Capitalism is in crisis once again. In early March we saw the first wave of bank failures since the 2008 global financial crisis. Why has this happened and what does it have in store for us? To answer these questions we first have to take a short detour into recent history.
The state of the economy before the banking crisis
To understand the roots of the current crisis we need to reach all the way back to the end of World War II. The war and the global depression that preceded it provided new space for a fresh round of capital accumulation. The global rate of profit exceeded 20 percent in 1950. The natural tendency for this rate of profit to fall, which Marx analyzed in volume three of Capital, was delayed through waste expenditure into armaments and a low level of international competition during the cold war in what’s come to be known as the “permanent arms economy.”
When competition began to be restored to the system toward the end of the 30-year post-war “long boom,” money had to be thrown into labor-saving technological innovation in order to undercut international competition. The trouble is that since human labor is the only source of value, less labor being employed in the production of each commodity actually means a declining rate of profit, as Marx described. This dynamic is what led to the crisis of the 1970s when the post-war boom finally came to an end.
Profitability was restored to a small degree with the neoliberal restructuring of the economy. The “Volcker shocks” (raises to the Federal Reserve’s interest rate initiated in 1979 by the then Chairman of the Federal Reserve Paul Volcker) raised Fed interest rates to a peak of 20 percent in 1981. This was ostensibly intended to slash inflation, but in reality served the dual purpose of disciplining labor into accepting declining living standards. A small amount of unprofitable capital was wiped out and workers were forced to accept declining living standards to prop up a declining profit rate.
As with the example of the Volker shock, before World War II, profitability was regularly restored to the system through periodic crises that wiped out large sections of unprofitable capital. Yet over time this produced a dangerous alchemy with another key feature of capitalism: its tendency toward the concentration of capital into smaller and smaller hands. If crises are necessary to restore profitability, what happens when the unprofitable capital is “too big to fail”? These unprofitable sections of the economy have been artificially kept alive by various forms of government support at the cost of stagnation—low profitability and low rates of growth. For the unprofitable sections of capital to fail today would mean a level of destructiveness that could threaten the system itself. These companies limp on as “zombie firms,” kept alive through state measures such as low interest rates and quantitative easing.
The trouble is that with low levels of profitability in productive investment, investment into financial markets has started to become more appealing to investors. The easy money coming from the state has often been put into finance rather than production as it was originally intended. The result has been speculative bubbles that can burst when the bill comes due, as with the housing collapse of 2007-2008.
The net result of all of this is the weak recovery since 2008, with low levels of profitability and sluggish GDP growth. This again led the world’s central banks to go on an “easy money” spree, producing bubbles that were inevitably going to burst.
All of this worked to prop up the system enough that it could limp along until an inflationary crisis hit following the pressures of COVID-19 and the war in Ukraine.
The inflation crisis
Seeking to insulate their own class from having to pay for the inflation spiral, the capitalist press has been targeting workers for apparently having too much leverage and doing too well, never mind two economic crises and a global pandemic in the last fifteen years. They pin the tight labor market as being responsible for increasing costs. It’s this reasoning that has led central banks to raise interest rates to combat inflation. The ruling class’ idea here is that when a central bank raises interest rates, there will be less money in circulation, since to make a profit private banks will have to charge a higher rate to the businesses who need a loan. This, in turn, raises costs for most businesses, which rely on some stream of borrowing, driving less efficient businesses under, and making most businesses more cautious in their spending. As a result, businesses have less need of workers, wages will fall, and unemployment rises. Under this theory, inflation will be reduced.
Thus, if you can afford the 40 dollar a month to get past a paywall, you get to read heart-warming passages in the business press like the following:
The big unknown now is whether jobs markets are already slowing enough to take the edge off wage growth—or whether central banks will feel the need to raise interest rates further and keep them high for longer, in order to engineer job losses and financial pain.
This logic has been on display each month when higher-than-expected job numbers have been published. The horror! Previously unemployed people are now able to choose between jobs, and the previously employed have some greater say over the conditions of their work!
The irony of the whole situation is that the evidence overwhelmingly suggests that the explanation for the inflationary crisis lies not on the demand side at all. As the economist Michael Roberts suggests,
The cause lies with the failure of the capitalist sector to supply enough to meet the demands of workers and capitalists as economies came out of the COVID slump; particularly in energy and food—and of course, the fossil fuel and other companies have taken advantage of shortages by raising prices.
Roberts’s argument here is that rather than a tight labor market leading to wage growth and then price increases, it is supply shortages that have led to prices trending up. This has led a minority of economists to argue for an entirely different sort of strategy focused on combating inflation at the supply side, with direct government intervention in production and the procurement of needed resources. But such an approach would impact who would end up paying for the crisis, and the ruling class is determined to find a way to make us pay for it.
But it wasn’t just these supply shortages that account for the increase in costs. As Joseph Choonara recounts from data from U.S. Bureau of Economic Analysis,
Between the second quarters of 2020 and 2022, 40 percent of average unit price rises were increased profit, 38 percent increased non-labour costs. Only 22 percent was due to increased labour costs.
The plurality of the price increases we have been seeing over the past two years have been from corporations using inflation as an excuse to increase their shrinking profit margins and line their pockets. Supply shortages have allowed companies to increase their margins if they have sufficient market power to force that upon us. Yet all we hear about in the news is that working class people are to blame and will have to pay.
Rather than stopping to consider that the failure of their strategy of raising central bank interest rates might mean their assessment of inflation has been incorrect, they just plow ahead, hoping against hope they can find a way to make working people pay for the crisis.
While deeper structural issues were at play too, it was precisely the ruling class’ strategy of tackling inflation that was the immediate cause of the recent banking crisis.
The March banking crisis
After years of low interest rates following the 2008 recession, central banks finally started to raise rates in 2022 in response to a level of inflation not seen since the early 1980s. How did this precipitate these collapses? The answer comes down to “liquidity,” or a bank’s ability to quickly turn investments into cash.
When the U.S. Federal Reserve started to raise interest rates, bonds (essentially a loan to a corporate or governmental agency that returns a dividend at a fixed rate and which can itself be traded on the market) that had been purchased when interest rates were lower began to depreciate in value. A bond purchased when rates were 1 percent loses its resale value when you can get a higher yield bond when rates are at 4.75 percent. The Federal Reserve has now hiked up interest rates nine times over the past year. As rates went up, newer bonds became more valuable to investors, and the rate at which the old bonds could be bought went down. These are known as “unrealized losses” since they only turn into real losses if the banks have to sell them. It’s estimated U.S. banks are facing $1.7 trillion, or 80 percent of their capital, in these types of losses.
The result is a case study of the collective madness of the paranoid opulent who run our economic system. It’s a self-fulfilling craziness of the tallest order and with enormous human stakes.
When people realize that a bank’s assets are tied up in bad bonds, they know that there will be a general worry about the bank’s ability to give them their investments back. Knowing that other people are thinking this, they know others will be trying to get their investments out while the bank still has the ability to do that. This creates a mad rush by investors to get investments out of the bank, forcing the bank to sell their bad bonds to obtain cash to cover the withdrawals and realizing those (formerly unrealized) losses. While the federal government attempts to create stability by insuring $250,000 of each bank deposit, 90 percent of Silicon Valley Bank’s deposits exceeded this amount (also 90 percent for Signature and 68 percent for First Republic). The result was that 25 percent of their deposits fled within a single day.
It was not a coincidence that the California tech bank and 16th largest in the nation, SVB, was the first to fold under the pressure of higher interest rates. After years of expansion that some had assumed would be practically infinite, the tech sector has run into limits upon its growth. As Derek Thompson writes in The Atlantic,
The period after the Great Recession was … an era of endless cash that venture capitalists, seeking high rates of return, poured into low-marginal-cost software companies … Then came the surge of post-pandemic inflation. Rising interest rates have meant the end of easy money … As the cost of risk has gone up, venture funding has gone down, and companies have had to cut costs, raise prices, or both. Meanwhile the narrative in markets has flipped from growth to profits, and valuations for tech companies have crashed.
This banking contagion has been international, with banks like Credit Suisse collapsing after more than 150 years in business, and Deutsche Bank running into serious problems as well. A worrying 10 percent of banks have larger unrealized losses than SVB.
This is a problem that is more acute for small banks, since their ability to turn investments into cash is generally poorer than larger ones.
Increased rates run the possibility of carrying with them a general debt crisis, as individuals and firms struggle to pay their debts.
A coming crisis in real estate?
Another crisis looms on the horizon in commercial real estate. Here we have another case where a low rate of profit in production has led to a potentially catastrophic financial bubble.
Before the pandemic, when interest rates were low, small banks had invested heavily in commercial real estate lending and bonds. But since the pandemic, the commercial real estate market has plummeted (19 percent of office space sits empty in the U.S.) and with mortgage rates going up with interest rates increasing, this could cause a wave of defaults on loans. €1.5 trillion of debt exists of this type in Europe alone. Citigroup estimates that the value of this market could fall by 40 percent by the end of 2024. Already this has impacted some $3 billion in loans that have defaulted. This will again hit small and midsize banks the hardest, who are already suffering the most. While loan-to-value ratios are generally better now than they were before 2008, the access to easy money following 2008 will not be available due to high interest rates.
In their own words, banks face a perfect storm “of weaker underlying demand for space, higher construction and maintenance costs, fewer potential buyers or lenders and higher interest charges.”
This is one part of a larger “credit crunch,” in which risk-averse banks, which are continuing to lose cash from withdrawals, become increasingly closefisted about how they lend out money. As one author put it in the New York Times, the question now “is whether banks and other lenders will pull back so much that the U.S. economy crashes into a severe recession.”
All of this puts central banks in an incredibly precarious position with no good options. Do they continue to raise interest rates in order to fight inflation, or do they keep them lower in order to minimize the risk of more banking (or housing market, or corporate, etc.) failures? With the profit rate so low and so much of the economy artificially propped up by low rates, raising them more and more will eventually result in disaster. The capitalists have no good options here.
So far the Federal Reserve has opted to continue with their previous strategy, raising rates by a quarter of a percentage point from 4.75 percent to 5 percent on March 22. The European Central Bank has done the same, raising rates to 3 percent earlier in March. This indicates that they feel strongly that the banking system as a whole is in good enough shape to take these further increases and are still prioritizing the fight against inflation. They are playing with fire, though.
We now have sections of the ruling class talking about the possibility of a “slow rolling crisis” that could potentially last for years. Bank lending to both productive businesses and individuals is likely to fall with tighter loan terms having an enormous impact on the economy.
As Nouriel Roubini writes,
As I have long warned, central banks confronting this trilemma will likely wimp out (by curtailing monetary-policy normalization) to avoid a self-reinforcing economic and financial meltdown, and the stage will be set for a de-anchoring of inflation expectations over time. Central banks must not delude themselves into thinking they can still achieve both price and financial stability through some kind of separation principle (raising rates to fight inflation while also using liquidity support to maintain financial stability). In a debt trap, higher policy rates will fuel systemic debt crises that liquidity support will be insufficient to resolve.
To translate this into ordinary language, in the long run, given the low rates of profitability, central banks will be forced to let inflation run free, producing an increasingly bad cost of living crisis in order to avoid a severe economic depression.
The question is not if capitalism is facing a coming period of crisis. The question is how deep that crisis will be. But if the banking crisis does become bad enough, the ruling class will try to ‘socialize’ the losses, i.e., make us pay for it. First, the rich will be bailed out with our tax dollars, driving up government debts at a time when the U.S. is at risk of defaulting on them. That deficit will then be made up through austerity in public spending.
The prospects for global capitalism over the next few years appear to be quite dim. The forecast coming even from bourgeois economists is for low growth, recession and crisis.
Unwilling to accept the massive level of destruction that restoring profitability to the system would entail, the bureaucrats who man the unwieldy controls of the system delayed the crisis in 2008. After a fifteen year period of stagnation, that decision eventually led to the crisis we’re experiencing today.
Given the political costs, it’s unlikely these bureaucrats will let the reins fly free to precipitate the destruction necessary to restore profitability. Rather, they will continue to try to manage a declining and increasingly contradictory economic system with a diminishing degree of success.
But there may be circumstances beyond their control that push the system past the point their imperfect tools can manage. War, environmental collapse, business failures, or some combination of the three, may eventually bring about the level of destruction necessary to remove unprofitable sections of capital to allow for a new round of expansion. But the human cost would be enormous, comparable to the period of the 1930s and 1940s, and likely worse. As in the 1930s, the threat of fascism could become increasingly acute. The suffering and premature death of untold millions (perhaps billions) of people – that is what lies between where we are now and restored profitability for the system.
What’s next for the working class?
The question again comes back to “why?” Is it because of material shortages that countless millions of working people are going to suffer in the coming years? There is materially more than enough to feed and house everyone. The crisis exists only as inhumane social relations: It is the price that must be paid for the dominance of a tiny number of individuals over the entire earth. This spell must be broken. The cost for not doing so at this historical moment will be unimaginable suffering.
How will workers respond to the crisis? We have seen some hopeful signs. Due to high inflation and low unemployment, 2022 and the beginning of 2023 have been high points for labor activity relative to the past forty years or so. We have seen mass strike waves in Britain, and mass resistance to the state in France that has been as inspiring to watch from afar as anything I can think of. There are hopeful indications this militancy will continue into the near future.
There are two possibilities for the working class going forward. The first is that we carry this spirit of resistance into this economic crisis and resist the imposition of capital to make us pay for the crisis. This can eventually be leveraged into the building of a better world, based upon rationally managed production and distribution focused on meeting general human need. The other is that we allow capital to steal from us in order to pay the blood cost of maintaining their insane system.
As always, the action or inaction of the working class determines the future. It’s up to us.
Featured Image credit: pingnews; modifed by Tempest.
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Thomas Hummel is a member of the Tempest Collective living in New York City.