The global financial crisis

In the new financial environment that has emerged as a result of the collapse of the Bretton Woods system of fixed exchange rates, and policies of financial deregulation, speculation rather than productive economic enterprise is the dominant activity. The world community must recognise the failure of this system which threatens to plunge the world into a global economic depression and adopt instead a coherent structure of financial regulations and inter-governmental cooperation.

by Michel Chossudovsky

BLACK Monday 19 October 1987 will be remembered as the largest one-day drop in the history of the New York Stock Exchange (NYSE) overshooting the collapse of 28 October 1929, which prompted the Wall Street crash and the beginning of the Great Depression. In the 1987 meltdown, 22.6% of the value of US stocks was wiped out largely during the first hour of trading on Monday morning... The plunge on Wall Street sent a 'cold shiver' through the entire financial system leading to the tumble of the European and Asian stock markets...

Almost 10 years later on Friday 15 August 1997, Wall Street experienced its largest one-day decline since 1987. The Dow Jones plummeted by 247 points. The symptoms were similar to those of Black Monday: 'institutional speculators' sold large amounts of stock with the goal of repurchasing them later but with the immediate impact of provoking a plunge in prices. Futures' and options' trading played a key role in precipitating the collapse of market values.

The tumble on 15 August 1997 immediately spilled over onto the world's stock markets triggering substantial losses on the Frankfurt, Paris, Hong Kong and Tokyo exchanges. Various 'speculative instruments' in the equity and foreign exchange markets were used with a view to manipulating price movements.

In the weeks that followed, stocks continued to trade nervously. Wide speculative movements were recorded on Wall Street; billions of dollars were transacted through the NYSE's Superdot electronic order-routing system with the Dow swinging spuriously up and down in a matter of minutes. The Asian equity and currency markets declined steeply under the brunt of speculative trading. In a three-week period the (Hong Kong) Hang Seng Index had declined by 15%. The Japanese bond market had plunged to an all-time low. In turn, billions of dollars of central bank reserves had been appropriated by institutional speculators.

Business forecasters and academic economists alike have casually disregarded the dangers alluding to 'strong economic fundamentals'; G7 leaders are afraid to say anything or act in a way which might give the 'wrong signals'... Wall Street analysts continue to bungle on issues of 'market correction' with little understanding of the broader economic picture.

In turn, public opinion is bombarded in the media with glowing images of global growth and prosperity. The economy is said to be booming under the impetus of the free market reforms. Without debate or discussion, so-called 'sound macro-economic policies' (meaning the gamut of budgetary austerity, deregulation, downsizing and privatisation) are heralded as the key to economic success.

The realities are concealed, economic statistics are manipulated, economic concepts are turned upside down. Unemployment in the US is said to be falling yet the number of people on low-wage part-time jobs has spiralled. The stock market frenzy has taken place against a background of global economic decline and social dislocation.

A new financial environment

A new global financial environment has unfolded in several stages since the collapse of the Bretton Woods system of fixed exchange rates in 1971. The debt crisis of the early 1980s (broadly coinciding with the Reagan-Thatcher era) unleashed a wave of corporate mergers, buy-outs and bankruptcies. These changes have in turn paved the way for the consolidation of a new generation of financiers clustered around the merchant banks, the institutional investors, stock brokerage firms, large insurance companies, etc. In the process, commercial banking functions have coalesced with those of the investment banks, stock brokers and currency dealers.

The 1987 crash served to exacerbate these changes by 'clearing the decks' so that only the 'fittest' survive. A massive concentration of financial power has taken place in the last 10 years: from these transformations, the 'institutional speculator' has emerged as a powerful actor overshadowing and often undermining bona fide business interests. Using a variety of instruments, these institutional actors appropriate wealth from the real economy. They often dictate the fate of companies listed on the NYSE. Totally removed from entrepreneurial functions in the real economy, they have the power of precipitating large industrial corporations in bankruptcy.

Their activities include speculative transactions in commodity futures, stock options and the manipulation of currency markets including the plunder of central banks' foreign exchange reserves (eg. Thailand, Indonesia, Malaysia and the Philippines in July-September 1997). They are also routinely involved in 'hot money deposits' in the emerging markets of Latin America and South-East Asia, not to mention money laundering in the many offshore banking havens. The daily turnover of foreign exchange transactions is more than $1 trillion a day of which only 15% corresponds to actual commodity trade and capital flows.

Within this global financial web, money transits at high speed from one banking haven to the next, in the intangible form of electronic transfers. 'Legal' and 'illegal' business activities have become increasingly intertwined. Favoured by financial deregulation, the criminal mafias have also expanded their role in the spheres of merchant banking.

The concentration of wealth

This restructuring of global financial markets and institutions has enabled the accumulation of vast amounts of private wealth,a large portion of which has been amassed as a result of strictly speculative transactions. No need to produce commodities: enrichment is increasingly taking place outside the real economy divorced from bona fide productive and commercial activities. In turn, part of the money accumulated from speculative transactions is funnelled towards the offshore banking havens. This critical drain of billions of dollars in capital flight dramatically reduces state tax revenues, paralyses social programmes, drives up budget deficits, and spurs the accumulation of large public debts.

In contrast, the earnings of the direct producers of goods and services are compressed; the standard of living of large sectors of the world population including the middle classes has tumbled. Wage inequality has risen in the OECD countries. In both the developing and developed countries, poverty has become rampant; according to the ILO, worldwide unemployment affects more than 800 million people. The accumulation of financial wealth feeds on poverty and low wages.

The post-1987 period is marked by economic stagnation. In the OECD countries, GDP growth has fallen from 3.1% per annum in the 1980s to a meagre 1.7% in the 1990s. In the developing world, economic decline exceeds that experienced in the USA during the Great Slump of the 1930s: many countries in Sub-Saharan Africa and Latin America have experienced negative economic growth rates. The figures on GDP, however, do not reflect the seriousness of the slide in production living standards around the world.

Replicating the policy failures of the late 1920s

Wall Street was swerving dangerously in volatile trading in the months which preceded the crash of 28 October 1929. Laissez faire under the Coolidge and Hoover administrations was the order of the day: in early 1929 the Federal Reserve Board declared that it 'neither assumes the right nor has it any disposition to set itself up as an arbiter of security speculation or values'.

The economics establishment largely upheld this verdict. The possibility of a financial meltdown had never been seriously contemplated. Professor Irving Fisher of Yale University stated authoritatively in 1928 that 'nothing resembling a crash can occur'. In 1929, a few months before the crash, he affirmed that'there maybe a recession in the price of stocks but nothing in the nature of a catastrophe'. (quoted in Michel Beaud, 'A History of Capitalism', Monthly Review Press, New York, 1983, p. 158). The illusion of economic prosperity persisted: optimistic business predictions prevailed even after the collapse of the New York Stock Exchange. In 1930, Irving Fisher stated confidently that 'for the immediate future, at least, the perspective is brilliant'. According to the prestigious Harvard Economic Society: 'manufacturing activity [in 1930]... was definitely on the road to recovery' (quoted in John Kenneth Galbraith, The Great Crash, 1929, Penguin, London).

Mainstream economics upholds financial deregulation

The same complacency prevails today as during the frenzy of the late 1920s: 'The [1987] crash had left many people wondering what happened, why it happened and what can be done to prevent it from happening again.' The broad economic causes of the crisis are not addressed. Echoing almost verbatim the economic slogans of Irving Fisher, today's economic orthodoxy not only refutes the existence of an economic recession, it also denies outright the possibility of a financial meltdown: 'Happy days are here again ...a wonderful opportunity for sustained and increasingly global economic growth is waiting to be seized...' ('Let Good Times Roll', Financial Times, 'editorial commenting the OECD economic forecasts', 1 January 1995). According to Nobel Laureate Robert Lucas of Chicago University, the decisions of economic agents are based on so-called 'rational expectations', ruling out the possibility of systematic errors which might lead the stock market in the wrong direction...

In the aftermath of the 1987 stock market crisis, the regulatory policy issues were never resolved. According to the various commissions set up by the US Congress, the White House and the New York and Chicago exchanges, the 1987 crash had been triggered by specific events leading to 'reactive responses' by major financial players including institutional traders and dealers in mutual funds. No other reason was given. 'Sound macro-economic policies' combined with financial deregulation were the irrevocable answers. The term 'speculation' does not appear in Wall Street's financial glossary.

A presidential task-force had been formed under the chairmanship of Nicholas Brady (later to become Treasury Secretary in the Bush Administration). The institutional speculators overshadowing bona fide corporate interests, represented a powerful lobby capable of influencing the scope and direction of regulatory policy. The task-force took on a detached attitude pointing to the 'adequacy' of existing regulations.

In the aftermath of the 1987 crisis, the policy errors of the 1920s were repeated. Government should not intervene; the New York and Chicago exchanges were invited to fine-tune their own regulatory procedures which largely consisted in 'freezing' computerised programme trading once the Dow Jones falls by more than 50 points.('Five Years On, the Crash Still Echoes', Financial Times, 19 October 1992). These so-called 'circuit-breakers' have proven to be totally ineffective in averting a meltdown.

Recent experience amply demonstrates that the Dow Jones can swing back and forth by more than 50 points in a matter of minutes facilitated by the NYSE's Superdot electronic order-routing system. Superdot can now handle (without queuing) more than 300,000 orders per day (an average of 375 orders per second) representing a daily capacity of more than two billion shares. While its speed and volume have increased tenfold since 1987, the risks of financial instability are significantly greater. Federal Reserve Board Chairman Alan Greenspan admits that: '[while technological advances have enhanced the potential for reducing transaction costs (...), in some respects they have increased the potential for more rapid and widespread disruption' (BIS Review, no. 46, 1997).

Moreover, in contrast to the 1920s, major exchanges around the world are interconnected through instant computer link-up: volatile trading on Wall Street 'spills over' into the European and Asian stock markets thereby rapidly permeating the entire financial system, including foreign exchange and commodity markets, not to mention the markets for public debt... The demise of national currencies under periodic attack by institutional speculators will inevitably backlash on the trillion-dollar Euro and Brady bond markets.

The fate of national economies

Under the brunt of an impending balance-of-payments crisis, several of the largest debtor countries in Latin America, South-East Asia and Eastern Europe are facing the same predicament as Mexico. Following the Mexican 1994-95 crash, the IMF Managing Director Mr Michel Camdessus intimated that ten other indebted countries could meet the same fate as Mexico requiring the application of potent doses of economic medicine: 'we will therefore introduce still stronger surveillance to be sure that the convalescence goes well...' (quoted in David Duchan and Peter Norman, 'IMF Urges Close Watch on Weaker Economies', Financial Times, London, 8 February 1995, p. 1). However, by crippling national economies and requiring governments to deregulate, the IMF's 'economic therapy' prevents the possibility of a 'soft landing'. 'IMF surveillance' of debtor countries' macro-economic policy tends to further heighten the risks of financial meltdown.

The present economic crisis is far more complex than that of the interwar period. Because national economies are interlocked in a system of global trade and investment, its impact is potentially far more devastating. The technological revolution (combined with delocation and corporate restructuring) has dramatically lowered the costs of production while at the same time impoverishing millions of people.

Macro-economic policies are internationalised: the same austerity measures are applied all over the world. In turn, large corporations have the power to move entire branches of industry from one country to another. Factories are closed down in the developed countries and production is transferred to the Third World where workers are often paid less than a dollar a day.

The social consequences and geo-political implications of the economic crisis are far-reaching particularly in the uncertain aftermath of the Cold War. In the developing world and in the former Soviet bloc, entire countries have been destabilised as a consequence of the collapse of national currencies often resulting in the outbreak of social strife, ethnic conflicts and civil war.... In the former Soviet Union as a whole, industrial output has plummeted by 48.8% and GDP by 44.0% over the 1989-95 period (Official data compiled by the United Nations Economic Commission for Europe). In some cases, wages have fallen to less than $10 a month; in Bulgaria, old-age pensioners receive $2 a month.

Budget austerity, plant closures, deregulation and trade liberalisation have contributed to precipitating entire national economies into poverty and stagnation. In turn, the evolution of financial markets has reached a dangerous cross-roads. The massive trade in derivatives undermines the conduct of monetary policy in both the developing and developed countries.

Dangerous cross-roads

The speculative surge of stock values is totally at variance with the movement of the real economy. Stock markets 'cannot lead their own life' indefinitely. Business confidence cannot be 'sustained by recession'. The price-to-earnings ratio (P/E) on the S&P 500 has risen dangerously to 25.8, well above the P/E level of 22.4 prevailing in the months prior to the October 1987 crash.

In many regards, the stock market frenzy is analogous to the Albanian 'ponzi' pyramid schemes. People who have invested their private savings will 'get rich' while the market rises and as long as they leave their money in the stock market. As soon as financial markets crumble, life-long savings in stocks, mutual funds, pension and insurance funds are wiped out. More than 40% of the American adult population has investments in the stock market. A financial melt-down would lead to massive loan default sending a cold shiver through the entire banking system; it would also result in bank failures as well as a tumble of pension and retirement savings funds.

Financial disarmament

Market forces left to their own devices lead to financial upheaval. Close scrutiny of the role of major speculative instruments (including option trading, short sales, non-trading derivatives, hedge funds, non-deliverable currency transactions, programme trading, index futures, etc.) should be undertaken.

A report published by the Bundesbank had already warned in 1993 that trade in derivatives could potentially 'trigger chain reactions and endanger the financial system as a whole' (Martin Khor, 'Baring and the Search for a Rogue Culprit', Third World Economics, no. 108, 1-15 March 1995, p. 10). Regulation cannot be limited to the disclosure and reporting of trade in derivatives as recommended by the Bank for International Settlements (BIS); concrete measures applied globally and agreed by governments of both developed and developing countries are required to prohibit the use of specific speculative instruments.

The risks associated with the electronic order-routing systems should also be the subject of careful examination. Alan Greenspan, Chairman of the Federal Reserve Board, admits that 'the efficiency of global financial markets, has the capability of transmitting mistakes at a far faster pace throughout the financial system in ways which were unknown a generation ago...'(BIS Review, no. 46, 1997).

It is essential that the world community acknowledge an increasingly dangerous situation and adopt without delay a coherent structure of financial regulation (and inter-governmental cooperation).

This is a broad and complex political issue requiring substantial changes in the balance of political power within national societies. Those in the seat of political authority often have a vested interest in upholding dominant financial interests. At the June 1997 Denver Summit, G7 leaders in a muddled and confusing statement called for 'stronger risk management', 'improved transparency' and 'strong prudential standards'. The destabilising role of speculative activity on major bourses was never mentioned. In contrast, the G7 statements by political leaders profusely heralding the benefits of the free market have generated an atmosphere of deceit and economic falsehood. 'Business confidence' has been artificially boosted by G7 rhetoric largely to the advantage of the institutional speculator.

A form of 'financial disarmament' is required directed towards curbing the tide of speculative activity. (The term 'financial disarmament' was coined by the Ecumenical Coalition for Social Justice; see 'The Power of Global Finance', Third World Resurgence, No. 56, March 1995, p.21.) In turn, 'financial disarmament' would require dismantling the entire structure of offshore banking including the movement of dirty and black money.

The global economic system is affected not only by the forces of recession and financial restructuring but also by complex social, political and strategic factors. The evolution of international institutions (including the World Trade Organisation and the Bretton Woods twins) is also crucial inasmuch as these international bodies play an important role in overseeing and regulating macro-economic and trade policies invariably to the detriment of national societies.

The world community should recognise the failure of the dominant neoliberal system inherited from the Reagan-Thatcher era. Slashing budgets combined with lay-offs, corporate downsizing and deregulation cannot constitute 'the key to economic success'. These measures demobilise human resources and physical capital; they trigger bankruptcies and create mass unemployment. Ultimately, they stifle the growth of consumer spending: 'recession cannot be a solution to recession'.

Regulating the stock market per se is a necessary but not a sufficient condition. Financial markets will not survive under conditions of global economic depression. An expanding real economy will not occur unless there is a major revamping of economic institutions and a rethinking of macro-economic reform...

There are, however, no 'technical solutions' to this crisis. Meaningful reforms are not likely to be implemented without an enduring social struggle. What is at stake is the massive concentration of financial wealth and the command over real resources by a social minority. The latter also controls the 'creation of money' within the international banking system.

The first crucial stage of this worldwide struggle is to break the legitimacy of the neoliberal agenda as well as disarm the so-called 'Washington consensus'. The latter is endorsed by national governments around the world. In other words, 'financial disarmament' is not tantamount to State 'regulation' narrowly defined, it requires democratic forms of 'social control' of financial markets as well as radical changes in the structures of political power.

Social action cannot limit itself to the mere indictment of national governments and of the Washington-based bureaucracy. Banks, transnational corporations, currency speculators, etc. must be pinpointed. This struggle must be broad-based and democratic encompassing all sectors of society at all levels, in all countries. Social movements and people's organisations acting in solidarity at national and international levels, must target not only their respective governments but also the various financial actors which feed upon this destructive economic model. (TWR No. 86, October 1997)

The writer is Professor of Economics at the University of Ottawa and has written widely on issues of international finance and macro-economic reform. He is the author of The Globalization of Poverty, Impacts of IMF and World Bank Reforms, Third World Network, Penang and Zed Books, London, 1997.

Copyright by Michel Chossudovsky, Ottawa 1997. All rights reserved.

The author can be contacted at, fax: 1-613-7892050.