Bubble bath in the American Economy

David Craig

Much has been made of the magnitude of the current credit crisis. No one at this point can really say much in detail about how deep the crisis will go, what the long-term effects will be or how the economy will get out of it. If we begin, however, by looking at the history of banking and of market collapse, we notice that, since the 1980s, asset price bubbles and subsequent credit constrictions have been a common and recurrent problem.

The particulars about what asset the financial system overvalued, whether computer technology, commodities (like oil) or some variation on real estate, does not change the fact that within the past 20 years there have been successive crises in the United States, Japan, Sweden, Spain, East Asia and elsewhere. Many of these required significant government intervention, and although some lasted for only a few years, the Japanese slump lasted over a decade.

Indeed, our collective memory of our own problems is quite short – the drop of the Dow of 778 points (a loss of about 7 percent), while the biggest drop in point terms in history, does not remotely come close to its fall on October 19, 1987 when it lost 22.6 percent of its value in a single day and signaled the beginning of the end of the real estate bubble which propped up the savings and loans. The meltdown in the late 80s required government intervention of about $140 billion; the loss from decreased output cost the public $500 billion more.

We might ask why bubbles occur when they did not previously do so? During the depression (which was itself partly caused by a bubble), Franklin Delano Roosevelt passed a series of regulations to govern securities and reign in speculation. These worked well until the 1970s, when, due to inflation and competition from new unregulated institutions, banks began to pressure Congress to deregulate. This has meant increases in speculative investments and in the volatility in the markets themselves.

This might have been justified if it led to greater output growth relative to the regulated period, but a cursory look at gross domestic product growth data does not seem to indicate this. If we think about the function of what the banks and financial markets do and their relation to actual production, this should not surprise us. Finance capital is, to an extent, fictitious; no amount of bonds, stocks, or securities by themselves increase the number of cars we drive or the number of TVs we own – only industrial machinery and real capital can do that. What finance capital does is to allow producers to expand production and exchange commodities among themselves through the use of credit – extremely speculative activity contributes little to these purposes.

It is not necessary that increasingly severe credit crunches occur and that production and investment seize up. Without an adequate international regulatory scheme and without fundamental changes in the institutional arrangement of banking and financial markets, bubbles will burst again and there is no guarantee that depression, as we seem to have so closely approached, will be avoidable.

David Craig is a senior political science and physics major and a guest columnist for the Daily Kent Stater. Contact him at [email protected].