve requirements.

Hence the Third Basel Accord (Basel III), agreed in 2010-11, tried to ensure that banks held enough capital, as well as sufficient liquidity to meet the demands of customers. The lack of apparent urgency in this legislation can be judged by the time scale agreed. Capital adequacy ratios were to be phased in by 2019. Further, the Basel Committee wanted banks to have sufficient liquid assets to withstand an intense liquidity crisis, such as the Northern Rock bank run in 2007, for at least 30 days. This requirement would not be implemented until 2015 (Brunsden et al 2013).

But as a result of intense pressure from bankers in January 2013 even these modest (arguably complacent) proposals were watered down. The definition of liquid assets has been significantly expanded, and now even includes mortgage-backed securities, whose very absence of liquidity led to the global financial crisis of 2007/8. Even more alarming, the time scale for compliance has been pushed back four years to 2019.

So not only has widespread criminal financial activity gone largely unpunished, but the modest international proposals to prevent criminal activity from causing an even greater crisis in the future have been greatly diluted, under pressure from the very banks which undertake the criminal activity which threatens the global financial system which, in turn, threatens the global economy through which we survive.   

(11)   Capitalism, capitalist crises and the destruction of capital

Before the above diversion into the question of unethical and illegal activities within the financial sytem, we had arrived at the conclusion that neither reduced labour income, nor greater access to credit, solved the problem of critically low rates of profit, in a capitalist system dependent on profit as its engine of growth. The fundamental problem is that there is too much capital in existence which is not sufficiently profitable. Put differently, the system suffers from ‘overcapacity’. Thus in China for example several of its industries produce far more than can be sold - such as microwaves, air-conditioners and television sets - and are capable of producing far more again (Kaplinsky 2005). 

There is, in other words, a ‘long-term crisis of overaccumulation and profitability’. In such a situation money is being put into banks - being saved, rather than invested - due to the lack of profitable opportunities in production. But the banks can’t use the money either, so there results a ‘savings glut’ and huge bank losses. These losses represent a vast amount of unprofitable capital (Callinicos 2010:91).

According to Karl Marx the only effective solution to capitalist crises of overaccumulation, within a capitalist framework, was the ‘destruction of capital’. Thus when firms are allowed to be bankrupted there are increased opportunities for profit among surviving firms. Not only can relatively unprofitable capital be eliminated through the straightforward destruction of the physical assets it represents, but also through the reduction of their monetary value. Through such mechanisms the total value of capital is reduced, which causes the rate of profit to rise. Hence crises unleash forces that permit a restoration of profitability and growth.

Remember that the rate of profit had reached critically low levels by the end of the long post-war boom, in the 1970s. Arguably the crisis of the 1970s should have been resolved through this process of capital destruction. This didn’t happen partly because of the way the economy had developed up to that time. Thus during this long period of growth there had been a world-wide process of ‘concentration’ of capital through which firms grew bigger and bigger. This trend towards larger firms was reinforced by the process of ‘centralisation’ whereby firms merged with others or took them over (so-called ‘mergers and acquisitions’).

The development of ever larger corporations played a major part in the domination of monopoly conditions with a corresponding fall in competitiveness. This contributed to the long-term decline in the rate of profit. So the crisis of profitability which reached a critical level by the mid-1970s, and the context of economies dominated by huge corporations, are two sides of the same coin.

As a result the mechanism of capital destruction necessary to clear out the system and resolve such a crisis had become more dangerous to that same system, due to the seriousness of the consequences of allowing huge corporations to be bankrupted. Such firms would have large numbers of employees, provide inputs and markets to other industries, and be hugely indebted to financial institutions. All of these would be threatened by their failure. So the very mechanism which could clear out the system had become more dangerous to it: the ‘collapse of one or two giant multinationals now posed the risk that profitable sections of the economy could be dragged down alongside unprofitable sections’ (Choonara 2009b:103)

For these reasons ‘a sufficient destruction of capital certainly did not take place in the 1970s or early 1980s. Instead mechanisms came into play that deferred the crisis at the cost of generating growing contradictions that permeated the system’ (Choonara 2009b:104). Of course it was the danger of endemic collapse which explained the panic over the implosion of Lehman Brothers years later, in 2008. Because of the dire consequences of the US Treasury refusing to bail them out, subsequently it ‘has intervened to manage the restructuring through bankcruptcy of the US car giants GM and Chrysler’ (Choonara 2009b:103).  But this creates its own problems, as such actions allow inefficient firms to survive, further aggravating the problem of falling profit rates. 

Alex Callinicos sums up this situation very well: ‘Capitalism is thus stuck in a structural dilemma: if the leading states let the market do its worst and sweep away inefficient capitals, [allowing unprofitable firms to go to the wall], the result may be a prolonged slump; but if they prevent the wholesale devaluation of capital, the long-term crisis of overaccumulation and profitability will continue ... any recovery will develop against the background of deep and unresolved structural problems’ (Callinicos 2010:94).

(12)   Conclusions

We began this discussion of the Greek Debt Crisis by challenging the widespread view that it was caused essentially by irresponsible government spending, and by a Greek work force which is lazy and over-paid. We then went on to examine a range of real problems confronted by the government. These included fiscal problems in terms of both revenue and expenditure. And these problems appear to derive from a combination of corruption and lobbying power among the rich and powerful, rather than any reflection on the working practices of ordinary Greeks. Other difficulties arise from the practical and logical mechanisms of international trade. But perhaps the biggest contributor to the government’s huge debt is the massive bail-out it had to undertake to save its banks.

We then saw that the attempted solutions have not been directed towards any of these profound problems, but instead to direct financial solutions. In other words the financial symptoms are being treated rather than the structural, systemic causes of the crisis. But neither have these financial solutions been well directed. They have involved loans to the very banks which caused the financial crisis, and have even permitted them to gain through passing on these loans to the governments which saved them.

As we have seen, none of this story is unique to Greece. The same set of events has affected all countries, in similar though not identical ways (for case studies of Spain, Ireland and California see Lopez and Rodriguez 2011, Allen 2009, and Walker 2010). Greece has the largest debt, but it only gained this distinction after the Crisis broke in 2008. Government debt is an endemic problem throughout the world, and one which is still getting rapidly worse, five years later.    

The problem of government indebtedness is, at first sight, clearly a financial one. But the dysfunctionality of the financial system stems from more fundamental problems, not of finance, but of economics. In the European Union average annual economic growth rates have fallen, as in Japan and the USA, steadily since the end of World War II. But the biggest fall took place from the 1970s to the 1980s. The actual data for the EU from the 1960s onwards are: 4.9% (1960s), 3.5% (1970s),  2.4% (1980s), 2.1% (1990s), and 1.4% (2000-2011) (Foster and McChesney 2012:4). 

Ironically many Marxists, in common with genuine free market capitalists (as opposed to neoliberals), would agree that the best solution, under capitalism, to long periods of stagnation is the ‘destruction of capital’ in which the least efficient firms go out of business, giving new opportunities to more efficient competitors to exploit newly redundant capital, and the resulting gaps in the market for their products. But this didn’t happen as it may have done in the 1970s because of the dominance of giant monopolies which were ‘too big to fail’, whose demise could have severe systemic effects. Low levels of profitability were instead tackled through the abandonment of the ‘corporatist’ social contract in which labour gained a share of the profits, relative to capital, higher than it would otherwise have done. Now there was instead an assault on the labour movement to restore profitability to the owners of capital.

The failure of these policies to drag Rich Country economies out of stagnation led to the growth of credit as a means of restoring demand. This liberalisation of credit has initiated more than three decades of the escalating dominance of finance, within economies the world over. This process is often called ‘financialisation’, whose main features are "the increasing dominance of the finance industry in the sum total of economic activity, of financial controllers in the management of corporations, of financial assets among total assets, of marketised securities and particularly equities among financial assets … (Dore 2002)”.

So we must not forget that although the Financial Crisis originated in the reckless behaviour of bankers and the subsequent decision of governments to bail them out, the process of financialisation which included this behaviour is rooted in the Crisis of Profitability beginning around 1970. And this crisis may well re-emerge should the problems of indebtedness ever be resolved. If this is the case then the financial crisis is merely a symptom – albeit a very important and currently intractable one – of the wider economic crisis of which it is a part.

As we saw above the global stagnation beginning in the 1970s led to the rapid financialisation of the economy. But it is equally clear that financialisation has done nothing to restore economic growth. It has failed as a strategy for resolving stagnation. But it has also generated, first through the abandonment of the Bretton Woods System of fixed exchange rates, the subsequent explosion in currency trading, the trading of a bewildering array of derivatives, and the escalation of systemic fraud, a level of instability in the entire financial system which culminated in the current global crisis.

Financialisation has not only damaged the interests of households, non-financial businesses and governments indirectly through its failure to restore economic growth, and the eruption of instability and fraud, but it has also damaged those interests through more direct mechanisms. Most obviously it has generated enormous levels of debt, through mortgages, student and credit card loans, causing widespread personal suffering. But there have also been growing revelations of nakedly fraudulent activities, such as LIBOR manipulation, which directly plunders huge amounts of money from the public purse.

Further, the increasing dominance of finance in the economy has led to a spectacular growth in inequality, largely precisely the inequality between financial and non-financial sectors of the economy. Thus from the end of the 1970s to 2011 the ratio of GDP going to finance, insurance and real estate (FIRE) relative to goods-producing industries grew from 31% to 92% (Foster and McChesney 2012:17-18) in the USA, while the corresponding ratio of employment in the two sectors stayed constant at around 22%. This shows just how spectacularly income in the financial sector has grown in comparison with the goods-producing sector.     

And with wealth comes power. The dominance of finance in the economies of Western countries has been translated into a capacity to dictate the regulatory framework in which it operates. The means whereby government becomes ‘captured’ by the finance industry are many and varied. First the direct lobbying of government by financial industries with the implicit or direct threat of transferring its business to another country. Second, the inability of governments to understand the finance industry sufficiently to be able to construct alternative effective regulations in the increasingly complicated world of finance. Hence the endless resort to giving the financial industry the right to ‘regulate’ itself. Thirdly the ‘revolving door’ principle through  which people move easily between political and financial jobs, often at the very highest levels. Fourthly the dominance of neoliberal ideology in the minds of ordinary people through the ownership and control of the media by powerful business interests, and in the minds of government through corporate influence, and the influence of economists trained within an academia dominated by the monopoly of neoclassical economics.

The issue of the relationship between economics in ‘the academy’ and in the real world is worth a brief mention here. Academic economists use models to understand economic and financial trends and to make projections into the future. Many critics including, famously, the British Queen, have asked why so few of the global army of well-trained economists had predicted the Financial Crisis of 2007-8. This question has been taken up, in turn, by many economists and they usually come to the conclusion that the discipline is dominated by models, and that these models have been grounded in the unrealistic principles of neo-classical economics (see Lawson 2009 for a useful discussion).

Furthermore, Foster and McChesney (2012) have criticised the relevance to the real world of the central concept of neoclassical economics, that of ‘perfect competition’. They begin by citing Milton Friedman, one of the gurus of the free market, and a powerful influence on both Ronald Reagan (1911-2004) and Margaret Thatcher (1925-). In 1962 he pointed out that in the competitive market place, ‘no one participant can determine the terms on which other participants shall have access to goods or jobs. All take prices as given by the market and no individual can by himself have more than a negligible influence on price though all participants together determine the price by the combined effect of their separate actions’ (Friedman 2002:119-120). 

But, as Friedman himself says, this concept of competition is ‘almost the opposite’ of that used in ordinary discourse, where ‘competition means personal rivalry’. Monopoly is the exact opposite of [neoclassical] competition in all these respects. ‘In some ways’, he says, ‘monopoly comes closer to the ordinary concept of competition since it does involve personal rivalry’. This is what Foster and McChesney call ‘the ambiguity of competition’.

The economic world today is dominated by fewer and fewer, larger and larger firms, each with considerable monopoly power. Thus in the USA in 2002 US multinationals and their foreign affiliates accounted for 77% of US exports and 65% of its imports (Foster and McChesney 2012:121). This system, in which production is dominated by a small number of large firms is called an ‘oligopoly’. Even in the nineteenth century, policy makers were aware of the threat posed by the growth of monopolies to the system of ‘competition’. So much so that in 1890 the US government passed the Sherman Antitrust Act ‘in an attempt to control the rise of cartels and monopolies’ (Foster and McChesney 2012). Its effect was clearly limited however, as in 1938 President Roosevelt (1882-1945) said that the USA was ‘experiencing a “concentration of private power without equal in history”, while the “disappearance of price competition” was “one of the primary causes of our present [economic] difficulties”’ (Foster and McChesney 2012:82).  

Although throughout the twentieth century such prominent economic thinkers as Joseph Schumpeter (1883-1950), Thorstein Veblen (1857-1929), Rudolph Hilferding (1877-1941), Vladimir Lenin (1870-1924) and Joan Robinson (1903-1983) incorporated the implications of oligopoly into their analyses, most mainstream economists continued to retain the perfect competition model ‘despite its inapplicability to real world conditions’ (ibid:81).

Not only was this version of economics largely irrelevant to the real problems faced by policy makers, its concept of competition has led to profound misunderstanding between academia and the real economic world. Thus J.K.Galbraith (1908-2006), academic and one-time economic advisor to US President Kennedy, argued that the definition of competition ‘led to an endless amount of misunderstanding between businessmen and economists’ (Galbraith 1952:14, cited in Foster and McChesney 2012:83), where businesses compete ferociously in the sense of rivalry, but not at all according to textbook economics.

In conclusion, neo-classical theory, or ‘free market economics’, with its central requirement of perfect competition, is at the very heart of the ideology which generates the ideas used for the justification of capitalism, both from academia and from policymakers with this same intellectual background. But in the real world economies are much closer to monopolies than competitive systems, and Marx’s concentration and centralisation of capital, together with its internationalisation, is continuing apace. The existing version of capitalism - ‘neoliberalism’ – is one in which monopolies normally collude over price-fixing and maximise their profits through lowering costs, in particular through reducing labour costs through a wide variety of strategies.     

To return to the argument before this brief diversion into the relevance of academia to economic decision-making in the real world. We have seen that a variety of deregulatory influences have been brought to bear, in several ground-breaking governmental decisions in recent years, furthering the cause of financial liberalisation.  In 1996 the US Federal Reserve permitted financial institutions to lower their bank reserves through the purchase of CDSs, unleashing a chain of dangerous CDS abuse. Four years later when the dangers of derivatives trading had become all too clear, instead of regulating the derivatives markets, the US congress chose instead to pass the Commodity Futures Modernisation Act, designed specifically to place such derivatives off-limits to regulation. The previous year the US government had chosen to repeal the Glass Steagall Act, through the Financial Services Modernisation Act, thereby giving banks free reign to become infettered market players.

Moving on to more recent times, governments failed to bring criminal prosecutions in 2012 against the numerous bankers responsible for the HSBC scandal, which had revealed systematic bank support for drug barons, and for the massive theft of money from public bodies, including pension funds, via the fraudulent manipulation of inter-bank rates. In 2013 the international regulators of the world’s central banks at Basel caved in to bank lobbying over reserve requirements which had been effectively ignored anyway over the quarter of a century since the first Basel Accords of 1988 .

We can conclude that the Greek debt crisis is merely the most severe among many others (including the UK whose credit rating was downgraded from AAA for the first time since 1978, by the ratings agency Moody’s, on 23^rd February 2013) which are becoming, in terms of debt as a proportion of GDP, more serious by the day. There is no need therefore to look for circumstances unique to Greece to explain its crisis. The problem is a global one and debt crises are lining up waiting to cause equally severe problems, while the inadequate and ill-directed response to the Greek crisis gives little or no cause for optimism.

Finally, what are the deeper problems which will have to be addressed in order to prevent a string of Greek-style crises in the years ahead? Firstly the economic stagnation which began around 1970, and which financialisation concealed for several years after, has to be understood and confronted. If the cause was the falling rate of profit, then the ways in which profits are generated, and the dependence of investment on profitability may have to be changed. In other words, whether promoters of the dominant neoliberal ideology like it or not, the profits system itself may be under threat (Shutt 2010).

Secondly the international system of monetary exchange, that of floating exchange rates, has failed to act as a natural balancing mechanism for international trade, and instead has  generated instability. This system itself floated into existence because of the failure of the Bretton Woods system of fixed exchange rates. But this failure itself occurred because of a combination of the privileged position of the dollar, and the absence of any mechanism for correcting trade imbalances. Trade imbalances obviously imply the indebtedness of countries with trade deficits. And unlike in most situations of lending and borrowing, in this case there is no systematic requirement of debtors to repay their debts. Only when the debts become unpayable – and then only for poorer countries - does the IMF offer loans together with structural adjustment ‘conditionalities’ of economic contraction on debtor countries: conditionalities which further suppress their ability to repay. This whole system of international trade debt needs to be radically overhauled, and some version of Keynes’s 1944 proposals at Bretton Woods would be a good place to start. Unfortunately this is not on any international agenda, and certainly not that of the World Trade Organisation (WTO).

A third problem is that of debt more generally. Huge volumes of loans are being transacted with an absence of responsibility. Some of the blame is on the side of the borrowers, some of whom borrow from financial institutions in order to gamble without due care, or even insurance. The failure of such speculation leads to bank losses, with implications for customers and governments. But most blame is to be attached to lenders who place profit ahead of security and pay little attention (in the case of the US mortgage scam often none at all) to the creditworthiness of borrowers. In enormous numbers of lending agreements, involving households, corporations, governments and financial institutions, the consequences of default are ignored. Unpayable debt has mushroomed as a result. The solution is the effective regulation of all loan agreements and, once that has been put in place, effective procedures in the case of all remaining (total or partial) defaults, to reach balanced agreements which are fair to both debtors and creditors, and not just creditors. In all of these respects there has been very little progress even in the recognition of the problems and their corresponding solutions, let alone concrete regulatory developments.           

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