It is blindingly obvious that in its more than two-century history capitalism’s international economic structures have undergone substantial modification. I want here to draw attention to recent developments in global financial structures that I argue have profound ramifications for capitalism’s trajectory; and consequently, in different ways, for the bourgeoisie and for the proletariat.
In this article I first outline the Post World War II issues that were to lead to the development of Offshore, the global financial conduits that enable the movements of trillions of dollars outside the purview of any one state. These networks, sometimes termed tax havens or secrecy jurisdictions, have contributed substantially to the recent acceleration of the virtualisation of money and capital, and have had major implications for the global economy and the shape of its crisis. I go on to summarise some aspects of credit derivatives – with a reminder of the development of the sub-prime mortgage market – and show how they contributed to the creation of a mass of capital whose nature has gone so far beyond fiction that I choose to describe it as fantasy capital. The text cannot do more than indicate the possible magnitude of the capital flows, the very secrecy of these conduits precluding accurate assessments. I would encourage more work to be done on these structures.
For the main sources of the raw material used here, much used here on offshore networks, the workings of the City of London and the Bank of England was gleaned from Nicholas Shaxson’s Treasure Islands; I found some of his claims so astonishing I checked many of his original sources, and I encourage readers to do the same. He has a website for challenges to his arguments. Material on how the credit derivatives work can be found in Gillian Lett’s Fool’s Gold, and on how the bankers bet against their own products and the link to the sub-prime mortgage scam, see Michael Lewis’s The Big Short. All the authors warn of dire consequences of a failure of the banking and financial trading systems to reform themselves. I hope that it is clear in this article that, on this point, I think they are quite mistaken.
Creating a post-war economic architecture
The experience of the 1929 Crash and the 1930’s Depression strongly affected the thinking of many of the people involved during World War II in putting together proposals for the post-war economic and financial structures, especially the main architects John Maynard Keynes of the UK and Harry Dexter White of the US. The Bretton Woods Agreement of July 1944 was to be the basis for building a stable world economy, a stimulus for the development of world trade, and contained mechanisms to facilitate governmental economic regulatory measures such as to maintain tight control over capital flows and stability in exchange rates. Keynes and White had both recognised the damage to the real economy that could be caused by flight capital and wanted to choke it off; this objective required constraints to be imposed on countries’ capital inflows as well as outflows. Through a basket of measures they effectively put restraints on the activities of the finance and banking industries – in particular, they wanted low interest rates to benefit the rebuilding of industrial capital after the destruction of the war. Such measures were seen by the finance sector to be to its significant disadvantage.
Bretton Woods set the framework for the post-War period of reconstruction (although several of the original ideas were later watered down by opposition from groups of financiers). With the help of Marshall Aid, industry in Europe began to recover; as it did in the US.
While Keynes’s and White’s views held sway, and the institutions proposed at Bretton Woods– the World Bank and the International Monetary Fund – were set up, they were not universally accepted; other interests with very different views were to organise around an oppositional agenda. A group that was to become the Mont Pčlerin Society, funded initially by three Swiss banks, met in April 1947. The funding of the Swiss banks was an expression of their readjustment to the world being reconstructed after a very profitable war in which they had played both sides. Significantly, Sir Alfred Suensen-Taylor was present; he provided strong links to the City of London (1) as well as funds from the Bank of England for subsequent delegations to the Society’s meetings. Also present was Milton Friedman. From groups such as these would the later neo-liberal challenge to Keynesianism come. Not only was there a tension between economic ideologies, but it also dovetailed into the ongoing one between manufacture and finance.
The Development of Offshore
Switzerland has a centuries-old tradition of financial secrecy while playing banker to the surrounding warring factions of monarchies, aristocrats and churches through mediaeval and early modern times. The bankers’ fortunes escalated through the major European conflagrations – the Thirty Years War (1618-48), the Franco-Prussian War (1870-71), World Wars I and II. As income tax became a fashion across Europe in the early 20th Century the very rich found Swiss banks to be a more and more attractive repository for their wealth. In the Depression, Luxemburg and Monaco took up ancillary roles. This was the historical backdrop to the Mont Pčlerin Society’s anti Keynesian views. The profitability of such intermediary financial roles – outside of domestic arrangements -- was an open secret.
Gradually, the post-war reconstruction of industrial capital took off, especially in the US and on continental Europe where dollars were pumped into Europe under the Marshall Plan, although this was not confined to Europe. These dollars presented new financial opportunities as some institutions found advantages in keeping dollar deposits outside the United States and using them for other purposes: this was the start of the so-called Eurodollar market. However, in the UK, industry and manufacturing were still languishing. Anxieties over the strength of Sterling (still an important international reserve currency) increased during the ‘40s and ‘50s, and further encouraged the use of the dollar to finance international trade.
All manner of crooked games were played to get around foreign exchange regulations. To begin with, the Eurodollars were only used to finance trade, but then a UK bank (the Midland, later absorbed into what has become the HSBC) started to take non-transactional dollar deposits and offer rates of interest higher than those permitted by the US. The Bank of England spotted this but given the parlous state of the UK foreign exchange reserves, decided not to stop this lucrative new line of business. The Bank of England (2) then started up a dollar market in London and business increased rapidly. It even got a fillip from the Cold War: the Soviet Union did not want to hold their dollars in the US where they might be impounded by their major enemy – so, via Cyprus, Russian money found its way to what some Russians still call “Londongrad.”
The Bank was able to couple this new-found business with its representations inside many small island states that became British Overseas Territories during the break-up of the British Empire, some close to home (like the Channel Islands) and others far away (such as Hong Kong and the Cayman Islands). These territories were then used to form a global network of offshore secrecy jurisdictions all tied back to Bank of England oversight; their most important attraction was that they were politically stable. These jurisdictions could then develop banking and other financial services rules – with UK steering – so as to offer taxation avoidance, a means of moving money between institutions without onshore traceability, and a means of re-introducing money back into the onshore systems without having to obey customary regulations concerning the maintenance of capital reserves, etc. Legal entities could be established offshore that could be repositories for all kinds of financial instruments – as with the so-called special purpose vehicles (SPVs) later used extensively as part of the credit derivatives industry structures. New horizons for finance capital opened up.
When the American bankers saw what was happening, they opened up shop in London to share in the action and thereby get round their domestic regulations such as the Glass-Steagall Act which they saw as being a restraint on profitable ventures. This move brought massive new flows of capital into the offshore systems.
Then the Americans came into the game on their home turf. In the late 1970s, with a judgement from the Supreme Court, Nebraska bankers were able to “export” higher lending rates to Minnesota residents; by March 1980 South Dakota eliminated rate caps and by incorporating in South Dakota US banks could generate credit card operations with very high rates of interest: usury had again been legalized. Delaware then went further and passed the Financial Center Development Act in 1981 and effectively set up an offshore jurisdiction onshore. This opened the floodgates for US banking to get involved in offshore activity on their own territories. With its own small islands round the world, US institutions now have a global offshore network of their own, and it is now the largest.
Globally, there are presently around 60 such jurisdictions. The scale of the financial flows through these networks is instructive. For benchmark figures, look at key GDP figures: global GDP is now running at about $75 trillions; US GDP is approximately $14 trillions; China about $4.5 trillions; the UK is just under $3 trillions. Sources are not systematic and information is compiled somewhat haphazardly, and by their very nature estimates of financial flows through the offshore networks cannot be accurate, but it is likely that such estimates as are made are under -- rather than over -- estimates. Shaxman cites the following:
Estimates of the money-laundering through the networks are also very approximate. Shaxman gives the following estimates for illicit flows in 2005:
Giving a total of somewhere in the range $1 - $1.8 trillions.
All capital flows now converge into the same pipeline – corporate money (from industry, manufacture or whatever), ‘legitimate’ money, drug money, mafia money, intelligence services’ money, racketeers’ money, blood diamond money, flight capital – later to diverge into a spectrum of legal financial instruments. Moreover, the states whose banks run these networks are well aware of the origin of much of the money. So, for example, it is legal for US banks to handle criminal money as long as the crime is not committed on US soil.
Yet, the OECD tax haven blacklist has been empty since May 2009. To be removed from the list a jurisdiction needed only say that it would cooperate with any future investigations into any suspect activity. This is farcical, of course; many of the jurisdictions forbid disclosure of information, proceedings drag on for years and, in any case, funds can be moved overnight.
The impact of these financial operations on the daily life of the world’s population is enormous. For the so-called developing world it is brutal. Estimates for 2006 indicate that global aid amounted to $100 billions, and the capital outflows were around $1 trillions. And in the developed world, large corporate entities – with government approval – move their money offshore to avoid tax payments, leaving the state machine to force the rest of the population to bridge the resulting tax gap. Each year this gets better for capitalists and worse for the rest of us.
The offshore industry distorts whole national economies. For example, in the UK, manufacturing and heavy industry contributed over 40% of GDP in 1950. When Labour came to power in 1997 manufacturing accounted for around 20%; today it is around 12% of GDP.
Credit Derivatives Meet Mortgages Meet Offshore
Now I want to look at one set of the toxic reagents that have gone into the offshore networks – from the credit derivatives industry.
Commodities derivatives have been around for a long time: they were rudimentary in Mesopotamia nearly 4000 years ago; English mediaeval monasteries used them in the 12th and 13th Centuries for wool forward contracts; they were used by the Dutch tulip industry in the 17th Century; and in more modern times they grew substantially with the formation of the Chicago Board of Trade in 1849 to deal with agricultural commodities. The idea of insuring against crop failures was later transferred to the currency exchange and interest rate fields. The breakdown of the Bretton Woods-based exchange controls substantially encouraged their development.
Derivatives activity can have a strictly technical use for normal capitalist business – for production, distribution and exchange of goods. However, there is no hard boundary between that functional use and their use for speculation; and speculative bubbles and bursts have been an integral part of financial history – look at the scam by which John Law, the French Controller General of Finance in France in the early 18th Century issued paper banknotes to fuel the Mississippi Bubble. (Its bursting was to contribute to the economic crisis that was to become part of the process leading to the French Revolution.) In the translation from supporting business transaction to providing a means to speculation, their effect changes from one attenuating adverse risks to a capitalist entity to one amplifying those risks.
The development of such instruments in recent decades has taken them onto another level: the creation of credit derivatives. This is not the place to go into the highly technical structure of these instruments – they have become fiendishly complex and difficult to understand (in part, deliberately, to mask their real content). (The industry for their creation has taken many mathematicians and physicists from scientific work; snake oil salesmen come from all parts of society.)
At the heart of their logic, however, is the identification of the risk of default by one party to another in a credit trade, and then the second party laying that risk off (as an explicit or implicit insurance policy) through further trades to other parties. The basic attraction of this activity to financial institutions is that it allows the consequences of any failure to be spread out among many more parties, each party suffering only a small proportion (theoretically) of the financial pain in any default. When this idea is applied to asset-backed securities, they can be traded, sliced and diced into another basket of financial instruments, all of which can be traded again. Significantly, each time this is done the more opaque is their content; it doesn’t take long to reach the state where no-one knows what’s in them. But the global financial system as a whole is “closed” and eventually all parties are betting against each other.
Enter the mortgage bonds based on the US housing market. The scams that the mortgage lenders got up to are well known. The relevant point here is that the flow of repayment funds was packaged into bonds that could be traded; these mortgage backed securities were then repackaged into the derivatives mill. As is well known, the payment defaults in the sub-prime mortgages turned the bonds, and therefore the derivatives, toxic – a fissile situation. One of the key mechanisms involved in the creation of many credit derivatives were the special purpose vehicles: shell companies set up for tax avoidance in the secrecy jurisdictions, the tax havens, offshore. The funds flows that accompanied derivatives trading could thus go global at light speed – and so did the toxicity.
From Fiction to Fantasy
Economic competition between capitals covers everything: between companies, between industries, between nation states. Economic competition between the state apparatuses of different countries is sometimes clear and at other times difficult to see: in currency exchange, in interest rates, in tax regime competition. The states are often playing with fire but usually they can see what they are doing; however, in their competition using secrecy jurisdictions/tax havens they are dousing the fire with gasoline. The very secrecy they peddle precludes any one state government seeing what is going on, even in its own offshore territory. The “safety rules” imposed onshore (such as capital reserve requirements) are thrown away. And, to date, nothing has yet been done to attenuate even those risks identified in the 2008 banking crisis.
Since 1945 the relative economic and political power of bourgeois factions inside capitalism has changed. Each state has its own history but in the US and the UK, the relative political weakening of industry and manufacture compared with the financial sector has been marked. The relative strengthening of this latter faction of the bourgeoisie inside the state has also been noteworthy; witness the bank bailout process in late 2008. Furthermore, even the OECD openly acknowledges this trend in reports under the rubric of “regulatory capture.” (You can also see this behaviour by other factions, such as by weapons manufacturers and oil companies.)
Given the power of finance capital it looks at present as if it is nigh-on impossible to rein in the activities of the offshore structures – they are too integrated into the economic structure of global capitalism. And if one jurisdiction were to be curtailed the capital could always fly somewhere else. We shall see. The industrial and manufacturing sectors of capitalism need a banking system; but the bankers in some countries have paid scant regard to them. In the decade leading up to the 2008 crisis, only 3% of UK banks’ lending went to manufacturing; 75% went to private and commercial real estate mortgaging. Moreover, those capitalists in the real economy are unlikely to want to be taken down by the excesses of the financial sector. They’ve seen the damage; the question is what are they going to do?
In daily life, $1 is $1. You don’t know whether it expresses the value of an item of production in the real economy, or the fiction of a financier’s promise. More and more the fictional component increases, yet these massive fictions are treated as real by these people. And when the system that manages both the real and fictitious moneys breaks down – perhaps because the population at large, economically strapped, can’t pay to house itself – it hits the real economic system that employs (or un-employs) that population. Stability in these financial markets is based on common confidence in the fiction – lasting until reality breaks through. But the financiers haven’t just continued with the same old fictions; they have gone on to create a full-blown fantasy world. Money used to be backed by some standard such as gold, later by, say, special drawing rights at the IMF underpinned by the real economies of several states. Today, with a vast amount of gearing (leverage) capitalism now depends more and more on a bunch of IOUs created through the collusion of armies of accountants, lawyers, ratings agencies, insurance companies – and even the English libel laws. So, where does the value reside that these instruments are supposed to represent? It resides in the polarisation of the domains of ferromagnetic grains glued onto disks spinning at 7200rpm; and in the promises on pieces of paper. No wonder some economists now argue for a return to the gold standard. Ah, the power of nostalgia.
When Fantasy Hits Reality
Finance capital today has gone into fantasy because the historical contradictions of capitalism as a whole have extended it further and further beyond material production and its reproduction. As a consequence, the creation of fictitious capital – a fundamental activity in banking – has gone viral. Perhaps the only word that covers the scale of this fiction, this enormous virtualisation of capital, is fantasy capital.
The fact that so much of all this capital is fantasy doesn’t soften the blow when the working population is made to suffer the austerity that is imposed to help balance the books. When the debts hit the state’s balance sheet, it all becomes very real - socially. All factions of capital have an interest in extracting as much value as they can from the population as a whole. We can see round the world today the consequences of the bourgeoisie imposing enormous austerity and cuts in living standards. With the financiers behaving much as before it is only a matter of time before the bourgeoisie has to impose further rounds of austerity. Give the reactions already seen around the world we can expect more widespread explosions of resistance.
As already said, offshore networks allow these capital flows to escape the oversight of individual capitalist states. This is consistent with the view that factions of capital compete inside the state apparatus, seeking influence over state policies – and it is clear that in many countries the financiers have benefitted at the expense of other sectors. Give the way these processes have panned out, we should not expect the current set of relationships to remain static: there will be reactions from other sectors as well as from the state apparatus itself. Especially when the next shock comes. What is apparent is that the forces moving the capitalist economic system are beyond the political powers of the bourgeoisie to stabilise.
While the construction of these offshore financial conduits has contributed considerably to the acceleration of the expansion of the productive forces for some decades and enabled the capitalist class to enjoy heightened levels of exploitation, the recent financial crisis shows the destructive power that can be unleashed. The bourgeoisie has created a monster outside its control. There is also another side to the story yet to be realised. For the working class, the funnelling of all these capital flows offers the possibility – when the time comes – to pull the plug on all the server farms that run these systems and to deal a deadly blow to the capacity of capital to move its funds and lubricate its system of power.
1. The City of London, ‘the City’, is a square mile section of the capital city. It has always been home to the headquarters of many financial institutions. While the term, The City, is often used loosely to describe financial institutions in a general way it also has a ‘state’ structure of its own. The Capital city has its Mayor; the City of London has its Lord Mayor. The Corporation of the City of London boasts that the House of Lords was based on its Court of Alderman, and that the House of Commons on its Court of Common Council. (Interestingly, the latter institution is the only municipal authority in the UK where businesses have a vote in elections; furthermore their vote exceeds that of resident voters.) If, for the bourgeoisie, the British House of Commons is the ‘Mother of Parliaments’, for the City of London the Court of Common Council is the ‘Grandmother of Parliaments’.
2. The Bank of England is not just a national central bank. In 1991, the then Governor of the Bank gave a speech explaining what the bank was for. As one might expect of a central bank, it aimed to protect the currency and keep the financial system stable. However, its third aim was to “ensure the effectiveness of the United Kingdom’s financial services” and advance a financial system “which enhances the international competitive position of the City of London and other UK financial centres.”
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