Credit where credit is due. For a long time now we have been harping in this space on the theme of a monetary system out of control; of the wild proliferation of new financial institutions, instruments, and markets; of the unchecked spread of a speculative fever certainly more pervasive and perhaps even more virulent than any recorded in the long history of capitalism’s get-rich-quick obsessions. With few exceptions, accredited economists, as is their wont, have ignored these bizarre goings-on: they are not part of the way the economy is supposed to operate and are hence unworthy of "scientific" attention. The media, on the other hand, especially the serious business press, have reported the facts as they have unfolded—the rapid growth of options and futures markets, the near bankruptcy and rescue by the government of one of the country’s largest banks, etc., etc.—but have generally steered clear of any attempt to put these discrete developments into a coherent account of an enormously powerful dynamic process rooted in the nature of the economic system and loaded with implications for the country’s future.
Now, very much to its credit, Business Week has broken ranks and made a serious attempt to fill the gap. The result, a cover story entitled "The Casino Society" in its issue of September 16, is a noteworthy journalistic achievement. Colorfully written and packed with facts, it tells an exciting story well worth the careful attention of everyone interested in understanding the current economic scene.
What is the casino society? Here, in an introduction (included on the cover of the magazine) is Business Week’s shorthand answer:
No, it’s not Las Vegas or Atlantic City. It’s the U.S. financial system. The volume of transactions has boomed far beyond anything needed to support the economy. Borrowing—politely called leverage—is getting out of hand. And futures enable people to play the market without owning a share of stock. The result: the system is tilting from investment to speculation.
Data in support of these statements are focused on the expansion in the volume of financial transactions. A composite quotation can serve as a summary:
On the NYSE [New York Stock Exchange], 108 million shares change hands daily, up from 49 million five years ago. In the government securities market, trading volume is averaging $76 billion a day, quadrupling 1980’s level. Yet this growth seems tame compared with the action in financial futures and options trading pits. For example, daily volume in Treasury-bond and T-bill futures tripled in 1984 alone, to $26 billion… The volume of financial transactions in this country has soared beyond calculation—and beyond economic purpose… Stocks are not greatly overpriced, and margin borrowing is modest [in contrast to 1929]. But the speculative use of debt and other forms of leverage is pandemic in the rest of the financial world. “The markets,” says NYSE Chairman John J. Phelan, “are leveraged to the teeth.” Washington, of course, is setting an unrivalled standard of profligacy, running a $180-billion annual budget deficit. Total federal debt doubled during the 1970s and hit $1 trillion in 1981, the Reagan administration’s first year. Next year, it will top $2 trillion. Meanwhile, borrowing is surging all across the economy. Total debt of households, corporations, and governments jumped by a postwar record of 14 percent, to $7.1 trillion, in 1984. That’s considerably faster than the economy is growing. Credit-market debt now stands at an ominous 1.95 times GNP, compared with 1.68 a decade ago. [Moreover, there is a vast debt equivalent which doesn’t show on anyone’s books.] Barred by law from underwriting mutual funds or commercial paper, the big banks have been retaliating against Wall Street’s incursions by offering corporate clients liquidity in the form of commitments—to make loans, to buy or sell foreign currency, or to guarantee the obligations of a creditor. Banks can charge tidy fees for making these commitments and yet not set aside capital to back them up, as they would loans. At the end of 1984 these “offbalance-sheet liabilities” at the 15 largest banks totaled $930 billion, or about 8 percent more than their assets.
Here, then, are the kind of figures which, taken together, give an idea of the fantastic dimensions of the financial explosion that has taken place in the United States in the last decade or so.*
On the question of what it all means—i.c., of the relation of the financial explosion to the performance of the economy as a whole—the Business Week story has little to contribute beyond dark hints and ominous warnings of unknown perils that lie ahead. But the editors of the magazine, in an accompanying editorial, show that they are fully aware of the problem, and their way of formulating it has the merit of pointing toward the kind of analysis that is needed: "Although the emergence of the casino society," they write, "coincided with the economy’s prolonged slowdown in the mid-197Os, nobody can demonstrate which is the chicken and which the egg. But clearly, slow growth and today’s rampant speculative binge are locked in some kind of symbiotic embrace." What we need to know is the nature of this embrace.
It is necessary to rule out at the outset a frequently encountered notion that what we are now witnessing is simply the most recent of a long series of speculative manias that have punctuated the history of capitalism since at least the famous "South Sea Bubble" of 1720. Beginning as long ago as the 1820s, speculative excesses of this kind became a normal feature of the capitalist business cycle, getting under way in the later stages of the boom and foreshadowing the panic and collapse to come. It was, in fact, the regular recurrence of this pattern in the United States that, after the panic of 1907, led to the establishment of the Federal Reserve System. The present situation, however, is very far from being an end-of-the-boom phenomenon. Its origins can plausibly be dated even earlier than the mid-1970s, and it has been more or less steadily building up ever since. This being also the period when economic stagnation set in after the long postwar upswing of the 1950s and 1960s, we evidently need to identify a causal mechanism different from the one that characterized the prewar business cycle.
The problem in our view, can be divided into two parts. First, why did the stagnation that had dominated the economy in the 1930s return in the 1970s? And, second, why, in the conditions of the 1970s, did a stagnant economy become a breeding ground for a financial explosion?
These are of course questions that in one form or another have been dealt with many times in these pages. Here we will only touch on the main points that need to be kept in mind.
First—and in a sense the real crux of the whole matter—in a mature monopoly capitalist society there is always a strong tendency to stagnation. In some historical contexts this tendency takes over and dominates the economic scene, while in others it is held at bay and the economy experiences a long wave of expansion punctuated only by brief and mild recessions. The period beginning at the end of the Second World War was an example par excellence of the latter kind. Why was this so?†
The answer is that the war altered the givens of the world economic situation in ways that vastly expanded the scope of profitable investment opportunities. The main factors were as follows: (1) the pressing need to make good wartime damage; (2) the existence of an enormous potential demand for goods and services the production of which had been eliminated or greatly reduced during the war (houses, automobiles, appliances, etc.); (3) a huge pool of purchasing power accumulated during the war by firms and individuals which could be used to transform potential into effective demand; (4) the establishment of U.S. global hegemony as a result of the war: the U.S. dollar became the basis of the international monetary system, prewar trade and currency blocs were dismantled, and the conditions for relatively free capital movements were created—all of which served to fuel an enormous expansion of international trade; (5) civilian spinoffs from military technology, especially electronics and jet planes; and (6) the build-up by the United States of a huge permanent armaments industry, spurred on by major regional wars in Korea and Indochina. Very important but too often overlooked is the fact that these developments were in due course reflected in a fundamental change in the business climate. The pessimism and caution left over from the 1930s was not dissipated immediately, but when it became clear that the postwar boom had much deeper roots than merely repairing the damages and losses of the war itself, the mood changed into one of long-run optimism. A great investment boom in all the essential industries of a modern capitalist society was triggered: steel, autos, energy, ship-building, chemicals, and many more. Capacity was rapidly built up in the leading capitalist countries and in a few of the more advanced nations of the third world like Mexico, Brazil, India, and South Korea.
In seeking the causes of the reemergence of stagnation in the 1970s, the crucial point to keep in mind is that every one of the forces that powered the long postwar expansion was, and was bound to be, self-limiting. This is indeed part of the very nature of investment: it not only responds to a demand, it also satisfies the demand. Wartime damage was repaired. Demand deferred during the war was satisfied. The process of building up new industries (including a peacetime arms industry) requires a lot more investment than maintaining them. Expanding industrial capacity always ends up by creating overcapacity: a strong incentive to invest generates a burst of investment which in turn undermines the incentive to invest. This is the secret of the long postwar boom and of the return of stagnation in the 1970s.
We turn now to the second part of the problem at issue: why, in the conditions of the 1970s, did a stagnant economy become the breeding ground for a financial explosion?
The answer here is more complicated than the answer to the return-to-stagnation question, but its main elements—even if not their specific form of interaction or ranking in order of importance—are clear enough. To begin with, the financial sector of the economy which had been moribund in the 1930s and under tight control throughout the war experienced a vigorous growth during the next three decades. Between 1945 and 1975, while the GNP grew by a factor of 7.3 (reflecting price inflation as well as real growth), the debt of nonfinancial business firms and consumers increased 19 times, with the bellwether interest rate on 3-month treasury bills rising from 0.375 percent to 5.8 percent. Up to about 1960, this expansion of the financial sector was pretty much in step with, and basically resulted from, the long postwar upswing in the underlying economy. After that, especially under the stimulus of the Vietnam war, the financial sector began to grow more rapidly than the economy as a whole. Already in 1975 we wrote in this space, "The specter haunting today’s capitalist world is the possible collapse of its financial institutions and an associated world economic crisis." (Banks: Skating on Thin Ice, February 1975) Against this background, what should we expect the consequences to be of the relapse into stagnation signalled by the severe recession of 1973–75?
In this connection we must remember that banks and other financial businesses, being capitalist institutions, operate under the same growth imperatives as do industrial corporations. They are spurred on by competition and the drive to expand the profit base. Since the commodity they deal in is money, the key to growth and higher profit lies in marketing an ever larger volume of debt. And if one source of demand for financing falters, they naturally work all the harder to cultivate others. So it was that with the slowdown of industrial investment as the long postwar wave subsided, the financial sector intensified the hunt which has continued to this day for alternative customers. It was no accident that it was just about at this time that U.S. banks started shovelling out funds abroad, especially to third world countries, many of which, as we now know, were seduced into taking on vastly more debt than they would ever be able to service, let alone repay.
But the money-pushers were busy at home as well as abroad, and it wasn’t long before the debt-creation process took on the character of a self-contained operation, with financial institutions (and wealthy individuals) playing leading roles on both sides of the market, i.e., as both suppliers and demanders. How this works is perhaps best illustrated by the rapid growth of money-market funds, which got their start by offering higher interest rates than banks, with a resulting flood of money from the banks to the funds. The banks then raised their rates to get deposits back. Billions of dollars worth of back-and-forth financial transactions thus pushed up interest rates without any relation to the underlying production and circulation of useful goods and services. Other examples of the proliferation of purely financial transactions are legion: most of the multi-billion-dollar activity in the area of corporate mergers and acquisitions is of this type, as indeed is the great bulk of speculative trading in markets specialized to an ever widening spectrum of negotiable assets: commodities, foreign exchange, stocks and bonds, futures and options (even options on futures!), and so on and on. The crucial point, and one that is almost totally missing from traditional economic discourse, is that the financial sphere has the potential to become an autonomous subsystem of the economy as a whole, with an enormous capacity for self-expansion.
Once the expansion process gets fully under way, as it was bound to do in the context of the reappearance of stagnation in the 1970s, it tends to feed on itself: like a cancer, it lacks internal control mechanisms. The only way it can be brought under control is through external intervention. In the case of cancer this may take the form of surgery or radiation or drugs; in the case of the financial system the only possibility is government intervention. But with the economy slowing down, governments, far from being interested in putting on the financial brakes, or even looking to the condition of the braking system with a view to future use, were concerned to facilitate financial expansion in the belief that this was one way, and perhaps the most effective way, of countering stagnation.
Thus federal deficits, reflecting the government’s generally expansionist policies, practically tripled, from an annual average of $13.6 billion in 1970–74 to $39.4 billion in the next five years (and again to $116.6 billion in 1980–84!). And whenever the debt expansion process showed signs of stalling, either because of restrictive laws and regulations dating back to the days of the New Deal and the Second World War or because of a threatened failure of a big bank or corporation that could trigger a chain reaction of bankruptcies, the authorities came to the rescue by reinterpreting the laws and relaxing the regulations and/or by emergency injection of money by the Federal Reserve to endangered banks or by government subsidies, loans, or loan guarantees to ailing firms or industries. These actions in turn broadened the base for a renewed expansion of debt and greater dependence of the economy as a whole on the ballooning of credit.
If the foregoing analysis is accepted, certain conclusions follow.
First, the financial explosion has in fact been a force counteracting stagnation. Not of course that it has done away with stagnation but in the more limited sense that without it stagnation would have been worse. There are two reasons for this: (1) The expansion of the financial sector has opened up significant opportunities for profitable investment in office buildings, transportation and communications equipment, business machines, etc.†† (2) The sharp increase in interest income associated with the financial explosion-net interest rose from 6.5 percent of national income in 1974 to 9.6 percent in 1984-plus the enormous profits raked in by Wall Street and its lesser counterparts around the country have acted as an important stimulus to consumption, especially in the booming area of luxury goods and services. Without these props to both investment and consumption, the performance of the economy these past few years would certainly have been much worse than it actually was.
Let us pause to ponder the meaning of these facts. Conventional wisdom has it that financial excesses of the kind we have been discussing that recur every so often in capitalist societies are deplorable aberrations that corrupt people, waste resources, and disrupt the normal functioning of the economy. As the Business Week editorial on the casino society puts it: "The case can be made that the casino society channels far too much talent and energy into financial shell games rather than into producing real goods and services, and that it is a significant drag on economic growth." On analysis, however, this turns out to be a much more complicated statement than may appear at first sight.
Does the casino society in fact channel far too much talent and energy into financial shell games? Yes, of course. No sensible person could deny it. Does it do so at the expense of producing real goods and services? Absolutely not. There is no reason whatever to assume that if you could deflate the financial structure, the talent and energy now employed there would move into productive pursuits. They would simply become unemployed and add to the country’s already huge reservoir of idle human and material resources. Is the casino society a significant drag on economic growth? Again, absolutely not. What growth the economy has experienced in recent years, apart from that attributable to an unprecedented peacetime military build-up, has been almost entirely due to the financial explosion.
We can now see why, though everyone deplores the increasingly outrageous excesses of the financial explosion and is aware of its inherent dangers, nothing is being done—or even seriously proposed—to bring it under control. Quite the contrary: every time a catastrophe threatens, the authorities spring into action to put out the fire—and in the process spread more inflammable material around for the next flare-up to feed on. The reason is simply that if the explosion were brought under control, even assuming that it could be done without triggering a chain reaction of bankruptcies, the overall economy would be sent into a tailspin. The metaphor of the man with a tiger by the tail fits the case to a tee.
Where is it all leading? Or perhaps the question should be reformulated: What alternative scenarios make sense as we try to peer into what is at best a very murky future?
First, a bust of classic dimensions. This indeed has been a plausible outcome for a long time, and there have been at least half a dozen occasions since the recession of 1973–75 when it seemed on the verge of happening. The remarkable thing about this scenario, however, is not that it could happen but that it hasn’t. And the reason of course is that the government has always successfully intervened to keep it from happening. We have now reached a situation in which (in the words of Business Week) "the financial system is more dependent than ever on swift intervention by government authorities to forestall disaster."
Continued successful intervention cannot be taken for granted but neither can it be ruled out. And this suggests a plausible alternative scenario that ought to be given serious attention. What would be the long-run implications of government’s undertaking to guarantee the financial system against the kind of collapse and generalized deflation that was the prelude to the Great Depression of the 1930s?
We don’t know the answer, nor do we know of any attempt by others to provide one. Perhaps even raising the question in this form at the present stage is premature: more experience may be needed before the elements of an answer can begin to fall into place. But discussion is certainly in order, and we would be glad to hear the ideas of any readers who are convinced, as we are, that sooner or later—and perhaps sooner rather than later—the left in this country is going to be forced by events to define a position on this and related questions.
- * The whole phenomenon can be approached from a wider angle, focusing not only on the volume of financial transactions but also on the rapid expansion—relative as well as absolute—of the financial sector of the economy in terms of real resources (employment and capital investment). See “Production and Finance” (this space, Monthly Review, May 1983) where some rough estimates of this kind are attempted. We will return to this aspect of the problem below.
- † What follows is taken, with minor modifications, from “Why Stagnation?” in this space, Monthly Review, June 1982.
- †† As demonstrated in the October Review of the Month, “The Strange Recovery of 1983-1984,” these are precisely the areas of buoyant capital formation in the economic recovery of the early 1980s.