We have heard this phrase – «a systemic crisis» – so many times that we no longer grasp its meaning. Besides, few of those, who ever said it out loud, understood what it really means. Now, let me explain.
Final demand can fall for two reasons: falling incomes and/or malfunctioning demand-stimulating mechanisms (e.g. by means of credit). Thus, as soon as demand starts dropping for whatever reason, the message in this regard is sent down the entire production chain causing production declines, lay-offs, and wage/salary cuts. As a result government and household incomes drop as well. This occurs quite regularly in the capitalist economy, which is cyclic by nature. The slump can be so intense that economic growth rates drop below zero (if that lasts sufficiently long, it is called a recession), but growth resumes sooner or later. It is not the case today. Why?
The reason is that household demand has been actively stimulated by means of credit for the last years. Pre-crisis household debts were growing rapidly (approximately 10% a year, which is significantly faster than the growth of their incomes, whose purchase power, technically, has not been growing at all). This did not only stimulate demand, but has also been increasing monetary liquidity at a constantly accelerated pace. In other words, growth rates for spare money in the economy has been higher than growth rates for the economy itself.
The result of all this should technically be inflation or – if the excess of money can be concentrated in specific sectors of the economy – financial bubbles. And this is exactly what happened: stock prices, real estate prices, prices for some other assets had been on a rapid rise. The more they rose, the more they stimulated the general public’s willingness to take out new mortgages, make an additional income or simply spend thus boosting the consumption.
But we all know that living on credit cannot last forever – the servicing of debts sooner or later starts eating up incomes. The US started this orgy of credit in 1981, and it is surprising that it lasted for almost 30 years up until now. Rather, it is not so surprising because a peculiar mechanism has been in operation in the US all these years – a constant interest rate reduction. To get the picture clear, you can have a look at a graph of the Federal Reserve discount rate, which was at 19% in 1981 and has finally dropped almost to zero by late 2008. This is what convinces me that the crisis could not be averted.
This situation makes it clear why this crisis is “systemic”. Because it affects the 30-year-old system of money redistribution based on the following basic principles: constant growth of demand, constant growth of money supply, constant reduction of interest rates.
This system allowed financial institutions to redistribute to their own benefit a considerable portion of profits generated within the economy. While the financial sector’s share in corporate profits in the 1950’s was not more than 10%, today it stands at more than 50%. While household debts back then did not exceed 50% of the annual household income, today’s figure exceeds 130%.
So households will now spend more on servicing debts rather then spending while no bank will be willing to grant them new loans since they are not capable of paying them off. The amount of money in the economy will stop growing thus compelling to change the entire system. In particular, the real sector’s share in corporate profits will have to increase otherwise it will not be able to function and pay out wages, which means there will be no sources for economic growth. But banks are strongly against changing the system (which channeled 50% of all profits into their pockets) thereby reducing their profits 5 (!) times. Bankers will sooner strangle themselves than consent. And they do have strings they can pull to oppose these initiatives.
In theory, demand – and the entire economy as a result – can be stimulated if household debts are written off or at least restructured. But there is another problem: all these debts are assets for the same old financial system. Writing them off means massive bankruptcies for banks, insurance companies, and other financial institutions. This would be a scary step to take. We must remember the old saying: “he that pays calls the tune” - over the last decades everybody has learned by heart that the biggest profits come from the financial system. Thus, that very system must be the one to call the shots in the economy. College courses (the notorious “monetarism”), management training programs, etc. have been tailored to meet the needs of the financial system. Even White House economic officials are pretty often former Wall Street employees.
In this situation, even discussing problems explicitly (let alone taking measures to address them) becomes impossible. And large international forums like G20 only confirm this reality – the causes of this crisis are a taboo subject for participants for some strange reason. At the same time, taking any measures – while the very “engine” that provided economic growth based on the three above-mentioned principles is now broken beyond repair – is hardly possible either. A new “engine” is required. In the mean time, even discussing this let alone do something about it is rather problematic.
Author: Mikhail Khazin