Financial Crises as Wars

transform! europe has set up a new Economics Working Group (EWG) in 2023 to react to the current crisis posed by late capitalism, which is causing an invisible cost of living crisis while at the same time increasing climate heating. This crisis is often described as a multiple or poly-crisis, while it has a single root: worldwide capitalism. The last few weeks have once again proved this root crisis when the collapse of a single regional bank in the West of the USA triggered a banking crisis that led to the spectacular collapse of one of the world’s 30 so-called “systemic banks” in Switzerland – a bank too big to fail. The Swiss government forced the merger of Credit Swiss with UBS (Union de Banques Suisses) to avoid a global meltdown of the financial system. Has the problem been solved and brought under control? Far from it. The government has only postponed a much bigger crisis to come, as the new bank now has a combined balance sheet twice the size of Switzerland’s GDP. There is no possibility whatsoever that the Swiss state will be able to keep this financial institution alive when the next crisis hits the financial system.

Financial crises punctuate the history of modern capitalism. In the same way as wars, financial crises are the consequence of the impossibility of the ordinary mechanism of capital accumulation to continue, although there are of course other causes. Moreover, like wars, they entail the demise of the weakest contenders and are ended by the full mobilisation of state resources. Discussing the nature of war, Carl von Clausewitz observed that it “could be more accurately compared to trade, which is also a conflict of human interests and activities; and it is still closer to politics, which in turn may be considered as a kind of commerce on a larger scale” (Clausewitz, 1976, p. 100). If we add the financial crisis to this picture, we get a wonderful synthesis of the links between war, politics and crises.

Each crisis has its own specific causes, which must be analysed in order to understand it, but above all they always have the same mechanism, which can be summed up as the need of capital to be accumulated at the maximum possible speed. The nature of capital is to overcome any limit, and anything that is posed as a limit is rejected like a cell that is foreign to the organism, as Karl Marx noted: “The real barrier to capitalist production is capital itself”. Paradoxically, the more capital succeeds in growing, the more obstacles it creates to itself on the road to accumulation, and therefore it is forced to resort to external aids. There are basically two: the state and the banks.

It was a profound Minsky’s intuition: the idea that the growing role of finance implied a growing role for public finance (Minsky, 1986). It was not easy to defend this analysis in the Thatcher-Reagan era, when the State seemed an old relic ready to be dismissed. Minsky explained that the bigger the banks and financial markets, the bigger the role of central banks and government in the economy must be. In reality, the rollback of the State never happened, because without the implicit or explicit public insurance on their activities, banks cannot survive for long. What has changed is the nature of the public role in the economy, which is now geared towards supporting capital accumulation and the growth of financial markets. A particularly clear example is social security, which has been undermined thus the fact that it has helped private pension funds to grow. Today, the financial markets and the State are like two objects suspended from the arms of a balance. If the weight of private finance increases, the other must also increase in order to keep the equilibrium. This idea is very different from the mainstream narrative of public debt crowding out private investment. The reality is that the modern investment machine is based on financial markets (equity, bond, credit, derivatives, etc.) and cannot survive without the balancing act of government.

The business model of banks is inherently fragile

This applies both to their liabilities and to their assets. The liabilities of banks are mainly composed of deposits, some of which are the savings of workers and the non-reinvested profits of companies, and some of which are directly created by banks in their credit function. The possibility for banks to create money (so-called “endogenous money”) has often been denied by mainstream economics, albeit with exceptions (McLeay et al., 2014; Jakab and Kumhof, 2015). In reality, banks are able to finance investment and financial speculation precisely because they can create money at will. Broadly speaking, they should create an optimum amount of money associated with the expectations of their customers, firms and households, to repay their debts, but no one knows ex ante what this amount is. Moreover, each bank tries to create the maximum part of the optimum quantity, creating an overall effect of financial bubbles followed by a credit crunch. The fact that almost all the money we use to buy anything (i.e. our bank deposits) is created by private intermediaries for profit-maximising purposes makes a public role essential. Public lending of last resort, deposit insurance, and banking supervision are tools created over the centuries to prevent the destruction of the economy by private banking behaviour.

Regarding assets, banks should select their debtors carefully, but the more loans they grant and the more assets they buy, the more profits they make. So prudence is an enemy of banks, imposed on them by public authorities. However, central banks and governments tend to be very close to the interests of the big banks. As Johnson noted: “Oversized institutions disproportionately influence public policy” (Johnson, 2009). This was true decades ago, but nowadays banks have become so big that they simply cannot be contradicted for the survival of a national economy. To take an extreme example, the proposed merge of Credit Suisse and UBS will create a bank with total assets more than twice the size of Switzerland’s GDP. It is not just a issue of lobbying or revolving doors, but a total annexation of public institutions into the realm of financial capital (Johnson and Kwak, 2010). After each major crisis, public authorities and international standard-setters such as the Basel Committee try to implement stricter rules that, while useful, do not eliminate future problems but only make the sector less contestable, thus favouring the big banks once again. The growing need for debt to keep the investment machine going defines what we call ‘financialisation’ (on this: Palley 2007; Whalen 2017). It makes banks increasingly important to the world economy, and the latter increasingly fragile.

If financial crises are inevitable, their lightning speed is also connected to the bank’s business model. We often hear that the value of money and the survival of banks is a matter of trust. This derives from the fact that the banks’ business model is based on a mismatch that may seem foolish. While most of their liabilities are deposits and can therefore be called in by their clients at any time, their assets tend to be long-term (think of a 10-year bond or a 25-year mortgage). This structural mismatch is unavoidable because it is the raison d’être of banks: they exist because they centralise liquidity and use it to fund firms and households. This is why bank runs have always been a mortal threat. Even worse, a run on a bank can easily spread to other banks, destroying the banking system in a matter of weeks or days. No private solutions to this issue have ever been found, and nowadays public insurance schemes, such as the FDIC in the US, ensure that everything should go smoothly.

Increased vulnerability to crises due to deregulation or market-friendly regulation

Banking regulation and public control of banks in general have been developed in the aftermath of the 1929-1931 double crisis and have allowed stability in financial markets for decades. It was called the era of “financial repression” because banks were State-owned or strictly regulated, capital mobility was low and financial capital was not free to operate. From the 1980s onwards, public regulation was scrapped or downplayed. Deregulation or market-friendly regulation was considered more efficient because banks knew better. But the more financial markets were deregulated, the more prone they became to crises. In 1992, the EMS (the European Monetary System, which regulated the European currency before the Euro) collapsed, ejecting Italy and Britain out of the mechanism. Financial speculators fought a bloody battle against important central banks and won. This did not change the course of the advanced economies. Privatisation and deregulation continued apace. Then a series of major crises hit developing economies, such as the Asian Tigers crisis in 1996, the Mexican crisis in 1994, the Brazilian and Russian crises in 1998 and the Argentine crisis in 2001. The mainstream economic explanation was that these crises were caused by the underdevelopment of their finance and capitalism in general. They were marred in the typical crony capitalism of Asia or Latin America. As for the dot.com crisis in the US in 2000, that was the beginning of the digital economy. Finally, in 2008, the deepest crisis of modern times hit the world’s most important and advanced financial hubs: Wall Street, the City were devastated by the collapse of markets and banks. Overnight, the endless chatter of economists about “market discipline” was silenced, and State and central banks poured trillions of money into the system to calm the situation.

After 2008, as always after a major crisis, a wave of re-regulation ensued. “No more bailouts from the taxpayers!” was the common slogan. However, as explained above, weaknesses are a key component of the banks’ business model of how money is created and investment is funded. Painful memories of a deep crisis fade rapidly. Thus, in 2011-2012, the meltdown of the Eurozone’s weakest member states, starting with Greece and Cyprus, unleashed the “spread crisis” that threatened to sink the Euro as a whole. Once again, the ECB (European Central Bank) was forced to intervene with unlimited amounts of money. In his famous “whatever it takes” speech, Mario Draghi (who was President of the ECB at the time) formalised this position and ended the crisis (ECB, 2012). For the umpteenth time, public authorities, not market discipline, were the only way out of a financial collapse. Of course, the European banks that bought Greek bonds were saved, but the Greeks were not, and they were forced to make a brutal cut in their living conditions, which was felt in every social indicator. After that, the Banking Union was created in 2014, giving the ECB responsibility for supervising the EU’s biggest banks. Once again, this and other new rules were presented as a vaccine against future crises. The vaccine analogy is used because a few years later, the Covid-19 pandemic broke out, forcing, among other things, central banks and governments to intervene to prevent the collapse of the economy and the banking system. Finally, at the beginning of 2023, the collapse of some medium-sized US banks such as Silicon Valley Bank and the giant Credit Suisse has opened a debate on the possibility of a new general financial crisis.

It is often said that the solution to a previous crisis becomes the cause for the next crisis – B. Mahapatra

The war which is coming is not the first one. There were other wars before it – B. Brecht