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THE GLOBAL FINANCIAL CRISIS

by

Michel Chossudovsky

Professor of Economics at the University of Ottawa, author of "The Globalization of Poverty, Impacts of IMF and World Bank Reforms", Third World Network, Penang and Zed Books, London, 1997.

(REVISED VERSION) Copyright by Michel Chossudovsky, 1997. All rights reserved. This text can be posted on the internet. For publication in printed form contact the author at chosso@travel-net.com, fax: 1-613-7892050

Black Monday October 19, 1987 will be remembered as the largest one day drop in the history of the New York Stock Exchange overshooting the collapse of October 28, 1929, which prompted the Wall Street crash and the beginning of the Great Depression. In the 1987 meltdown, 22.6 percent 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 day to day, ten years later on Monday October 27th, 1997, stock markets around the World plummeted in turbulent trading. The Dow Jones average nose-dived by 554 points, a 7.2 percent decline of its value, its 12th-worst one day fall in the history of the New York Stock Exchange. European stock markets were in disarray with heavy losses recorded on the Frankfurt, Paris and London exchanges. The Hang Seng index had crashed by 10.41 percent on the previous Thursday ("Black Thursday" October 24th) as mutual fund managers and pension funds swiftly dumped large amounts of Hong Kong blue chip stocks. The slide at Hong Kong's Exchange Square continued unabated at the opening of trade on Monday morning: a 6.7 percent drop on Monday the 27th followed by a 13.7 percent fall on Tuesday (Hong Kong's biggest point loss ever)...

Table 1:

New York Stock Exchange: Worst Single-Day Declines
(Dow Jones Industrial Average, percentage change)
   
                               Percentage
Date                           Decline
__________________________________________
October 19, 1987                -22.6%
October 28, 1929                -12.8%
October 29, 1929                -11.7%
November 6, 1929                 -9.9%
August 12, 1932                    -8.4%
October 26, 1987                   -8.0%
July 21, 1933                           -7.84%
October 18, 1937                   -7.75%
October 27, 1997                   -7.16%
October 5, 1932                     -7.15%
September 24, 1931              -7.07%


The danger signals of an impending financial disaster were visible in mid-Summer 1997 with the collapse of the Southeast Asian currency markets under the brunt of speculative trading. A critical turning point was reached on Wall Street on Friday August 15: in panic trading, the New York Stock Exchange experienced its largest one day decline since the 1987 meltdown with the Dow Jones plummeting by 247 points. The symptoms were similar to those of the 1987 crash: "institutional speculators" had sold large amounts of stock with the goal of repurchasing them later but with the immediate impact of provoking a plunge in prices. Various speculative instruments including futures' and options' trading played a key role in precipitating the collapse of market values.

The Asian Foreign Currency Crisis

When viewed historically, the present financial crisis is potentially far more devastating and destructive. In 1987 national currencies remained relatively stable; in contrast to the crashes of 1987 and 1929, the present financial crisis is characterised by the concurrent collapse of national currencies under the brunt of large scale speculative activity. An almost symbiotic relationship between the stock exchange and the foreign currency market has unfolded: "institutional speculators" are not only involved in manipulating stock prices, they also have the ability to plunder central banks' foreign exchange reserves, undermining sovereign governments and destabilising entire national economies. In the words of Malaysia's Prime Minister Mahathir Mohamad: "This deliberate devaluation of the currency of a country by currency traders purely for profit is a serious denial of the rights of independent nations".(Statement at the Meeting of the Group of 15, Malacca, Malaysia, 3 November 1997, quoted in the South China Morning Post, Hong Kong, 3 November 1997)

In the last five months, currency speculation in Thailand, Indonesia, Malaysia and the Philippines has been conducive to the transfer of billions of dollars of central bank reserves into private financial hands. Several observers have pointed to the deliberate "manipulation" of equity and currency markets by investment banks and brokerage firms. (Philip Wong, member of the Beijing appointed Legislative Assembly accused the Manhattan Brokerage firm Morgan Stanley of "short-selling the market". See "Broker Cleared of Manipulation", Hong Kong Standard, 1 November 1997). Ironically, the same Western financial institutions which looted developing countries' central banks, have also offered "to come to the rescue" of Southeast Asia's monetary authorities. ING Baring, for instance, well known for its speculative undertakings, generously offered to underwrite a one billion dollars loan to the Central Bank of the Philippines (CBP) in July 1997. In the months which followed, most of these borrowed foreign currency reserves were reappropriated by international speculators when the CBP sold large amounts of dollars on the forward market in a desperate attempt to prop up the Peso.

Economic Falsehoods

Business forecasters and academic economists alike have casually disregarded the dangers of the present financial crisis 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. The structural causes of the stock market crisis are not mentioned.

The plunge on the New York Stock Exchange on October 27th was casually blamed on the "structurally weak economies" of Southeast Asia, until recently heralded as upcoming tigers, now depicted as "lame ducks". The seriousness of the financial crisis is trivialised: Alan Greenspan, Chairman of the Federal Reserve Board reassured Wall Street pointing authoritatively to "the contagious character of national economies, spreading weaknesses from country to country". Following Greenspan's verdict (October 28th), the "consensus" among Manhattan brokers was that "Wall Street had caught the Hong Kong flu"...

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) had unleashed a wave of corporate mergers, buy-outs and bankruptcies. These changes 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.

The 1987 Wall Street 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 ten 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 New York Stock Exchange. Totally removed from entrepreneurial functions in the real economy, they have the power of precipitating large industrial corporations in bankruptcy.

By 1995, the daily turnover of foreign exchange transactions (US$ 1300 billion) had exceeded the World's official foreign exchange reserves estimated at US$ 1202 billion. (Martin Khor, SEA Currency Turmoil Renews Concern on Financial Speculation, Third World Resurgence, No. 86, October 1997, p. 14-15). In other words, the command over privately held foreign exchange reserves in the hands of "institutional speculators" far exceeds the limited capabilities of central banks, --ie. the latter acting individually or collectively are unable to fight the tide speculative activity.

In the currency crisis of the last few months, billions of dollars of official reserves have been plundered by institutional speculators. These reserves have been transferred out of the coffers of the central banks into private hands. This depletion of official reserves is part and parcel of the financial crisis. As speculators assault the fragile vaults of central banks, there is a danger that the Southeast Asian currency crisis will spill over into other regions of the developing World triggering a ruinous chain of "Mexican style" currency devaluations and the concurrent impoverishment of millions of people. Already in early November, following the spectacular nose-dive of the Sao Paulo and Buenos Aires stock markets (on the 27th and 28th of October), Latin American currencies (including the Brazilian real which is pegged to the US dollar) were under pressure in a renewed wave of speculative activity...

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. The number of billionaires in the US alone increased from 13 in 1982 to 149 in 1996. The "Global Billionaires Club" (with some 450 members) has a total Worldwide wealth well in excess of the combined GDP of the group of low income countries with 56 percent of the World's population (Forbes Magazine, International Billionaires, the World's Richest People, 1997. The data is based on recorded wealth. It tends to grossly underestimate the concentration of global wealth). Family fortunes are in some case in excess of the GDP of countries (for instance, the private wealth of the Walton Family owners of Walmart (27 billion), is of the same order of magnitude as the GDP of Bangladesh with a population of 120 million people...

No need to produce commodities: enrichment is increasingly taking place outside the real economy divorced from bona fide productive and commercial activities. According to Forbes: "Successes on the Wall Street stock market [meaning speculative trade] produced most of last year's [1996] surge in billionaires". (Charles Laurence, "Wall Street Warriors force their way into the Billionaires Club", Daily Telegraph, London, 30 September 1997). In turn, part of the money accumulated from speculative transactions is funnelled towards confidential numbered accounts in the numerous offshore banking havens. This critical drain of billions of dollars in capital flight dramatically reduces state tax revenues, paralyzes 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. Health and education programmes are downsized; wage inequality has risen in the OECD countries. In both the developing and developed countries, poverty has become rampant; according to the International Labour Organisation (ILO), Worldwide unemployment affects one billion people or nearly a third of the global workforce (ILO, Second World Employment Report, Geneva, November 1996). The accumulation of financial wealth resulting from speculative transactions feeds on poverty and low wages.

Replicating the Policy Failures of the late 1920s

Wall Street was swerving dangerously in volatile trading in the months which preceded the crash of October 29, 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 had stated authoritatively in 1928 that "nothing resembling a crash can occur". The illusion of economic prosperity persisted several years after the Wall Street crash of October 1929. 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 broad economic causes of the crisis are not addressed. Echoing almost verbatim the economic slogans of Irving Fisher, today's economics orthodoxy not only refutes the existence of an economic recession, it also denies outright the possibility of a financial meltdown. 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... It is ironic to say the least that precisely at a time when financial markets were in turmoil, the Royal Swedish Academy announced the granting of the 1997 Nobel Prize in Economics to two American economists for their "pioneering formula for the valuation of stock options [and derivatives] used by thousands of traders and investors" (meaning an "algebraic formula" which is routinely used by stock market speculators). (See Greg Burns, "Two Americans Share Nobel in Economics, Chicago Tribune, October 15, 1997).

In the aftermath of the 1987 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. ("Five Years On, the Crash Still Echoes, The Financial Times, October 19, 1992). These so-called "circuit-breakers" proved to be totally ineffective in averting a meltdown. On Monday the 27th of October 1997, a first circuit breaker halted trading for 30 minutes after a 350 point plunge of of the Dow Jones. After the 30 minute trading halt, an aura of panic and confusion was installed: brokers started dumping large quantitites of stocks which contributed to accelerating the collapse in market values. In the course of the next 25 minutes, the Dow plunged by a further 200 point triggering a second "circuit breaker" which served to end the trading day on Wall Street...

Computerised Trading Exacerbates Stock Market Instability

In contrast to the 1920s, major exchanges around the World are interconnected "around the clock" 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.

Recent experience has amply demonstrated the destablising role of computerised programme trading: the Dow Jones can swing back and forth by several percentage 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.

The Fate of National Economies

The social consequences and geo-political implications of the global financial crisis are far-reaching particularly in the uncertain aftermath of the Cold War. Because national economies are interlocked in a system of global trade and finance, the potential impact of the stock market meltdown is potentially far more devastating.

Moreover, macro-economic policies are internationalised: the same austerity measures are applied all over the World under the survellance of creditors and international financial institutions. In the developing World and in the former Soviet block, entire national economies have been destabilised by currency devaluations often resulting in the outbreak of social strife, ethnic conflicts and civil war...

Economic stagnation in all major regions of the World largely marks the ten year period since the 1987 financial crash. In the OECD countries as a whole, GDP growth has hovered between 1.5 % and 3.0 %. These figures, however, do not in any meaningful way assess the depth of the economic crisis. 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.

In turn, in the former Soviet Union, economic decline has surpassed the plunge in production experienced in the USSR at the height of the Second World War following the German occupation of Bielorussia and parts of the Ukraine in 1941, and the extensive bombing of its industrial infrastructure. The Soviet GDP had by 1942 declined by 22 percent in relation to pre-War levels (World Development Report, 1997, fig 2.1, p. 26). In contrast in the former Soviet Union as a whole, GDP plummeted by 44.0 percent over the 1989-1995 period. (According to data compiled by the United Nations Economic Commission for Europe, Independent estimates indicate a substantially greater drop and there is firm evidence that official figures have been manipulated).

Dangerous Cross-Roads

A massive contraction in global purchasing power has occurred. With the exception of a buoyant luxury goods' economy for a privileged upper income stratum, markets for basic consumer goods have dwindled. In other words, the surge of stock values observed in recent years 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 Standard and Poor 500 index (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 forty percent of the American adult population has investments in the stock market. A financial meltdown could lead to massive loan default sending a cold shiver through the entire banking system; it could 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, 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, however, 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..."(Bank for International Settlements 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 (including Conservatives, Social Democrats and Socialists) often have a vested interest in upholding dominant financial interests. At the June 1997 Denver Summit (which coincided with the onslaught of the Asian currency crisis) G7 leaders in a muddled and confusing statement called for "stronger risk management", "improved transparency" and "strong prudential standards" (see Final Report to the G-7 heads of state and government: "On promoting financial stability", Denver, June 21, 1997). 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 evolution of international institutions (including the World Trade Organization 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 recognize 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 can not 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 overshadowing the functions of central banks.

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.





Michel Chossudovsky

Department of Economics,
University of Ottawa,
Ottawa, K1N6N5


Fax: 1-613-7892050
E-Mail: chosso@travel-net.com


Alternative fax: 1-613-5625999


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