[OPE] David McNally, "Global Instability and Challenges to the Dollar: Assessing theCurrent Financial Crisis"

From: glevy@pratt.edu
Date: Thu Jul 17 2008 - 11:52:44 EDT

New Socialist: WORLD ECONOMY: Assessing the Financial Crisis 

Global Instability and Challenges to the Dollar: 
Assessing the
Current Financial Crisis 

By David McNally 

We are
living through financial turmoil so serious at the moment that the
International Monetary Fund calls it ‚€œthe largest
financial crisis in the United States since the Great
Depression.‚€Ě Already, commercial banks have collapsed in both
Britain and Germany, as has the fifth-largest investment bank on Wall
Street. A series of hedge funds have gone under or are teetering on the
brink of ruin. It is a near certainty that more financial institutions
will fail before the crisis burns out. 

It is clear that the
Left needs serious analysis of just what is happening to world capitalism
at the moment. Too often, however, our assessments are stuck in the past,
revolving around debates as to whether or not this crisis represents a
repeat of 1929 and the Great Depression. 

Such debates detract
from the hard work of analysis that is needed. Ignoring the inherently
dynamic and historical nature of capitalist society and the continual
transformations this involves, they take one particular historical moment
in the history of capitalism as the norm against which all others will be
measured. The end result is a sterile exchange between, on the one hand,
those who assume that history tends to repeat itself and, on the other
side, those critics who so exaggerate what has changed (particularly the
ability of central banks to dampen tendencies to financial instability)
that they present a picture of a capitalism whose contradictions have been
effectively muted. 

The real challenge for Marxist analysis,
however, is to grasp both the changes and the enduring economic
contradictions within capitalism, in order to understand how capitalist
transformation displaces and reorganizes crisis tendencies without
eliminating them. 

In the absence of such analysis, much of the
radical commentary on offer tends to focus on the blatant deceit and
corruption of financial players who have contributed to the market
upheaval. This has its purposes. But it runs the risk of downplaying the
structural features of late capitalism that breed financial meltdowns
‚€“ and in so doing of suggesting that the Left should
focus on issues like financial regulation rather than class struggle
against capital. 

Trying to make sense of this crisis is one
important step toward developing both an analysis of late capitalism and
some of the tasks that confront the Left. To be sure, any assessment of
unfolding events will necessarily be partial and incomplete. Nonetheless,
it is possible to offer some crucial guidelines for making sense of this

A Banking Crisis, Not a Liquidity Crisis 

It is critical to recognize at the outset that, contrary to the claims
of central banks, this is not a liquidity crisis, i.e. financial turmoil
caused by insufficient supplies of money flowing through the financial
system. Instead, we are dealing with an insolvency crisis caused by the
fact that many financial institutions are effectively broke. The result is
a trauma in the banking sector. 

This trauma persists because a
myriad of lending institutions hold billions of dollars in massively
depreciated paper that nobody is interested in buying from them. There is
a host of exotic names for this paper ‚€“ Collaterallized
Debt Obligations (CDOs), Asset Backed Commercial Paper (ABCP) and so on
‚€“ but essentially it is an array of debt obligations,
or titles to payment of interest and principal on a vast array of loans.
Until the crisis broke, investors had been treating such paper as a stock
of assets that could at any time be sold, i.e. as liquid wealth. Yet, the
value of a debt rests in the first instance on the capacity of the
borrower to pay. If the borrower cannot pay, the alternative is for the
creditor to seize the asset. But if the asset itself is losing value, then
it may not cover the loan ‚€“ and there might not be
anyone out there who wants to buy it. In short, it may not be convertible
to cash. 

And that is precisely what is happening on a larger
and more complex scale today. Economic reality is demonstrating that much
of this paper ‚€“ tied in the first instance to tens of
millions of US mortgages ‚€“ is worth billions of dollars
less than what was paid for it. So, much of it is being written off or
written down (revalued at amounts that involve enormous losses). It is as
if you once had $1000 in the bank, against which you had borrowed many
times that amount (say, ten times that amount or $10,000), and you have
now learned that you only have $500. Once your creditors discover that,
they will scramble to collect in the knowledge that
there‚€™s no way you will ever pay off all that you owe.
But your $500 will be gone pretty fast. And since you owe $10,000, a lot
of your creditors won‚€™t be able to collect. And they
won‚€™t be able to sell off your debts to anyone else

Fictitious Capital in the Current Crisis 

To their holders debts, no matter what their exotic names, are forms of
fictitious capital, to use Marx‚€™s term. Rather than
consisting of actual assets ‚€“ such as machines,
equipment, factories, buildings or stocks of commodities
‚€“ that have been produced by past labour, fictitious
capitals are paper titles to future wealth. So, if I purchase
someone‚€™s mortgage, I have bought a claim to their
future mortgage payments. But this claim only becomes real when they have
met all the payments required. Until such time, my
‚€œcapital‚€Ě in the form of
someone‚€™s mortgage remains largely fictitious, or
unreal. Stocks, bonds and a whole host of complex financial instruments
all qualify as fictitious capitals, where money has been paid for future
returns that may or may not materialize. 

When capitalism is in
a boom or prosperity phase, capitalists rarely worry about the idea that
future returns might not materialize. Banks, corporations and investors
frenetically buy and sell paper claims to wealth, often with manic
get-rich-quick expectations. These are the moments when asset bubbles
develop, i.e. ridiculously inflated prices for things like shares of
dotcom companies or real estate in Tokyo or San Francisco. So
over-confident are investors about the solidity of their fictitious
capitals that they use them as means of payment between financial
institutions and investors as if they were hard cash. 
Bubbles burst,
however. And when they first start to lose air an investor panic sets in.
All of a sudden, those holding commercial paper realize it is not as good
as cash. Indeed, as its value plummets, buyers are hard to find and the
values of fictitious capitals start to collapse. At such moments,
institutions and individual investors begin panic selling. And they start
to call in their loans to other companies or investors. Over night, cash
and cash alone becomes king. 

‚€œA monetary
crisis,‚€Ě writes Marx, ‚€œoccurs only where
an ongoing chain of payments has been developed along with an artificial
system for settling them. Whenever there is a general disturbance . . .
money suddenly and immediately changes over from its merely nominal shape,
money of account, into hard cash…” [1] 

And at
such moments, capitalists start to trust only those who have great stacks
of cash in reserve. Those whose assets consist overwhelmingly of dubious
debt paper quickly find they are being abandoned. In such circumstances,
an institutional ‚€œrun on a bank‚€Ě can
occur, of the sort that rocked Bear Stearns in mid-March of 2008. In the
course of 48 hours, Bear‚€™s holdings of cash and liquid
assets plummeted from $17 billion to $2 billion as investors pulled their
funds from the bank. 

So, the root problem is not a lack of
liquidity in the system. It‚€™s that there are all kinds
of institutions out there that to whom nobody wants to lend, and whose
ostensible ‚€œassets‚€Ě nobody wants to buy.
Worse, none of the players in the system are entirely certain as to who is
holding increasingly worthless paper, or how much of it they have. As a
result, the flow of funds between banks and between banks and other
lenders (like mortgage companies) keeps seizing up. 

This is
the reason that injecting cash into the system does not restore
confidence. In fact, despite deep cuts to interest rates by central banks,
particularly the US Federal Reserve (designed to encourage borrowing) and
massive injections of money into the banking system, American banks have
continued to tighten lending to consumers, corporations and other banks
[2]. The loss of confidence in Bear Stearns thus took place for a
fundamental economic reason, not a simply psychological one:
Bear‚€™s actual assets, particularly those tied to real
estate loans, had been losing massive amounts of value for months. In
fact, in June of 2007 two of the bank‚€™s hedge funds,
which were deeply invested in sub-prime mortgages, effectively collapsed.

>From Housing Bubble to… 

And it is
there, in the housing sector, that we find a key link between the
financial crisis and material assets in the wider economy. For, central to
this crisis is the collapse of a manic bubble in US house prices. 

For a hundred years after 1895, as Dean Baker has noted, US house
prices increased at the rate of inflation. Then, as a result of
speculative mania in housing, from 1995 to 2007 they rose 70 per cent more
than the cost of everything else. That created an extra $8 trillion in
paper wealth for US homeowners. And, with that ostensible wealth in their
sights, American consumers ran to the stores, often after taking out loans
against the increased value of their homes. At the same time, banks
started to loosen up mortgage lending, often far beyond the real capacity
of borrowers to pay, and then turned around and sold the debt to all kinds
of investors. As a result, huge amounts of fictitious capital from the US
mortgage sector built up throughout the financial system. 

bubble started to burst last summer, with a rise in the number of mortgage
holders in default. Many of the mortgages that US buyers had taken out
were designed with very low payments in the first year or two. But as they
‚€œreset‚€Ě at higher levels, large numbers of
borrowers could not keep up. And it just kept getting worse. US housing
prices dropped about 13 per cent last year, and have continued tumbling
this year. As the houses on which they have taken mortgages fall in value,
the cost of buying them has risen for millions of Americans. Huge numbers
are just putting the keys in the mail and sending them back to the
mortgage lender. Others, unable to make payments, are suffering
foreclosure. In March of this year, foreclosures jumped 57 per cent in the
US, while house repossessions by banks more than doubled compared to a
year earlier. In May, despite claims that the worst was over, foreclosures
rose another 48 percent over a year earlier [3]. Many analysts now expect
US house prices to decline by another 10 to 20 per cent over the next
year. Some believe prices will fall for the next five years. 

Meanwhile, the meltdown in the value of their paper assets is calamitous
for those who bought those mortgages ‚€“ through a
variety of schemes known as mortgage-backed securities. The borrowers
cannot pay and the underlying assets are in freefall. The fictitious
character of their assets has been thrown into sharp relief. Buyers for
these toxic debts cannot be found, unless it is at staggering low prices.

This is why the asset-backed commercial paper (ACPB) market
has been frozen in Canada for the last six months. And now the same thing
has happened to the $300 billion auction rate note market in the US. There
are simply no buyers of these ‚€œassets‚€Ě to
be found. 

Yet housing is just part of the problem. Equally
dubious junk is now turning up in commercial paper tied to credit card
loans, commercial (not just residential) real estate, auction rate notes,
leveraged buyout loans and much more. Indeed, growing numbers of analysts
are also raising warnings about corporate debt [4]. 

surprisingly, estimates of the total damage of the crisis to the financial
system keep rising. Initial predictions had the figure between $50 and
$100 billion. Then as bank after bank wrote off billions more, estimates
in the range of $400 billion and even $600 billion emerged. In April, the
International Monetary Fund calculated that the meltdown will result in
losses of nearly $1 trillion. One analyst writing in the Wall Street
Journal suggests the global damage will hit $1.4 trillion. 

Whatever the ultimate figure ‚€“ and it is likely to be
at the higher end of the predictions ‚€“ it represents a
very large hit for the system. It also means that there are huge losses
still to be recorded before the financial system recovers. Nouriel
Roubini, among that very small minority of economists who saw the
sub-prime meltdown coming and one of the few who have consistently warned
that its consequences would be extremely serious, has argued that
‚€œthe worst is still to come‚€Ě for the US
and global economies. Indeed, in May of this year the number of companies
at risk of receiving a credit rating downgrade ‚€“ i.e.
as being more financially precarious than before ‚€“ rose
to record levels, indicating that much more turmoil lies ahead [5]. 

Global Slowdown 

Just how deep and prolonged the
slowdown in the global economy will be remains to be seen. But in recent
years as much as half of all US economic growth has been housing-driven.
Borrowing against rising home values, American consumers fed the engine of
the world economy, particularly in their enormous purchases of
manufactured goods from around the world. During this round of
credit-driven growth, US household debt more than doubled, increasing from
$6.4 trillion in 1999 $13.8 trillion in 2006. 

Between 1980 and
2000 US imports increased 40 per cent, accounting for 19 per cent of world
imports and roughly four per cent of world GDP. Now, as the housing bubble
bursts, as consumers hold off on big purchases and try to pay down debt,
world exports to the US will decline, and global growth will taper off. In
fact, imports into the US dropped by over $6 billion in March, a clear
sign that the global slowdown is spreading. Moreover, even a modest move
by US consumers to rebuild their savings will knock about 1.5 per cent off
US economic growth per annum. And with US consumer confidence now at a 28
year low, it is clear that consumption spending in the US will no longer
be driving global growth. 

Across the US, construction
spending, industrial production, private employment and manufacturing
output are all falling. The US economy is clearly in recession. It remains
to be seen just how significant the accompanying global slowdown will be.

The Dollar, World Money and the Current Crisis 

Alongside the turmoil in financial markets, the current crisis also
poses major challenges to the US dollar as the dominant form of world
money today. 

World money is necessary to the measuring and
allocating of value ‚€“ prices, profits, wages, etc.
‚€“ within and between regions and nations. It is also
essential as a store of value, as a stable asset in which wealth can be
stored. In order to do this efficiently, global money must be effectively
‚€œas good as gold‚€Ě ‚€“
something that everyone will accept because it is a stable and universally
recognized means of payment. This is what it means for money to play the
role of a genuinely universal equivalent. 

For most of the
history of capitalism, gold anchored the system of world money, either
through an actual gold standard (in which international payments were made
in gold) or a gold convertibility standard, under which the leading
currency could be converted into gold by the world‚€™s
central banks. 

Since 1971, however, when US President Nixon
broke the dollar‚€™s tie to gold, the US dollar has
operated as inconvertible world money. This has produced two tendencies:
first, a significant long-term decline in the value of the dollar relative
to other major currencies; and, secondly, a new volatility in world
currency markets, as investors try to avoid holding on to currencies whose
value may plummet. In fact, much of the proliferation of those complex
financial instruments called derivatives is a product of the new
instabilities in prices, currencies and profits that monetary instability
creates. But in the absence of any other viable candidates for world money
status, the dollar continued its reign. 

Indeed, throughout the
last decade or more, the status of the dollar seemed to be rising. Despite
huge deficits in the US current account ‚€“ the balance
between what economic actors based in the US owe the rest of the world and
what the rest of the world owes these US actors ‚€“ the
dollar kept riding high. This led some pundits to argue that current
account deficits (i.e. debts to the rest of the world) are irrelevant
where the dominant imperial power is concerned. Even as the US economy
started to run deficits of $500 billion per year and more with the rest of
the world ‚€“ deficits that are essentially paid for by
printing and shipping off dollars ‚€“ these commentators
insisted that there would be no meaningful consequences for the economy of
the United States. 

The reality is much more complex. It is
true that the world money-issuing state can get away with deficits that
would not be tolerated in the case of any other nation-state. But it is
not true that it can do so infinitely. Sooner or later, as more and more
of the currency floods into world markets to cover these deficits, a point
must be reached at which some of those holding dollars become tempted to
unload them in favour of other currencies or assets. And at that point, an
inevitable decline in the dollar‚€™s value would set in,
increasing the pressure on others to dump it as a depreciating financial

Flight from the Dollar? 

In fact, precisely
this process has been underway for some time now. Beginning in 2001,
private investors began to dump dollars. As a result, the greenback has
lost 40 per cent of its value relative to other currencies since 2002. And
the decline would have been much worse were it not for the fact that
central banks in Asia, particularly China and Japan, stepped into the
breach and invested massively in the US. 

These Asian central
banks have been effectively returning to the US the dollars it ships
overseas to pay for its current account deficit. (This is done by making
foreign investments in the US, be it in US treasury bills or the stocks of
banks and corporations.) Some commentators have held that this process
could continue for decades, dubbing it ‚€œBretton Woods
II,‚€Ě after the original Bretton Woods agreement that created
the post-World War 2 dollar-gold regime. 

But there have always
been three inherent flaws in this arrangement. First, this massive
recycling of dollars back to the US only fuels speculative bubbles, as US
financial institutions try to make profits by finding borrowers for this
money, be it investors in dotcom stocks, or low income home buyers. Yet,
when these bubbles burst, as has the most recent one in housing, it makes
the US national economy a less attractive place for investment (since
investments have become highly risky and unprofitable). Secondly, as the
Federal Reserve lowers interest rates to prevent the bursting bubble from
becoming a full-fledged crisis (as it has been doing in recent months), it
makes dollar-denominated assets less and less attractive, since higher
interest rates are available elsewhere. Finally, as low US interest rates
provoke a flight from the dollar, investors holding the US buck have a
greater and greater incentive to get out of it. 

And even
foreign central banks are doing so, albeit incrementally, under the byword
of ‚€œdiversifying‚€Ě their holdings
‚€“ i.e. reducing the percentage of international
reserves they keep in dollars. In recent years, China, Russia and South
Korea have all reduced the proportion of international reserves they hold
in dollars. Russia, for instance, has gone from 30 per cent to 50 per cent
of its reserves in currencies other than the dollar. More recently, a
number of Middle East oil-exporting states have done the same. So worried
are US officials by these moves that, when the United Arab Emirates was
musing about dropping its currency peg to the dollar, US officials visited
the UAE central bank governor to lobby against the move. 

does the US government care about countries reducing their dollar
holdings? Put simply, the ability to print dollars to pay debts is a huge
imperial privilege. It is, in the words of the Economist magazine, as if
you could ‚€œwrite cheques that were accepted as payment
but never cashed‚€Ě [6]. This privilege, known as seigniorage,
allows the state that issues world money to appropriate a disproportionate
share of global value and surplus value just by virtue of its role in the
world monetary system. This has allowed the US great flexibility in
financing imperial wars and it has provided an enormous boost to the US
national economy, which has paid for goods with paper. 

But now
private investors and central banks are becoming increasingly reticent
about taking ever-growing amounts of these blank cheques. Furthermore, for
the fist time in several generations they now have a meaningful
alternative to the dollar: the euro. And many signs indicate that the euro
is starting to play a larger world money role. 

When it was
first introduced in 1999, for instance, the euro comprised 18 per cent of
all global reserves. Today it represents 25 per cent of international
reserves. As a means of payment for cross-border operations, the euro now
figures in 39 per cent of all such transactions, versus 43 per cent for
the dollar. And in international bond markets, 49 per cent of all debt was
denominated in euros in 2006, compared to 37 per cent for the dollar. 

None of this is meant to suggest that the euro will simply
displace the dollar. The European Union economy is not large and dynamic
enough for that to happen and the dollar is still the
world‚€™s dominant currency by a considerable measure.
But these trends do suggest that the dollar‚€™s role is
diminishing now that there is a viable alternative. With this in mind,
Deutsche Bank predicts that the euro will constitute between 30 and 40 per
cent of world reserves by 2010. 

What these developments
indicate is a genuine contradiction between regionally based accumulation
projects. Capitals based primarily in Europe are using the European Union
and its central bank to strengthen their global standing relative to
American-based capitals. To be sure, capitals share convergent interests.
But they are equally divided by divergent ones. Indeed, one of the keys to
understanding the patterns of regional rivalry in the age of the new
imperialism is to grasp the complex ways in which convergence and
divergence of interests interact. The long-term conflict between the
world-money capacities of the euro and the dollar figures centrally here.
Without a doubt, this is not the territorially-based rivalry that was at
the core of early 20th century competition among imperialist powers. But
it does nevertheless involve new patterns of competition between regional
political-economic projects for the appropriation of larger shares of
world value. 

And at the moment, the capacities of the American
state look to be constrained by a declining global appetite for the dollar
among investors. In 2007, for instance foreign residents borrowed $596
billion in long-term stocks and bonds in the US, down from $722 billion
the year before [7]. This relative decline in the appetite for the dollar
poses a real dilemma for the US state. In order to prop up the dollar, and
retain the seigniorage privileges that boost its national economy and
underwrite the financing of imperial militarism, it would have to raise US
interest rates. But interest rate hikes would deepen the recession in the
US (making it harder to borrow and pushing many indebted Americans into
bankruptcy and default), and they might topple more indebted corporations
and banks. 

For the moment, the US state has chosen to try to
offset the recession by keeping interest rates low. But this only
depresses the value of the dollar and weakens its world money status. And
this gives the US state less financial means to maneuver on the world
stage. As a result, the chairman of the Federal Reserve Bank, Ben Bernanke
has taken to talking up the dollar, though so far to mixed results [8].

And so, the US state confronts a dilemma: to prevent a deep
slump it must pursue policies that weaken the world standing of the
dollar. In the medium to longer term, however, a diminished dollar will
create tighter constraints on the financial capacities of US imperial
operations. This is a real and abiding contradiction and the US state is
not able to wish it away. 

Persistent Contradictions 

If the current financial crisis illustrates anything, then, it is the
persistence of fundamental contradictions of neoliberal capitalism. With
an enormous ‚€œdollar overhang‚€Ě sloughing
through the world economy, asset bubbles regularly form
‚€“ in Japanese real estate, in East Asian stock markets,
in dot-com, or in US real estate. And each time, central banks intervene
to monetize debt obligations, i.e. to give legal tender for junk. And the
end result is to flood the financial system with money that will flow into
yet another speculative bubble, as seems to be happening at the moment in
commodities such as oil, gold and foodstuffs. Meanwhile, global dollar
surpluses will continue to exert downward pressure on the value of the

Thus far the US Federal Reserve has offered up $500
billion in US treasury bonds, effectively as good as cash, for junk on the
books of banks and investment houses. The Bank of England is proceeding
along the same lines. 

But as they flood the system with money,
these central banks also prime the pump of their nemesis
‚€“ inflation. This has prompted the International
Monetary Fund to issue a stern warning about rising inflation. As soon as
central banks think they have stabilized the financial system, they are
likely to heed the warning by turning to anti-inflation policies that will
trigger corporate bankruptcies, job losses and declining living standards.
Already the European Central Bank has indicated that fighting inflation is
its priority and the Bank of Canada surprised observers by failing to
lower interest rates in June 2008, citing worries about inflation. 

Of course, capitalist classes the world over will try to make sure
that working classes and the global poor bear the brunt of the
inflationary hardship. And the weakness of the international left is not
promising in this regard, despite important and inspiring movements of
resistance, particularly in much of Latin America. 

Too often,
however, sections of the Left imagine that their role is to offer policies
that will avert crises of capitalism. In so doing, they gravitate to a
kind of Keynesian politics designed to boost demand and consumption. 

It is not the job of the Left to save capitalism from itself,
however. To be sure, we have an obligation to advocate and agitate for
policies to protect the victims of the crisis, policies that cut against
the very market logic of neoliberalism. A case in point would be campaigns
for publicly-funded social housing programs at a time when, in the US,
millions face foreclosure. Equally important are campaigns to raise social
assistance rates in order to protect the most vulnerable. 

equally vital is a Left that names the actual contradictions of
capitalism, one that addresses the disasters of the neoliberal model and
publicizes the inherent conflict between capital accumulation and the
satisfaction of human needs. And this requires a Left that speaks openly
of socialism as the alternative. 

We now confront a significant
crisis of the neoliberal reorganization of capitalism. And every crisis
represents an opportunity ‚€“ for both the old order and
the forces of the new. The Marxist Left is not especially well-equipped in
this regard. But we must do what we can so that the forces of authentic
change are better prepared when the next crisis breaks, as surely it will.
To this end, it is incumbent on us to seek to understand this crisis, to
agitate to protect its poorest victims, and to do the patient work of
socialist education about real alternatives to the logic of the market.


1. Karl Marx, Capital, v. 1, trans Ben
Fowkes (Harmondsworth: Penguin Books, 1976), p. 236. 

2. See
Financial Times, May 6, 2008, and Tony Jackson, ‚€œLack
of trust lurks at the heart f banking troubles,‚€Ě Financial
Times, June 2, 2008. 

3. ‚€œU.S. Foreclosures
surge 48% in a year,‚€Ě Toronto Star, June 14, 2008. 

4. Sean Farrell, ‚€œThe next banking
crisis?‚€Ě _ The Independent_, June 3, 2008. 

Elena Moya, ‚€œCredit woes set May record,‚€Ě
Reuters, June 7, 2008 

6. ‚€œThe disappearing
dollar,‚€Ě The Economist, December 5, 2004. 

7. Wall
Street Journal, June 15, 2008 

8. Barrie McKenna,
‚€œBernanke endorses strong dollar,‚€Ě Globe
and Mail, June 4, 2008. 

David McNally is a regular contributor
to New Socialist. An earlier and shorter version of this article appeared
in Relay. A Korean translation will appear in the journal Marxism 21. 

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