November 26 , 2010

Does the World Financial Crisis Portend Systemic Shift?

 

Considering the panoply of crucial world financial institutions and major industrial powers and their common interest in buttressing the existing system of market economy, no major shift in the basic capitalist philosophy is indicated, although regulatory adjustments in its operation have become inevitable. Also, there is no potential alternative and no challenging ideology to the existing system. Capitalism and market economy may have several inherent flaws, as borne out by the crises in the past couple of decades and the recent upheaval that is next only to the Great Depression of the early 1930s, yet in the foreseeable future they are likely to keep on driving the world economy.

The system is based essentially on two great works published almost simultaneously in 1776: ‘The Declaration of Independence’, authored by Thomas Jefferson, and ‘The Wealth of Nations’ by Adam Smith. Both underline the significance and wisdom of individual liberty and extol the importance of personal responsibility. Adam Smith foresaw the ill-effects of his precept of laissez faire (non-interference by government in the operation of market economy) leading to the accumulation of too much wealth and therefore power into the hands of a few and expressed confidence that ‘an invisible hand’ will cause the wealthy to use their assets for the welfare of all sections of society. While Bill Gates and Warren Buffet, the two wealthiest persons, have indeed institutionalized the utilization of a good portion of their enormous wealth for various humanitarian causes, bulk of the stock market barons, lending institutions and investors succumbed to their greed to keep feathering their own nests particularly as the regulatory laws remained suspended. Hence, the lingering global crisis: an economic crisis on the heels of a financial crisis.

The present world financial system is based on the decisions taken at the conference in 1944 of world leaders at Bretton Woods, a picturesque mountain resort in New Hampshire. The most influential thinker at this conference was Lord Maynard Keynes, leader of the British delegation and Chairman of the World Bank Commission. He had already made his mark as an outstanding economist. His magnum opus ‘The General Theory of Employment, Income and Money’ published in 1936 is now generally accepted as the foundation of modern macroeconomics.

He offered the theory that the total income in a society is defined by the sum of consumption and investment and one can enhance employment and total income by first increasing expenditures for either consumption or investment.

It was his influence over Presidents Herbert Hoover and Fredrick Roosevelt that had led to the New Deal launched in 1938. Also, he played a significant role in the birth of the International Monetary Fund (IMF) and the World Bank.

The market economy system was augmented years later, in 1993, with the formation of the World Trade Organization (WTO) that regulates the world trade and has already succeeded largely in bringing down customs barriers and ensuing the globalization of world economy. This marked the culmination of the process of laissez faire that had started in late eighteenth century during the scramble for markets for European manufactures.

A decade back, Dr. Henry Kissinger had warned: “Free-market capitalism remains the most effective instrument for economic growth and for raising the standard of living of most people. But, just as reckless laissez faire of the 19 th century spawned Marxism, so the indiscriminate globalism of the 1990s may generate a worldwide assault on the very concept of free financial markets”.

The current world financial and economic crisis might mark the beginning of such a process.

What we have witnessed recently is an implosion of the system owing to the excessive and unfettered greed of the operators of the financial markets interlinked through the facilities of globalization. The distortions that have already set in have inspired demands for a review by the international community of the Bretton Woods institutions, the WTO and the virtually unregulated system of credit and investment. The French President, who is convinced that laissez faire has come to an end with the onset of the current currency crisis, is among the world leaders who have given the call for a global summit.

The US government’s rescue operations through purchase of depressed financial instruments are being viewed by the excessively conservative sectors of the society, including some extremist Republican congressmen, as a resort to socialist intervention in the operation of market economy. One Congressman called it “the slippery slope to socialism”; another labeled it as “un-American” and a “financial socialism”. Far from that, the government injection of funds in cash-starved institutions is to provide them with temporary crutches so that they could stand on their own feet. It is thus to reinforce the system, as it would foster rapid growth in money supply that encourages spending and restores customer confidence.

A contraction in US spending triggers a chain reaction affecting markets in the rest of the world, inasmuch as 25% of the enormous US consumption is served by imports. For instance, 35% of Chinese exports are to the US, and 50% of Mexico. If the US has to cut down its imports, factories in these and so many other countries that are dependent on exports to the US will start closing down. That underlines the significance of quick fixes for the US economy.

The $700 billion bailout bill, enacted by the US congress on October 3, 2008, was meant to ensure fast remedial actions to stem further financial debacle and stop the economy from slipping into a horrible recession. $250 billion were provided to major banks in return for their preferred shares to enable them to continue with their lending activities and for restoring confidence in the financial institutions of the country. Among the beneficiaries are four big banks: Citigroup, JPMorgan Chase, Bank of America and Wells Fargo, each of which received $25 billion, and numerous smaller banks got smaller amounts.

A section of the media has called it “a partial nationalization of banks”. A closer study of the process will show that it was neither calculated to, nor it would actually amount to, a government take-over of the concerned banks. The stocks of the banks that the government has received in return for the cash, are “non-voting”, that is the banks did not cede any control to the state. Matter of fact, the measures were not intended to take over the free market, but to preserve it.

The basic idea of the bailout plan was to spur spending to stimulate the economy, in line with the Keynesian precept. The wound has started healing, as envisaged, but it may take time for a total recovery.

Still, The situation begs for a thorough revision of the Bretton Woods System by the world community in the light of the experience of the past 66 years and the flaws that have been responsible for the loopholes in the system.

arifhussaini@hotmail.com