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What’s driving the new economic crisis?

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Markets and the pound are in turmoil after Tory chancellor Kwasi Kwarteng’s mini budget last month. Sam Ord asks Marxist economist Joseph Choonara crucial questions about what lies behind the meltdown—and how it might impact working class people
Issue 2825
Prime minister, Liz Truss

Many questions are being asked about Liz Truss’ chaotic rule (Picture: Simon Dawson/No 10 Downing Street)

Why are interest rates going up?

Central banks, such as the Bank of England, the US Federal Reserve and the European Central Bank, can use interest rates to influence how cheap or expensive it is to borrow money. They do that by altering the rate at which they pay interest to commercial banks that keep deposits with them.

What we’re seeing at the moment is an increasingly inflationary environment. That’s been triggered by a collision of pent-up demand during the Covid lockdowns and disrupted supply. It was then reinforced by the impact of Russia’s invasion of Ukraine and the sanctions imposed by the West.

That burst of inflation is kept alive by firms passing on increased costs to consumers and by them bolstering profits through price rises.

The idea that the central banks have is that if they raise interest rates, borrowing becomes more expensive, so in turn economic activity will slow down and prices will stop surging. But it’s important to understand, it’s a fairly crude instrument—particularly in a situation where lots of inflation has been imported through things such as rising energy costs.

It’s also quite problematic because over the past decade and a half capitalism has come to rely on ultra low interest rates. That means there are a lot of heavily indebted companies and cranking up interest rates will cause a lot of these companies to fail.

This will crush economic activity so much that the central banks may trigger a deep and prolonged recession. There’s some evidence that this is already beginning to happen in Britain. 

Why don’t the markets like the new Tory policies?

Prime minister Liz Truss and chancellor Kwasi Kwarteng mark a break from previous Tory governments.

In the David Cameron and George Osborne years, we saw the Bank of England provide ultra-low interest rates and quantitative easing. Those measures, combined with brutal austerity to reduce the budget deficit and public debt, helped to drag the economy out of the 2008 to 2009 recession.

More recently, we’ve had the Boris Johnson and Rishi Sunak years in which interest rates stayed low. But we also had huge state intervention in the economy, particularly during the pandemic when the state supported about a third of workers. Johnson wasn’t particularly pushing austerity. He was more interested in securing support among less affluent voters in former Labour areas.

Johnson and Sunak were prepared to accept some tax raises to fund those policies.

Truss and Kwarteng have a very different approach. They want the state to play a smaller role economically while being relaxed about using public sector debt to drive through emergency measures.

This includes the energy price cap and, more significantly, tax cuts for the richest. They’re gambling on what are known as supply side reforms to boost growth. That means they are very serious about driving through deregulation, tax cuts, attacks on trade unions and more, in the hope of increasing firms’ profitability.

But most ruling class people don’t think it’s a great idea to engage in a mass of unfunded tax breaks for the super rich, along with a hugely costly energy price cap scheme. They think that public spending is on an unsustainable footing.

That is why markets have crashed in the wake of Kwarteng’s fiscal event. Even the International Monetary Fund (IMF) has condemned what the government is doing.

That doesn’t mean that the IMF is socialist. It’s a disagreement over what kind of capitalist policy will work to secure profitability. 

Why are there splits between the Bank of England and the government?

Kwarteng has, to an extent, declared war on the Bank of England. One of his first acts as chancellor was to sack the most senior treasury civil servant. And he’s challenged Bank of England officials, telling them to focus on growth.

Then came the fiscal event, which the Bank of England believes will weaken the pound and boost inflation. That means that the Bank of England is now under enormous pressure to raise interest rates further —which it claims will likely trigger a recession.

If that happens it will make government borrowing even more expensive, worsening the problem of public debt.

There’s a big mismatch between what the government is doing and what the Bank of England is doing.

The government is expanding its public debt in order to pay for these tax cuts. But the Bank of England wants to raise interest rates to tame inflation. The two are not compatible approaches. Now, the Bank of England is stepping in to try to quell the fires lit by Kwarteng.

The value of long term treasury bonds—which were issued by the government to fund its debt—has collapsed. This was starting to threaten the viability of pension funds, which play a massive role in the financial system and hold vast amounts of government bonds.

The Bank of England was forced to step in to buy these treasury bonds in order to prop up their value. That’s the opposite of what they want to do.

In the aftermath of the 2008 economic crisis, part of the bank’s quantitative easing programme was to acquire a vast amount of these bonds to flood the financial system with liquidity.

It’s now trying to unwind this quantitative easing programme by trying to sell these kinds of bonds, not buy more. 

Why does the pound shift in value?

Since the early 1970s we’ve lived in a world of mostly free floating exchange rates. That means different currencies shift in value relative to one another.

That depends on a range of factors, such as the strength of different economies, the rate of inflation and more. What we’ve seen since the fiscal event is a really sharp fall in the value of the pound, because currency traders have dumped the pound and bought other currencies.

That’s reinforced by the growing strength of the US dollar. The dollar is seen as a safe currency. That’s because the US is the world’s most powerful state and has the biggest economy, and because the dollar plays a key role in the global system.

So in moments of turmoil in markets, people tend to look to the dollar. The US Federal Reserve has reinforced that by pushing up its interest rates very sharply. This makes US assets much more attractive to investors and pushes up the value of dollar.

There are all kinds of reasons why, in relative terms, the pound is falling in value. It matters because key imports such as oil and gas are priced in dollars. So as the pound falls in value, those imports become more expensive and that’s going to make inflation worse.

It also reinforces the pressure on the Bank of England to raise interest rates here to counteract the fall in the value of the pound and make sterling assets more attractive to international investors. 

What did Karl Marx say about the power of finance and markets?

Marx was writing in a much earlier period so there’s been lots of innovation and change in the world of finance that we must understand. But it’s also true that Marx wrote his major works on capitalism whilst he was living in London, which then, as now was a major global financial centre.

Marx was both fascinated and horrified by the workings of finance. He saw banks and finance as a central element within the workings of capitalism, but one that also created problems for the system.

So one of the points that I take from Marx is that he sees credit and finance as a force that pushes capitalism beyond its limits but also a source of swindle and crisis.

That insight is something that has become clearer in recent decades as profit rates across many major economies have been at relatively low levels. Because of that, the system has become much more reliant on credit and financial innovation to drive it forwards. This is despite these financial activities not generating any new value.

Much of the financial system is, to some extent, parasitic on the production of value that takes place in what people sometimes call the “real economy”. These developments mean you have a bloated and fragile global financial system, which can spread and amplify crises.

We see panics, like the one that just hit pension funds, in which the state or central bank suddenly has to intervene to prop up the market.

Another important dimension of this system is the development of “zombie companies”. These are firms that don’t make much profit or invest very much, but are kept alive by cheap credit. That weighs down on the whole economy.

Traditionally capitalism would be able to fix this through an economic crisis, which would destroy unprofitable firms. But today we live in a world of huge multinationals bound up with this complex financial system and the state. So it’s very hard to envisage a crisis that can solve these problems without doing colossal damage to capitalism.

Marx would recognise these very deep contradictions of capitalism, which is why he was committed to overthrowing the system.

Why should the current situation matter to working class people?

We may not like capitalism but we live and work under it, so what happens to the system matters to us.

Many workers have pensions or mortgages that can become much more expensive as interest rates rise. Also, the cost of living crisis affects absolutely everyone, both in the sense of intensifying hardship for workers but also driving revolts against the system.

If a recession is around the corner, it can mean a surge in unemployment, further attacks on pay and so on.

If Truss and Kwarteng’s plan goes wrong, we might also see another huge round of austerity that hits ordinary people hardest.

The kind of splits at the top of society that we’re seeing also matter. My sense is that Truss is on shaky ground. She doesn’t have huge support among her own MPs, or in the wider Conservative Party, let alone among the electorate.

She’s alienating wider sections of the ruling class which destabilises her rule. That gives us—the left—the space to put forward our own alternatives from below.

For example, many people will welcome the fact there is an energy price cap but think it would be much better to seize the profits of the energy firms and use those to reduce costs. There’s lots of talk about controlling wage rises to tame inflation. But we should reply that the answer is not to control wages, but to control profits and prices.

Those sorts of ideas can gain a very wide hearing in the current period. And, at least among a minority of those who are interested in those ideas, you can talk about how the capitalist system is failing and needs to be overthrown.

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