The core of the international financial crisis is the uncompetitive state of the US economy reflected in its huge balance of payments deficit. This reflects major overvaluation of the dollar, which in turn was reflected in the last period in an unsustainable overpricing of US assets compared to their real international values.
The result of this was that US assets would inevitably eventually adjust downwards to nearer their real international levels – which is why this crisis broke out in the most overpriced part of the US asset market, sub-prime mortgages. But many other US assets, including shares on Wall Street, were also overvalued in real international terms and will also inevitably adjust downwards - either due to dollar devaluation, or falls in their price, or both.
As these US assets fall in price this has weakened, or in some cases entirely wrecked, the balance sheet of US financial institutions - which in turn sets up a severe liquidity squeeze as financial institutions are no longer able or willing to lend. Contagion from this has spread through the rest of the world economy.
This driving force of the situation also determines the only shift that can permanently overcome this financial crisis and re-establish balance in the world economy. The devaluation of US assets is inevitable. This shows that markets have demonstrated that the US does not have the economic resources to attempt to maintain its present role in the world - and the attempt to do so is spreading havoc through the world economy.
The US must lessen the strain on its economy - retrench by cutting its military spending and accepting a reduced role in the world economy. The US must either accept this voluntarily, which would be the wise course, or it will eventually be forced through crisis to accept this, but in the meantime severe damage will be inflicted on everyone.
The US role as world’s sole economic superpower has ended. The US has become one very large power in the world among others such as European Union, China and India.
In the medium term all this will require major shifts in the British economy - including the need for much closer relations with Europe, China and India. But in the short term the crucial question is to protect ordinary people to the maximum degree possible from the fall-out from this financial crisis.
To achieve this seven key points must be included in any programme to deal with the economic crisis. This financial crisis is continuing to develop, and therefore so must programmes to deal with it. But there are already elements of the answers required that are clear.
Each corresponds to a particular and crucial part of the present crisis. Further measures to deal with other aspects of the situation will therefore be required, but these seven points are indispensable in any adequate policy response.
First, the government, in order to avoid huge contraction in the economy, must take over the functioning of large part of the banking system. The present scheme for the government to purchase shares in private banks was well intentioned but, due to the huge fall in share prices, which may well continue, creates huge risk and threatened loss to the taxpayer of over £40 billion. This is because it is likely that the real value of both HBOS and Royal Bank of Scotland, once the balance of their devaluing assets and their real liabilities is taken into account, is not only far below the present share prices but may well be zero. The government must not pay money for shares that may be considerable overpriced or even worthless – to do so would be to suffer losses for the taxpayer that would damage public spending, or necessitate higher taxation, for years to come. The government should instead announce it is ready to take over the functioning of any of the banks that turn out to have no value for shareholders. This means that deposits should be guaranteed but not shareholders.
HBOS and Royal Bank of Scotland (RBS) will almost certainly finish up being nationalised, given they are very likely already worthless in terms of real share value once their losses are fully revealed, but by this approach a large loss on share purchases by the taxpayer will be avoided. As shown by Northern Rock, which is now one of the most attractive banks in the country to savers, nationalised banks can be reorganised rapidly and effectively – indeed the productive economy will benefit as such nationalised banks resume lending.
Second, there must be further sharp reductions in interest rates and the government, through banks under its control, must start lending directly – as is already being done in the US. Without this severe damage will be done to individuals and viable companies.
Third, the government should be prepared to run large budget deficits. Keynesian budget measures by themselves are not sufficient to overcome a financial crisis on this scale but they are necessary as a short term measure to counteract recession.
Fourth, as the economy moves into recession, those with the least responsibility for the present situation, those on medium earnings and the least well off are threatened most, while the highest paid will be relatively most protected. This is not only economically and socially unjust but politically disastrous for Labour - whose support is precisely concentrated among those on medium incomes and the less well off. There must therefore be a shift to a more redistributive system of taxation to recycle resources from the best off to those on medium incomes and the least well off. To finance this at a minimum a new 50 per cent rate of income tax for those earning over £150,000 a year must be introduced.
Fifth, the most severe driving force of inflation is high energy prices which are generating extra profits for the energy companies. Such extra profits must, instead, be redirected back to energy consumers by means of a windfall tax on energy companies that is used subsidise those paying extra energy bills.
Sixth, the recession, and probably a decline in exchange rate of pound, will shrink the economy both domestically and in real international terms. In relation to incomes an increase in taxation on the highest paid has already been dealt with. But there will also be a squeeze in public expenditure. The public expenditure that must not be cut is on health, education and welfare and instead resources must be freed up for these through reductions in military spending. This means the replacement for Trident must be cancelled, the new aircraft carriers must be cancelled and British troops taken out of Iraq.
Seventh, polluters must pay. Given that the planet is threatened with climate change, and ordinary people are suffering economic hardship, it is unacceptable that damaging and entirely unnecessary activity such as driving large gas guzzling and polluting cars is taking place. In London the £25 a day CO2 congestion charge on gas guzzling cars must be reintroduced and nationally high levels of taxation on such cars much be strengthened.
There are of course many other economic and social effects of the financial crisis that must also be dealt with in any government programme. As there is a severe squeeze in the private housing market large scale state funded programmes of house building will have to be undertaken. Recession will mean an increase in crime, or the threat of crime, and therefore spending on the police must be maintained – another reason why military spending must be reduced in order to ensure the resources for policing are maintained. The threat from racism will increase, as will the danger of domestic violence against women, and therefore programmes against these must be stepped up.
But the seven points outlined above, while not a full economic programme, are indispensable parts of any policy to deal with the present economic situation.