In providing the historical backdrop to the current crisis (which they correctly refer to as a multiple crisis – health, economic, financial and environmental), Lim Mah Hui and Michael Heng argue that it should be a wake-up call for humankind to rethink its hyper-consumerist economy that prioritises growth, and growth that benefits just a tiny segment at that.
IT is widely known that the Chinese word for ‘crisis’ consists of two characters – wei ji. Wei stands for ‘danger’ and ji stands for ‘opportunity’. Every crisis is pregnant with danger and risks but also with opportunities – for some to make money, for others to learn valuable lessons, and for society to reorient or restructure its priorities, institutions and even the social system itself.
The COVID-19 pandemic could turn out to be the single biggest crisis in a century – a one-in-100-years event. It is a health crisis which, if not checked in its tracks, would be the most serious since the Spanish flu of 1918 that killed over 50 million people.
This crisis has further morphed into an economic and financial crisis as a result of globalisation. Due to the high degree of economic, financial and transportation integration, countries have become so inter-connected and interdependent that a breakdown or severe shock in one part reverberates through the whole system. That is why when COVID-19 hit China and forced a shutdown in certain regions, it delivered a supply shock to the world economy. Economists initially focused on the supply shock and hoped that when China recovered, the impact on the world economy could be minimised and a recovery would be swift. However, with air travel so prevalent, the virus was transmitted worldwide within a matter of weeks. In February only a few countries were affected, today 193 out of 195 countries are affected.
While the initial epicentre of COVID-19 was China, the aftershocks felt throughout the world are now more serious. The West, in particular Europe and the United States, have become the next pandemic epicentre. Already the number of deaths in Italy and Spain, as at this point of writing, is more than double the toll in China. Entire countries are in lockdown. This is not a demand shock but a demand collapse, the likes of which we have not seen for over a hundred years.
The repercussions are almost indeterminable. When businesses are closed, companies lose their revenue, workers are laid off, firms with interrupted cashflow slide into illiquidity and eventually bankruptcy, more workers get laid off, aggregate demand drops. The Federal Reserve Bank of St Louis predicted unemployment in the US could reach 32%, surpassing that of the 1929 Great Depression.
Monetary policies – setting the stage for crisis
Even though this economic crisis did not emanate from the financial sector, what happened in the sector over the last decade played a critical part in aggravating it.
Central banks in the US, Europe and Japan have lowered interest rates to near zero, hoping that this will encourage people to borrow, spend and invest. It is intended to reduce the debt burden, as the indebtedness of households and enterprises has been ratcheted up in recent years (see below). But the past few years have shown that this has little traction. It’s like pushing on a shoestring. Worse still, the credit and liquidity are not going to the right places. Individual households with little financial resources and small businesses are shunned by banks. Instead, banks lent to corporations and financial institutions. Corporations gouged on this cheap money and the world debt-to-GDP ratio rose from under 200% to over 300%. Unfortunately, much of this debt did not go towards financing productive investment, with investment remaining stagnant as a percentage of GDP. Instead, it went towards inflating financial asset prices and financial engineering tricks such as share buybacks.
When companies buy back their own shares, demand pushes up price, and the number of stocks in the open market is reduced by the amount bought. With a lower denominator and the same earnings, EPS (earnings per share) is automatically inflated. The stock price is based on EPS; the higher the EPS, the higher the stock price and the greater the CEO’s remuneration as the exceutives are rewarded based on share price performance. The average remuneration of CEOs in the US has risen 940% since 1978 while that of workers inched up by only 12%. CEOs made 287 times more than their average employees in 2018.
It is reported that the top 10 US airline companies used 96% of their free cashflow for stock buybacks, pushing share prices to record highs, instead of paying down debt and strengthening their balance sheets. This practice is ubiquitous and not limited to the airline industry. The moral hazard is that having depleted their cash, airlines are now seeking $200 billion in bailout funds from government. In 2019, corporations buying their own stocks constituted the dominant source of equity demand, more than households, mutual funds and exchange traded funds.
Causes of crises
Irrespective of the causes of financial crises, of which there are many, the one constant condition is excessive debt – companies and individuals borrowing in excess of their ability to generate the income to pay off the debt. The huge amount of liquidity unleashed by central banks created a mountain of debt leading to a big asset bubble. It is a dry powder keg waiting to explode.
For months economists had been debating what might trigger the financial crisis that was waiting to happen. Could it be the trade war between the US and the rest of the world, the US-Iran standoff, cyberwarfare, diversification of US Treasuries? Few, if any, anticipated that a bug invisible to the naked eye would be the agent to ignite the powder keg.
Significantly, all the major financial crises over the last few decades were not caused by consumer price or wage inflation, which the central banks watched over like hawks. They were caused by financial asset inflation, which is a direct result of the loose monetary policies described above. As usual, central banks kept their eye on the wrong ball. Not only that, they encouraged such behaviour with their asymmetric policies: on the one hand, allowing asset prices to rise, eschewing any state policy intervention and chanting the free-market mantra; and on the other hand, intervening to bail out or prevent declines in asset prices on the way down.
Despite the measures taken to strengthen the banking sector after the 2008 global financial crisis, other structural reforms did not occur. Banks’ balance sheets were significantly strengthened thanks to public bailouts and stringent capital ratio requirements, but other parts of the financial system became more speculative, fragile and unregulated. Finance, which caused the 2008 crisis, was the big winner post-crisis as the structural fallout was not severe enough. Today the health and economic crises threaten a major financial crisis again.
Where do we go from here?
We started this essay by stating that a crisis offers opportunities for us to do something different. It can be for the better or for the worse. Major crises are moments when classes in society engage in a contest for power to restructure the economy, politics and society. The failure of President Hoover to deal with the devastation of the Great Depression in the US led to the election of President Franklin Roosevelt (1933-38), who introduced major structural reforms in the economic, financial and political spheres. His ‘3 Rs policies’ were relief, recovery and reforms. He implemented large-scale public works programmes to mop up unemployment, introduced a social security safety net which still exists today, tamed and regulated finance by separating investment banking from commercial banking via the Glass-Steagall Act, and set up regulatory watchdogs for the stock market such as the Securities and Exchange Commission. These led to the eventual recovery of the economy and, most significantly, to a well-regulated financial system that did not experience major financial crises for over 40 years. Government took on a bigger role in the economy.
The stagflation crises of the 1970s, triggered by oil price hikes and countered by accommodative monetary and fiscal policies, led to serious inflation and the demise of Keynesian policies. Discretionary policy by governments had become discredited by the failure to produce growth while reducing unemployment. As a result, President Reagan in the US and Prime Minister Thatcher in the UK resurrected neoliberal market ideology – the role of government was severely rolled back, and the private sector and the market took control. Liberalisation, deregulation and privatisation were the order of the day. Government’s role was limited to creating conditions for business to grow and to fix the problems when market failures arise.
The financial sector was the main beneficiary of these policies. Finance became deregulated, banks merged and became ‘too big to fail’. The US financial sector nearly doubled its size to account for 19% of GDP, but it took home 40% of total US corporate profits. Financial innovations exacerbated speculation, risk taking, volatility and fragility. Consequently, major banking crises erupted approximately every 10 years with almost clockwork precision – from the US-Latin American banking crises in the early 1980s to the Asian financial crisis in 1998, the global financial crisis in 2008 and the imminent financial crisis in 2020. Finance, instead of serving the real economy, became its master as these crises originated in the financial sector; the tail is wagging the dog. In each of these crises, the financial players were bailed out at taxpayers’ expense only to grow even bigger.
If there is any silver lining to this dark cloud, it is found in some of the unintended positive consequences of this crisis – carbon emissions that have been choking the world are down significantly, traffic congestion has lightened, the mountains of garbage generated have shrunk, communities have gotten together to help the more unfortunate, and nature is reclaiming its space. As one US celebrity who was infected said in an interview, it is nature’s way of hitting back at what humanity has done to it. We were supposed to be the guardian and trustee of this earth but we abused it. Deforestation and the destruction of natural habitats have reduced the space between humans and wildlife, opening more chances for new pathogens to emerge. Epidemiologists have warned for decades about the potential and dangers of new pandemics. This is the most serious but unfortunately it may not be the last.
This multiple crisis – health, economic, financial and environmental – is a wake-up call for humankind to rethink its hyper-consumerist economy that prioritises growth, and growth that benefits just a tiny segment at that. It offers us the opportunity to restructure society into one that is more socially and economically equitable, is more respectful of nature and our environment, and strikes a saner balance between non-materialism and materialism. Since the 2008 global financial crisis, there have been nascent efforts to move away from the obsession with GDP growth as the measure of a society’s welfare and wellbeing. The small nation of Bhutan spearheaded the alternative concept of Gross National Happiness. But these movements are muted and sidelined. This crisis offers us the opportunity to bring them to the fore. Prime Minister Ardern of New Zealand recently said she would prioritise her people’s wellbeing over growth.
Karl Polanyi published The Great Transformation over 70 years ago. His great contribution was in showing that markets had existed for thousands of years before the rise of industrial capitalism in the 18th century. Markets where goods and services are exchanged to meet social needs were also subordinated to social, political and cultural norms. But this arrangement was overturned when the market was deified to become the only organising principle in society. Markets in society became the market society. This formed the basis of the neoliberal ideology that has dominated politicians and their policies over the last 40 years.
This crisis lays bare the myth of the invincibility of the market. The market has broken down in a big way and the state is asked to step in to resolve this crisis – from bailing out companies to paying wages of workers, cutting interest rates and guaranteeing soft loans to small businesses etc. US President Trump invoked emergency authority and directed companies to produce vital health equipment needed to fight the epidemic.
Once this is over, we should not be going back to business as usual. Markets will continue to exist and play a part in the economy. But they must be subordinated to society, regulated by the state to serve a greater good. The new economy must prioritise people’s as well as nature’s wellbeing over profit making for a few.
Dr Lim Mah Hui has been a university professor and banker, in the private sector and with the Asian Development Bank. Dr Michael Heng is a former professor in Management Science. This article was earlier published in The Edge (Malaysia).
*Third World Resurgence No. 343/344, 2020, pp 4-6