Interview with Economist Jack Rasmus
Published 18 October 2014
TAYLAN TOSUN: Your 2010 book, ‘Epic Recession: Prelude to Global Depression’ provides a unique interpretation of the causes of the economic crash that occurred in 2008-09. You predicted the global economy would not fully recover from the crisis. You also warned this ‘Type II epic recession’, as you call it, could lead somewhat sooner to yet another financial crisis and this time a true global depression.
My first question is, what has changed essentially in the global capitalist system since the late 1970s that seems to suggest the system is shifting from productive investment to more financial asset speculative investing which you argue is fundamental to the instability in the global economy?
JACK RASMUS: The decade of the 1970s was one of severe economic crisis, especially for the advanced economies of the USA and Europe. A quarter century of USA economic dominance and easy growth since 1945 was coming to an end. Competition between capitalist economies was beginning to intensify, with the recoveries of Europe and Japan. Internally, unions and labor parties were demanding a bigger share of national income and were having some successes. In response, key capitalist sectors and politicians began restructuring internally and developing new strategies. The first fundamental change was the USA’s abandonment of the old Bretton Woods international monetary system, where the US dollar was pegged to gold and other currencies loosely to the dollar in turn. That would have the result of capitalist economies’ central banks, especially the US Federal Reserve, constantly pumping fiat money supply into the US and global economy. Over time this led to the rapid over-expansion of liquidity in the global economy, to the creation of new highly liquid financial asset markets, to new forms of financial securities traded in these markets, and to the rise of a new global financial elite with massive economic power and eventual unprecedented political influence as well.
Further developments thereafter intensified these trends: controls on international money capital flows were eliminated in the 1970s and 1980s, led by the USA but quickly followed by others. That opened the door to a more rapid expansion of finance capital worldwide. Then in the 1990s a revolution in digital technology created the internet that further accelerated the globalization of forms of speculative finance. Concurrently, regulations on banks were removed to clear the obstacles from the global expansion of finance capital. So financial deregulation was the consequence, not the fundamental cause, of the growth of finance capital. The more fundamental causes were the end of Bretton Woods, the shift of central banks thereafter to excessive liquidity creation, end of controls on international capital flows, and technology.
All of this accelerated the development of global speculative finance, since it paved the way for its true globalization. Capitalist investors discovered that it was easier to make money by creating money and speculating in financial assets they created instead of making (producing) real goods and assets.
Financial asset investment is therefore ‘crowding out’ real asset investment slowly worldwide. Global capitalism is slowing its rate of real investment. That’s why it is having trouble creating jobs and incomes for the rest. That’s why consumption is stagnating in the west, and why consumer debt is being offered as a substitute to households lagging in income growth. And that’s why the AEs are experiencing this ‘stop-go’ economic growth that continues. It’s a lack of real investment. But that slowing of real investment, it should be understood, is directly related to the shift to speculative financial investment by the global capitalist elite since the 1970s. The proliferation of shadow banks globally, the establishment of numerous highly liquid financial asset markets, and the creation of countless new financial security instruments to trade in those markets are all an expression, a reflection, of these changes. Together, they constitute what I call the new ‘global money parade’.
TOSUN: My second question is why do you define the last financial crisis as an ‘epic’ recession’, as a separate phenomenon from ‘normal’ recession?
RASMUS: I chose the term ‘epic’ recession to distinguish it from what has been called the ‘great recession’ that happened in 2007-09. I have a problem with that latter term. It was created by mainstream economists in 2009 in order to explain how that recession was different from the prior 10 recessions in the USA since 1948—i.e. that were ‘normal’. But the ‘great recession’ concept used by Krugman and others simply means it was ‘worse than’ a normal recession and ‘not as bad as’ a depression. That really tells you nothing. If one is to explain how the 2007-09 was different from previous recessions, it is important to explain how it was different both quantitatively and qualitatively. This I did in the first two chapters of my ‘Epic Recession’ book in 2010. In those chapters I provide a list of variables, both quantitative and qualitative, that constitute an ‘epic’ recession.
Because ‘normal’ recessions are due to shocks that destabilize the economy, traditional fiscal-monetary policies in capitalist economies since 1948 were able to restore stability. But depressions don’t respond to traditional fiscal-monetary policies very well. Nor do what I call ‘type II’ epic recessions, which I explain are ‘anterooms’ to a possible eventual depression. ‘Type I’ epic recessions are not as severe and can return to a normal recession condition. But ‘Type II’ epic recessions have a tendency to transform into depressions.
TOSUN: In your 2010 ‘Epic Recession’ book you describe inner dynamics of three successive phases: debt-deflation-default. Could you explain how this sequence leads to a big financial crisis?
RASMUS: To start, the explosion of excess liquidity globally by central banks and the expansion of ‘inside credit’ by the private banking system related to financial engineering and new securities creation together mean there is now massive total credit available for borrowing—far more than is needed to finance real asset investment. Investors and financial speculators put up part of their own money capital, but borrow the larger percentage. That leads to excessive debt creation.
When financial assets collapse in a banking crash, as happened in 2008, asset deflation occurs. Asset deflation then spills over to goods deflation, as lending by banks to non-bank businesses dries up and those businesses have to lay off millions. Mass layoffs mean less household income to purchase real goods and services. That in turn leads to rising business inventories and business reducing prices for real goods—i.e. deflation. The deflation in turn leads to rising defaults, as businesses can’t generate income to service their debt and previous loans.
TOSUN: In your book you refer to the ‘shadow banking system’ as a vehicle of the financial crisis. How’s that different from the classical banking system and how do shadow banks contribute to financial breakdown?
RASMUS: Shadow banks are the preferred financial investment institutions of the finance capital elite. That’s because they are basically unregulated. When a crisis occurs and the State intervenes to bail out the banking system with massive liquidity injections, a period follows when the State imposes some degree of financial regulation on the banking system, including the shadow banks. But capitalist investors eventually find a way to do a ‘run around’ the regulated banking system and create new, unregulated financial institutions again. They prefer the unregulated because they allow them, the investors, to take big risks and speculate big time. Big risks mean big profits. So following a crisis, investors rebuild their shadow banking system again. As this occurs the former, regulated banking sector demands the State allow them to engage in the risky high profit return speculative investing again. They demand financial deregulation and they eventually get it from the State. Then the two sectors, commercial regulated and shadow unregulated merge in various ways.
Because the shadow banks are linked to the commercial banks and in turn the real sector of the economy, when the shadow banks go bust in a crash, it spreads to the entire financial system and drags the entire edifice down. The banking system ‘freezes up’ in the wake of a crash and no one can get credit—including non-bank businesses, households, and even local government. The bigger the shadow system, the greater that the percentage of total investing is in financial asset speculation, the greater the risk factor of those investments, the more that debt has been used to finance the speculation—the greater the eventual financial bust when it comes.
TOSUN: How did the mortgage crisis in the USA turn into an ‘epic recession’ in the real economies of the many advanced capitalist countries?
RASMUS: The mortgage crisis occurred when the subprime mortgage securities market collapsed in price. About $4 trillion were issued in the period from around 2002-07. The mortgage crash did not ‘cause’ the crisis; it was the precipitating event for the financial crash. To understand the process, it is essential to understand the idea of ‘securitization’. Securitization occurs when a financial asset is combined with other financial assets to create a new security, a new financial asset. So securities are bundled together and then resold, often with a markup. Financial assets are based on real assets to begin with. A house is a real asset. The mortgage is the financial asset for it. But mortgages combined together create a mortgage bond. When the bond is sold, it means money is made on the bond as well as the original mortgage. When mortgage bonds are then combined with other financial assets, like an Asset Back Security, for example, it creates what’s called a Collateralized Debt Obligation (CDO). Some other ‘derivative’ instruments are also created in the same way, each built upon the other. This pyramid of securities is based, however, still on the original ‘house’ and mortgage, a real asset.
So we begin with financial assets based on real assets, but then financial assets based on other financial assets in the pyramid. But when the base of the period declines in value—i.e. the house—then the prices of all the financial assets built on it also eventually decline. That’s what happened with the subprime mortgage crash. Because many shadow and commercial banks were all in the game, lending each other to make subprime mortgages, the crash spread to all of them. Because other forms of credit were also connected, those too were afflicted with financial asset price deflation. A general credit crash set in. As credit dried up everywhere, the financial crash transformed into a sharp contraction of the real economy. Non-financial companies and households could not get loans from banks. Payments on pervious debt and loans could not be made, and defaults followed. That caused financial asset deflation to intensify. As the rest of the real economy contracts, asset deflation spreads to price deflation of goods and services in turn. Deflation leads to defaults and vice-versa, and in the process real debt rises. It becomes a vicious mutual self-amplifying process.
TOSUN: I’m living in an ‘emerging market’, Turkey, where after the short contraction of 2009 for us, and other emerging markets, our economies grew remarkably. How could such remarkable growth rates have been possible and to what extent were they healthy?
RASMUS: That’s because the massive liquidity injections by the central banks of the advanced economies—the USA, UK and now the Bank of Japan and soon the ECB—flowed out of those economies to a large degree to finance investment in the emerging markets (EMEs), especially China. China’s initial response to the 2009 crash was a massive fiscal stimulus, equal to around 15% of its GDP, which focused on direct government investment. China recovered rapidly. Because China’s recovery stimulated demand for commodities and other resources and goods produced by the EMEs, China ‘pulled up’ the EMEs. The EMEs were also the direct beneficiaries of the money capital inflows from the AE central banks. AE banks diverted the QE and zero rate loans to offshore markets, both into real asset investment and financial asset investment. Because the EMEs and China were growing, the stock and corporate bond markets in the EMEs boomed. The AE liquidity flowed also into speculation in foreign exchange currencies of the EMEs, real estate markets in the EMEs, and so on. So the combination of China rapid recovery and the US-UK-Europe monetary policies together benefited the emerging market economies like Turkey, the BRICS, and others like Mexico, Indonesia, etc.
Was this growth healthy? So long as the money capital flowed into these EME economies from the AEs and so long as China boomed. But now China is rapidly slowing in terms of growth, so demand for EME commodities, resources, and imports is slowing there. At the same time, the USA and UK are phasing out their QEs and are about to raise interest rates. That will reverse the money capital flows back to the AEs and slow the growth rates in the EMEs as well still further.
TOSUN: In a series of articles you wrote recently you observe that the center of the global crisis is shifting to the EMEs. Can you explain the reasons behind this shift?
RASMUS: It’s basically what I described above. Now that the central banks of the USA and UK have fully bailed out their banking systems via QE and zero rates, they realize there is no need to continue to do so by these monetary measures. The governors of the central banks realize that more liquidity injection won’t deliver much more results and, more importantly, that it is beginning to create new financial asset bubbles worldwide again. So they are reversing these policies. What it means is that, as interest rates rise in the USA-UK in 2015, money capital will start to flow out of the EMEs and back to the AEs. The stock and bond markets in the EMEs will begin to decline. Capital will leave the EMEs for the higher returns in the USA-UK. In turn, less capital in the form of foreign direct investment into the EMEs will also take place. The EME currencies will then decline and have already begun to do so. The EMEs will attempt to stem the capital outflows and currency declines by raising their own domestic interest rates to attract capital. But that will slow their domestic economies further. Those EMEs weakest in terms of exports to the AEs and China, will be hit the hardest. So we are entering another ‘phase’ of the epic recession globally.
TOSUN: Recent data shows the Eurozone, including France, Italy and even Germany are entering a recession and the Japan economy can’t bring about a recovery in any way. You claim that this state of affairs in Europe and Japan can interact with a weak recovery in the US and financial instabilities in China that may mean a new global recession. Can you explain the reasons why we can expect a new global recession?
RASMUS: Look at the bigger picture today, and in historical perspective. After six years of so-called recovery from the 2008-09 financial and real crash, the Eurozone is slipping into deflation and another recession. Its banking system is increasingly fragile. It continues along the path of fiscal austerity. It has not central bank in a real sense and no fiscal union at all. And now it has been dragged into a war in the Ukraine by the USA that will further weaken the Eurozone economy. The United Kingdom economy experienced a short recovery, because it returned to a policy of artificially boosting its housing markets—a repeat of the problem that led to the speculation and crash of its banks back in 2008. The UK has also benefited from foreign capital inflows. The economy is already looking like it has peaked.
In Japan, new massive QE injection by its central bank had the typical impact of boosting stock and currency markets but had little effect on Japan’s real economy. Wages and consumption were all falling despite QE and then, this past spring, consumption collapsed with the sales tax increase implementation. Japan’s economy has been pretty much a ‘spent force’ since the late 1990s.
Then there’s China, which is increasingly struggling with hot money inflows from shadow banks and global finance capitalists who have been speculating with its currency until recently and causing bubbles in its local housing and local government spending markets. Each time China tries to check the speculation, its real economy slows. China has had to introduce two ‘mini’ stimulus packages in the past two years to offset this effect, and to delay much needed economic reforms as well. But its economy at best is just able to ‘mark time’ at around 6%-7% GDP growth rates. It will continue to drift lower in the months ahead, although slowly.
Emerging markets, as we noted, will in turn slow as China slows and as USA-UK raise rates. So that leaves the USA economy. Because it can, and has, successfully ‘exported’ part of its economic slowdown, and will continue to do so. It’s been in a long term stagnant 1.5-1.8% GDP growth rate now for several years. That growth has been volatile, some quarters falling to zero or less and other quarters rising to 3-4%. But the average long term is a clear subpar historical growth rate.
In all the AEs real wages and disposable income are stagnant at best, keeping consumption from a real recovery. Consumer spending is heavily dependent on more consumer debt or driven by the big capital gains of the wealthiest 10 % households. Every time business invests in inventories in expectation of the consumer spending big, it doesn’t happen. Inventories are reduced and the US economy falls to near zero growth rates. As USA interest rates rise, the economy growth will be still slower. As rates rise, so too will the USA dollar, which will slow its exports and serve as a further dampening effect on USA economic growth. Off and on business investment, chronic low consumer spending, and slowing exports will keep the USA economy on a 1-2% GDP long term, sub-historic average, growth path.
In today’s newest phase of the global epic recession, Europe and Japan will not add anything to global recovery and will remain a drag on that recovery. What’s new is that China is slowing and the EMEs are about to as well. As a recent Bank of International Settlements Report has shown, the global economy has not reduced its level of debt. Debt has grown, especially in the private sector and among households. That means if another financial crisis erupts somewhere, it may precipitate a more general financial crisis spreading elsewhere. And a new financial crisis, should it occur, would almost certainly prove worse than the 2008 event and will come on a real economy that hasn’t recovered in terms of household spending. It will come on a global economy with even more total debt today than in 2008, with government deficits in many places even greater than before, and with political instability rising worldwide as well.
Another financial instability event will definitely appear and likely well before the end of the current decade. That financial instability event will materialize on the foundation of a global real economy that is not recovering in any sustained sense, but appears even to be weakening further. Another financial crisis is therefore inevitable.