Archive for September 25th, 2008

Peeling the Onion: What's Behind the Financial Mess?

Sharon September 25th, 2008

If you want a pat answer to what has caused the financial crisis that is reverbating around the world, and now threatening the derivatives market, we’ve got one. Nearly everyone - in the mainstream media and outside it, tells the same story - that the crisis was caused by the unravelling of the housing market, particularly the US housing market.  And if you ask what’s behind that, well, we’re told there was a bubble.  And if you ask what was behind the bursting of the bubble, well…it is turtles all the way down.

 I’m not a turtles kind of gal, and so I thought it might be worth playing with root causes some more.  Now it is absolutely the case that original causes are virtually impossible to come by - everything is always multicausational. And there’s no question that the housing market was so ridiculously overvalued that in no sense could it have been sustained.  Still, it is sometimes interesting and productive to tease out some of the major causes of our problems, the things that explain why now and how, and I think there’s one that people haven’t been looking too carefully at - and one I think bears some exploration of.

I’m going to suggest that if you peel off the layers of the financial crisis, we’re going to find some pretty basic things.  And one of the basic things is, well, food.  It seems sort of anti-climactic, I think, if you are a pundit, to talk about the cost of rice and soybean oil as part of the root problem of such a massive financial crisis, but I suspect we’ll find it there.  And underneath the food, I think we’ll find oil. 

Most commentators have taken the food crisis, which has run more or less in parallel with the financial crisis - growing gradually through 2007, and beginning to move more dramatically towards crisis in the winter and spring of this year, as an irritating factor, a small push against already strapped consumers.  But I’m not really sure this is the right way to look at this.  Instead, we might look at the question of how the growth economy grows.  Some of it, of course, is through population increase - new workers, new consumers.  But population growth itself has proved over and over again to be insufficient - not only do we need more people, but the industrial growth economy always needs a larger percentage of the populace to serve it.  This is one of the reasons I tend to agree with Vandana Shiva that the population problem is not primarily a cause of our current crisis, but a symptom of it.

We might look at the boom and bust cycle of our economy, and indeed, the world economy, as one moved not just by energy, but by new workers (who then conveniently become new consumers and create new markets - remember, 70% of the economy is consumer spending).  Each boom cycle has followed the move of vast numbers of new workers into the economy, essentially creating more money in the form of productivity, and more income to spread around and lubrication to the economic system. 

 So, for example, after the Great Depression, we got the country moving in large part by the industrialization of a large portion of the agricultural population - millions of farmers were brought into the industrial economy either to serve in the service or work in the factories.  After the war, many of them never returned to the farms - and the GI bill and the conversion of wartime industry to peacetime industry encouraged lower income farmers to go to work.  The movement of people employed largely in the subsistence economy into the industrial economy created a huge boost - poor black farmers in the South moved to industrial centers in vast numbers to take advantage of good wages, and low income women who had worked in the factories never did return to pre-war levels of women’s work.

In the 1970s, as the economy began to stagnate again, the answer was a new influx of workers and consumers - quite rapidly, women began entering the workforce in staggering numbers, requiring new work wardrobes, second cars, fast food restaurants and daycare providers to take the place of what we had.  Workers who had primarily provided subsistence labor not counted into the GDP were transferred into the formal economy, and disproportionately as low wage laborers.  The excesses of the 80s began just as the numbers of women workers fully doubled - all of a sudden there was more money to go around - and this is hardly surprising since there was more work being done, and more money being spent both on luxuries and on paying to do the jobs that had previously lived in the subsistence economy.

The next wave of prosperity was a world scale one, running from the 1990s until pretty much the last couple of years - and again, millions of new workers and new consumers were inserted into the world economy, spreading money.  Suddenly there was new movement of funds, new workers doing new things and buying new stuff.  There were new markets again, and plenty of growth to go around.  Again, we find that the growth is primarily produced not by high value, highly educated workers in the new information economy - the most important economic growth during those periods was of new, low wage workers, moving from the subsistence economy into the industrial economy. 

It is worth asking why these low wage workers are so important to each bubble.  There are a couple of reasons.  The first is that even in the booming periods of cheap energy, it was never possible to mechanize or use oil for the majority of jobs - and as energy supplies rose in cost and tightened, it is less and less possible to do so.  The majority of all world farmers, builders and factory workers do use some machinery, but the primary engine of production is human work.  The other thing that matters is while there is a substantial difference in the pay scale of, say, an IT professional over a construction worker or a farmer, and the value of the work of the IT professional in the industrial economy is higher, moving people over to the white collar economy isn’t nearly as effective or profitable as taking people out of the subsistence economy and putting them on the lower rungs of the industrial economy.  First of all, you take a large portion of the productivity of a human being (remember, new industrial workers generally work long, long hours), without any amortized costs to provide him or her with health insurance or education.  That is, the total society investment in someone in the subsistence economy who then moves to working 12 hours a day in the industrial economy is very small, and the amount of work she does is quite dramatically more than what she did to serve the industrial economy when she was a subsistence farmer or a housewife.  Education, on the other hand, is expensive, and white collar workers like things like health care and vacation.  The money is in the new workers.

So what happened? Well, in America and the UK, some of it really just was a bubble popping.  But what, oh what funded the bubbles?  To a large degree it was the purchase of various American assets, including a lot of mortgages, by the newly cash flush emerging economies.  And gradually, gradually those purchases have slowed down - they began slowing in the fall of last year, after some rumblings even before that, and the slowdown has accellerate - it hasn’t stopped, but the flow of money into the American economy through various routes, including buying bundled paper, has slowed.  And it has slowed at least in correlation - I do not swear about causality - with the housing market.  Now the assumption has been that the slowing is due to the increase of risk - and that’s probably true to a degree.  But I think some further scrutiny might find that there’s another factor - that it has slowed as the emerging economies have been dragged down.

One of the news stories that came out last week was that in addition to the 100 million starving people that made the UN news last spring, we’ve now got still 75 Million more hungry people in the world than there were before.  The UN announced that essentially all of the progress made on global poverty up until now is being erased by the food crisis.

Now it might be worth asking - where are those 175 million new starving people coming from?  Before they were starving, who were they?  And the answer would be that many of them were the people who left their farms in China and Vietnam and Indonesia and a host of other places to go live in the slums of various cities and work there.  They were the people who were just getting by - the ones who sent a daughter to the factories and who did day labor in construction building up the economies.  They lived quite close to the edge, and then, they crossed the edge when food prices began to rise.   Now these were the lowest level new industrial workers - they weren’t buying cell phones, but they might have bought a few things that they wouldn’t have when they needed every penny for rice or bread - they sent their children, even their daughters to school, and bought clothes and pencils, they might save up for a radio for the family, and all these things, over millions of people, added up.  And they produced more than they were paid for the economy as a whole - their work was more valuable than their salaries could account for, as is the way of things.  But now they aren’t buying those things - their kids are out of school, there is no money for radios or batteries, and there’s no food - so they are working less, getting sick more, contributing less to the industrial economy, unable to make money selling things to the other people in their neighborhoods, because their neighbors have no extra money for anything either.  Not only are they starving, but they’ve stopped adding money into the economy - and stopped spending it on anything but food.

Meanwhile, the next tier up in income were the people who had a little more than just enough - enough and a bit to send back home to their families, to get a cell phone and some jeans and buy meat a bit more often.  These people worked pretty regularly at the new jobs - in factories, in building, in making the new globalized economy.  And they spent money too and moved it around within their communities, and back into the global economy - the spent a little money buying coca cola, which came back this way.  Now they aren’t starving yet, but the rising cost of food has pushed them too - now the coca cola and the meat are gone, except for the holidays, and there won’t be any more jeans.  Because now the money goes for food - they have food to eat, but not enough for those other things.  And so the money increasingly doesn’t move around that much - because the farmer who grew the rice they are buying spent most of his money buying fertilizer.  And so the money is headed mostly back to a few small companies - without a lot of stops around the neighborhood. 

 It is easy not to pay attention to such small things, and small people - after all, they aren’t spending much money, and their wages aren’t much. But they produce the stuff we need, they move money around - and hundreds of millions and billions of these small personal economies add up to quite a lot.  And the money that they made went places  - it took trips.  The money a poor Chinese worker generated in productivity went a bit into his pocket - and some of that went back to American corporations that made things.  And a lot of what he generated went into companies that invested in other things that fed our economy.  And some of it went to the Chinese government that used it to buy up dollars and other things that seemed to have some value.  It is perhaps not totally surprising, then, that as the Chinese worker got functionally poorer because of rising food prices, there was less money to pour back - times some millions.

And so it goes, down the latter.  The new workers, and the lubrication they provide in the global money system are being systematically impoverished, and what money they do spend goes to an increasingly narrow band of companies - instead of spreading the money around, money goes for very basic things - mostly food, and mostly basic foods.  And the farmers who make the basic foods mostly send that money back to a very small number of companies - the ones that produce oil and the ones that produce fertilizer - many of them located in the same countries and places. 

What is reducing the amount of productive work accomplished, and moving the money increasingly only into a few pockets?  It is the high price of food.  And what is the root cause of the high price of food?  Well, the single biggest factor, according to a number of studies, including the UN studies, has been the move to food based biofuels.  So if we peel back the onion one more layer, what we find is that one of the major factors slowing the economy has been, well, oil.  The rush to biofuels is a response to tightening oil supplies and rising costs, and the aggregate effect has been to push up food prices all over the world, while doing pretty much nothing to increase energy security, reduce greenhouse gasses or do much of anything else useful.

I’m no economist, and I don’t pretend to be.  But I wonder, when we peel back the layers of the onion later, and look at the history of this Depression, I wonder if we’ll see that in fact, what happened was that we squeezed out the lifeblood of the very thing we’d built our economy upon - new workers/consumers who could be counted on to grow the economy outwards and upwards.  We could have forseen this - but we chose not to - we chose, as we struggled to keep our lifestyle intact on the backs of the world’s poor, not to see that we stand on their backs, and it is people…all the way down.  In killing them, we killed ourselves. It may be that besides the tragedy of starving millions of poor people, we may also have brought down our own system, simply because we did not see, did not realize that the poor matter more to us than we like to admit.