INFLATIONARY DEFLATION
OR THE DOMINANCE OF THE GLOBAL FINANCIAL MARKETS

By Elmar Altvater

[This essay is translated abridged from the German on the World Wide Web. Elmar Altvater is an emeritus professor of political economy at the Free University of Berlin.]

ABSTRACT

The price deflation in goods and services is paradoxically accompanied by an increased price of capital, namely real interests. “Inflationary deflation” is a consequence of the competition of currencies on global financial markets. The stability of money value and the height of profits of financial ventures are central parameters. High real interests as a result of restrictive monetary- and fiscal policy and falling prices contribute to financially repressing accumulation and growth (“financial repression”). When real interests are above the real growth rates of the GDP (gross domestic product) – and this has been true since the beginning of the 1980s -, debtors are structurally overstrained. The debt crisis of the 1980s and the financial crises of the past decade suggest that a kind of post-modern “plundering capitalism” is arising. For this to function, rules of “good governance” are developed to mediate a system of political stability and coherence from the outside that no longer brings societies under the conditions of “financial repression” from within. Thus deflation on the markets for goods and services has a backside that shines here: the “inflation” of the prices of capital, interests and the resulting political consequences.

THE PROBLEM: ‘FINANCIAL REPRESSION’ REQUIRES ‘GOOD GOVERNANCE’

Since the beginning of the 1980s, real interests have been higher than the real growth rates of the gross domestic product (GDP) in the countries of the globalized world. Nominal interests fell at the end of the 1990s while firstly interest rates and secondly the real growth rates of the GDP also declined in most countries…

The financial sector flourished under these conditions. The global financial markets grew enormously (cf. the data of the 2002 Enquete commission). At the same time, the real economy was put under pressure by the over-reaching financial sector. This could be called “financial repression” since the financial demands on the real economy and society represented an overstraining of the output. Most neo-classical neoliberal economists only speak of “financial repression” when the financial markets are governmentally regulated or controlled and possibilities of private financial market actors are restricted..

The state of “financial repression” of the private by the public sector was radically removed during the transformation processes (in Central- and Eastern Europe after the system change), in opening markets of developing countries since the beginning of the 1980s (as a result of structural adjustment measures) and in the course of integrating financial markets in the European Union (EU) through liberalization since the beginning of the 1990s. In other words, politics has promoted the financial markets, stopped their “repression” and implemented liberalization so that these markets now act repressively on the real economy. The real economy includes the industrial sector, private sectors, the public sector providing public goods and the private households central for social reproduction.

In a “financially-driven” accumulation regime, the profit expectations of financial market actors can soar so quickly that the profit rates of real capital are not enough to permanently satisfy the monetary demands. That interests rise in certain economic phases and depress the profits and wage incomes of the real economy is not new. This situation is part of the classical scenario of the economic- and crisis cycle. However the fact of high real interests today straining the real output is a structural global problem, not a business cycle problem.

Profits from 15 to 20% are declared the “benchmark” on global financial markets by rating agencies and fund managers in the interests of their financially powerful investors although the profit rates for real capital can never be permanently raised to a comparable level and the real growth rates of the GDP are considerably lower…

As a result, the global accumulation regime is changing toward “accumulation dispossession” (Harvey 2003). In “post-modern” global capitalism, elements of a “pre-modern” plundering- and extortionate capitalism are effective again that were also described as “predatory capitalism” (Helmut Schmidt). Securities are appropriated by financial market actors who did not produce these securities. Appropriation in the form of profit claims becomes more important than the production of surpluses from which alone the “claims” can be satisfied. The ways of appropriation and production fall into a contradiction that is suddenly revealed when debtors can no longer meet their obligations…

The financial crises of the past decades show the instability of the “financially-driven accumulation regime”. That social coherence indispensable for the reproduction of society is lacking. This is recognized as a deficiency but can be remedied. The rules of “good governance” come into play considering the pressure of the financial markets on the real economy, society and politics. These rules are codified as conditions in the IMF’s awarding of credits or funds for development. They are the outer support corset, so to speak, of an economy and society thrown out of joint by financial repression. The international institutions demand observance of the rules of the financial system because their stability is “essential for macro-economic and financial stability in a world of increased capital flows”. In this way, the IMF justifies its conditions in the “Financial Sector Assessment Program” and the “Reports on Observance of Standards and Codes (ROSCs)” ( http://www.imf.org/external/np/fsap.asp). What is central is stability for international investors and for the hegemonial system of the “sole super power”, not only in the respective countries. Thus financial repression is transformed into a repressive global mechanism of “good policy” whose quality is measured with a system of indicators by the goals formulated by the international institutions, the mammoth “think tanks” and non-governmental organizations. The promise of the overseers to government leaders is that growth can accelerate with orderly budgets or trifling budget deficits. Budget revitalization should be achieved “by cutting subsidies, transfers (such as pensions) and the government wage bill” and not by “increasing taxes and cutting public investment”. Thus good governance is in no way good for everyone, as for example pensioners and employees in public service but for the rich taxpayers and transnational corporations often favored by public investment contracts.

In this connection Susanne Soderberg also refers to the March 2002 “Millennium Challenge Account” of the Bush administration that used indicators of “economic freedom” as selection criteria for “economic aid” or “development assistance’ along with criteria for evaluating governmental action and provisions of the population. She describes this as a strategy of “preemptive development”. State failure threatens in many world regions with the conditionality of “good governance” considering globalization, the repressive effect of the financial markets and autonomous policy independent of external practical necessities and not in the explicit interest of the superpowers and the financial market actors can be counteracted. As we will see later, the rules of “good governance” are much less binding for businesses and the private sector. Liberalization of the financial markets allows the exercise of financial repression toward the public sector and the real economy and protects these markets from disciplinary conditions that only have the status of codes of conduct or guidelines. Thus the organization of “good governance” is asymmetrical regarding the private and public sectors.

THE REALITY: FALLING PRICES, HIGH REAL INTERESTS AND DECLINING GROWTH

In the 1970s, Paul Mattick called attention to the paradox of “deflationary inflation” under the conditions of price inflation in industrial countries and low to negative real interest rates. In the meantime, deflationary tendencies can be identified with commodity prices and inflationary tendencies with “capital prices” or interest rates. Both are interdependent. To stabilize the price level and lower the inflation rates, restrictive fiscal- and monetary measures raise the price of credits and loans for debtors while making possible a handsome profit for creditors. The latter are helped further when the exchange rate of currency is stabilized in the global currency competition. This did not always succeed because loans are issued in US dollars and therefore decrease the exchange rate risk for creditors – as in Mexico before the 1994 financial crisis or Brazil after 1999. Thus the risk of a loss in value was socialized on liberalized and highly volatile markets.

After the 1997 Asian crisis, the Philippines Central Bank published data on the real interest rates (difference between the prime rate and the inflation rate) in Southeast Asian countries that were intensely shaken by the crisis. In late summer 1999, the real interest rate was 5.34% in the Philippines, 17.23% in Indonesia, 14.60% in Hong Kong, 9.30% in Thailand, 8.95% in South Korea, 7.25% in Taiwan, 5.28% in Singapore and 4.6% in Malaysia (Central Bank of the Philippines News Release, October 22, 1999). The real interest rate was lowest where the financial markets were regulated against the advice of the IMF: in Malaysia and Singapore, although this did not protect them from a negative growth. The real growth rates of the GDP declined in the countries impacted by the crisis that previously were described as “dynamic Asian economies” or “tiger states”. In the years 1997/98 the real growth rates amounted to –5.3% in Hong Kong, -13.1% in Indonesia, -6.7% in South Korea, -10.8% in Thailand, -10.8% in Malaysia and in the 1998/99 time period in the Latin American countries –3.4% in Argentina, -1.1% in Chile, -4.1% in Colombia, -7.3% in Ecuador, -2.8% in Uruguay, -6.1% in Venezuela (data according to UNCTAD,  http://www.unctad.org/).

Both growth rates and inflation rates are declining according to the IMF data. The tendencies are different in the world regions. The yields of state securities, an indicator for the interest rate of financial assets, did not decline to the same extent as the inflation rate so the real interests – in the US and the Euro space – remained positive and high. The real interests as a result of the global arbitrage on liberalized and highly integrated financial markets are comparable and different through the risk spread. The real interests are high and “absorb” the socially produced surplus reflected in the real growth rates of the GDP.

The calculation of the development of real interests and real growth rates of the GDP by David Felix (2002) shows that the difference was positive at the end of the 1970s and the beginning of the 1980s. Since then, the real interests have been above the real growth rates. In comparing the real growth rates of the GDP with short-term real interests, the same picture shows a reversal of the relation of real interests and real growth of the GDP toward the end of the 1970s…

These realities are not independent but influence one another. The higher interests press on investments and therefore monetary demand. The demand weakness depresses prices and negatively influences the growth of the GDP. Lower interests could set things right and stimulate growth since investments can be financed more reasonably. However currency competition counteracts this possibility on liberalized global financial markets.

Financial investments and currencies are only attractive as long as the profits and interests are competitively high. When the deflationary spiral has been turned long enough, even interests lowered to the zero mark cannot stimulate any investments. As in Japan, the economy obviously falls into a “liquidity gap”. Thus a precarious situation arises since the base on which the finance-driven economy alone can be successful, namely a dynamic real economy, is strangled, reproved and driven into crisis by this process.

STABILITY PROCESS SEEMINGLY WITHOUT ALTERNATIVE

…High real interest rates can be explained as attempts to gain financial stability through attractive interest- and yield possibilities for investors in countries stricken by financial crises and capital flight. The currency competition is waged with high interest rates and lower inflation rates…
The consequences of high interests (and yields) are a greater dependence on global financial markets and repression of the real economy. Investments become more expensive and small and medium enterprises are cut off from access to credit… The costliness and shortage of credit severely impacts the informal sector and raises the debt service –and the public budgets – that often must take over the bad debts of private parties. The profits and assets of private parties are not infringed (a property tax is very unpopular among owners). However the losses are charged to the general public that has to bear the high costs of restructuring distressed banks. Enormous cuts in social expenditures are the result. These cuts were very deep and painful in the course of the financial crises, 40% in Chile at the beginning of the 1980s, 40% in Indonesia after the crisis of 1997, 20% in Mexico in 1995, 15% in the Czech republic in 1994, 40% in Russia since 1994 and 30% in Argentina from 1994 t0 1997 and an incalculable amount of the gross domestic product after 2001 for rescuing the collapsed banking system. Only the neoliberal hope that readiness for investment will increase after the purgatory of high real interest rates and the inevitable financial crisis can justify the stability policy. However no single example supports this hope.

The real interest rate was below the real growth rate of the GDP as long as the fixed rates of Bretton Woods functioned (the causes are even more complex and involve the accumulation model after the Second World War, the phase of the so-called economic wonder). This was the presupposition for the Keynesian positive sum-game of credit-financed investments that brought positive profit rates to capitalists from which (positive) credit interests could be paid to the creditors. Only this constellation in a capitalist economy makes possible accumulation of real capital and positive growth and – ceteris paribus – creation of new jobs on one side and financial stability on the other side. Up to the end of the 1970s, the level of real interests was very low, almost zero in some countries. Then the wicked surprise occurred: public and private borrowers who took loans in US dollars when the real interest rate in the US was nearly zero, growth rates of the world were high and export prices were favorable had to “face high real interest rates, depressed growth demands and plunging commodity prices. In the three years following the Mexican payments suspension in August 1982, 24 middle income countries were forced to renegotiate their debts with commercial banks” (World Bank 2003).

The debt crisis of the 1980s began there. The level of real interests rose above the growth rates of the GDP for more than the next two decades. At the end of the 1990s, real interests declined slightly and were even negative for a short while in Austria and Portugal. In the meantime the new economy boom was over and the real growth rates of the GDP were declining so the difference between real interests and real growth remained positive.

AN EXAMPLE: BRAZIL UNDER THE LULA GOVERNMENT

The consequences of high real interest rates are mainly negative for the real economy, that is investments (except for financial investments), employment and the social state. This can be shown in the example of Brazil after the first year of the Lula government (cf. the account of the World Bank in World Bank 2003). Interest rates were raised to the usurious 26.5% from the middle of 2002 when “the financial markets” reacted nervously to Lula’s approaching election as Brazil’s new president to June 2003. The Brazilian financial market should remain attractive for external creditors. [Interest rates were traditionally very high in Brazil in the years of stabilization under Lula’s predecessor, president Fernando Henrique Cardosa. They fluctuated between 40% and 16% and never fell below this margin since the financial crisis of 1999. Cf.  http://www.bcb.gov.br/Pec/Copom/Port/taxaSelic.asp#notas.). This was the reaction of the central bank and government to the conduct of investors who saw a higher risk in Brazil and wanted to secure themselves by refinancing. Therefore the credit costs shot upward. The higher interests were partly explained with the specific functioning of the globalized financial markets:

“…growing concerns about Brazil’s ability to service its sovereign debt in 2002 led many financial institutions with illiquid exposures to hedge their risk, raising the demand for default insurance…” (World Bank 2003).

When the demand for these insurances rises these price increases impact the interest rate of the debtors.

A positive effect of the higher interest rate was the rapid reduction of the inflation rate from 2.7% in December 2002 to 0.37% in November 2003. The real interest rate (nominal interests less the inflation rate) did not noticeably fall after the nominal interests were lowered by the Brazilian central bank by December 2003 to 16.5%. In the international comparison, Brazil had a top position with 11.1% at the end of 2002 and 10.03% in December 2003.

At the same time, the Real was devalued against the US dollar; the US paid 3.63R$ at the beginning of the year and 2.91R$ at the end. With its restrictive interest policy, Brazil could realize a greater surplus of the primary budget than the IMF demanded as a condition for a credit in 2002, namely 4.25%. This was emphasized as a plus point by the Lula government in a “Letter of Intent” to the IMF on November 21, 2003. The IMF honored the Brazilian stability efforts with the payment of a credit pact of $6 billion US on December 15, 2003.

The price of the financial stability of internal and external monetary assets – owing to the “damaging high levels” of the interests (World Bank 2003) – was the strangulation of the real economy. The real growth of the GDP fell from 3.87% in the fourth quarter of 2002 to –1.07% in the second and –1.49% in the third quarter of 2003. The real average income of a worker fell from 1110.21 R$ [one Real (R$) is approximately 0.30 Euro] in December 2002 to 841.31R$ in September 2003, almost 25%. Real investments shriveled nearly 10% in 2003. In contrast, unemployment rose from 10.5% to 12.9% from December 2002 to October 2003. That precarious employment conditions increased in the informal sector is not recorded in the official statistics. Unlike bank profits, these conditions increased in double digits in the first year of the Lula government. A connection obviously exists between an “inflation” (real increase) of interests and a dis-inflation or deflation of commodity prices, between high real interests and low growth.

THE CAUSES: CURRENCY COMPETITION, HEGEMONIAL CRISIS AND FINANCIAL MARKET LIBERALIZATION

What are the reasons for the high real interests? The OECD conventionally names: (1) The credit demand for financing public deficits forcing up the interest rate on the demand side, (2) the inflation pressure in the 1970s and early 1980s that explains both the development of demand and the development of costs (“wage-price-spiral”). The nominal interests first rise with inflation. The assumed inflation dangers are then combated with a restrictive monetary policy, that is high interests. Then (3) the globalization of financial investments is mentioned as a cause since interests must be raised everywhere in all financial sites in the search for the greatest profits to hinder the “capital flight” of mobile financial assets or bind mobile capital “to the location” and thus strengthen the respective currency in the global currency competition. That (4) the high interest policy is also a direct result of the attempt to secure US hegemony on world markets and in world policy with monetary means is not mentioned by the OECD.

In 1979 under Carter’s presidency the interest rates were raised to stop the decline of the US dollar. This political measure was continued under the succeeding president Reagan to the middle of the 1980s. The real interests and exchange rate of the US shot up, a debacle for all real debtors who had denominated their obligations in US dollars. As Susan Strange said, the high interest policy of the US marked the transition to a “predatory hegemony”, an exploitative and financially repressive “new world order” of a hegemony at the expense of other that provides specific rules of “good governance” for countries exposed to financial repression.

On top of this, the real growth rates of the GDP shifted downward in the G7 countries from 3.1% on the average of all countries in the 1980s to 2.5% in the 1990s. Four reasons are cited for this although only two will be briefly mentioned here. Firstly, the absolute (real) growth must become ever-greater with the rising level of the gross national product to keep the growth rate constant. This does not cause any problems as long as the potential production is not exhausted. Regarding labor, part-time labor markets industrial countries given structural unemployment and the great informal sector in developing countries are nearly inexhaustible reservoirs.

Potential limits exist for capital that are measured by possible profitability or profit rates. If this profitability is not high enough compared to alternative (financial) investments, investments are withdrawn from the real economy and the accumulation- and growth process falters. Thus the potential limit of capital becomes narrower, the lower the profit rate compared with financial investments. Thus the financial repression narrows the growth possibilities because it diminishes the profit rate for the capital of the real economy. Secondly, an absolute growth of material- and energy streams also has negative economic effects on account of the ecological repercussions. In the neoclassical economy, these are registered as “external effects”. The ecological consequences of economic conduct need not be taken into account.

The degradation of the environment increases both labor- and capital costs. Massive expenditures are necessary to remedy the degradation. These expenditures are described by Jim O’Connor (with Marx) as “general conditions of production” whose importance increases in the accumulation process. For David Harvey, they are the “special fix” enabling capital co-efficiency to rise and the reciprocal, capital productivity, to fall. If real interests are very high in this situation, the profit rate can only be stabilized if the distribution is changed to the burden of wage- and salary incomes.

We face the paradoxical situation that the liberalization of the financial markets since the 1970s intensified the competition of “financial sites” and currencies so that rising (nominal) yields and interest rates can only be surpassed and not underbid. Otherwise capital flight and in the worst case financial crisis will result. In the global competition, the commodity prices compete downward while the interest- and profit levels compete upward. The simultaneous stability-race leads to lower inflation rates. The real interests are also forced upward through this mechanism. Investments increase in price. Thus growth is impacted negatively…

The financial repression is becoming harsher. David Harvey points out that capitalism in the “neoliberal” age has “cannibalist, predatory and fraudulent characteristics”. These injurious features are even enhanced by a central rule of “good governance” that debt service has the highest priority before all other responsibilities. As to public indebtedness in Brazil and the industrial countries, the primary budget (without debt service) shows a considerable surplus realized through severe cuts in state spending. Nevertheless a deficit of the total budget arises because of the payments of debt service.

CONSEQUENCES OF HIGH REAL INTERESTS: FINANCIAL INNOVATIONS AND FINANCIAL CRISES

Real interests above the GDP-growth rates are problem-free since financial assets are trifling in relation to the GDP. A small part of the increase of the GDP falls to interest revenues while a larger part falls to contract revenues and corporate profits. The dynamic of this constellation may not be ignored. Higher real interests than the growth rates of the GDP are seen as an increased financial asset. The high real interests exert pressure on the incomes of employees and entrepreneurs (on wages, salaries and profits).

High real interests on financial assets – compared to other investments and considering risk factors – make their investment very attractive. This is a crucial impulse for liberalizing financial markets, developing innovative financial products and new management strategies and utilizing possibilities for small, large, illegitimate, half-legal or even criminal businesses. The deregulated financial markets are infested by the virus of “Enronitus” or “Parmalactose”. The medicine of “good governance” is administered against this virus. Businesses should comply with the rules of “corporate governance”. However their degree of obligation is lower than in the case of conditionality toward governments. Voluntary self-commitments or informal guidelines or codes of conduct are usually emphasized.

Neoliberal economists and spokespersons see everything but financial repression in the widening gap between real interest development and growth rates of the GDP. The see the positive incentive to order economic conditions in the economy and state rationally and efficiently in allowing for the disciplining effect of the financial markets. This is even elevated to a “fifth branch” in modern democracy. The debtors forced to pay interests contribute efficiently to the investment goals. David Felix criticizes this “efficient market hypothesis” as theoretically dubious and empirically uncertain. The selected project conditioned by high real interests can have “adverse” effects. Long-term growth- and employment-friendly investments are cancelled in favor of seemingly more profitable short-term engagements. These have played a disastrous, extremely destabilizing role in the financial crises of the last decade (cf. Stiglitz 2002).

The high volatility of short-term capital investments has to do with the attractiveness of yields on global financial markets. Financial crises are triggered by the sudden invasion and evasion of large capital (“herd behavior of investors”). This was the reason for the 1998 “Financial Stability Forum” and for the criticism of UNCTAD on the functioning of the global financial markets. Small countries and smaller businesses are less protected against the volatility of capital investments than large corporations and large countries. The mammoth funds, especially the highly speculative hedge funds, do business with the price fluctuations upward and downward which bars them from reducing the volatility. This is an unequivocal imbalance of the effect of global financial markets to the disadvantage of developing countries and the favor of the rich investors from industrial countries.

Real interests above the real growth rates are responsible that inequality in the world has not become less but even increases contrary to the millennium goals (cf. World Bank 2000; UNDP 2002) because of the one-sided transfer from indebted countries to creditors. The failure in combating poverty will not end as long as financial repression remains. “Adverse selection” is inevitable with high real interests. The higher the interests, the shorter is the running time of projects. Thus myopia and short-sightedness increase with the interest rate. Long-term projects are prevented. The tendency even intensifies when periodic financial crises are triggered as a result of high real interests that are extremely expensive to people in the impacted countries.

POLITICAL CONSEQUENCES: APPROPRIATION AGAINST EXPROPRIATION

The liberalization of financial- and currency markets has not led to stable rates of exchange or less volatile (positive but lower) real interests. Rather the volatility of the two strategic prices of money is high and “damaging” to the interest level measured by the real growth rates of the GDP as the World Bank writes (World Bank 2003) or “predatory” (Susan Strange) or “cannibalistic” (David Harvey). Financial globalization only functions well for the owners of financial assets and is injurious for everyone else, for those dependent on earned income and jobs. The wealth of the owners increases and assumes extreme and absurd dimensions.

The lack of formal jobs is a consequence of investments that are too expensive and therefore do not occur. Earned income stands under the pressure of financial stability criteria. These determine policy in the form of the Maastricht criteria in Europe or structural adjustment plans according to the “Washington Consensus’ in threshold- and developing countries. Thus an injurious global pension capitalism with potential financial pressure arises. This means redistribution of produced income with the support of the global financial markets under active cooperation of the international institutions and nation-state governments. This occurs to the advantage of the financial investors, particularly in assuring the investors’ assets (“bail-out”). This effect results from the political measures of the industrial countries. The developing countries are integrated unconditionally in the political regulation and economic exploitation and subjected to the corresponding rules of “good governance”.

The dominance of the financial markets results from a systematic connection that can only be annulled or dissolved systematically, not through individual measures. On top of this, the system is contradictory in that measures do not always have a clearly predicted effect. Nevertheless several conclusions can be drawn. If competition on liberalized financial markets has led to higher interest levels and the volatility of prices and interests remains very high, this competition must be controlled and the deregulation of the markets cancelled. Multilateral measures like a currency transaction tax (“Tobin tax”) are good but are less suitable than capital transaction controls. However these require the power and self-awareness of the political actors toward the financial markets and the politicians and media dependent on them. Nothing runs merely as a technocratic act.

Without the mobilization of a global public, the system of expropriation to the advantage of the financial markets cannot be overcome. The conflicts in Seattle 1999, Cancun 2003, at the World Social Forum in Mumbai and at regional events like the European Social Forum have shown that mobilization is possible.

When the markets are less free than in the times of the current bonanza and politics has more possibilities and suffers less under the practical necessities of financial repression, target goals for interest rates can be negotiated and gray- and dark zones of the non-legal economy brought into the bright light. Thus the breeding ground could be withdrawn from injurious speculation. The risk impacts and thus the interests will fall with the lower risk of capital investments.

In the medium term, a policy of lower interests and exchange rate stabilization is imperative. Real growth cannot increase permanently either in industrial- or developing countries. Natural laws exist, not only economic laws. The high yields to which owners of financial capital and owners of financial assets have grown accustomed cannot be permanently assured by plundering those without financial assets.

Thus development at the beginning of the 21st century no longer means first of all investments and growth. This was the program of the Bretton Woods institutions for realizing the millennium goals. Despite an immense publicity campaign (cf. the reports on the World Bank’s website, www.worldbank.org), this can hardly lead to success. The mechanisms of inflationary deflation are real obstacles.

Brazil is a good example here. Lula promised financial stabilization for calming the financial markets, land reform, combating hunger (“fome zero”) and the political promotion of the informal sector to create a “solidarian economy”. These measures necessary for social-political reasons and indispensable for legitimated government conduct can only be realized when the dominance of the financial markets is removed and its logic counter-acted by political regulation. Governments follow the pressure of the markets. “Leftist” governments are not exceptions – they are under the pressure of people who are against expropriation by financial mechanisms and for the appropriation of their country and its values.