Michel Chossudovsky on Tue, 6 Jan 1998 00:21:06 +0100 (MET)

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<nettime> The Global Financial Crisis



        Michel Chossudovsky

The writer is Professor of Economics at the University of Ottawa and has
written widely on issues of international finance and macro-economic
reform. He is the author of "The Globalization of Poverty, Impacts of IMF
and World Bank Reforms", Third World Network, Penang and Zed Books, London,

Copyright by Michel Chossudovsky, Ottawa 1997. All rights reserved. (This
text can be posted, for publication in printed form, contact the author).

The author can be contacted 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 ten years later on Friday August 15, 1997, Wall Street experienced
its largest one day decline since 1987. The Dow Jones plummeted by 247
points. The symptoms were similar to those of Black Monday: "institutional
speculators" sold large amounts of stock with the goal of repurchasing them
later but with the immediate impact of provoking a plunge in prices.
Futures' and options' trading played a key role in precipitating the
collapse of market values.

The tumble on August 15, 1997 immediately spilled over onto the World's
stock markets triggering substantial losses on the Frankfurt, Paris, Hong
Kong and Tokyo exchanges. Various "speculative instruments" in the equity
and foreign exchange markets were used with a view to manipulating price

In the weeks that followed, stocks continued to trade nervously. Wide
speculative movements were recorded on Wall Street; billions of dollars
were transacted through the NYSE's Superdot electronic order-routing system
with the Dow swinging spuriously up and down in a matter of minutes. The
Asian equity and currency markets declined steeply under the brunt of
speculative trading. In a three week period the (Hong Kong) Hang Seng Index
had declined by 15 percent. The Japanese bond market had plunged to an all
time low.
In turn, billions of dollars of central bank reserves had been appropriated
by institutional speculators. (The Thai Central Bank lost more than ten
billion dollars of its official reserves in the period extending from June
through September 1997).

Business forecasters and academic economists alike have casually
disregarded the dangers 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

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.

Table 1: Single-Day Declines on Wall Street

(Dow Jones Industrial Average, percentage change)

    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 5, 1932                 -7.15%
    September 24, 1931           -7.07%

    October 19, 1987               -22.6%

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) unleashed a wave of corporate mergers, buy-outs and bankruptcies.
These changes have 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. In the process, commercial banking functions have coalesced with those
of the investment banks, stock brokers and currency dealers.

The 1987 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 NYSE. Totally removed
from entrepreneurial functions in the real economy, they have the power of
precipitating large industrial corporations in bankruptcy.

Their activities include speculative transactions in commodity futures,
stock options and the manipulation of currency markets including the
plunder of central banks' foreign exchange reserves (eg. Thailand,
Indonesia, Malaysia and the Philippines in July-September 1997). They are
also routinely involved in "hot money deposits" in the emerging markets of
Latin America and Southeast Asia, not to mention money laundering in the
many offshore banking havens. The daily turnover of foreign exchange
transactions is more than one trillion dollars a day of which only 15
percent corresponds to actual commodity trade and capital flows.

Within this global financial web, money transits at high speed from one
banking haven to the next, in the intangible form of electronic transfers.
"Legal" and "illegal" business activities have become increasingly
intertwined. Favoured by financial deregulation, the criminal mafias have
also expanded their role in the spheres of merchant banking.

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. No
need to produce commodities: enrichment is increasingly taking place
outside the real economy divorced from bona fide productive and commercial
activities. In turn, part of the money accumulated from speculative
transactions is funnelled towards the 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. Wage inequality has risen in the
OECD countries. In both the developing and developed countries, poverty has
become rampant; according to the ILO, Worldwide unemployment affects more
than 800 million people. The accumulation of financial wealth feeds on
poverty and low wages.

The post-1987 period is marked by economic stagnation. In the OECD
countries, GDP growth has fallen from 3.1 percent per annum in the 1980s to
a meagre 1.7 percent in the 1990s. 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. The figures on GDP, however do
not reflect the seriousness of the slide in production living standards
around the World.

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 stated authoritatively in 1928 that
"nothing resembling a crash can occur". In 1929, a few months before the
crash, he affirmed that "there may a recession in the price of stocks but
nothing in the nature of a catastrophe".(quoted in Michel Beaud, A History
of Capitalism, Monthly Review Press, New York, 1983, p. 158).

The illusion of economic prosperity persisted: optimistic business
predictions prevailed even after the collapse of the New York Stock
Exchange. 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 [1987] crash had left many people wondering what happened, why it
happened and what can be done to prevent it from happening again". The
broad economic causes of the crisis are not addressed. Echoing almost
verbatim the economic slogans of Irving Fisher, today's economic orthodoxy
not only refutes the existence of an economic recession, it also denies
outright the possibility of a financial meltdown: "Happy days are here
again ...a wonderful opportunity for sustained and increasingly global
economic growth is waiting to be seized..." (Let Good Times Roll, Financial
Times, editorial commenting the OECD economic forecasts, January 1st,
1995). 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...

In the aftermath of the 1987 stock market 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

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 once the Dow
Jones falls by more than 50 points.("Five Years On, the Crash Still Echoes,
The Financial Times, October 19, 1992). These so-called "circuit-breakers"
have proven to be totally ineffective in averting a meltdown.

Recent experience amply demonstrates that the Dow Jones can swing back and
forth by more than fifty 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. Federal Reserve
Board Chairman Alan Greenspan admits that: "[while technological advances
have enhanced the potential for reducing transaction costs (...), in some
respects they have increased the potential for more rapid and widespread
disruption" (BIS Review, No. 46, 1997)

Moreover, in contrast to the 1920s, major exchanges around the World are
interconnected 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, including foreign exchange
and commodity markets, not to mention the markets for public debt... The
demise of national currencies under periodic attack by institutional
speculators will inevitably backlash on the trillion dollars Euro and Brady
bond markets.

The Fate of National Economies

Under the brunt of an impending balance of payments crisis, several of the
largest debtor countries in Latin America, Southeast Asia and Eastern
Europe are facing the same predicament as Mexico. Following the Mexican
1994-95 crash, the IMF Managing Director Mr. Michel Camdessus intimated
that ten other indebted countries could meet the same fate as Mexico
requiring the application of potent doses of economic medicine: "we will
therefore introduce still stronger surveillance to be sure that the
convalescence goes well...".  (quoted in David Duchan and Peter Norman,
"IMF Urges Close Watch on Weaker Economies", Financial Times, London, 8
February 1995, p. 1). However, by crippling national economies and
requiring governments to deregulate, the IMF's "economic therapy" prevents
the possibility of a "soft landing". "IMF surveillance" of debtor
countries' macro-economic policy tends to further heighten the risks of
financial meltdown.

The present economic crisis is far more complex than that of the interwar
period. Because national economies are interlocked in a system of global
trade and investment, its impact is potentially far more devastating. The
technological revolution (combined with delocation and corporate
restructuring) has dramatically lowered the costs of production while at
same time impoverishing millions of people.

Macro-economic policies are internationalised: the same austerity measures
are applied all over the World. In turn, large corporations have the power
to move entire branches of industry from one country to another. Factories
are closed down in the developed countries and production is transferred to
the Third World where workers are often paid less than a dollar a day.

The social consequences and geo-political implications of the economic
crisis are far-reaching particularly in the uncertain aftermath of the Cold
War. In the developing World and in the former Soviet block, entire
countries have been destabilised as a consequence of the collapse of
national currencies often resulting in the outbreak of social strife,
ethnic conflicts and civil war... In the former Soviet Union as a whole,
industrial output has plummeted by 48.8 percent and GDP by 44.0 percent
over the 1989-1995 period. (Official data compiled by the United Nations
Economic Commission for Europe). In some cases, wages have fallen to less
than ten dollars a month; in Bulgaria, old age pensioners receive two
dollars a month.

Budget austerity, plant closures, deregulation and trade liberalisation
have contributed to precipitating entire national economies into poverty
and stagnation. In turn, the evolution of financial markets has reached a
dangerous cross-roads. The massive trade in derivatives undermines the
conduct of monetary policy in both the developing and developed countries.

Dangerous Cross-Roads

The speculative surge of stock values 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 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 would lead to massive loan default
sending a cold shiver through the entire banking system; it would 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, programme trading, index futures, etc.) should be

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 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..."(BIS 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 often have a vested interest in upholding
dominant financial interests. At the June 1997 Denver Summit, G7 leaders in
a muddled and confusing statement called for "stronger risk management",
"improved transparency" and "strong prudential standards". 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

A form of "financial disarmament" is required directed towards curbing the
tide of speculative activity. (The term "financial disarmament" was coined
by the Ecumenicl 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 global economic system is affected not only by the forces of recession
and financial restructuring but also by complex social, political and
strategic factors. 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 en 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.

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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