System failure: Economic turmoil and endless war

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As the worst economic crisis since the 1929 crash rips through the world's markets, Alex Callinicos analyses the factors driving ever greater political instabilities across the globe

The world took a big step into even greater economic and geopolitical instability in the summer and early autumn of 2008. The credit crunch that started when the financial markets froze up in August 2007 shows every sign of becoming a global economic crisis. And the drive by the US to shore up its position as the hegemonic capitalist state has precipitated a potentially very dangerous confrontation with Moscow after the brief war between Russia and Georgia in August. Never has there been a greater need for a powerful anti-capitalist and anti-imperialist left.

For months after the onset of the credit crunch many establishment commentators argued that it was containable. Their reasons varied - that the crisis would only affect the financial markets, or the free market "Anglo-Saxon" economies, that the eurozone would continue to grow robustly, that the big "emerging market economies" such as China and India had "decoupled" from the US and were becoming the motor of world capitalism - but the implication was the same. Alan Greenspan, ex-chairman of the Federal Reserve Board (the US central bank), was claiming back in the spring that "the worst is over".

How foolish he must have felt as Wall Street was engulfed in chaos after the collapse of the global investment bank Lehman Brothers on Monday 15 September. It is now clear that a generalised global economic slowdown is under way that is affecting all the main regions of world capitalism. As is always the case, the slowdown is uneven. In the last period for which there are figures, the second quarter of 2008, the economies of the eurozone, Japan, Britain and Canada stagnated or shrank, while that of the US - where the crisis began - grew at an annual rate of 3.3 percent. Capital is beginning to flee emerging market economies - $29.5 billion between early June and September. The Shanghai stockmarket fell 57 percent in the first eight months of 2008.

Three main mechanisms are at work driving the developing economic recession. The first is the credit crunch. At the beginning of the present decade Greenspan and his fellow central bankers sought to prevent falling US profitability generating a full-scale slump by flooding the US and world economy with cheap credit. It was the resulting speculative bubble centred on the housing market (not just in the US, but also, for example, in Britain, southern Ireland, and Spain) that burst in August 2007.

The huge bad debts that US and European banks were left holding, plus uncertainty about which banks were in deepest trouble, have paralysed global financial markets. Banks have, in effect, stopped lending to each other. To the extent that full-scale recession develops, this will produce further feedback effects that will make the situation worse. As firms go bust and households find they can't service their debts thanks to inflation and/or unemployment, the banks will be stuck with yet more bad loans. Since the availability of credit is a crucial condition allowing the process of capital accumulation to continue, this is a very serious problem.

The second mechanism is inflation. The credit-fuelled US economic recovery and China's headlong expansion as a supplier of cheap manufactured goods to the US allowed the world economy to boom in the mid-2000s. Growing demand bid up the price of oil and of other natural resources - although the sharp drop in the oil price from its July peak of nearly $150 a barrel to under $100 in mid-September underlines the important role played by financial speculators in commodities markets.

Higher inflation has a doubly negative impact on the present economic situation. First, it cuts real incomes. For many poor people in the Global South this can make the difference between survival and starvation. But even when the impact is less severe, people have less to spend on goods and services. As in their different ways Karl Marx and John Maynard Keynes showed, lower spending means that some of the workers producing goods and services will be laid off, leading to further reductions in demand and employment in a downward spiral.

Secondly, one of the main effects of the triumph of neoliberalism over the past 30 years was to institute a new economic policy regime. This has given unelected central bankers the power to set interest rates. Usually this power is tied to the duty to keep inflation low. In present circumstances this means that central banks are under pressure to keep interest rates high, even if this has the effect of making credit even more scarce and expensive than it already is. Both the European Central Bank and the Bank of England have made it clear that recession is an acceptable price for reducing inflation.

The final mechanism driving the crisis is fluctuation in exchange rates. Reflecting the position of the US as the leading capitalist state, the Federal Reserve is much less inhibited than its counterparts in cutting interest rates to stimulate growth. This can have the effect of making investors less willing to hold dollars, since they can get higher returns elsewhere. The Bush administration has more or less openly pursued a cheap dollar policy designed to increase the competitiveness of US exports.

The decline of the dollar - it fell by a quarter between early 2002 and early 2008 - was accelerated by the initial onset of the credit crunch. The effect was to boost US exports by making them cheaper. Almost all the growth the US economy experienced in the second quarter of 2008 reflected higher exports and lower imports. But this had the reverse effect elsewhere. The exchange rate of the euro, now the dollar's main rival as a global reserve currency, has risen sharply.

By making the exports of the eurozone more expensive, this has helped produce the economic slowdown in this area. For Germany, which re-emerged in the mid-2000s as the world's biggest exporter after a brutal industrial reorganisation that forced real wages down sharply, this is a very serious problem. Japan, whose weak recovery from the long recession of the 1990s has been entirely driven by exports, is even more vulnerable.

The complexity of the capitalist economic system, in which different mechanisms and tendencies interact, means that it's hard to predict the course and severity of the present crisis. Exchange rates illustrate the problem. After falling 7 percent in the early months of 2008, the dollar then rose 10 percent by early September. This is probably because, as the scale of the crisis becomes clear, funk money (funds which flow into a country to take advantage of a favourable interest rate) is taking refuge at the very core of the system. As a result, the euro has fallen, and the pound, reflecting Britain's special vulnerability to the housing and financial crises, has dropped like a stone. If sustained, this reversal could precipitate a sharp slowdown in the US.

This is something that the US state is striving to prevent. The most right wing Republican administration since the 1930s has thrown vast amounts of money at the financial markets. The most important interventions have been organised by treasury secretary Hank Paulson. First came the rescue of the investment bank Bear Stearns in February. This was followed by the effective nationalisation of the mortgage giants Freddie Mae and Fannie Mac in early September. Fannie and Freddie account for three quarters of all new US mortgages. Their takeover increased US government debt by the equivalent of two fifths of national income. Then in the dramatic week of 15 September Paulson sought to halt the panic after Lehman Brothers collapsed first by using a $85 billion loan to take over the insurer AIG and then by announcing a mammoth $700 billion fund to buy up the dodgy financial assets banks are stuck with thanks to their earlier speculative adventures.


These dramatic steps reflect the determination of state managers to stop the US financial system collapsing in the way that it did in the early 1930s. The fact that comparisons can be made to the 1930s, as they have been by, among others, Greenspan, the International Monetary Fund, and New Labour's hapless chancellor of the exchequer, Alistair Darling, is a symptom of how seriously the world's ruling classes take the crisis.

But there are limits to what the state can do. Paulson let Lehman go bust for two reasons. First, he feared a rescue would encourage bankers to speculate yet more, assuming they would be rescued if their bets went astray. Secondly, according to financial academic Avinash Persaud, after the huge increase in US government debt, "credit markets have begun to price in the possibility of a default by the US government". This "unprecedented development" means that even Washington has to worry about keeping the markets' confidence. The fact that Paulson subsequently reversed course is a sign of how worried US state managers are. It doesn't mean the financial system is out of the woods.

Moreover, capital accumulation is driven by the competitive rivalries among individual capitals. Each of the leading states tries to ensure that the firms based on their territory are shielded from the worst of the crisis. The fluctuations in exchange rates are like a game of pass the parcel, in which the countries with strong currencies tend to suffer falls in output and rising unemployment, which then push their currency down, shifting the burden to countries whose currency has risen. The recent collapse of the Doha round of talks on trade liberalisation doesn't necessarily mean that there will be a dramatic protectionist lurch. But it does show how the margin for compromise among the big trading economies (south as well as north) has shrunk.

Greater economic instability meanwhile interacts malignly with the geopolitical tensions within the international system of states. This is important because modern capitalist imperialism is defined by the fusion of economic and geopolitical competition. World politics since the 9/11 attacks has been dominated by the efforts of the Bush administration to maintain the global hegemony of the US by exploiting its military superiority. The conquest of Iraq was to be the key step in this process, initiating the transformation of the Middle East along liberal capitalist lines, entrenching US domination of the region where the world's most important oil reserves are concentrated, and intimidating the hell out of everyone.

The balance sheet of Bush's war drive is not a good one. The administration can claim to have brought a degree of stability to Iraq after the first disastrous three and a half years of the occupation. This is less a consequence of the famous "surge" in US troop numbers than because of two sets of political deals. The first is with Iran, the regional power that has been strengthened by the overthrow of Saddam Hussein, and with the Shia parties aligned with Iran that dominate Nouri al-Maliki's client government. The second is with Sunni resistance groups that initially fought the occupation but were willing to ally themselves with the US for a mixture of money and protection against both the Maliki government and the sectarian fanatics of Al Qaida.

The problem with this strategy is obvious. The US currently holds the ring between two sets of allies who are deeply hostile to each other. Its ability to keep this ramshackle arrangement together is likely to deteriorate over time - particularly because Maliki has been able to force Washington to agree, very reluctantly, to the withdrawal of US troops by the end of 2011. Already the Sunni Awakening movement is complaining that the Maliki government is persecuting its supporters and refusing to honour US promises to find them jobs in the client army and police. Meanwhile Moqtada al-Sadr's Mehdi Army, which combines the support of the Shia poor and opposition to the occupation, remains silent, but this won't last forever.

In Afghanistan the US and Nato are waging an unwinnable war against the same forces that broke the USSR's Red Army in the 1980s. Even more dangerous, the war has spread to Pakistan, where it helped to bring down Pervez Musharraf. In the run-up to the election of his successor, Asif Ali Zardari, the US mounted a commando raid and a missile attack across the Afghan border into Pakistan. Anger at the resulting civilian deaths can only strengthen the growing Pakistani Taliban. Bush and Cheney may bow out by attacking Iran, maybe in a last-ditch effort to secure the White House for John McCain, but only the kind of right wing crazies who have made a heroine of Sarah Palin could imagine that this will do anything but make the situation even worse.

Meanwhile the Bush administration has generated yet more blowback - not as spectacular as 9/11, but potentially as serious - by provoking a confrontation with Russia in the Caucasus. One key dimension of US grand strategy since the end of the Cold War has been to exploit Russia's weakness ruthlessly by expanding the European Union and Nato into eastern and central Europe as a way of both encircling Russia and expanding US influence deep into Eurasia. Begun under Bill Clinton in the 1990s, the policy has been extended by the Bush administration, which has given enthusiastic support to the rather shaky pro-Western regimes in Ukraine and Georgia.

Exploiting Russian weakness may have seemed like a low-cost policy during the disarray and disintegration of Boris Yeltsin's presidency in 1990s. Russia under Vladimir Putin and his protégé and successor Dimitri Medvedev is an altogether different proposition. The Russian economy has been a major beneficiary of the energy boom of the mid-2000s. Putin re-established effective political control over the oil and gas industries. He brought order to the Russian state, rebuilt its military capabilities, and promoted a kind of authoritarian capitalism ideologically central to which is a strident nationalism committed as far as possible to reversing the collapse of the Soviet empire.


In any circumstances, seeking to expand Nato to incorporate Ukraine and Georgia, in two of Russia's key border zones, would have been reckless. Given the shift in the relative balance of power between Washington and Moscow, the policy - strongly pushed by Bush at the Nato summit in Bucharest last April - was the height of folly. As in Iraq, hubris has been punished, according to the decree of the Greek gods, with nemesis. There has been, as usual, much speculation about the relative role of cock-up and conspiracy in the outbreak of the war between Russia and Georgia. Was Georgia's grubby president, Mikheil Saakashvili, encouraged to seize South Ossetia by Cheney and other Washington right wingers? Or did he blunder into a trap carefully laid by the chess players in the Kremlin?

Maybe the answer to both questions is yes. But in a way this is less important than the three decisive advantages on which the Russians could rely. First, they had overwhelming local military superiority - something that no amount of arms and advisers supplied to Saakashvili by the US and Israel could surmount. Secondly, any attempt by the US to respond militarily - something that would have been required if Georgia had been a member of Nato - would have risked a general war. It is highly improbable that even Bush and Cheney are ready to wage a thermo-nuclear war over Georgia. In any case, such a large proportion of US military capabilities is tied up in Iraq and Afghanistan that Washington's options are hugely restricted. It shouldn't be forgotten that, in the most dangerous crisis of the Cold War, the Cuban missile crisis of October 1962, the US enjoyed massive local conventional superiority.

Thirdly, Putin and Medvedev could play the same game of divide and rule between "new" and "old" Europe that Bush's then defence secretary, Donald Rumsfeld, publicly espoused in the lead-up to the Iraq war. The central and east European states see membership of the European Union (EU) and Nato as a package offering both admission to the liberal capitalist club and a security guarantee against Russia. Since the Georgian war they have been joined in their denunciations of Moscow and demands for Nato solidarity with Georgia and Ukraine by Washington's pathetic Whitehall gofers, Gordon Brown and David Miliband. Poland rushed to sign a highly unpopular missile defence deal with the US.

The leading continental powers, France and Germany, have taken a very different line. They vetoed Nato membership action plans for Ukraine and Georgia back in April. They have ensured that Nato and EU summits since the invasion have confined themselves to words and not deeds. Even Silvio Berlusconi's right wing government has taken a soft line on Georgia. The reasons for this stance are thoroughly ignoble (especially in Berlusconi's case), but the most important of them - the EU's growing energy dependence on Russia - isn't going to change any time soon.

European natural gas production is projected to fall to half its 2006 level by 2020. Russia has the world's largest natural gas reserves. It's not rocket science to predict that the contribution of Russian gas to European consumption is going to rise above its current level of around 25 percent. Simon Blakey of Cambridge Energy Research Associates told the Financial Times, "The scale of the inter-dependence is so huge it is really not possible to make a major difference to it even over the space of two decades."

This gives Russia a long term advantage, by enabling it to divide Washington's European allies and thereby to undermine its ability to brigade them together in a confrontation with Moscow. This is one among many reasons why we aren't going to see a new Cold War. But the most important is that Russia's relative power has declined significantly over the long term, even if it has revived somewhat recently. The USSR emerged from the Second World War as the biggest land power in Eurasia. By the 1970s it had a massive thermo-nuclear arsenal and the capability to project conventional military power globally. As recently as 1980 the Soviet Union produced 14.8 percent of global manufacturing output, nearly half the US share of 31.5 percent.

In 2007, on the most favourable measure of national income (purchasing power parity), Russia accounted for 3.2 percent of world gross domestic product, less than its 1992 share of 4.2 percent, and way below the US share of 21.63 percent. The highest estimate of Russian military spending put it at $70 billion in 2006, compared to the Pentagon's $535.9 billon. Russia has lost strategically and economically vital territory in Ukraine and Central Asia, and its population continues to decline. It is also vulnerable because of its much greater integration in global markets than in the state capitalist era. Since the Georgian war Russia has experienced a significant flight of capital. The Moscow stock market fell 50 percent between its May peak and mid-September (though this was partly caused by a local version of the global credit crunch).

But these weaknesses should be put in perspective. The gap between Washington's and Moscow's economic and military capabilities is indeed far greater than it was during the Cold War. This means that the US is the only genuinely global imperialist power. So it has to spread its resources much more widely than any other state and hence is vulnerable to what the historian Paul Kennedy called "imperial overstretch". It is precisely such a crisis, arising from the US's entanglement in western Asia, that Russia has been able to exploit.

Moscow still has very formidable military capabilities that have been renewed thanks to the energy bonanza. It has demonstrated in Georgia both its capacity and its will to assert its own imperial interests along its borders. Russia may not be able to compete with the US globally, but it can contest Washington's influence in several important regions, particularly those that are critical energy suppliers - certainly the Caucasus and Central Asia and potentially the Middle East as well.

What this shows is that, despite US primacy, contemporary global politics is still shaped by what Marxists have traditionally called inter-imperialist rivalries. And this is without taking into account the significant redistribution in global economic power that is currently under way as a result of China's headlong expansion. The hype about China as the "next superpower" is nonsense. Even if it continues to grow at the rate of 8 to 10 percent a year, it will remain a poor country for decades to come.

But China is set to become the most powerful state in East Asia, the most dynamic region of global capitalism over the past quarter century. Given that the US seeks to dominate this region, along with Europe and the Middle East, and given that China's appetite for raw materials has already dramatically rejigged traditional relations of dependence in Africa and Latin America, there is bound to be greater rivalry between Washington and Beijing. Already the Pentagon is required to submit an annual report to the US Congress on the development of China's military capabilities.

So we are confronted with a cocktail of instabilities. One could throw in more: what, for example, if China's ramshackle hybrid state and private capitalism implode, as many commentators think they might? But the main sources of instability are clear enough - the interaction between capitalism's crisis-driven economic development and the efforts by the US to maintain its hegemony at a time when changes in the relative power of states are undermining its position. The dangers that this interaction generates have been underlined by the war in the Caucasus.

The remedy is clear enough, if hard to achieve. In the face of the declining "sole superpower" we need to revive the "second superpower" that the New York Times invoked at the time of the mass anti-war protests of 15 February 2003. But this time we need to direct its power not just against the warmongers and profiteers, but at the system that drives them.