The financial crisis is the capitalist economy working, not failing.

The financial crisis is the capitalist economy working, not failing.

Economists delight in recalling the Dutch tulip mania of 1636, the South Sea bubble of the 1720‟s, and in current times the internet investment bubble of the 1990‟s, because it involved colourful characters in what turned out to be awesome booms that turned quickly to bust. These were random events, responses to either luck (such as the alleged discovery of gold) or invention (money-making schemes of fertile imaginations). They could not have been predicted using the standard tools of the economist.
The financial crisis that broke in 2007 is different. This crisis was pre-determined by the structure of the economy. The present crash is NOT a market failure: it is actually proof that the monopoly capitalist system is working, and working well. The instability of the system is inbuilt into the DNA of the economy. The process is underpinned by the enclosure of the economic rent, a concept first formalised by English economist, David Ricardo.
Ricardo‟s Law of Rent states, simply, that the economic rent is not a cost of production. A house costs pretty much the same to build, wherever you build it – wages are the same, and materials costs are the same. But the selling price will depend on the location. So builders, for example, will bid more for the best locations. That money doesn’t go to the workers building the house, and nor is it spent on improving the materials used. It purely benefits the owner of the land. This bid is what Ricardo was first to identify as a „surplus‟: the economic rent. Property investors know it today as locational value.
Wherever a price is put on this locational value of land, a property cycle will develop as speculators and companies chase land prices higher and higher, reducing the proportion of wealth being invested in creating jobs and investing in productive businesses. This cycle is beyond the control of central banks. The enormous credit created by banks based upon this value now gives us the violence of the property boom, then bust. This cycle has so far manifest clearly in 14 years of rising prices, then four years declining.
It runs like clockwork: from the 1955 land price low in most Western „rent-enclosed‟ economies (i.e. where land is privately owned), the 18-year cycle has been exact: 1955 to 1973/4, to 1991/2 and now to what was most assuredly another property low in 2010. This real estate cycle has actually been repeating since 1800 in the U.S. and since 1600 in the UK, where the cycle originated.
The current banking problems at the end of yet another 18-year real estate cycle are certainly nothing new. It is amazing to witness how quickly investors forget the previous banking panics, as land prices began to deflate. In October 1973, the collapse of the US National Bank of San Diego was the biggest in 40 years. The bank collapsed because of the activities of its major shareholder, C. Arnholt Smith, chief fund-raiser for Richard Nixon and a major real estate speculator in southern California.
An even bigger bank failure, that of the Franklin National Bank of New York, followed twelve months later, in October 1974, also property related. The Fed chairman, Arthur Burns, when asked by a Newsday reporter what stopped the world financial system from
imploding after the massive failure of Franklin bank, replied: “Luck, more than anything. We were sitting on a volcano. People were concerned in this country, but they were really scared abroad. We can‟t let it happen again, because we might not be so lucky the next time.”
The  “next time” arrived right on que, one cycle later with the implosion of the US banking system in 1990, led by the Savings and Loans institutions. Said one staff member of the Senate Banking Committee enquiry at the time, set up to make sure a banking crisis would never happen again: “„This (banking) industry is very close to the heart of the American economy. We teetered on the edge of a major, major problem here… we teetered on the edge of a major collapse … You know, all these [financial] industries could bring down the whole economy!”
Yet we never seem to learn.
The current UK property cycle will continue to repeat into the future. The current bad debts will have to be either paid off or wiped out, and the wreckage cleared away, (as has always been done at past cyclical lows), before the economy can move on. This process takes years, not months. But it does eventually happen. Ricardo‟s Law of Rent guarantees it.
Phillip J. Anderson
Author, The Secret Life of Real Estate and Banking.
Director,
Economic Indicator Services.