The Communists may not understand Capitalism, but Marx did. He knew that the way it works is through cycles and crises. Every now and then when the economy grows for a few years running, people start talking about the end of the business cycle, a new paradigm, end of boom and bust. Then reality kicks in and, voila!, we are back in the same old ship tossing and turning on the waves.
This is where we have been since last summer in the developed countries and as yet there is no end in sight. George Soros has said this is the most serious crisis since 1929. He may be right or he may have merely shorted the market and is hoping his prophecy will yield profits. In 1929, the stock market crash did not immediately bring depression. It took the next four years for the full shock to be felt. Here, we have been in crisis for about a year, and still bank failures continue, each as much of a surprise as the other. When the US mortgage giants Fannie Mae and Freddie Mac began having trouble, the crisis hit a new depth. Their outstanding bond debt is $7 trillion; even China holds $300 billion of that. The US Congress has to do something, but it is not clear what.
Normally the answer is pump in liquidity and bail the defaulting company out. The bank/the corporation is ?too big to fail?. But there are cautious voices. There is a libertarian tradition which believes investors should learn to suffer the consequences of what they have done. They have enjoyed dividends in the past, and perhaps even borrowed against the value of the stock. So, now if the stock is worthless, so be it. Capitalism can only be healthy if the losers lose and winners win.
Lately, the call for regulation and for intervention has allowed the loss makers to run to the government and get bailed out thanks to the taxpayer. When the same companies make profits they hate paying tax on it. Socialism when we lose and capitalism when we gain is neither fair nor a healthy way of running the market system.
When the crisis first hit last August, there were hopes that the emerging economies?China and India especially?would be unaffected. There was even hope they would provide countercyclical weight to the rich economies. Alas, a different sort of crisis?inflation?has hit them. This is mainly because of oil and agricultural commodities. The latter is a seasonal matter, and perhaps harvests will ease the pain. But oil is still too high despite being $20 down on its peak in early July. The same principle of ?profiteer pays? should apply to these economies. Thus, subsidies to oil consumers are not only inequitable but inflationary since they do nothing to curb the demand for oil. People cannot hope to enjoy the good things of capitalism and not pay for the bad things. It is not a question of morality but of efficiency as well as equity.
But as the Fannie/Freddie example shows, the emerging economies holding large reserve surplus in the form of US T-bills and other paper will be as badly hit as the rest if the Fannie/Freddie rescue imposes proper costs as it should. If China dumps all that paper on the market, interest rates would shoot up and the dollar would go in freefall. But is that such a bad thing? A lot of the present malaise has come from the seigniorage gains that the US dollar enjoys. That has allowed the US to dissave and dump its excess liabilities on a trusting world. Perhaps we should end that inefficient regime and the US should save for its investments like the rest of us.
We have been here before. This is where the old Bretton Woods system broke down in August 1971. It did not end capitalism, only its Keynesian phase. Maybe now we can see if the end of seigniorage will shift capitalism in a new direction of a more symmetrical globalisation. Hold fast while we hit the rocks !
The writer is professor emeritus of economics at London School of Economics and a Labour peer. Write to m.desai@lse.ac.uk