This is a guest post republished from the socialist worker and explains in more detail some of the history to the current looming crisis in the funny money markets:

From Northern Rock to the subprime mortgage scandal, financial markets are in turmoil. Jacob Middleton looks at what lies behind the current crisis

The ongoing woes of Northern Rock continue to the extent that even the latter-day Thatcherite Lib Dem Treasury spokesperson, Vince Cable, is calling for it to be nationalised. It is clear that something is seriously amiss in the financial system. Capitalism seems unable to shake off the growing sense of crisis.

The root of the problem lies in the failure of profits to recover to the levels seen in the decades after the Second World War. From the early 1970s onwards, the world economy, which had for years grown, began to slow down.

Growth slowed, profits slumped, and unemployment returned to the heart of the system. The tendency of the rate of profit to fall, a long term feature of capitalism that Karl Marx had identified 100 years previously, reasserted itself.

The response of governments throughout the world, tentatively at first but gathering pace over the next 20 years, was to introduce the measures we now know as neoliberalism.

First, great chunks of the state itself were broken up and sold off, releasing huge sums into private capitals’ hands – one estimate suggests that around one third of all the value in all the world’s stock exchanges comes from privatisation.

Second, controls on the movement of goods, services and – especially – money from country to country were removed, allowing capital to move more freely around the globe.

Third, and most fundamentally, attacks were made on working class standards of living. Capitalism makes profits from paying workers less than the value of what they produce. Often the quickest and easiest way to restore profits is to pay workers less – either directly, in their pay packages, or indirectly, through attacks on the welfare state.

In the US this assault on the working class was successful – between 1975 and 1995 average real wages for full-time male workers in the US stagnated, or even declined slightly. Elsewhere the attacks were less thoroughgoing, but in Europe the welfare systems that had been the social democratic parties’ proudest achievements were whittled away, and job insecurity was increased.

Stagnant

These attacks had some success in boosting profits. Growth returned to some areas of the system, but was unevenly distributed – the US economy boomed in the late 1990s and early part of this century, while those in what is now the eurozone in general remained stagnant. Growth was not generalised throughout the developed world.

The picture was even more mixed in the underdeveloped economies. While a few – China being the most spectacular example – were able to hook themselves into the global economy, many, such as those in sub-Saharan Africa, went into steady decline.

There was no return to capitalism’s post-war “golden age”. But the relative underlying weakness of the recovery was masked by the explosive growth of the world financial system.

Financial markets and financial institutions play a very specific role under capitalism. They help coordinate the system, moving capital to wherever it can make the greatest profit.

An individual capitalist may not be able to see where the best profits can be made, anywhere in the world, but the financial markets, collectively, can do this, taking money and redistributing it according to the returns it can make.

Theoretically, financial markets make capitalism work “better” – they will hunt the places where highest profits can be made, and so (theoretically) boost profits throughout the system.

However, the financial system carries two great risks. First, it can misjudge real profits and simply indulge in speculation, with financial markets talking themselves into a frenzy of ever increasing share prices, based on not much more than the whims of traders. These are called “bubbles” and the consequences, when they burst, can be dramatic.

Second, the speed and flexibility with which the financial system can find profits may also turn it against capitalism as a whole, rapidly transmitting a crisis in a single economy into others. This is known as “contagion” – the crisis in one region spreading very rapidly to others.

Since the London stockmarket’s so-called “Big Bang” in 1986, when electronic trading was introduced and many of its old rules were torn up, the City was able to build on its historic role to become one of the most important hubs of the new global financial system. The value of traded shares in London has increased by fifteenfold since then, from £161 billion in 1986 to £2.49 trillion today.

Money can be moved round the world at the press of a button. Financial institutions are able to scour the globe looking for profitable opportunities for investment, moving into and out of markets, buying and selling shares, with incredible speed. With some recovery in profit rates on the back of attacks on working class living standards, financial markets were able to suck in more and more money and capital, and so inflate themselves to greater heights.

Moreover, the expansion and growing sophistication of the financial system created an intriguing new possibility for capitalism. It is in every individual capitalists’ interests to pay workers as little as possible to boost profits. But if every capitalist did that, workers would not be able, collectively, to afford what the capitalists, collectively, are selling. What is good for one capitalist is not necessarily good for the system as a whole.

However, by offering cheap loans to workers, capitalists could simultaneously pay workers less and still sell their goods and services. The expansion of the financial system allowed them to do that, tying workers into global finance with cheap loans and easy credit.

The effects are dramatic. In Britain, where this process has perhaps gone furthest, real wages have for the last few years grown weakly, if at all. Yet consumer spending has risen by 40 percent since 1998.

The gap between weak wage growth and rapidly rising consumer expenditure was closed by consumer credit, with individuals in Britain now owing over £1.2 trillion.

But because the underlying rate of profit, though somewhat recovered, remained too low to produce a generalised expansion of capitalism, this new high speed financial system actually rested on very rickety foundations. It could shuffle money around the globe at breakneck speed, but the flow of real profits into the system was much less dramatic.

This increased the risk of speculative “bubbles” developing, and the last 20 years have seen a succession of these, inflating and bursting. But they have not, until now, hit the core of the system.

The bursting of the dotcom bubble in the early part of this decade resulted in some high profile fraud convictions, and some spectacular losses, but swift action by the US government bank, the Federal Reserve Board, prevented it spilling over too far into the real economy.

The Federal Reserve did this by creating another bubble, in the property market, slashing interest rates and encouraging many millions of Americans to keep on borrowing and consuming.

Borrowers

As the property bubble continued to expand, more and more consumers were pulled into its orbit. The subprime lenders sought out, and mis-sold mortgages to, people who otherwise could not afford a mortgage. There were reports of subprime loans being made to those without any income at all.

This is very risky. People who cannot afford interest payments on their loans are at a high risk of defaulting on them, and a small wobble in the property market meant many of these very marginal borrowers suddenly could not afford to keep up with their interest payments. Mortgage lenders were left with billions of dollars of bad debt.

The sophistication of the financial system had encouraged the major banks to engage in increasingly speculative activities. They had been responsible for loaning money to the subprime lenders, who in turn passed the credit on to their own customers. The banks, realising they had difficulties, began to panic. They called in some of their loans, and stopped lending money to each other.

Northern Rock relied on this inter-bank lending to make its money. Banks lend money at a much cheaper rate to each other than they do to you or I – they trust each other not to default, and so charge less.

When banks stopped lending to each other, the company was in serious trouble. And due to the way the financial system ties capitalism together, a serious problem in one small part of the system can rapidly turn into a serious problem, system-wide.

In addition, years of deliberate government policy have tied consumers into the financial system as never before. British consumers owe, on average, 163 percent of the earnings in debt.

The system relies on their borrowing, and others like them across the developed world, to keep running. So a crisis developing in the financial system has the potential not only to hit capitalists’ investments – it can hit workers’ consumption.

The last time a financial crisis threatened, the Federal Reserve was able to create a property bubble to keep the system afloat. If the property bubble bursts, it is hard to see what bubble the central banks can create next.

The only real way to deal with this crisis is to boost profits by hammering workers. This helps explain Gordon Brown’s enthusiasm for a public sector pay freeze – he hopes that he can give a lead to British capitalism generally by weakening workers’ confidence and keep wages down. He wants them to pay the price for the capitalists’ crisis.

The following should be read alongside this article:
» Financial graphs

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Flop2.0 Predictions 2008. The dollar has plummeted, the bubble's are popping, the recession's kicking in, yet we have NOTHING to fear!

• What is a bubble? It's an overinflated market where big money distorts the playing field, greedy investors muscle their way into the market copying every potential innovation until the market is over saturated and no-one can possibly stand out, long since forgotten are the original innovators that pioneered the first killer application that paved the way for the others to emulate. SOUND FAMILIAR?
• What is a recession? It's where an overinflated (VC backed) group of companies start dropping like flys. It starts off slowly and gains pace exponentially then slowly levels off again like a sinusoidal wave. SOUND FAMILIAR?

So I'm looking forward to this one! Lets face it, one thing there won't be is a reduction of eyeballs on the internet. The internet is going to continue to grow exponentially - just like it did through the first bust in the dotcom orgy.

But why is such a decline to be celebrated? Despite the excitement associated with these greed based booms there is little good to ever come out of them. Innovation is NOT facilitated by greed, it is a natural phenomenon that occurs when the conditions are right on the ground. In fact bubbles actually hinder innovation as the true innovators are plagiarized till the point that they drop, no way of competing with the millions that are invested into wannabe emulators (competition 'they' call it) of their original ideas, they quietly drop out of sight often disillusioned and disheartened by the ice cold realities of so-called 'business' and lost from the collective genius that is the force behind all bifurcations.

Those hoping for a miracle, that they would have been one of those lucky few who do make it into the limelight with 15 seconds of fame and an article on the front page of Techcrunch, covering their announcement that so-and-so have invested so many millions in an x-round of angel funding, fear not. It was a scam to begin with, the innovators and entrepreneurs rarely ever get real dough, instead are forced to slave away for 5 years or more growing the business and if are lucky, get to stand behind a long que of others who have proir claim to their labor, efforts and success.

The nerds were once an untrendy bunch of losers, outcasts according to the 'in crowd'. Yet now it is the nerds that are all the fashion. Yes it's fashionable to be a nerd. Who would ever have thought that? But as with all fashions their comes the emulators and then you get everyone and his uncle who wanna be a billionaire nerd like Gates (well maybe not like Bill per say). But these are not real nerds they are simply cling-ons who are only in it only for the money and glory. They couldn't care less about innovation, let-alone the hours and hours of unpaid dedication that goes into to creating true genius.

"Wheres the business angel?" That's what they keep asking for, "how are you going to monitise it? You call that an invention, you haven't even got a 'buy it now' button!". These are the cries from the skeptics to this latest boom, and right they are but for the wrong reasons. See it's not about making a business, it's about making a hobby that becomes a success organically. So while the skeptics and analyzers lecture you about what your doing wrong and tell you all how to do it right, let it be understood that today it's no longer fashionable to be a nerd, we've been there and done that. The next big fashion is going to be 'the hobbyist' developer.

SO WHO ARE THE HOBBYISTS?

Everyone is competing for the limelight, screaming for attention, looking for a model that has traction, and yet most of the fruit is going sour simply because there is far too much of it. The market is saturated with nearly every conceivable innovation coupled with the desperation of a starving man, so getting the cream to rise in the new marketplace is akin to pushing the cattle uphill to the pumps.

There is a subtle undertone felt by every competitor in this uphill struggle who feels the desperation of this market. All of the entrepreneurs locked into little online cages barking, crying, singing and dancing for attention and at a moments silence threatened with being discarded as scrap.

The internet is a very different market than that in which we have traditionally traded, where the separation between us has vanished, no miles to travail to find a competitor, no space to walk and hardly any effort takes you to the next guy with a pitch.

The market can sense this anxiousness and has become desensitized to the common peddlers and their Mickey mouse offerings who stare now only at the sight of spectacles which in someway they can exploit, like the gathering of dealers at auctions of the dead who look for bargains from redundant factories.

The market has become fickle and you will loose them to the next guy at the first sign of trouble, which might well be in the form of a request for registration, not having the right style, don't even mention money, difficult navigation, or a host of other minor causes that could demand something of the user without giving him his fix first.

As a result the effort to capture an audience has reached epic proportions, with ever greater investments being made in marketing and with ever simpler systems developed for the competitors, to the point now that one can enter the market and publish his own website with as little as 3 clicks of a mouse.

Then as soon as anyone notices the vague whiff of success you will have 10 copycats most of them undercutting themselves to the point of giving whatever you was offering away free, in order to get your slice of the bacon.

We have reached the point now where the winner is actually the one who can give it away the fastest. Forget sound business models, forget making money, forget quality and focus on finding rubbish that you can tout to anyone who will take it off your hands, then auction off segments of your floor space to others who will pay you to offload their own piles of crack.

Then for a few fleeting moments you will have been the champ, the top dog on the stage which will last until your resources are depleted or your competitors have surrounded you, or the market has simply had its fill and cannot stomach a single ounce more.

Unfortunately this is where we have arrived and naturally at these tipping points when the market is selling short the inevitable collapse is just around the corner.

The survival guide is kiss, keep it simple stupid, observe but don't follow, build organic companies from seeds, don't try to muscle your way into markets, and don't be fooled by venture capital from which there is no return to sanity.