At the end of the 60s America had to deal with two rivals that had come back to life: Europe and Japan. At that same time, America got tangled in the war against the independence of Vietnam and other countries in the region of South-East Asia. The arms race with the Soviet Union was also quite expensive. The dollar tap was kept running and vast amounts of dollars landed in European banks (so-called Eurodollars). At the start of Bretton Woods in 1944, the Fed still owned 60% of the world's gold reserves. But now that European national banks were converting these vast amounts of dollars into gold –a sort of second Gold rush -, that share quickly fell to just 15%. So Nixon took the unilateral decision to stop the direct convertibility of dollars into gold. Two years later fixed exchange rates were also abandoned and the dollar started to float. It lost value until 1979. Then, the Volcker-Reagan duo began to follow a different path.
Letting go of Bretton Woods gave the US more room to maneuver because the dollar could no longer be devaluated by re-claiming its value in gold from the federal gold reserve. More than ever the dollar became a global currency, only now, the US government could also manipulate the exchange rate at will. Until today, it has more than taken advantage of this possibility.
For thirty years the United States revived financial markets all over the world. It used a three-way mechanism as a lever: dollar, credit and speculation which led to a huge increase in the size of financial markets. In 1980, the value of financial instruments was estimated to be equivalent to the world Gross Domestic Product (GDP). In 1993, that value was twice as high. And, by the end of 2005, it was more than three times higher i.e. 316% of world GDP. Between 2000 and 2004, government and private debt securities accounted for over half of this increase. This shows the growing role of debt and leveraged buyouts as the motor of this process.
In 2004, daily trade of derivatives totaled 5.7 billion dollars and trade of currency 1.9 billion dollars. Together amounting to 7.6 billion dollars daily. That's more than the value of annual exports.
How did this trend appear? To keep its preeminent position, the United States chose paths during the 80s that all contributed to pump up the financial bubble.
In 1979, Paul Volcker, the Fed's chairman, suddenly decided to raise interest levels. In a few months they rose from 11% to 22%. That's unbelievably high, especially with the slump still very much present! The fact that credit was still incredibly expensive continued to slow down the economy. An inflation rate of 10% meant that capitalists were losing 10% of their fortune annually. High inflation is good for people who are in debt because they're paying back the money they owe with low-value money. Banks however see the credit loans they have granted lose 10% of their value. Reagan and Volcker quickly made up their minds.
This decision was also conditioned by the fact that the debt previous to high inflation could be attributed to high salaries and "excessive" social benefits. In short, capital holders wanted the fight against inflation to take precedence and they won their case. [Owner2] As a result, inflation decreased down to 2 or 3% at the end of the 80s. It was the first big gift to the US financial world.
The consequences quickly caught up. The crisis worsened and reached a peak. The biggest victims were those heavily in debt who could do nothing but watch as interest rates rose sharply. It was a disaster for Latin-American countries.
Western banks had granted loans to third world countries who were all too happy to see capital being injected to help build their industries. The US was particularly well-off: 40% of all loans were made by their banks and US industry received many orders to provide equipment for their industrialization which was often just starting up. All seemed rosy until interest rates flew out of proportion and countries which had borrowed money had to pay off more interest than what they were earning from their exports. In 1982, Mexico was on the verge of bankruptcy. In 1983 it was Argentina's turn and Brazil followed in 1984. Naturally the banking industry was also in big trouble but, at the same time this was once again an opportunity for America, via the IMF, to push for radical restructuring schemes which would open Third World economies to US multinationals. In the name of the free-market all national protection barriers were torn down to the advantage of transnational companies.
Volcker's decision to raise interest rates made the dollar more appealing. The dollar's exchange rate stopped falling and high interest rates helped to attract investors. The way was now clear for the two remaining elements: credit and speculation.
Capital holders demanded also a fiscal reform. Reagan gave them the Economy Recovery Tax Act of 1981. The tax rate on the highest slice of incomes was reduced during the 80s and 90s from 70% to 28% partly under Reagan, and partly under Clinton. As the income of America's wealthiest (1% of citizens) increased by 50% during that time, the average tax rate on their income fell from 37% in 1979 to 29% in 1990. This meant a 70% raise after tax income. For America's poorest (20% of citizens) however, income and fiscal pressure remained the same. In 1980 that same 1% of wealthiest US citizens owned 30% of all assets, a share that rapidly reached 38% during the 80s. In 1998, the richest 5% of US citizens owned 59% of wealth i.e. more than the remaining 95% of US citizens.
The consumption of the well-off underwent a double incentive. Firstly, because they had more income, and secondly, because the increase of their assets provided hedging if they wished to take out loans. The share of private consumption in GDP increased from 62% in 1980 to 68% in 2000.
This was reflected by the savings of US families. 50% of US families with low incomes always barely had enough to set money aside, but regardless of this fact, annual savings made by all families fell from 8% of GDP in 1980 to 5% in 1990 and 1.5% in 2000. Private debt increased and was further encouraged. In 1980 the debts of US families accounted for about 50% of GDP and increased to 65% in 1990, 75% in 2000 and 100% in 2007. The second element had been put in place.
This giant credit rise was not without consequence for the global economy. US consumption, which accounts for an average of 30% of private global consumption, promoted global demand. Indeed, since the 60s, US multinational companies have increasingly been producing abroad: in Europe and in cheap labor countries. Consumption was increasing which meant imports were also on the rise. America soon had to deal with a growing trade deficit.
The dollar's increasing exchange rate (because of high interest rates) had a double effect. On one hand a strong dollar enabled people to buy better value foreign goods and on the other hand it also attracted foreign investors. So the dollars that left the country when paying for the goods were then reinvested as capital in US government bonds and in US banks. The dollar guaranteed that the overconsumption of the wealthy would be perpetuated. In other words, the US economy was being supported by the outside world.
A crucial evolution in company life occurred at the same time. Companies were working more and more for the stock exchange. It was Jack Welch who set the tone. In 1981, Jack Welch was head of General Electric which had a work force of 400,000. His ambition was to turn General Electric into the most competitive company in the world and he had his own methods to reach that goal. Step one? Lay off 10% of least efficient workers every year. Step two? On top of industrial activity, introduce the company to the financial world. This is what Welch did with General Electric. The group's revenue soared from 1.5 billion dollars in 1980 to 4 billion in 1990 and 7.3 billion in 2000. Shareholders were jubilant.
Welch's method was so successful that it soon became the norm in the US and even the whole Western industrial world. Earnings yields were set in advance, generally around 15% which was much higher than the average profit rate. And that profit margin was already being calculated in advance in production costs. Profit deduction was made in advance, not after. This led companies to cut corners constantly wherever possible and take many financial risks. They rushed into the financial world, worked mainly with borrowed cash and relied on financial leverage.
Share returns had become the ultimate criteria; a company's stock valuation became the only way to measure its worth. The higher the market value, the more investors were attracted. This is how the third element came to life.
US industry started to focus primarily on high-tech products and on central activities per branch, i.e. the most profitable sectors. Secondary activity was subcontracted and often moved to countries where labor was cheap. This is how Mexican maquiladoras continued to develop. From 620 in 1980 (with 120,000 workers), they increased in 2006 to 2,800 and they employed 1.2 million people. A similar development took place in countries like Malaysia, Singapore and Taiwan.
The same methods were used all over the world. Currently, many monopolies use the 15% rule to satisfy their shareholders and many European and Japanese monopolies earn more from their financial operations than their actual industrial production.
Financial deregulation and unbridled proliferation hasten today's financial collapse.
The United States took several measures after the crash of 1929 and after several banks went bankrupt to try and stop these events from happening again. The Glass-Steagall Act of 1933 introduced the separation of bank types according to their business (commercial and investment banking), and it founded the Federal Deposit Insurance Corporation for insuring bank deposits. It also implemented what was known as Regulation Q which aimed at prohibiting a differentiation in interest rates according to the size of the client's wealth. Without this regulation, banks would attract wealthier clients by offering them higher interest rates which would put ordinary banks in danger.
However, in the early 60s, these legal restrictions were gradually being dismantled and by 1980 they were completely repealed. An ever growing market of derivatives (financial securities of which the value is determined by other assets) saw the light of day. This led to surprising constructions. Bonds were created with any hedge, even debt. A real revolution in the financing of investment and takeover was instigated. Companies no longer relied on bank loans but could finance operations by issuing financial securities. Some even specialized in issuing these securities. When Clinton came to power the differentiation of financial institutions was revoked. Total deregulation occurred. Other countries followed the US example.
Financial instruments proliferated and became in turn objects of speculation. They grew to such an extent that the traditional relation between bank and industry ended up assuming entirely different forms. In his work Imperialism, the Highest Stage of Capitalism, Lenin shows how the merger of bank monopolies and industrial monopolies creates what was then called finance capital. He explains that property and interest are linked because, with credit, banks gradually become owners of the industry. Lenin concludes: "The concentration of production; the monopolies arising therefrom; the merging or coalescence of the banks with industry—such is the history of the rise of finance capital and such is the content of that concept." The hold of the financial world over industry and their intertwinement is not lessened. But big merchant banks founded financial institutions with much more flexible structures and which, preferably, resort to new financial instruments. They are capable of coming up with larger sums of money for takeovers and preferably work on international markets, whereas, generally, banks have strong ties to national markets.
The share of the regular market that banks and insurance brokers held in US financial assets halved between 1980 and 2007, decreasing from 70% to 35%. The share of private equity funds, pension funds, hedge funds, etc. increased in the same proportions. Hedge funds have been undergoing a bustling growth since 1990; they make very aggressive investments and account for 40% of all stock exchange transactions. In 2007, 11,000 hedge funds were handling 2,200 billion dollars. For many, hedge funds represent the next black hole and they think they may lead to a new financial cataclysm.
Today, a few giant private funds like KKR, Blackstone, Carlyle and Cerberus control the international financial market meaning they also control many company shares. Banks are given a new role: granting loans to these specialized funds.
Therefore Lenin's definition of finance capital is still very much up to date. Lenin also talked about the growing separation between production control and the layer of parasites known as "coupon cutters". His book was written in 1916, almost a century ago, but it could have been written today: "It is characteristic of capitalism in general that the ownership of capital is separated from the application of capital to production, that money capital is separated from industrial or productive capital, and that the rentier who lives entirely on income obtained from money capital, is separated from the entrepreneur and from all who are directly concerned in the management of capital. Imperialism, or the domination of finance capital, is that highest stage of capitalism in which this separation reaches vast proportions. The supremacy of finance capital over all other forms of capital means the predominance of the rentier and of the financial oligarchy; it means that a small number of financially “powerful” states stand out among all the rest."