Economic crisis: the new 1929 or the new Japan?

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Costas Lapavitsas is an economist at the School of Oriental and African Studies in London. He has written extensively on Marxist theories of finance. He spoke to Socialist Review and answered questions on historical parallels with the current economic crisis and its impact.

Many mainstream economic commentators are comparing the current economic crisis to the one that hit Japan in the late 1980s, which saw the country stagnate for 15 years. How strong are the similarities?

There are some clear similarities. First, the bubble that is now bursting in the US economy is in property. That was the same in Japan. Much of the speculation that led to the crisis of the late 1980s in Japan was related to housing and commercial property.

A second similarity is the bad debt that accumulated in the banking system. This seriously hampered the banks in their day to day operations and their ability to extend credit. The crisis in the US is still in its early stages. Nevertheless it is obvious that banks are pulling in their horns in terms of making loans and generating credit. That is bound to have serious negative repercussions on the rest of the economy if it continues. The difficulty in offering credit was also a key factor that led the Japanese economy to stall.

A third similarity could be a decline in individual consumption. Obviously the two economies start from very different points. The US working class and the population more generally have been spending way above their means in the past few years, by getting heavily into debt. Not so much of this happened in Japan in the 1980s. But after the crisis Japanese people were forced to reduce consumption significantly, and something similar seems to be happening in the US. That could make the general economic situation much tighter.

What about the differences between Japan and the US?

One key difference is the simple fact that the Japanese disaster has already happened. This allows the US ruling class to draw on Japan's experience. They have spent ten to 15 years arguing that the Japanese are useless in policy terms, but now they are finding that Japanese responses to the banking crisis are replete with lessons.

More significantly, in terms of the economics of it, the housing crisis in Japan did not begin with ordinary mortgage holders defaulting and losing their homes. In Japan mortgage companies became bankrupt because they had borrowed heavily and speculated enormously. Ordinary people continued paying their mortgages, and often continued to do so long after the price of their house had declined dramatically.

Essentially Japanese people continued paying money to the financial system for nothing since they had huge negative equity in their homes. But the fact that they continued paying their mortgages allowed the banks to continue operating. In the US huge numbers of people are stopping payments and are in the process of losing their homes. This makes the crisis far more severe, not just economically but socially.

Another difference is that the Japanese housing crisis was accompanied by stock market collapse - a sharp and relentless decline in stock prices. The combined effect of stock market decline and the bursting of the housing bubble crippled banks for a long time.

Perhaps the most important difference between the US and Japan, though, is the attitude towards large companies getting into trouble. In the US, less than a year into the crisis, one huge financial firm, Bear Sterns, has already been allowed to go under. In Japan policy makers were far more reluctant to let this happen. Japanese capitalism has historically been unwilling to allow bankruptcies in large enterprises. During the crisis they tolerated loss-making for a long time. Things are different in Japan now, and financial companies have been allowed to fail. But in the early 1990s bad debts were allowed to accumulate and eventually became a festering sore. US capitalism seems less concerned about the localised effects of a company going under and more prepared to countenance sudden bankruptcy, even of large corporations.

Effectively, Bear Sterns has ceased to exist at the instigation of the Federal Reserve. JP Morgan has acquired its loan book for next to nothing, while also taking advantage of a $30 billion loan from the Fed. Bear Sterns' headquarters is a New York skyscraper which by itself is worth several times the price that JP Morgan initially offered for the whole of the fallen bank. It is a classic case of a company going under and the competition being able to pick up the best bits for nothing. But they seem to have overdone the greed and might have to raise their price a little.

Bear Sterns went within a week, seven months into the crisis. Similar events took years to occur in Japan. People knew that large companies and banks were in a bad state, but they only started going under in the late 1990s.

People often talk about Japan's problems in purely economic terms. What was the social impact?

The Japanese crisis lasted well over a decade and was slow to develop. The impact was seen on many levels. Unemployment went up. For the first time one saw homelessness in Tokyo, people sleeping in railway stations and killing themselves in despair.

But that was just the tip of the iceberg. When phenomena like that appear, it indicates that much larger numbers are suffering without reaching these extremes.

The majority of workers had to survive collapsing values of housing and other assets they might have had. They found it very hard to sustain consumption as well as spending on health, insurance, education, and everything else they planned for their children. There was an enormous cost borne by working families across the country.

On top of this, vast amounts of public money went to the banks. This meant that the population effectively took the cost of bad debts. This caused huge political disquiet and unhappiness in Japan. Gordon Brown stands a reasonable chance of getting back the money he committed to bailing out Northern Rock, but people are still up in arms about it. You can imagine what happened in Japan when the government spent far larger amounts of public money on the banks, without ever getting it back.

The other great nightmare for the commentators is the Wall Street Crash of 1929 and the Great Depression of the 1930s. What do you think about these comparisons?

Interestingly, several commentators on the right have been almost panicking about what is happening in the US economy, while many on the left have been far more complacent, saying that capitalism has survived lots of earlier crises. Both attitudes are problematic and a balanced assessment is needed.

The ruling class response certainly has an element of hysteria, but that does, in part, reflect the seriousness of the situation. Those who are panicking often know that the books of the banks look very bad and that money markets are in a bad shape.

The 1930s are stamped on the minds of ruling class commentators. Will it go that way this time? It's very hard to tell. There's no doubt that this is not a blip like we have seen in the past. If the policy makers get it wrong then they could easily lose control of things, which is part of the reason why the 1930s were so severe.

The crisis originated in bad debts made for mortgages. As long as house prices fall and people continue to default in the US the banks will remain weak. But this will not last forever by itself - perhaps another year or two. What would complicate things enormously would be for other sections of the financial system or other areas of lending to go bad at the same time.

The times are very dangerous and the actions of the authorities in the US are very important. My feeling is that, if they make wrong moves, a very serious crisis could materialise. Things could get out of hand in the financial system if the authorities make mistakes about who they let go under and who they do not, or if they fail to reassure bank depositors, and so on.

Will this lead to the 1930s situation with rising unemployment, stagnant markets and all the social and political turbulence that comes from that? The possibility cannot be discounted. Last year people would have laughed it off. Six months ago people would have been sceptical. Today you can say it might happen.

You've written on the growth of the financial system. How has this changed capitalism?

We have witnessed a huge expansion in finance in the past three decades. The past ten years are beyond parallel in the period since 1945. About a third of total profits in the US are financial profits, most of it coming from people's personal income. It does not come from the profits of industrial corporations, which make their money by exploiting labour, but originates in banks directly exploiting individuals. This profit-making mechanism has backfired and led to an enormous crisis.

Capitalism has been restructuring non-stop during the last three decades. New technologies, working practices and telecommunications have changed the economy. Nonetheless we have not witnessed a successful expansion of real accumulation. We do not see new technology leading to a new period of growth. That does not necessarily mean that profit rates are low, but we have seen production shifting east to China and other countries now sharing in the global division of labour.

Do you think US hegemony, already damaged by Iraq, will be further undermined by the crisis?

Those who hold large sums of money globally can now pick up banks very cheaply, and that is what they are doing. This is a reverse of the 1997-1998 East Asian crisis, when US institutions went across Asia picking up banks. Today developing country institutions are picking up US banks. This has a huge impact on US hegemony. Foreign state-run institutions such as sovereign wealth funds [that invest the surplus savings of developing countries] are bailing out US capitalism.

Much of the power of US capitalism came from domination of the global financial system over the past three decades. Now this system is reliant on capital from the Arab world, Russia, Singapore and elsewhere.

How useful is Marxist political economy in understanding what's going on?

Marxist political economy is very important. It provides a powerful understanding of finance, but also has a distinctive approach to the capitalist economy in general. For instance, it treats the economy from a class perspective and explains the nature of exploitation.

One has to read Marxism flexibly, with an open mind. It makes it possible to see that the financial system is a vast exploitative structure, one that has become particularly brutal in recent years. Marxism calls a spade a spade in terms of the social cost of the crisis of finance. Mainstream economists spend much time talking about the technical side of things, while forgetting that people are suffering enormously as a result.