Solutions to the Economic Crisis

By Johan Galtung Reprint | | Print |

ALFAZ, SPAIN, Apr 23 2012 (IPS) - One of the hidden faces of the economic crisis lies in the famous Black-Scholes equation to find the “correct price” for financial derivatives, a complicated equation adapted from thermodynamics, for which Myron Scholes and Robert C. Merton received the 1997 Swedish State Bank’s prize in honour of Alfred Nobel. Fischer Black had died in 1995 and was no longer eligible.

The equation uses classical calculus for continuous change, useful within a zone of stability, but not at the edge of that zone, the ‘tipping points’ explored in Rene Thom’s catastrophe theory years earlier. Using Black-Scholes is like calculating the increasing speed of an accelerating car heading for an abyss. But if the scientists had warned that the formula could fail catastrophically under certain conditions they might not have received the prize.

In the first three years after its founding in 1994, their company, Long Term Capital Management, made profits of nearly 40 percent, borrowing over 25 times its own capital. But in 1998 it lost its clients 4.6 billion dollars with liabilities of over 100 billion dollars, and collapsed. Rather than being sent to prison, the financiers were bailed out by a group of financial institutions, encouraging others to take similar risks.

The trade in derivatives now stands at one quadrillion a year (15 zeros), ten times the industrial economy of the whole 20th century! Many got rich, but the system collapsed.

The Black-Scholes equation is part of the closed paradigm of economism. It helps a few profit at the expense of the vast majority. In 2007, the top 0.1 percent in the United States had an average income 140 times higher than the bottom 99.9 percent, an unbelievable inequality, both cause and effect of the most recent crisis.

Germany, with decreasing unit labour costs, high employment, quality export products, and a single euro currency, had an eurozone trade surplus growing from 64 to 140 billion euros in the period 2002-2009. They financed the trade deficits of Greece-Italy-Portugal-Spain-Ireland (GIPSI) with credits from German banks, which amounted to 522 billion euros by 2009. They do not invest in GIPSI, but offer high interest credits to be paid back, thereby putting the GIPSIs in debt bondage.

This is a dangerous policy, close to a ‘tipping edge’, endangering not only the euro but also the European Union as a peace project. Debt forgiveness, buying out legitimate creditors, letting other banks collapse, would be better than debt bondage feeding hatred and memories of Nazism in Greece. Is terrorism next? The way out of a complex man-made catastrophe is not to punish the victims.

But we also need political action, which is unlikely to come from the Berlin-Frankfurt-Brussels triangle. Better, “GIPSIs unite, you have only your German banks to lose.” They could jointly negotiate better terms, compare successful policies, increase trade with each other, lift themselves out of bondage. But shady Goldman-Sachs has former employees as prime ministers in Greece and Italy, an economy minister in Spain and the head of the European Central Bank. That spells finance, not real economy.

Inside ‘victim’ countries, cooperation could alleviate much suffering from basic needs deficits. Class warfare from above shifted the crisis down to the vulnerable: women, the elderly, the youth and the excluded, depriving them of money for food-clothes-housing-health-education. But an old lady in poor health with little money may offer housing to a younger person in good healthin exchange for cleaning, help, company. Money need not change hands when you have service for service, togetherness.

Students could help on farms in return for food, and bring farmers closer to culture. Farms could sell directly to consumers. At a global level, a four-lane highway through Africa could help Latin America, Africa and Asia revive, and expand, the “silk road” trade of 500-1500 AD. GIPSI countries might link to South-South-South through North Africa.

Periphery-periphery cooperation is the best remedy against hierarchy and exploitation, not legislation when State politicians have been bought by Capital. Another approach is to lift the bottom up. In the giant Chinese campaign of 1991-2004 that lifted 400 million from poverty to middle class, the local community was the unit of development. The five-pronged approach –the public, private and technical sectors, civil society and a coordinator– gave micro credits to small companies dedicated to producing necessities like food-clothes-housing-polyclinics-schools at low cost, employing the most needy. When their own needs were met, they sold to others at low prices, paid back the credit, and entered the economy with some cash in their pockets. “Capi-communism”, the latter for needs, the former for wants and markets. But the U.S. might not be able to bridge this gap mentally.

Some of the finance economy should be criminalised, like those who give credit far beyond their capital and those who contract loans far beyond their capacity. The trend towards globalisation should move away from Western neo-liberalism to more rational and human Buddhist, Islamic, Japanese and Chinese economic models. And global economies should be balanced with more local economies.

But the whole focus of economics should be changed, from the growth of market economy to meeting basic needs. From gross national product (GNP) to the United Nations Development Programme (UNDP) Human Development Index.

The Czech economist Tomas Sedlacek (Der Spiegel, 12/2012) concludes from the years after communism that egoism is not the alternative; some state regulation is indispensable.

And hopefully, we will not resort to war to get a stagnant inflation-deflation economy running again. (END/COPYRIGHT IPS)

* Johan Galtung, rector of the TRANSCEND Peace University, is author of the forthcoming book “Peace Economics: From a Killing to a Living Economy” (www.transcend.org).