ARTICLE

Financial Tsunami in US:
Investigating the Root Causes and Broader Implications

Part - II

Arindam Sen

“The contradictions inherent in the movement of capitalist society impress themselves upon the practical bourgeois most strikingly in the changes of the periodic cycle, through which modern industry runs, and whose crowning point is the universal crisis. That crisis is once again approaching, although as yet but in its preliminary stage; and by the universality of its theatre and the intensity of its action will drum dialectics even into the heads of the mushroom-upstarts of the new, holy Prusso-German empire.”

In our last issue we discussed late capitalism’s strategic response to the stagnation that reappeared in the early 1970s after roughly a quarter century of post-war prosperity. This escape route allowed the system to limp forward in the usual uneven fashion, but the resultant bubbles in the FIRE sectors (finance, insurance and real estate) failed to reinvigorate the real economy.
Thus it was only in 1 among 20 years between 1986 and 2006 that private non-residential (i.e., non-business) fixed investment in the US measured as percentage of GDP reached 4.2 per cent -- the average for the nearly 20-year period between 1960 and 1979. According to economist Philip O’Hara, the profit rate of the Fortune 500 corporations went down and down: from 7.15 in 1960-69 to 5.30 in 1980-90 to 2.29 in 1990-99 to 1.32 in 2000-02. Real GDP figures released by the US Bureau of Economic Analysis (BEA) on October 30, 2008 indicated that the US economy was in the midst of a slowdown even before the financial storm hit the world economy in the middle of September. Real GDP in the US contracted at an annual rate of 0.3 percent for the third quarter (i.e., for the months of July, August and September), led by a sharp fall in consumer spending.
If this was the pre-crash situation, now with the financial tsunami unequivocally announcing the failure of the grand strategy of liberalisation-globalisation-financialisation, the entire system encompassing the global Wall Street and Main Street is in for a prolonged recession and probably a veritable depression. The US is deep in recession and the Euro-zone’s expected 2009 growth rate has been revised down from 1.9 to 0.1 percent. The latest IMF forecast for world economic growth, released early November, has cut world growth by 0.75 percentage point to 2.2 per cent with output in advanced economies forecast to contract on a full-year basis for the first time since World War II. A number of countries have already seen capital flight and currency depreciation of such severity that they have been forced to turn to the IMF (Iceland, Ukraine, Pakistan) or enter into emergency financial arrangements (Hungary, South Korea).
This reciprocal relation between the surface froth of financial turmoil and fundamental problems in the real economy shows that it is necessary (a) to comprehend the financial crisis on its own terms in the historical context of the evolution of the credit system and the increasingly dominant  role of finance, (b) to move on  from the particular to the general -- i.e., to equip ourselves with the theoretical wherewithal needed for understanding the deeper currents of crisis formation in the overall process of capitalist accumulation, so that (c) we can then return to the current crisis to grasp its broader implications. Having attempted (a) in the first part of this article, we should now try and tackle (b) and conclude our investigation with (c) in the next issue.
But before we proceed, we should recall that Karl Marx had to take leave of the international proletariat before he could systematically work up a comprehensive theory of capitalist crisis. Capital Volumes II and III, the Theories of Surplus Value and the Grundrisse were not made ready for publication in his lifetime; nor could he take up his plans for investigating various other facets of capitalist economy and polity. Naturally there is a wide array of differing interpretations of Marx’s theory, with Luxembourg for example differing with Lenin, and Ernest Mandel arguing against Paul Sweezy and others. Available space does not permit us to review the rich and continuing debate among these schools; we can only present here in barest outline the basic Marxian approach towards understanding capitalist crises.
The Tendential Fall in the Average Rate of Profit
Take a look at the quotation from the Communist Manifesto placed at the head of the article in our last issue. Marx and Engels talk of an “epidemic of overproduction”. This is overproduction of commodities relative to effective demand: more is produced than can be sold. Thanks to inadequate purchasing power of the masses, a big chunk of commodities remain unsaleable and drag their owners (producers/traders) down to ruin. This characteristic feature of capitalism led Marx to remark, “The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses as opposed to the drive of capitalist production to develop the productive forces as though only the absolute consuming power of society constituted their limit.” (Capital Volume III p. 484)
The problem thus appears simply as a realisation crisis and prompts one to ask: why on earth do practical men of business commit the folly of producing more than they can sell?  Don’t they, or their associations, make proper market surveys?
Going deeper, we find that crises are not caused by capitalists’ callousness, nor do they fall from the blue. They are produced in course of trade/business cycles resulting from a complex interplay of several partially independent variables, the most important being movements in the average rate of profit. As Marx showed in Part Three of Volume III of Capital, over a period of time and in the economy as a whole, this rate tends to fall. Here is how, in brief.
We all know that capitalists are prone to use more and better machinery to boost production and save on labour costs. In Marxist economic theory this is known as increasing the ratio of constant capital (plant and machinery, raw materials, various fixed assets, etc) to variable capital (capital expended on purchasing labour power -- “variable” because this part, unlike the “constant” part, grows beyond its own value, i.e., creates surplus value in the process of production) -- a ratio which is called the organic composition of capital. Since living labour is the source of surplus value or profit, replacing labour by machinery means a proportionate decrease in the rate of profit for every unit of total (constant plus variable) capital employed. Suppose a capital worth 100 crore comprised 60 crore in constant and 40 crore in variable capital and the rate of surplus value was 50%. The amount of surplus value was therefore 20 crore (50% of 40 crore expended on variable capital) and the rate of profit (calculated on total capital of 100 crore) was 20%. After say 10 years, the organic composition is increased -- constant capital is raised to 80 crore and variable capital slashed to 20 crore. The rate of surplus value remaining the same, the amount of surplus value would be 10 crore (50% of 20 crore) and the rate of profit 10%.
The illustration is deliberately simplified, but the fact remains that increase in the organic composition of capital and a downward tendency of the average rate of profit, conditioned by the former, are the general laws of development of the capitalist mode of production. However, reduced rate of profit can go hand in hand with increased mass of profit if the total magnitude of capital on which profit is earned is sufficiently increased. And that is what usually happens in real life. As Marx puts it,
“…the same development of the social productiveness of labour2  expresses itself … on the one hand in a tendency of the rate of profit to fall progressively and, on the other, in a progressive growth of the absolute mass of the appropriated surplus-value, or profit; so that on the whole a relative decrease of variable capital and profit is accompanied by an absolute increase of both. This two-fold effect… can express itself only in a growth of the total capital at a pace more rapid than that at which the rate of profit falls.” [Capital, Volume III, p 223]
This has another consequence that has acquired much practical- political importance in the current context of development debate:
“… as the capitalist mode of production develops, an ever larger quantity of capital is required to employ the same, let alone an increased, amount of labour-power. Thus, on a capitalist foundation,the increasing productiveness of labour necessarily and permanently creates a seeming over-population of labouring people. If the variable capital forms just 1/6 of the total capital instead of the former 1/2, the total capital must be trebled to employ the same amount of labour-power. And if twice as much labour-power is to be employed, the total capital must increase six-fold. [ibid, emphasis added]

We thus see that the tendential law of falling rate of average profit does not operate in a simple, linear fashion. It is realised only in course of cyclical movements of capital, through breakdowns and restorations of equilibriums. It has its own “internal contradictions” and unleashes a slew of countervailing forces or “counteracting influences”, such as more intense exploitation of labour, depression of wages below value, cheapening of the elements of constant capital, relative over-population (the “reserve army” of unemployed), foreign trade (skewed terms of trade and imperialist super profits), expansion of share capital -- and to this list prepared by Marx we must add more modern techniques like monopoly pricing. We should therefore view the law “rather as a tendency, i.e., as a law whose absolute action is checked, retarded and weakened by counteracting circumstances” (ibid, pp 234-35).

Our stress on the tendency of the average rate of profit to fall -- which Marx regarded as “in every respect the most important law of modern economy and the most essential for understanding the most difficult relations” (Grundrisse, p 748) -- should not lead one towards a monocausal understanding of economic crises and business cycles. Crucial other causes are also there, such as anarchy of the capitalist mode of production which, inter alia, periodically upsets the conditions of equilibrium between the two main sectors -- one producing consumer goods and the other producing capital goods -- of capitalist economy. Marx also discussed several auxiliary factors which influence the specific courses and peculiar features of particular crises. More important among them are: movements in wage levels, competition among capitalist concerns, fluctuations in raw material prices, expectations (or “confidence”, to use a more modern term), movements in interest rates and financial turmoil, trends in international trade, and so on. A composite study of all these, and of other factors discovered in post-Marxian experience and research, is needed for seeking out the truth from the mountains of facts and data that are easily available; what we are attempting here is only an initiation.
Barriers on Capitalist Production and their Removal
The exposition of “the internal contradictions of the law” takes Marx to a discussion of certain “contradictory tendencies and phenomena” which “counteract each other simultaneously”. He mentions a number of such contradictory features -- such as falling rate of profit alongside the growing mass of capital, enhanced productivity alongside higher composition of capital -- and declares,
“These different influences may at one time operate predominantly side by side in space, and at another succeed each other in time. From time to time the conflict of antagonistic agencies finds vent in crises. The crises are always but momentary and forcible solutions of the existing contradictions. They are violent eruptions which for a time restore the disturbed equilibrium. …”
Here we have the most concise description of the essential role of crises as an inbuilt mechanism of capitalism that, up to a point, prepares the way for a new upturn, just as a forest fire can prepare the woodland for a new period of growth. To explain how, Marx makes another move ahead in his exposition.
Over-accumulation and Depreciation/Destruction of Capital
Where bourgeois economists see the surface phenomenon of commodity glut during depression, Marx lays bare the deeper substance of overproduction/over-accumulation of capital and shows how this comes about:
“A drop in the rate of profit is attended by a rise in the minimum capital required by an individual capitalist for the productive employment of labour… Concentration increases simultaneously, because beyond certain limits a large capital with a small rate of profit accumulates faster than a small capital with a large rate of profit. At a certain high point this increasing concentration in its turn causes a new fall in the rate of profit. The mass of small dispersed capitals is thereby driven along the adventurous road of speculation, credit frauds, stock swindles, and crises. The so-called plethora of capital always applies essentially to a plethora of the capital for which the fall in the rate of profit is not compensated through the mass of profit — this is always true of newly developing fresh offshoots of capital — or to a plethora which places capitals incapable of action on their own at the disposal of the managers of large enterprises in the form of credit. This plethora of capital arises from the same causes as those which call forth relative over-population, and is, therefore, a phenomenon supplementing the latter, although they stand at opposite poles — unemployed capital at one pole, and unemployed worker population at the other.
“Over-production of capital, not of individual commodities — although over-production of capital always includes over-production of commodities — is therefore simply over-accumulation of capital.”(ibid, p 250-51)
Such a situation naturally leads to an unseemly scramble among capitalists:
“So long as things go well, competition effects an operating fraternity of the capitalist class … so that each shares in the common loot in proportion to the size of his respective investment. But as soon as it no longer is a question of sharing profits, but of sharing losses, everyone tries to reduce his own share to a minimum and to shove it off upon another. The class, as such, must inevitably lose. How much the individual capitalist must bear of the loss, i.e., to what extent he must share in it at all, is decided by strength and cunning, and competition then becomes a fight among hostile brothers. The antagonism between each individual capitalist’s interests and those of the capitalist class as a whole, then comes to the surface … [ibid, p 253]
In the age of imperialism this is replicated on an international scale, with nation states engaged in fierce battles over who is to bear the brunt of the huge losses. Costs of crises are spread differentially according to the economic (including financial), political and military prowess of rival states. Imperialist war – war being the fastest method of this destruction – appears on the horizon as a real or potential ‘solution’ to capitalist crisis.
In whatever manner and through however fierce a struggle the losses maybe distributed among individual concerns (and among different states or trade-and-currency blocs on the international plane), the overriding need for returning the system to some kind of equilibrium has to be fulfilled. And that is fulfilled through destruction of part of capital values:
“…the equilibrium would be restored under all circumstances through the withdrawal or even the destruction of more or less capital. This would extend partly to the material substance of capital, i.e., a part of the means of production, of fixed and circulating capital, would not operate, not act as capital… The main damage, and that of the most acute nature, would occur … in respect to the values of capitals. That portion of the value of a capital which exists only in the form of claims on prospective shares of surplus-value, i.e., profit, in fact in the form of promissory notes … is immediately depreciated by the reduction of the receipts on which it is calculated. … Part of the commodities on the market can complete their process of circulation and reproduction only through an immense contraction of their prices, hence through a depreciation of the capital which they represent. The elements of fixed capital are depreciated to a greater or lesser degree in just the same way. … definite, presupposed, price relations govern the process of reproduction, so that the latter is halted and thrown into confusion by a general drop in prices. This confusion and stagnation paralyses the function of money as a medium of payment, whose development is geared to the development of capital and is based on those presupposed price relations. The chain of payment obligations due at specific dates is broken in a hundred places. The confusion is augmented by the attendant collapse of the credit system, which develops simultaneously with capital, and leads to violent and acute crises, to sudden and forcible depreciations, to the actual stagnation and disruption of the process of reproduction, and thus to a real falling off in reproduction.”  (ibid, pp 253-54)
But all this does not, by itself, mean the end of the world. Once the necessary devaluation has been accomplished and over-accumulation eliminated, ‘normal’ accumulation can go on:
“…the cycle would run its course anew. Part of the capital, depreciated by its functional stagnation, would recover its old value. For the rest, the same vicious circle would be described once more under expanded conditions of production, with an expanded market and increased productive forces.”  (ibid, p 255)
But what is normal need not be permanent. Expanded capitalist reproduction is intensified reproduction of all its contradictions and within the recurring cycles reside the seeds of violent destruction of the system:
“The highest development of productive power together with the greatest expansion of existing wealth will coincide with depreciation [devaluation] of capital, degradation of the labourer, and a most strained exhaustion of his vital powers. These contradictions lead to explosions, cataclysms, crises, in which by momentous suspension of labour and annihilation of a great portion of the capital, the latter is violently reduced to the point where it can go on.... Yet these regularly recurring catastrophes lead to their repetition on a higher scale, and finally to its violent overthrow” (Grundrisse, p 750).
Credit and Crisis
As noted in the first instalment of this article, credit plays a dual role in the process of production and circulation. Drawing attention to a basic contradiction of capitalist accumulation, Marx observed: “the self-expansion of capital …in fact constitutes an immanent fetter and barrier to production, which are continually broken through by the credit system. Hence, the credit system accelerates the material development of the productive forces and the establishment of the world-market. …At the same time credit accelerates the violent eruptions of this contradiction — crises — and thereby the elements of disintegration of the old mode of production.” (ibid, p 441)
Is not the correctness of Marx’s observation self-evident? As recent experience especially in the US has demonstrated, expended credit can, for a period, enable the system to sell more commodities than the sum of real incomes created in current production plus past savings could buy and also to invest more capital than really accumulated surplus value would have permitted. But this could not be continued ad infinitum. The working people of America kept up their consumption levels with easy credit made available through aggressive credit card promotions, new and reckless mortgage practices, and other means. The US economy as a whole kept running with astronomical current account and fiscal deficits -- with borrowed money, that is. The collapse into recession was thus delayed no doubt, but at the same time and in the same measure the latter was made more inevitable and more intense. By the beginning of 2008, total debt in the US economy was touching 350 percent of GDP. The catastrophe had to strike, and did strike, first Wall Street and then Main Street, just as it did way back in 1929 and thereafter.

“The US will lose its status as the superpower of the world economic system. The world will become multipolar”, German finance minister Peer Steinbrück famously said when the “made in US” crisis began to invade Europe. More recently, he has discovered that “generally we have to admit that parts of Marx’s theory are not so bad”. Once again the crisis, even at this early stage, seems to be drumming dialectics -- not only of boom and slump, but also of the transient character of bourgeoisdom -- into the heads of the descendants of “the mushroom-upstarts of the new, holy Prusso-German empire” and of the arrogant international bourgeoisie in general.

(To be concluded)

1. Afterword to the second German edition of Capital Volume III

2. Increased organic composition of capital entails higher productivity of labour insofar as the same number of workers in the same time period “convert an ever-increasing quantity of raw and auxiliary materials into products thanks to the growing application of machinery and fixed capital in general."  (ibid, p 212) It should be noted that this also means greater intensity of exploitation, i.e., increased rate of surplus value.