Analysis: Lee Sustar

A new Great Depression?

October 17, 2008

A few weeks ago, bankers and politicians reassured us that the turmoil on Wall Street could be contained without damaging the underlying economy. Now, as the Washington Post noted recently, "The worst financial crisis since the Great Depression is claiming another casualty: American-style capitalism."

Suddenly, three decades of pro-market, neoliberal ideology have been shattered as the U.S. government carries out its greatest intervention in the economy since the Great Depression of the 1930s, including the partial nationalization of the banking system. The crisis marks an epochal shift--one that will transform U.S. society and politics in the months and years ahead.

As the economy worsens, tens of millions of working people are rightly worried about their future. How bad will it get? Are we looking at a rerun of the 1930s depression? Lee Sustar looks at whether the latest government attempts to boost the economy can keep a recession from becoming something far worse.

THE GOVERNMENT bailout plan was supposed to use $700 billion to buy up bad mortgage-related securities from financial institutions. Now the U.S. Treasury is investing $250 billion directly into bank stocks. If this is a better deal for taxpayers, as some say, then why didn't they do it in the first place?

THE SHORT answer is that Gordon Brown made them do it.

Brown, the British prime minister, rolled out a plan to inject $700 billion directly into the eight biggest British banks, effectively nationalizing them. With the British government standing fully behind its banks, and the other big European banks prepared to do likewise, Treasury Secretary Henry Paulson had to do the same in order to avoid a big flow of money out of U.S. banks.

This was only the latest flip-flop for Paulson, who just a week earlier had vowed the U.S. wouldn't invest directly into banks under the so-called Troubled Asset Relief Program (TARP).

Since the crisis broke 14 months ago, the U.S. government--or rather, Paulson, since George W. Bush is just a figurehead at this point--has continued to cling to free-market, neoliberal dogma.

First, we were told that the crisis was "contained" to the sub-prime mortgage market. Then, Paulson's actions became totally contradictory--forcing the sale of investment bank Bear Stearns and nationalizing the mortgage companies Fannie Mae and Freddie Mac, but allowing the investment bank Lehman Brothers to go bankrupt. But two days after Lehman went under, Paulson nationalized the huge insurance company AIG to the tune of $122 billion and counting.

By letting Lehman go bust, Paulson turned a months-long credit squeeze into a total credit lockdown. Banks refused to lend to one another, and short-term loans for big corporations, known as the commercial paper market, ceased to function. It was then that Paulson went to Congress with his demand for the TARP, which in its original version was a plan to transfer $700 billion from the working class to the banks in order to buy up their bad assets at inflated prices.

But when this failed to stop the panic on the stock market, he had no choice but to sign up with the British approach. As a result, Gordon Brown--who a month ago was perhaps the most unpopular and weakest political leader in Europe--is now driving economic policy for the U.S. and the European Union (EU) as well as Britain.

CAN THIS kind of international cooperation end the crisis?

WHAT'S HAPPENING is less cooperation than an attempt to keep pace with international rivals.

Two weeks ago, EU leaders failed to come up with a Europe-wide rescue plan because the German government balked at having to pay for it. But after Brown made it clear that the British government would do whatever it takes to keep British banks afloat, France, Germany and Italy were pressured into taking similar measures, followed by the U.S.

The numbers involved in this effort are staggering. Analyst Barry Ritholtz estimates that the various U.S. bank bailout measures so far have committed $4 trillion to $6 trillion in tax dollars. In Europe, the initial figure for a continent-wide bank bailout was put at $2.3 trillion. But these are just down payments--the real costs will be much higher.

These actions may stem the crisis, in that they could prevent the kind of total breakdown of the world financial system that happened in 1931 during the Great Depression. But it won't end the crisis.

For what's really going on here is competitive financial state capitalism, in which each nation-state steps in to protect its own banks and other financial institutions. Such efforts may force banks to lend to one another again and ease the credit lockdown, but credit will remain very tight as banks write off losses and raise new capital. The banks' unwillingness to extend credit will therefore make the recession deeper and longer.

What's more, the bank nationalizations will create other, long-term problems. The countries with the biggest economies can carry out these bailouts only by raising taxes and imposing austerity on the working class.

In the U.S., for example, the budget deficit hit a record $454.8 billion in the fiscal year ending September 30, double the amount of a year earlier. And according to the Congressional Budget Office, the next year could see a deficit of $750 billion, a figure equivalent to 5.5 percent of gross domestic product (GDP), the broadest measure of economic output.

But with the cost of the economic bailout rising practically by the day, that figure is sure to increase. And the U.S. commitment to maintaining wars in Iraq and Afghanistan will further raise the deficit.

The European Union--the world's biggest economy--faces an additional complication. While the U.S. Treasury and the Federal Reserve can virtually print money to pay for the crisis, the European Central Bank (ECB) isn't backed by any national government. So the question arises as to whether and how the ECB churns out more euros to fund bailouts in the 15 countries that use the currency. The decision as to which country will get more money for its banks will lead to political clashes between countries.

Also, the EU is tied to a common "growth and stability pact" that limits budget deficits to 3 percent of GDP. Those rules will have to be loosened, if not junked. But if each country is free to go its own way, then the very existence of the euro will come into question (Britain doesn't face that particular problem, since it has remained outside the euro).

Moreover, once the banks are effectively nationalized, the health of the financial system will depend on the fiscal situation in each country. The U.S. has been able to get away with large budget and trade deficits for decades because it has the largest economy and the dollar functions as the world's reserve currency.

For the smaller of the 27 EU countries--in particular, its newer members in Eastern Europe--there are still more problems. Several, such as Hungary, Poland and the Baltic states of Latvia and Estonia, are heavily indebted and already experiencing capital flight and runs on their currencies.

We are likely to see entire countries go bankrupt--like Iceland, which prospered as an offshore banking haven during the boom, but which has now suffered a complete economic meltdown. Instead of selling stocks short, international investors will "short" entire countries, much as they did during the East Asian financial crisis of 1997-1998.

So in the developing countries, the picture will be grimmer still. Brazil, a rising star of the world economy in recent years, has seen its stock market crash by 50 percent in recent weeks, and it faces a run on its currency. As the recession sets in, the price of oil, gas and foodstuffs is dropping, which will turn Latin America's commodities boom into a slump.

A few developing countries can withstand this pressure much better. Key Asian countries, including Japan and China, have $4.4 trillion in foreign currency reserves, including $1.8 trillion in China.

But China is experiencing a sharp drop in demand for its exports as demand from both the U.S. and Europe dries up. That, in turn, is leading to a manufacturing slowdown in China, which thus curbs the enormous Chinese demand for raw materials from Latin America and Asia, and machine tools from Europe and Japan.

In short, we're seeing a classic capitalist crisis of the sort analyzed 150 years ago by Karl Marx. At bottom, it is a crisis of overproduction--there are too many goods to be sold at a profit, not just in the U.S., but worldwide. In recent years, demand could be stimulated by debt, but the bursting of the housing bubble means that this is no longer possible.

So while the bank bailouts may keep the financial system functioning, they can't prevent a slump. As the International Monetary Fund warned in a report published this month, "Faced by increasingly difficult conditions, the global economy has slowed markedly. The advanced economies grew at a collective annualized rate of only 1 percent during the period from the fourth quarter of 2007 through the second quarter of 2008, down from 2.5 percent during the first three quarters of 2007."

SO ARE we facing a new Great Depression?

THERE ARE some frightening parallels between today's financial crisis and the one that followed the stock market crash of 1929.

Then, as now, major banks failed under the weight of a chain of bad debt. A bank failure in one country spread the crisis to the next. Policymakers did practically nothing to intervene, believing that the free market would drive out inefficient companies and open the way to renewed growth.

Andrew Mellon, the Treasury Secretary of the time, infamously declared "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate," adding, "It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people."

As a result of this attitude, 25 percent of U.S. workers became unemployed.

Today, even the most committed neoliberal governments are less ideologically bound to free-market doctrines. Henry Paulson could be dragged into partially nationalizing the banks, and Federal Reserve Chair Ben Bernanke, formerly an academic specialist on the Great Depression, has made a virtually unlimited amount of money available to loan to banks. Even George Bush was willing to back a $168 billion stimulus program earlier this year that, while inadequate, did succeed in spurring growth for a time.

Measures like these will likely prevent a replay of 1931--though there's no guarantee. That's because neither private capital nor the government can control a shadow banking system worth $10 trillion--the same size as the traditional system. It's impossible to be certain that another failure of a financial institution (or government) won't trigger an even greater financial panic, whether next week or next year.

What is certain is that the recession will be the worst since the Second World War and perhaps the longest as well. The latest economic statistics for September make this clear: a slump in retail sales by 1.2 percent, and a fall in manufacturing by 2.8 percent. Some 760,000 jobs have been lost since late last year.

Continued tight credit will only add to the downward momentum. Unemployment will rise--not to Depression levels, but perhaps close to the 10.8 percent jobless rate seen during the 1982 recession.

HOW BAD will it get for workers who do manage to hold onto their jobs?

THEIR STANDARD of living will be cut sharply. As David Leonhardt pointed out in the New York Times, "Income for the median household--the one in the dead middle of the income distribution--will probably be lower in 2010 than it was, amazingly enough, a full decade earlier. That hasn't happened since the 1930s. Already, median pay today is slightly lower than it was in 2000, and by 2010, could end up more than 5 percent lower than its old peak."

Increases in health insurance costs will be passed on to workers. Retirement savings will evaporate because of the stock market downturn. Then, there will be budget cuts by governments at all levels, further pushing all kinds of other costs onto workers' backs.

At the same time, overall taxes will have to increase. While it may be a bit better that the government is spending your tax money to take partial ownership in some banks rather than just buying up their bad debts, either way, the tax burden for the bailout will still fall on the working class.

Millions of people will lose their homes to foreclosure. The 26.4 percent of U.S. workers who were already on poverty wages before the crisis began will soon have to choose between paying for food, rent or health care. The poor and the elderly will likely see cuts in the services they depend on most, such as Medicaid and Medicare.

So while the economy may not go as bad as during the Great Depression, it will still be horrendous for tens of millions of people and miserable for the working-class majority.

If Barack Obama becomes president, as seems likely, his administration will try to sugarcoat some of these measures.

It's no longer possible to proclaim that the free market is the solution to all problems, as was offered during the administrations of Reagan, Bush I, Clinton and Bush II. To sell the notion of shared sacrifice, an Obama administration may put curbs on the pay and business practices of the banks that they partially own. Bush's tax cuts to the wealthiest will be rolled back, and the rich may have to pay a bit more.

Also, there may be some job creation programs--perhaps based on Obama's proposal to "make service pay" through education benefits for young people who do community service, join the Peace Corps or go into the military.

But behind the scenes, Obama's economic policy team is made up of pro-business moderates who are averse to liberal policies, let alone radical ones. Many of Obama's closest economic advisers served in the Clinton administration, including Robert Rubin, who was Treasury Secretary between stints as a Wall Street executive.

HOW CAN working people respond to this?

THERE WILL be a lot of hope in a new Obama administration.

For example, organized labor will call on Obama and the Democratic Congress to pass the Employee Free Choice Act, legislation that would make it much easier for workers to form a union. Liberal groups will lobby for more social spending. But if history is any guide, a Democratic administration will also absorb people who have been advocates for social change.

The key will be rebuilding working-class organization of all kinds--labor unions, immigrant rights groups, grassroots networks to fight budget cuts and more.

Here and there, some workers may find individual solutions to the crisis. Yet these will be the exceptions. The only way workers can improve their lot in this crisis is to organize and fight back. There's no way to predict when and where resistance will take shape, or even over what issues. But the struggle will come.

In the meantime, it's crucial that we prepare ourselves politically. That requires developing an analysis of the economy that cuts through the business-media double-talk, and which arms the working class with a theory that can explain why capitalism leads to crisis.

But organizing resistance also means taking up the need for a socialist alternative. Already, "socialism" is being discussed in the media--in a highly distorted and often ridiculous way to describe government nationalization of financial institutions.

Nationalizing industries isn't equivalent to socialism--a point that the founders of modern socialism, Karl Marx and Frederick Engels, always argued. After the conservative German leader Otto von Bismarck "went in for state ownership of industrial establishments, a kind of spurious Socialism has arisen," Engels complained, "degenerating, now and again, into something of flunkyism, that without more ado declares all state ownership, even of the Bismarckian sort, to be socialistic."

What's needed is to give the idea of socialism its original content--democratic working-class power, a society based on meeting human needs rather than the blind, destructive scramble for profit.

As workers see their jobs eliminated, their home values wiped out and their retirement funds slashed, it's crucial to put forward that alternative. As the slogan of the global justice movement put it, another world is possible--and the deepening capitalist crisis has made the struggle for that world an urgent one.