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The role of credit in booms and slumps

August 24, 2007 | Page 8

PAUL D'AMATO explains how debt greases the wheels of the capitalist market--until it doesn't.

THE WORLD economy experienced a global credit crunch last week. Suddenly, nobody wanted to lend, and nobody wanted to pay money out.

The crisis of "liquidity," that is, of available cash, prompted the U.S. Federal Reserve Bank, the European Central Bank and Japan to inject billions of dollars into the markets in order to stabilize them. The Fed also reduced what is known as the discount rate--the rate at which it lends money to banks--by 0.5 percent.

The cause of the crunch was the deflation of the massive housing bubble as a result of the extension of large numbers of "sub-prime" loans--loans to borrowers with bad credit--which led to the collapse or near collapse of several financial institutions that held these loans. An unknown number of financial institutions, many of them unregulated funds, had "exposure" to these loans and are in danger of bankruptcy.

After several years of easy money and low interest rates, suddenly nobody wants to extend loans to anyone--that's what is meant by a credit crunch. The credit squeeze will lead to lower growth rates, and possibly to a recession in the not-too-distant future.

This is perhaps a good time, then, to step back and take a look at the role of credit in the capitalist economy.

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THE FIRST thing to understand is that debt greases the wheels of the capitalist free market.

Historically speaking, credit allowed for large concentrations of otherwise idle funds that could be used to make colossal investments, which no single capitalist could make on their own. As Marx wrote in Capital Volume 3, credit tremendously expands the "scale of production, and enterprises which would be impossible for individual capitalists."

Marx outlined the main effects of credit on the development of capitalism: It helps equalize the rate of profit throughout the system; it reduces circulation costs (because most transactions no longer involve direct money transactions); and it accelerates the speed at which commodities circulate in the economy.

It also accelerates and expands the socialization of capital--that is, its transformation from the property of individual capitalists to that of giant financial institutions. Moreover, it transforms many capitalist into mere "money capitalists"--that is, investors without any relationship to the production process.

The rise of credit accelerates the growth of monopolies--of huge corporations dominating entire industries. It also increases the importance of state intervention in the economy--to prevent, for example, a run on the banks as happened in the early 1930s.

Finally, to quote Marx, credit "reproduces a new financial aristocracy, a new kind of parasite in the guise of company promoters, speculators and merely nominal directors; an entire system of swindling and cheating with respect to the promotion of companies, issue of shares and share dealing. It is private production unchecked by private ownership."

In other words, credit allows for a great deal of financial gambling that appears to have no relationship to the "real" economy--that is, the production and distribution of goods and services--but seems to live and breath in its own realm.

That this speculation (for example, in the housing markets) is ultimately related to more basic economic developments becomes clear only when the system suffers a shock or a crisis. As Marx wrote in Capital Volume 3, "Business is always thoroughly sound, and the campaign in the fullest swing, until the sudden intervention of the collapse."

Credit plays a dual role. The very role it plays as promoter and facilitator of capitalist expansion in times of boom creates a much larger financial overhang when the crisis finally hits. It therefore makes both the boom and the crisis more extreme.

Rosa Luxemburg acknowledged both aspects. "When the inner tendency of capitalist production to extend boundlessly strikes against the restricted dimensions of private property," she writes, "credit appears as a means of surmounting these limits...

"Credit, through shareholding, combines in one magnitude of capital a large number of individual capitals. It makes available to each capitalist the use of other capitalists' money--in the form of industrial credit. As commercial credit, it accelerates the exchange of commodities, and therefore, the return of capital into production, and thus aids the entire cycle of the process of production."

But the very fact that credit allows capitalist production to "exceed the limits of the market" also explains why it is also extends a boom without eliminating crisis. At a certain point, the extension of capitalism as a result of massive borrowing reaches a point where production outpaces the market--overproduction.

At a certain point, the debt overhang becomes too large, and earnings begin to shrink. In these conditions, a shock to the system (a bankruptcy or series of bankruptcies, or a stock market collapse) can trigger a credit squeeze, higher interest rates and a slowdown of growth--and, depending on other factors not discussed here, a deeper economic crisis.

The irony of capitalism is that credit dries up when it is most needed. "After having (as a factor of the process of production) provoked overproduction," writes Luxemburg, "credit (as a factor of exchange) destroys, during the crisis, the very productive forces it itself created.

"At the first symptom of the crisis, credit melts away. It abandons exchange where it would still be found indispensable, and appearing instead, ineffective and useless, there where some exchange still continues, it reduces to a minimum the consumption capacity of the market."

From the standpoint of creating a new society out of capitalism, credit accelerates the process of the socialization of the means of production--although it does so without actually transcending the bounds of capitalism. Marx described the credit system under capitalism as "the abolition of the capitalist mode of production within the capitalist mode of production itself."

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