Stock Market Crash, New Market Failure Theory and Extremely Great Economic and Financial Crises

Bin Yang. World Review of Political Economy. Volume 8, Issue 1. Spring 2017.

The disastrous stock market crash in China in 2015 shows the huge destructive effect of the inflating asset bubble. One important cause for such a crash is that the popular market economic theory ignores the harmfulness of bubble economy. Stephen S. Roach, a famous American economist, pointed out in his article (2015) that the dominant Western economics is blind to bubble economy which is a mar­ket failure causing substantial harm, so that the governments in countries around the world cannot take measures to prevent the formation of bubble economy at an early date, and disasters such as Japan’s financial crisis, South-eastern Asian financial crisis and subprime mortgage crisis come up repeatedly. The liberalism theory holds that the free market mechanism is perfect and will not lead to any crisis, while Keynes’s crisis theory blames the economic crisis on the imbalance between saving and investment, but they ignore the important role the inflating equity bubble plays in inducing crises prior to the Great Depression. The equity bubble on the eve of 1929 induces not only the Great Depression, influencing the world, but also World War II due to intensified social contradictions and unrest, and the shift of the economic crisis onto others through the war results in huge losses of wealth and tens of millions of lives.

Harmful Bubble Economy Calls for New Market Failure Theories

The Western economics discusses classic market failures such as natural monop­oly and economic externality, but neglects bubble economy, causing greater harm and inducing excessive speculation. This is because it aims to safeguard the need of financial capital for chasing exorbitant speculative profits to a great extent, and meanwhile, bubble economy reveals the fatal flaw in the free market mechanism, that is, the unregulated free market cannot restore the balance between supply and demand under many conditions, but also exacerbates the imbalance between sup­ply and demand, sharp rise and drop in prices and distorted allocation of economic resources. Therefore, it is necessary to develop new market failure theories to rectify the flaw in the Western economics, which is of great theoretical and practi­cal significance to currently deepening the reform and opening up, avoiding the impact of global financial turmoil frequently occurring, and safeguarding the security of national economy and finance and social stability.

Marx believes that the law of value plays a role in adjusting socialized mass production, and prices influenced by the supply and demand situation fluctuate around values and regulate the allocation of resources. Where a gap between supply and demand arises on the market, price fluctuations will deviate from values, that is, when supply falls short of demand, prices will be higher than values, and when supply exceeds demand, prices will be lower than values. If the gap between supply and demand is small, the balance between supply and demand may spontaneously restore under the law of value; however, if such gap is too large so that prices are far away from values, the law of value will fail and it is difficult to restore the bal­ance between supply and demand. Where supply is far greater than demand, prices will be much lower than values, and for survival, producers will increase the supply instead of reducing it so as to obtain the income required for survival in this way. In the event of drastic fall in prices, supply is increased to maintain a steady income when the expected income effect promotes the collapse in prices. Where supply is far less than demand, prices will be much higher than values, and the sharp rise in prices will attract a large amount of speculative capital to be invested in for huge profits, so when the expected income effect brings about spurt in prices, demand increases and the situation of short supply becomes more serious, leading to a fur­ther surge in prices. Marx does not discuss the phenomenon that short supply gives rise to bubble economy and failure of the law of value, but deeply discusses the problem that the law of value fails to play its regulating role and it is difficult to restore the balance between supply and demand in the course of oversupply due to overproduction resulting in an economic crisis. Marx also discusses the following issues: capitalists’ pursuit of maximum surplus value limits workers’ income growth; the contradiction between unlimited expansion of production and effective social demand leads to overproduction; in case of an economic crisis, it is difficult to achieve values, a lot of resources are wasted, and extremely serious oversupply and failure or disorder of the market regulation mechanism occur. In fact, Marx’s economic crisis theory is a kind of market failure theory, which mainly discusses the process of how the basic social contradiction in the era of industrial capitalism inevitably leads to a glut due to overproduction on the market, thus causing market failure and destructive spontaneous adjustments to the economic cycle.

At present, it is imperative to develop and extend Marx’s economic crisis theory from the overproduction crisis in the era of industrial capitalism to the financial cri­sis in the era of financial capitalism due to bursting of bubbles. After Western coun­tries enter the stage of financial monopoly capitalism, the rise of consortiums of financial monopoly capital and the development of new financial instruments make the characteristics of the economic cycle and the economic crisis change a lot gradu­ally; margin financing and securities lending, borrowing for investment in stocks and financial derivatives, etc., arising on the eve of the Great Depression in 1929 start to trigger a spurt in prices and huge bubble economy on the markets of equities and other capital, forming extremely serious short supply and market failure on the capital market; with the interference from speculative demand, prices no longer fluc­tuate around values, resulting in the failure of the law of value; when bubbles inflate, prices are pushed up by speculators unceasingly so that they are increasingly further away from values, and after bubbles burst, panic drives prices to fluctuate far below values; on the one hand, the false wealth bubble effect temporarily alleviates the insufficiency of consumer demand and postpones the outbreak of market failure and economic crisis caused by overproduction, and on the other hand, it leads to further exploitation and plunder of public wealth by excessive financial speculation, and once the false wealth bubble bursts, consumer demand will decrease further, greatly deepening the glut of real economy and overproduction crisis.

Marxist theory of political economy upholds that unlike the third industry serv­ing the real economy such as scientific research, education and medical treatment, virtual financial speculation does not create value but plunders the value created by the real economy, and it has no social positive significance but causes huge waste of economic resources. The famous “Glass-Steagall Act” for financial regu­lation formulated in Roosevelt’s time strictly distinguishes commercial banks serving the real economy through deposit and lending from investment banks car­rying out speculative trading on equity and futures markets, and strictly prohibits commercial banks from granting loans to investment banks for supporting their speculative trading, effectively restricting the expansion of the scale of specula­tion with financial capital through borrowing and leverage and achieving a great success of avoiding financial crises and banking crises for decades. The principle of the above act is conforming to Marx’s theory that finance must serve the real economy and new market failure theories established on the basis of the develop­ment of Marxism, thus effectively preventing the gap between supply and demand on various asset markets and market failure as well as asset prices deviating from values for a long term and attracting and plundering social wealth, and avoiding the direct and indirect flow of public deposits to equity markets and other specula­tive fields, and the panic of bank runs and the collapse of money supply, which arise from failure in speculation, causing a comprehensive deflation, overproduc­tion and economic recession. For the current reform of the financial system, China must also take Marxist theories as guidelines, draw lessons from successful expe­rience in strict regulation in Roosevelt’s time and the social reform period of the United States and Europe, especially the formulation of regulation laws strictly distinguishing commercial banks from investment banks, and establish the fire­wall strictly restricting the flow of commercial banks’ loans to investment banks and shadow banks, and never follow the current financial liberalization policies of the United States and Europe which deny the successful experience in the social reform, nor imitate the mixed operation mode of the United States and Europe which repeals the financial firewall effectively limiting speculation.

It is worth pointing out that Keynesian theories blame the economic crisis on the imbalance between savings and investments, but ignores the important role virtual financial speculation plays in inducing crises prior to the Great Depression. Ruling elites of the United States and Europe admit that the obvious moderation of the economic cycle in the post-war golden economic period of Western countries should be attributed to social reform policies which contain the greed of financial capital and protect public interests and whose ideological basis is Marxism attach­ing great importance to social justice and real economy rather than Keynesianism neither paying attention to social distribution nor distinguishing real economy from virtual economy. Although the United States and Europe have adopted Keynesianism in recent years to stimulate their economy, their fiscal and monetary policies foster virtual financial capital but ignore real economy and public interests, so plenty of financial resources have been spent on the rescue of the equity market but the effect achieved is less than one tenth of that in the social reform period. The key reason is that the United States and Europe have repealed the Glass-Steagall Act at present, so they cannot prohibit commercial banks from engaging in speculative trading irrelevant to real economy or commercial banks’ loans from flowing to speculative and unregulated shadow banks, which causes various banks to indulge in financial speculation and are reluctant to support real economy, and the inflation of virtual bubble economy makes the whole financial system in a precarious state. The bail­out and stimulus polices adopted by the government and the Federal Reserve System also ignore real economy but rescue virtual bubble economy which grabs the value created by real economy rather than creates value so that the United States and Europe fall into the new normal of flagging real economy for a long term, can­not create enough jobs or stimulate the growth of income or consumption, are forced to manage to maintain the inflating virtual bubble by repeated capital injec­tion under quantitative easing, and make public opinions on false recovery to attract social capital and plunder public wealth. American mainstream public opinions publicly acknowledge that stimulus policies only have “trickle-down effect,” reflecting visually the disadvantage that they cannot benefit the real economy and the public. China should not be misled by American public opinions on false recov­ery to stimulate the stimulus policies for equity and property bubbles, but foster scientific research, education and medical treatment, etc., that serve real economy in the development of the service industry, and should not provide credit support for financial speculation that plunders value instead of creating it, but pay special attention to the harm of the policy using Keynesianism to stimulate virtual econ­omy. Only in this way can China avoid serious social unemployment due to down­turn of real economy as well as losses of stock market crash and turmoil of capital market resulting from speculative borrowing and lending, and leverage.

Currently, efforts should be made to develop Marxist theories of economic crisis and market failure to form a unified theory frame that discusses the role extremely serious oversupply and short supply play in inducing market failures of the type of overproduction crisis and of the type of bubble economy and applies to local micro market failures caused by general merchandise and assets but also macro market failures and economic and financial crises caused by important products and assets. New market failure theories reveal different characteristics of the Great Depression and the economic crisis in Marx’s time, and why the bursting of equity bubble first brings about the financial crisis in the field of virtual economy and then spreads to the field of real economy and causes the economic crisis due to overproduction, contrary to the outbreak order of the economic crisis and financial crisis in Marx’s time. The intertwined two crises more serious than ever before lead to the Great Depression for which the spontaneous adjustment can hardly be achieved without strong government intervention, and form the extremely great mixed economic and financial crises different from the traditional economic cycle. Marxist crisis theory is able to fully explain the overproduction crisis in the era of industrial capitalism, while new market failure theories are needed to explain the Great Depression in the era of financial monopoly capitalism.

Facing Flaws in the Mainstream Western Economics

The curves of supply and demand on the commodity market stated in the main­stream Western economics seem to be very scientific and wonderful, but in fact, they just apply to the small gap between supply and demand near the price equilib­rium point. In case of any too large gap between supply and demand, which is far away from the equilibrium price, due to a variety of reasons, the supply curve will become a vertical straight line after inclining upward for a while, and the reason is that it is difficult to continue to expand production for such restrictions as enterprise equipment and factories. The spurt in prices often leads to the inflow of a large number of capital for chasing huge speculative profits, so that the normal demand curve suffers serious distortion and changes from tilting down to tilting up, and suppliers may also be attracted by high profits to become speculators and their unwillingness to sell out and speculative hoarding will distort the supply curve which tends to slope down. This means that the stagnation of supply and sharp increase in demand cause prices to rise faster, even out of control, and the market price mechanism fails and hardly impels the recovery of balance between supply and demand. Dutch tulip bubble is a kind of classic commodity bubble economy.

Thus, it can be seen that once the gap between supply and demand is too big, resulting in spurt in prices and then inducing excessive speculation, the price mecha­nism for free markets will lose the function of impelling the recovery of balance between supply and demand, and also allocate a large number of resources to specu­lators independent of producers and consumers, and the exit of speculators after they obtain profits will be a huge blow to production and consumption. A too big gap between supply and demand of general commodities will give rise to local market failure, and for some important commodities such as grain, steel and other bulk com­modities with wide upstream and downstream links, the sharp rise in prices and excessive speculation will have negative impact on the national economy. Compared with commodity markets, asset markets are more suitable for investors to participate in, for example, properties, and equities are apt to induce the bubble economy with extensive negative effect. The upsurge in asset prices will make suppliers more unwilling to sell out or more willing to hold assets, and the supply curve will tend to slope down after tilting up. As the demand for assets is more prone to be distorted by excessive speculation than the demand for commodities, the demand curve of assets will tip up greater after sloping down, which means that compared with commodity markets, it is more difficult to achieve the balance between supply and demand on assets markets; more serious spurt in prices out of control and market failure will occur; and the negative feedback process that the gap between supply and demand gradually decreases and supply and demand tend to be balanced will become the positive feedback process that the gap between supply and demand gradually increases and tends to be out of control. The serious harmfulness of market failures caused by such bubble economy far exceeds that of classic market failures such as natural monopoly and economic externality. To maintain the security of public wealth and national finance, it is necessary to carry out in-depth study on new mar­ket failure theories discussing the bubble economy, despite inevitable deprecation and opposition from financial speculation capital groups.

The above new market failure theories discussing the bubble economy show that the extremely serious short supply caused by natural or human factors may trigger the positive feedback process of surge in speculative demand and spurt in prices. This is not the normal market price regulation process prompting the mar­ket supply and demand to trends toward balance, because the market supply and demand and prices will not tend to a stable equilibrium, but after a peak of prices out of control is reached and the power for climbing up is exhausted, speculative capital that manipulates the market will suddenly shift to sell-off, which brings about a widespread market panic and then the avalanche-type exit from the market and too large glut, and deepens the positive feedback process of market panic, scrambling to sell off and slump in prices, resulting in prices far lower than normal values and hold-up and heavy losses of investors, and the market supply and demand and prices fluctuate at a place far below the normal equilibrium point until panic vanishes gradually and a new wave of speculation occurs. In the process of market failure due to expansion of the bubble economy above, market partici­pants’ wealth inflates rapidly and bursts suddenly like a bubble, and normal mar­ket suppliers and demanders are deprived of a large number of wealth, which is transferred to speculators who are not interested in the supply and demand. The result of market failure is that a large number of resources are allocated to a small number of speculation manipulators, leading to the waste, spending and ineffi­ciency of economic resources and the polarization between the rich and the poor, and then intensifying social contradictions, instability and political manipulation by economic oligopolists and resulting in the transfer of crises by launching for­eign economic or military wars and shift of losses onto others.

The textbook of Western economics has a very large section on the theories of balance between market supply and demand and price, which seem to be universal truth and apply to various markets of commodities, labor force, capital and others, without any reference to the circumstance that the function of wonderful and spon­taneous recovery of the balance between supply and demand under the regulation of the free price mechanism only applies to the small gap between supply and demand near the price equilibrium point or that in case of any too large gap between supply and demand, the supply and demand curves will be distorted seriously, and the free price mechanism, which is a wonderful “invisible hand” as the core of Western economics, will change from the stability and balance of negative feed­back to the destructiveness and loss of control of positive feedback. In the face of bubble economy, turmoil and crises taking place frequently in the real world, a famous American physicist who has won the Nobel Prize tries to introduce the chaos theory and positive feedback mechanism of physics into economic theories, as he thinks that the ability to explain the complex reality of the chaos theory and positive feedback mechanism is far stronger than that of the free market equilib­rium theory of orthodox Western economics, but he is in a great puzzle about the stubborn attitude of exclusion held by Western economists. However, his theory does not consider some more complex economic systems, such as monopoly capi­tal interest groups and their needs for control over influences of theories and public opinions. Even though the positive feedback mechanism has achieved satisfactory results in the real world simulated by computers, it is intolerable for powerful capi­tal interest groups and their agents in academic circles, and inevitably excluded and opposed by new liberal economists for professional interests as it completely over­turns the “invisible hand” in the sacred free market theory and the wonderful func­tion of spontaneous recovery of the balance between supply and demand exercised by the free price mechanism.

The difference between economics theories and physics theories is involving complex human motives and behaviors. As human behaviors will change in a flex­ible and diversified manner beyond the relatively narrow scope of adaption, the methods of detective science should be used for reference to carefully study the application scope of theories and the evidence for failure thereof, and put forward new theoretical hypotheses with a wider application scope and effective explana­tion on new evidence. If a detective indulges in the mathematicization of theoreti­cal hypotheses applicable to some cases, but ignores the new evidence of failure of theories and does not put forward new theoretical hypotheses, he/she will surely be seen as a ridiculous stupid detective due to the capture of the wrong person.

It is noteworthy that the mainstream Western economics just adopts such a wrong method overlooking real evidence, and it neglects the serious failure of the theory of balance between market supply and demand in the case of a too large gap between supply and demand and is addicted to the complex mathematicization of the theory with a narrow application scope, making people consider that economics will be scientific as physics in this way, which actually is ridiculous like the detective who solves a case with the mathematical formula rather than investigates the new evidence. Like solving a case, the key of the assessment on economics theories involving complex human motives and behaviors is to straightforwardly but convincingly explain various doubts and real evidence rather than ignore any real evidence and indulge in the establishment of abstruse mathematical models.

In solving a case, a detective will be faced with difficult problems far more complex than the economic research and have the testimony, analysis and judg­ment provided by the parties concerned with different profit motives; if traditional economic research methods are adopted, the case will enter into endless argu­ments, without agreement reached on what is right, but if methods of detective science are used for reference, the only criminal and scientific conclusion will be found. Never laugh at the method of using detective science for reference because it is deviant and whimsical. China’s Ministry of Public Security discovers the involvement of American capital in the stock market crash in China by adopting such a method. The unique research method of using detective science for refer­ence is especially suitable for economic research, because economic research, like settlement of cases by detectives, also involves complex human motives and behaviors, which are significantly different from mechanical, chemical and physi­cal laws involved in natural science research and often undergo colorful and com­plex changes with the objective environment. Unlike theories of natural science that have the wide application scope and stability, economic theories cannot be described with mathematical tools accurately reflecting mechanical and physical laws. Economic theories applying to special occasions may fail in other occasions. It is necessary to continuously deeply study new real evidence and continuously establish new theoretical hypotheses able to effectively explain new case evidence like solving cases by detectives rather than simply copy previous successful expe­rience and theoretical hypotheses in case solving.

China should require the press of academic journals on social science to abolish the wrong provision that mathematical models shall be established for economic papers, because it is difficult to describe complex human motives and behaviors with the mathematical formula like mechanics. Western economics uses complex mathematical models to cover up the specific application scope of the market equi­librium theory and its serious defect of neglecting bubble economy and economic and financial crises, which goes against the in-depth study by academic circles on new market failure theories of Marxism, and will weaken China’s ability to control market economy and mislead the development of policies for economic reform.

Mechanism of Generating Extremely Great Mixed Economic and Financial Crises

In Marx’s time, dominated by industrial capitalism, the economic cycle arises from industrial expansion and overproduction, and its spontaneous regulation is generally not intervened by the governments. After Western countries enter the era dominated by financial monopoly capitalism, the cause, characteristic and intensity of economic crises change fundamentally. The reason why the damage caused by the Great Depression in 1929 influencing the whole world is much more serious than that by previous economic crises is because after Western countries enter the stage of financial monopoly capitalism, through a series of innovations in financial systems and tools, Wall Street consortiums gradually develop a variety of financial levers able to artificially make and manipulate bubble economy, including margin financing and securities lending, borrowing for purchase of stocks, stock index futures and embryo financial derivatives, whose principle is that plenty of public wealth is looted by and a large number of economic resources are allocated to a few monopoly consortiums by making use of market failures, namely, to greatly enhance the expansion and destructive power of bubble economy by enlarging the gap between supply and demand of various financial assets, to utilize spurt in asset prices to induce public greed and speculation, and to utilize sharp drop in prices to make market panic, crash and dumping. As banks use enormous deposits gathered to generate all kinds of financial bubbles, equity markets and other virtual econo­mies develop to a scale so that they exert a vital influence on national economy; the lack of demand will be alleviated when bubbles inflate, while overproduction will be greatly increased when bubbles burst; the sharp rise of financial magnates makes virtual bubbles have the great power of destroying national economy; and the tradi­tional economic cycle evolves to the extremely great mixed economic and financial crises with the characteristics of the Great Depression.

President Hoover refused to acknowledge that the Great Depression resulting from the bursting of the new equity bubble was a serious market failure and needed powerful government intervention, but mistakenly believed that like previous eco­nomic cycles, the Great Depression may be ignored and subject to spontaneous adjustments, resulting in the decrease in industrial production by a quarter and seri­ous unemployment. The principle of the New Deal and improved financial regula­tion carried out by President Roosevelt that produced remarkable effect is also that a series of new financial regulatory policies and measures are adopted to strive to restrict and reduce the gap between market supply and demand of various financial assets and prohibit commercial banks from participating in all kinds of financial speculation by using huge social deposits, especially providing financing for pur­chase of equities by using huge public deposits, thus effectively restricting the gap between market supply and demand of financial assets and market failures. President Roosevelt also formulated the Glass-Steagall Act limiting financial speculation, pro­viding that commercial banks absorbing public deposits shall not engage in the busi­ness of securities investment banks, while investment banks engaging in the trade in equities and other securities shall not absorb public deposits, and financial derivatives are banned due to high risks. The financial regulation and government intervention policies implemented by President Roosevelt effectively prevent the fluctuations in prices of financial assets from being far away from market equilib­rium points and maintain the stability of the national economy and effective opera­tion of the market economy mechanism.

Early after World War II, America hoped to fight for world supremacy by using the status of the world’s leading power formed after its economy recovers from the Great Depression with the help of the war rather than sincerely foster allies. Prior to the end of World War II, America had made the strategy of con­taining old China, and wanted to turn its rivals in the World War II, namely, Japan and Germany, into agricultural countries. Therefore, early after World War II, America recommended liberal policies to China, Japan and Germany, etc., with an attempt to give play to its competitive advantages through free trade to occupy industrial markets of those countries, and give allies no chance to rejuve­nate their war-torn industries. The “Sino-US Friendship, Navigation and Commerce Treaty” entered into by and between the United States and the Kuomintang government causes old China’s national industries to go bankrupt in the dumping of surplus products by America, and America also colludes with corrupt bureaucrats of the Kuomintang and four big families (Chiang Kai-shek’s family, Song Ziwen’s family, Kong Xiangxi’s family and Chen Guofu and Chen Lifu’s family) to carry out speculation for staggering profits by using the lack of resources such as foreign exchange and materials in old China. However, the Kuomintang’s regime failure and the defeat in the War to Resist U.S. Aggression and Aid Korea make America realize that it must restrain financial capital from “rapaciously plundering like wild animals, which may stir up civil commotion,” and cannot continue to promote the liberal policy of non-intervention benefiting itself at the expense of others; otherwise, it will lose Japan and Western European Allies like losing Chinese mainland, and America is forced to use Marxism for reference, recommend social reform policies to allies, permit allies to implement the policy of combining trade protection with opening up to foster national indus­tries, encourage allies to strengthen financial regulation and control capital accounts, exchange rates and interest rates, and restrict speculative capital from flowing in the speculation in inadequate foreign exchange and materials to enlarge the gap between market supply and demand, so as to ensure that various resources in short supply are used for post-war economic reconstruction rather than are wasted. A series of social reform policies carried out by Western coun­tries after World War II, including nationalization, financial regulation and restriction on all kinds of speculation, avoid big financial crises and bank bank­ruptcies for decades and successfully promote post-war economic reconstruction and rapid economic growth (Brown 2013).

In the social reform period after World War II, Western countries implement financial regulation by government, strictly restrict virtual bubble economy and vigorously foster real economy, which propels the economic crisis to go back to the traditional cycle in the era of industrial capitalism. The strict control over capital accounts, interest rates and exchange rates carried out by Western coun­tries in the social reform period indicate that the ruling class actually knows that the too large gap between supply and demand will lead to market failures; interest rates and exchange rates are important prices with wide influences; after the restriction on capital accounts is lifted, speculative capital may participate in the artificial speculation in interest rates and exchange rates, resulting in the suppres­sion to economic growth as interest rates and exchange rates are not tolerable for enterprises; and the sudden and sharp rise and drop in important prices are bad for the exertion of the role of regulation by the market and the development of real economy. It can be seen from faster economic growth of Western countries for decades in the social reform period after World War II that the control over capi­tal accounts, interest rates and exchange rates does not affect the exertion of the role by market economy; on the contrary, those government intervention policies effectively restrict the excessive speculation with financial capital, the manipula­tion of sudden and sharp rise and drop in market prices by artificially making too large gaps between supply and demand, and market failures that distort the price mechanism and mislead the allocation of resources to plunder the real economy, so as to make the social reform period of Western countries become a rare golden period for economic growth in history. In the social reform period after World War II, countries generally restrain the speculation in their equities markets to facilitate smooth and steady growth of equity markets and economy, the reason for which is that limiting the gap between market supply and demand effectively avoids market failures. Since 1980s, the West has been making great efforts to promote financial liberalization so that the boom in equity markets in one year often exceeds that in the past decade or so, but after the bursting of equity bub­bles, economic growth stagnates for a long time and the wealth owned by com­mon people also often falls back to that a decade or so ago in one year, the reason for which is that enlarging the gap between market supply and demand leads to serious market failures.

Through the joint struggle of developing countries in 1974, a United Nations’ resolution on establishing a new international economic order is adopted, requir­ing the West to make a concession in economy, share the results of the social reform and promote the industrialization of developing countries. In 1975, in order to contain the desire of developing countries to realize the rise, American ruling elites formulated the “1980s plan for driving the world economy to disintegrate under control,” deciding to turn the tide of the social reform and financial regulation promoting post-war economic rehabilitation. When developing the “strategy of disintegration under control for the world economy,” ruling elites of the United States and Europe also clearly point out that post-war economic growth of the United States and Europe is attributed to the mixture of Marx’s and Hamilton’s thoughts, and it is necessary to promote neoliberalism in turn to pre­vent the imitation by developing countries. This historical fact is explicitly recorded in the work published by ruling elites of the United States and Europe (Zoakos 1979). Marx profoundly reveals the underlying reasons for economic cri­ses of capitalism, providing important inspirations for the West to relieve such market failures through the social reform. After World War II, the West carries out the social reform to improve income distribution and alleviate class contradic­tions, implements nationalization and financial regulation policies to restrict the greed of capital, controls exchange rates, interest rates and capital accounts and strictly cracks down on financial speculation, which actually is the forced use of Marxism rather than Keynesianism for reference under the pressure of the Cold War, as freely acknowledged by senior elites, experts and brain trusters of the United States and Europe in their works.

Since 1980s, when Regan and Margaret Thatcher came into power and pro­moted the Conservative Revolution and neoliberalism instead of social reform and financial regulatory policies, the tide of financial liberalization continuously occurs in the United States, British and European countries, causing the character­istics of the economic cycle once controlled to go back to the era of financial capi­talism. The most serious economic crisis after the Great Depression occurring in the West in 2008 is an extremely great mixed economic and financial crisis with the characteristics of the Great Depression, the reason for which is that the West repeals Roosevelt’s New Deal and highly effective regulatory policies in the post­war social reform period, allows again commercial banks to participate in all kinds of financial speculation by using huge social deposits, especially providing financ­ing for purchase of equities by using huge public deposits, allows again trading in financial derivatives which is prohibited in Roosevelt’s time and after World War II, enlarges again the gap between market supply and demand of financial assets and market failures, makes and manipulates again the expansion and bursting of bubble economy to promote the disintegration of world economy, lifts the control over interest rates to allow them to surge to 20% and deals a heavy blow to real economy. Soon afterward, the increasing strong wave of bank bankruptcy and frequent financial turbulence arise and spread from Latin America, Asia and Russia to the centers of world economy including the United States and Europe. American subprime mortgage crisis in 2008 gives rise to the global financial crisis and causes huge wealth losses, thus triggering the most serious global economic crisis since 1929.

This extremely great crisis featuring the recurrence of great depression without government intervention forces the United States and Europe to give up the doc­trine of non-intervention by government and invest heavily in rescuing the equity market; the bubble of virtual financial derivatives unprecedentedly inflating is far beyond the size of national economy, which forces the United States and Europe to take fiscal and monetary stimulus policies reaching a unprecedentedly large scale, and the stimulus of several rounds of public and secret quantitative easing is also far beyond the size of national economy. As the governments of the United States and Europe abandon the successful experience in the social reform period in containing such crisis, and are unwilling to uphold the policy of restraining virtual economy and fostering real economy simultaneously, but take the measure of fuel new bigger virtual bubbles to save old ones from bursting, a plenty of financial resources are spent on rescuing the equity market with the effect less than one tenth of that in the social reform period. The reason for the occurrence of a new normal or new abnormal, namely, “no employment or low growth in employ­ment,” is that the inflation of virtual bubbles is out of control and the recovery of real economy lacks momentum. The expansion of virtual economy should only play a weak role in boosting real economy through its spillover effect; once new virtual bubbles burst, they will bring about new crises more destructive, just like saving the network bubble from receding induces the more serious subprime mort­gage crisis. At present, American real economy is sluggish, and inflating bubbles of equities and other financial derivatives are out of control. Fischer, a senior officer of the Federal Reserve System, publicly acknowledges that the resources for stimulating the economy have been used up and it is unable to invest heavily in rescuing the equity market, which heralds the possible outbreak of an extremely great mixed economic and financial crisis similar to the Great Depression in the world. Soros claims at the World Economic Forum in Davos that no country knows how to cope with the current global deflation that occurred in the Great Depression in February 1929.

Fiscal and Monetary Stimulus Policies in the United States and Europe Have Lost Effectiveness

During responses to all previous economic crises in the social reform period after World War II, the fiscal stimulus policies adopted by the West concentrated on fields of the real economy and social security. In spite of a small percentage of GDP, fiscal stimulus expenditure made outstanding results. As strict financial control restricted the inflation of speculation and bubble economy, and public investment concentratively drove employment and the real economy, there was no need to rescue speculative bad debts, and demands for social security such as unemployment relief remained stable during economic downturn. The public investment and social security expenditure of governments were highly efficient social investments, which urged the full recovery of national economy and real­ized full employment in a year only. In those years, Western countries were com­monly confronted with war debts far in excess of sovereign debts today, arduous reconstruction tasks, shortage of materials, financial difficulties and lack of cumu­lative social security funds. However, under the great pressure of the Cold War, the West was forced to largely enhance the level of social security such as pension and medical treatment (the non-salary social security of private enterprises was raised by more than ten times as compared with 1929), implemented strict control over capital accounts, interest rates and exchange rates to restrict financial specu­lation, in a bid to guarantee scarce economic resources to flow to real economic sector and not to be wasted by the financial speculation. Ultimately, such meas­ures did not aggravate financial burdens, but stimulated growth and improved financial position. As proved by practices, the improvement of social security was favorable for narrowing the gap between the rich and the poor and easing social contradictions, and made obvious achievements of increasing social demands, sta­bilizing market and reducing fluctuations of economic cycle. In addition, the per­centages of sovereign debts of governments greatly declined step by step along with stable economic growth.

Over the years after the outbreak of international financial crisis in 2008, the crisis rescuing ideas of the United States and Europe have been completely oppo­site to those in the social reform period after World War II. Previous restraint of virtual financial speculation and real economy supporting policies have been changed into the restraint of the real economy and virtual financial speculation supporting policies, in a bid to maintain interests of financial capital and realize the strategic objective of controllable collapse of world economy. As a result, effects of stimulation of economy by fiscal and monetary policies are less than one tenth of those made during previous post-war crises. The financial crisis of the United States was ascribable to the spending of a lot of taxpayers’ money by the government to rescue astronomical debts of financial speculation of financial syn­dicates rather than the unemployment, pension and medical security as criticized for by Western mainstream media.

In 2007, the United States recorded the financial deficit of US$160 billion. After the outbreak of the financial crises in 2008, the financial deficit of the United States sharply rose threefold, up to US$460 billion. In 2009, the financial deficit of the United States significantly rose by three times again, up to US$1.4 trillion. In the three years afterward, the financial deficit remained around US$1.5 trillion. By 2011, only several years after the outbreak of the crisis, treasury bonds of the United States have risen by about US$5 trillion, exceeding the growth amount thereof over previous two centuries and far more than the growth in fiscal taxes than the real economy can support. Therefore, the quantitative, loose and abusive issuance of money must be adopted by the Federal Reserve to support the inflating bubble of treasury bonds (Weiss 2011). Owing to population growth restriction, the number of retirees and patients of the United States did not upsurge by nine times, just as the increase in the financial deficit. Apparently, it could not be the main reason for the growth in the treasury bonds exceeding the growth amount over previous two centuries and the prescribed upper limit. Although scholars with a good conscience in the United States often cited these dates, mainstream media controlled by syndicates intentionally avoided such objective facts (Weiss 2011).

During previous economic crises after World War II, the United States and Europe implemented loose monetary policies to stimulate economy. The central banks of many countries definitely took full employment and stable prices of com­modities as objectives, monetary policies targetedly supported the real economy, especially promising emerging industries, and financial regulatory policies of governments strictly restricted the flow of bank credits into different speculative fields, therefore making economic stimulus effects with a smaller credit amount, which effects were ten times of those today. In recent years, the quantitative and loose policies adopted by the United States and Europe have been aimed to pri­marily support large banks embarrassed by speculative bad debts. Monetary poli­cies have been targetedly supporting the development of virtual bubble economy rather than the real economy. The unemployment rates of the countries soaring in a long time fully indicate that employment has no longer been a target of such policies, and the economic recovery with no change in employment rate or a low employment rate has become a common phenomenon or a new normal state of economy. Owing to the special status of USD as an international currency, the United States can abuse the issuance of money to stimulate economy unrestrict­edly by virtue of USD hegemony. In that light, economic conditions of the United States seem slightly better than those of Europe. In particular, in the situation of bad economic fundamentals, the stock market has been still bullish in a long term and has hit a historical high repeatedly. In the periods of inflating network bubble and subprime mortgage bubble, the United States seemed more prosperous than Europe. After the network bubble burst, the economic situation in the United States was far worse than that in Europe, for Europe implemented strict financial control and was therefore not involved in the bubble of the United States in those years. Later, Europe followed the example of the United States to carry out finan­cial liberalization, thereby involved in subprime mortgage bubble. Europe became an object to which the United States exported harmful subprime mortgage bonds, and was worse than the United States during the economic crisis. However, as Europe cannot abuse the issuance of USD, its economic recovery has been weak, and its bubble of treasury bonds cannot be supported, leading to more serious sovereign debt crisis.

If the financial deficit and inflating sovereign debts in the United States are surprising, the quantitative, loose and abusive issuance of money by the Federal Reserve is stunning. In addition to the disclosed three rounds of quantitative and loose stimulus policies, the United States provides capital injections privately according to the crisis situation of financial market at any time. The intensity of such little-known measures has far exceeded that of disclosed quantitative and loose policies. As early as 2007, the Federal Reserve privately provided the capital injections of US$7.7 trillion (Xinhuanet 2011), and quietly postponed the outbreak time of the subprime mortgage crisis for more than one year, in order to defraud other countries of continual investment, including China’s purchase of bonds and stocks on the verge of slump. After the crisis broke out in 2008, the sharp rises on the stock market of the United States were surely ascribable to the secret capital injection by the Federal Reserve in part. The secret capital injection that the United States was forced to disclose in 2010 amounted to US$12.3 trillion, far exceeding the total amount of three rounds of quantitative and loose measures disclosed by the Federal Reserve (Sanders 2010).

Senator Sanders, a current candidate of president of the United States, has surged in popularity and has recorded a support rate second only to Hillary, for he criticized that the financial syndicates of the United States damaged public inter­ests. Sanders, one of minority politicians upholding public interests, once addressed inquiries to Bernanke, former chairman of the Federal Reserve, at a congressional hearing, and insisted on the addition of an amendment clause in the financial reform bill. In such a case, the Federal Reserve was forced to disclose limited inside information on bailout. By such a glance of mysterious veil, the astronomical figure of US$12.3 trillion was found (Sanders 2010).

Most terribly, huge resources used by the United States to rescue speculative bad debts failed to make good economy stimulating effects, and seemingly fer­mented a huge time bomb of a severer financial crisis in future. Through huge capital investment, the United States induced the hyperinflation in the field of virtual economy, and manually promoted worthless toxic financial assets to surge in terms of prices again, leading an unprecedented large scale of inflating bubble of virtual financial assets. It means that a financial crisis more destructive will break out sooner or later. It is like the stock market bubble generated by margin financing and securities lending, speculation in stocks by loans and so on of the Wall Street during 1927-29. Although unreal bubble wealth effects temporarily eased inadequate consumption demands and postponed the market failure incurred by overproduction and the outbreak of the economic crisis, they deepened the exploitation and pillage of public wealth by excessive financial speculation. After the bursting of unreal bubble of the stock market, effective consumption demands shrank more seriously, greatly deepening overproduction crisis and inducing the global economic depression. In 2002, the United States invested huge resources to create the bubble boom of subprime mortgage of real estate, for the purpose of turning around the severe economic recession arising from the bursting of network economy bubble. After being robust over years, the bubble boom led to more destructive subprime mortgage crisis. At present, the United States has invested the unprecedented scale of resources in virtual economy in order to rescue the crisis, and the stock market has been separated from supports of economic funda­mentals but has hit a record high again and again. In that light, after the bursting of virtual bubble economy in future, an economic crisis will reach an unprece­dented scale.

Stock Market Crash Bubble and New Market Failure Theories

China once was predetermined to realize the free exchange of RMB after joining the World Trade Organization. However, the cruel reality of the Asian financial crisis in 1998 made clear to China the danger of opening capital account, urging China to reconsider the route of financial reform and opening up and greatly post­poned the predetermined schedule, thereby successfully realizing the steady and high-speed growth and resisting the shock of several external crises in more than ten years. After the outbreak of the subprime mortgage crisis in the United States, China specially stressed that finance should serve the real economy, pay attention to the adoption of measures to restrict the supply-demand gap on the real estate and stock markets and avoid another serious stock market crash and a real estate bubble crisis similar to that in Dubai, whose principles are to effectively prevent the market failure incurred to a large supply-demand gap and avoid resource wastes aroused by the inflation and bursting of bubble economy due to excessive speculation.

In world public opinions, it is commonly praised that China dares to persist in a financial mode different from that suggested by the United States, has avoided great crisis and achieved a long-term economic growth amazing the world, and the success of “Chinese model” is primarily ascribed to the powerful state-owned economy and financial regulation. The United States deeply feels that the fragile economic recovery over the years since 2009 has been unsatisfactory and unfa­vorable to maintain the strength of USD, curb inflating assets bubble and attract­ing stock investors to enter the market and imitation by all other countries in the world, intensifying the abusive issuance of money to enter the stock market and manually generating soaring prices and bull market. As a result, by virtue of an upsurging stock market, the financial mode of the United States became enviable once again. The United States also urged China to imitate the financial liberaliza­tion thereof in terms of reform by means of pressing and temptation. Therefore, China waived the prudent attitude toward inflating bubble in respect of financial reform, and began to bravely follow different policies and measures taken by the United States to stimulate the stock market and virtual economy, such as the “SH- HK Stock Connect” frequently rejected by governmental high-level officers in previous years, and margin financing and securities lending, stock index futures and elimination of capital account control. However, China failed to realize a bull market just as the United States hit a historical record in the stock market repeated in the two years, but suffered losses of RMB20 trillion hitting a historical record and far more than the losses during the stock market crash in 2008.

In the first half of 2015, the economy of the United States apparently slowed down, trade amounts of basic industries, manufacture industry, transport industry and import and export declined month by month, and service industries like com­merce, catering, and finance were seriously sluggish, meaning that the great bull market bubble of the United States has been drawing to a close and been on the verge of collapse. In 2015, the economic recession of the United States made the great bull market bubble unable to be maintained. The United States was urgent to find an object and scapegoat to shift losses of financial crisis. So, the United States made every effort to export its disaster mode to China before bursting of the stock market bubble, induced China to fully implement the short selling mechanism of the stock market by imitating the United States in April 2015, and then rapidly transferred the chief culprit of short selling of global stock market to China. In June, 76% capital withdrawn by the United States from emerging market was from China. Soros, who then removed his office to Hong Kong for commanding in person, applied hedge funds acting as market beater of the Federal Reserve, result­ing in the outbreak of great stock market crash in China and making China become an object that the United States put the blame upon and repeat the mistake of receiving the crisis transferred by the United States on the eve of previous crisis.

Practices indicate that the blind faith of the financial mode and theories of the United States pays a huge price, resulting in not only disastrous microscopic losses of stock investors but also the macroscopic losses of national economy. According to the report issued by the central bank of China in 2015, the circulation market value on the Shanghai and Shenzhen stock markets, during the stock market crash since June 15, decreased by RMB22 trillion (approximately equivalent to US$3.46 trillion), with each investor losing nearly RMB240,000 on average. This meant that the stock market crash generated remarkable negative wealth effects curbing effec­tive demands, made market demands become more sluggish in the condition of fewer exports, intensified the downward trend of national economy and incurred import slowdown in excess of export shrinkage. The stock market crash with huge losses indicated serious market failure, which was ascribable to repeat of the mis­take before the outbreak of the stock market crash of the United States in 1929. The stock market with no government intervention is a reflection of efficient liberalism theory. The adoption of a series of financial innovation measures such as margin financing and securities lending, leveraged stock investment and stock index futures aroused an excessive market gap, excessive speculation and serious market failure. The scale of margin financing and securities lending in China sharply expanded by twenty times, increasing from around RMB100 billion in 2013 to RMB2 trillion in 2015. A huge supply-demand gap on the stock market was created artificially, leading to soaring prices and the crazy out of control by proprietary funds and the sense of risk of stock investors, ultimately incurring breathtaking losses of RMB20 trillion with expanded leverage multipliers during the stock mar­ket crash. The exchange-traded and over-the-counter (OTC) financing provided by brokers were finally from banking institutions, indicating that losses of the stock market crash generated systematic risks to the entire banking system. The stock market rescuing funds of hundreds of billions of RMB invested by the central bank, brokers and listed state-owned enterprises failed to realize the noticeable rebound of the stock market, which was still volatile at low points (Rui 2015).

The slow increase in stock market demands and share prices incurred by changes in economic fundamentals such as profit growth and the increase in incomes of people is normal market reaction. Artificial stimulation by margin financing and securities lending, leveraged loans and stock index futures will result in the expan­sion of supply-demand gap on the stock market, the sharp rise and slump of share prices and market failure. The large amount of deposits of the public used by banks to provide speculative capital largely aggravated the stock market failure. Speculative capital was withdrawal after making profits by going long, and going short market was conducted to make profits, intensifying the slump on the stock market. In addition to margin financing and securities lending, etc., such practices were important reason for the great depression, bank failures and losses of deposits of the public. In the social reform period, the United States and Europe conducted financial regulation to strictly restrict different speculations and capital account control to restrict the sudden inflow and outflow of speculative capital. In that situ­ation, the stock market grew slowly, but there were less serious stock market crash, bank failures, and financial crises. In 2015, China loosened capital control, opened capital outflow channels such as SH-HK Stock Connect, fully implemented the short selling mechanism of the stock market and vigorously developed margin financing and securities lending and stock index futures, largely expanding the supply-demand gap on the stock market, sudden rise and slump and market fail­ures, and thereby leading to the great stock market crash with painful losses of tens of trillions of RMB and aggravated economic downturn. China should reinforce regulation and prevent margin financing and securities lending and stock index futures to arouse market failures, and promote the determination of the stock mar­ket by economic fundamentals so as to form a sustainable “slow bull market.”

Huge losses during the stock market crash cannot be explained by the neoliber­alism and effective financial market theories of the West. However, new market failure theories, based on which I have been studying the bubble economy, can satisfactorily explain them. It is clear that measures such as margin financing and securities lending, investment in stocks with loans and stock index futures are not financial reform measures able to realize the good operation of stock market mechanism but artificial measures aggravating the supply-demand gap, excessive speculation and sudden rises and slump of prices. Crazy bull market is a typical market failure with great damages and making investors lose the capabilities of rational judgment and risk control. The slogan that “as the stock market is risky, it needs to be prudent to enter the market” is known by all, and exhort people to keep expenditures within the limits of income and control risky assets. That “do not invest in stocks with borrowings” is a classic commandment of normal investment in stocks. However, measures including margin financing and securities lending of the mode of the United States do not keep expenditures within the limits of income and control risky assets, but indulge a greedy person to conduct highly risky speculations with loans. From a micro perspective, speculation failure will make stock investors lose a family fortune and be heavily in debt; from a macro perspective, it will bring systematic financial risks, a rise of liability ratio and a decrease in crisis resisting ability.

In 2016, Liu Shiyu, new chairman of CSRC (China Securities Regulatory Commission), pointed out at the interview during the NPC (National People’s Congress) and CPPCC (the Chinese People’s Political Consultative Conference): when abnormal fluctuations in the stock market lead to a continuous and severe market failure, it is necessary for government to use stability maintenance capital to intervene in and rectify the market failure. Nevertheless, it should be avoided to induce a market failure before the use of a lot of capital to conduct ex post inter­vention. Margin financing and securities lending as well as stock index futures will widen market supply-demand gap and aggravate market failure. It is appar­ently unreasonable to spend a lot of money first in incurring a market failure and then in rectifying the market failure. A correct stock market reform direction should be the prior elimination of any element aggravating market failure. In the Roosevelt times and the social reform period of the West, it was strictly forbidden to support any stock market speculation through financing, and Glass-Steagall Act was formulated to prohibit the mixed operation of finance. The capital of brokers and OTC financing was ultimately from deposits of the public at commercial banks. The separate operation of finance was favorable to avoid market failure and maintain the safety of deposits of the public. Margin financing and securities lend­ing were important reasons for the crash of the stock market and bank failures during the Great Depression. The United States abolished the aforesaid act, lead­ing to the outbreak of the subprime mortgage crisis in 2008. In 2016, Sanders, a popular presidental candidate of the United States, claimed to restore the act, which cut into the present-day malpractices and helped him win the support of people, indicating the ongoing change in the trend of the times. China should use for reference the successful experience in the Roosevelt times and the social reform period of the United States and Europe, and should not blindly imitate the current financial mode of the United States and Europe for the purpose of avoiding the outbreak of a crisis again.

Speculations would widen supply-demand gap, lead to market failure and sud­den rise and slump of prices, distort market, and mislead resource allocation to the speculators not engaged in production or consumption, according to the practices on most occasions such as the stock market, real estate market and the markets of foreign exchanges, futures, bulk commodities and financial derivatives. Once speculators withdraw after making profits from bubble, both supply and demand will be heavily shocked. This is the reason why a large amount of credits and abu­sive issuance of money used by central banks of the United States and Europe to stimulate virtual economy led to overproduction and deflation after speculation bubble burst. The creation of bubble by speculations in the economic rise period generates an illusion of active market for people. However, in reality the potential of wealth growth of people is overdrawn, creating a crisis and curbing economic development. After bursting of the bubble, speculations are conducted to go short in order to fish in troubled waters, thereby aggravating the crisis. If speculations on the stock market are indulged on the excuse of all-people innovation, venture and new strategic industries, it is actually to permit speculation capital to withdraw the growth potential of such industries and the wealth of the public in advance, which will heavily shock development opportunities of hi-tech enterprises just like the network bubble of the United States.

Non-typical Global Economic Crisis and New Market Failure

In early 2016, the stock market of all the countries in the world including the United States went down remarkably, making people realize the serious problem of global economy. Media of the United States is hyping that the global stock market slump is ascribable to the stock market crash of China, and global economic downturn is also incurred by the easing economic growth of China. When interviewing Rogers, a famous investor of the United States, a media reporter of the United States asked him what influences the economic slowdown and stock market crash of China had on the global economy and stock market; he definitely said “although many people ascribed this to China, China is actually a victim. The problem is actually ascribable to the Federal Reserve and the government of the United States.” The aforesaid reporter was not interested in the real root stated by Rogers, and always asked ques­tions by focusing on how China disturbed the global economy, and continually asked whether the debt bubble of China would arouse global economic recession. Rogers definitely pointed out again that the route of the global problem was not China but the United States, and the scale of treasury bonds continually increased by the United States was the biggest debt trigger in the history of the world. In early 2016, the stock market of all the countries in the world including the United States went down remarkably, making people realize the serious problem of global econ­omy. At present, the people of all the countries in the world pay attention to the stock market slump. They may ignore a more worrying dangerous economic signal: oil price has been going down or fluctuating at low levels since the end of 2014, and economists of big banks in the United States predict that global oil price will be sluggish in the coming years. People cannot believe that the oil price is a problem only involving some industries and partial areas, but should recognize that the oil price is a global economic problem involving the industrial blood of all the coun­tries. The sudden rise and slump of oil price will influence more industries and arouse serious global economic recession.

People should not forget that in 1973, the United States, together with Saudi Arabia, manipulated the sudden rise of oil price by four times, giving rise to the more serious global economic crisis over decades after the World War II and the common, continuous and noticeable drop of industrial production of all the coun­tries in the world. The industrial production of the Western developed countries dropped by 8.1% and that of Japan fell by 20.8%. The stock market of all the countries in the world also commonly plummeted, a number of enterprises went bankrupt, over 120,000 enterprises in the Western countries went bankrupt, and the number of unemployed people increased sharply, hitting a record high after World War II. After the global economic crisis, the West did not enter into the period of economic recovery, but suffered “stagflation” including economic stag­nation and inflation in a long time. In 1973, the United States, together with Saudi Arabia, manipulated the sudden rise of the oil price to promote the remarked increase in USD demands by petroleum trade by virtue of link of petroleum to USD, in a bid to rescue the USD decline trend. Prince Yamani acting as oil minis­ter of Saudi Arabia then publicly admitted this fact (Engdahl 2008, 146).

As it was unable to ascribable the global economic crisis to the sudden rise of oil price, Western economists claimed the failure of Keynesianism seemingly effective to respond to the crisis after the World War II. In the 1980s, the Reagan administration implemented neoliberalism on the excuse of that. New market fail­ure theory can explain not only the global financial crisis aroused by the stock market crash and virtual bubble economy, but also the global economic crisis incurred by the sudden rise and slump of the oil price. The global economic crisis of stagnation and inflation aroused by the sudden rise of the oil price in 1973 and the current global economic crisis of overproduction incurred by slump of the oil price prove the important significance of new market failure theory and the serious defect of Western economics, and indicate that the scientific and wonderful “invis­ible hand” in the Western economics only applies to a small supply-demand gap near price equilibrium point. When there is a large supply-demand gap and equi­librium price is deviated for different reasons, both supply curve and demand curve will be distorted, making market regulation mechanism fail and unable to spontaneously restore supply-demand and price balances.

The volatile fluctuations in prices of general commodities and assets will give rise to the market failure in partial areas. For example, those in prices of important commodities and assets like petroleum, stocks and real estate will result in the economic crisis of overproduction or the financial crisis of bursting of bubble. Specifically, in terms of the sudden rise of oil price in 1973 and the present slump thereof, the supply curve of petroleum was distorted, changing from uptrend to downtrend. At the time of the sudden rise of the oil price, exporting countries of petroleum reduced output and hoarded petroleum for speculation, while at the time of slump of the oil price, such countries expanded production and increased supply. The slump of the oil price aroused the decline in prices of relevant prod­ucts including coal, minerals and metals, leading to the common recession of basic industries of petroleum, mining, metallurgy, etc., in all the countries in the world. In order to make adequate profits, enterprises in the basic industries expanded production and increased supply, giving rise to the vicious circle of market failure with overproduction and price drop, which was spread to the whole industry and service industries step by step through industrial association. Such major wide­spread market failure inevitably aroused the global economic crisis. In respect of both theoretical analysis and response policies, people have not yet been familiar with the non-typical global economic crisis incurred by the sudden rise and slump of the oil price.

In 1973, the United States, together with Saudi Arabia, manipulated the sudden rise of the oil price, giving rise to serious global economic recession and an eco­nomic crisis of “stagflation” with both economic recession and inflation. At pre­sent, the United States, together with Saudi Arabia, manipulates the slump of the oil price in order to attack international strategic opponents like Russia, which probably leads to a global economic crisis of overproduction with economic recession and deflation. The sudden rise of the oil price in 1973 aroused the severe global economic recession after two years’ spread. The current slump of the oil price will give rise to global economic recession upon step-by-step spread through wide industrial association. In those years, people were unfamiliar with the gen­eration mechanism and countermeasures of such global crisis, making the global economy involved in the long-term stagflation with economic stagnation and inflation. Now people should deeply discuss the generation mechanism and coun­termeasures incurred by the global economic dilemma, so as to find out effective methods to prevent the global economy from falling into serious recession again.

The present global economic turmoil is ascribable to the largest economy—the United States rather than China. The turning point was the time when the United States, together with Saudi Arabia, suppressed the oil price in the second half of 2014, which made basic industries of all the countries in the world such as the United States involved in severe recession. Numerous enterprises in industries of petroleum, mining, metallurgy, etc., of the United States laid off lots of employ­ees, leading to the recession of the whole industry and service industries through industrial association. In the first three quarters of 2015, the basic industries, man­ufacture industry, transportation and foreign trade of the United States went down­ward continuously, and service industries of commerce, catering, finance, etc., were depressed severely too. The large chain supermarket of Target closed numer­ous branch stores and laid off lots of employees. McDonald’s also closed more than seven hundred branches, recording losses. More than seven hundred hedge funds in the financial industry went bankruptcy and closed. Many of them were closely related to junk petroleum bonds and financial derivatives. The depression of many industries in the United States lacked the economic growth points provid­ing a number of job opportunities, exposing the seriously counterfeit official sta­tistical data of economic growth and unemployment (Snyder 2015).

In 2015, the global economy showed serious weakness, the global GNP domi­nated in USD greatly dropped by 3.4%, and the Baltic dry index reflecting inter­national trade declined astonishingly, down by 60% as compared with the same period of 2014 (even lower than the minimum level during the global crisis in 2008). Except for global economic recession, these have never occurred, indicat­ing that the global economy probably fell into recession in the first half of 2015. As the slump of the oil price led to the drop of prices of coal, minerals and primary commodities, countries including Russia, Brazil, Australia and Canada fell into economic recession. Rogers definitely pointed out that what we should be con­cerned about was the world economy rather than the so-called Chinese problems. He stated that “all the regions around the world suffer unspeakably, and Japan, as the third economy in the world, has formally fallen into recession. Europe is also confronted with disaster,” and the United States is the real root of global economic hardship and China is just a victim. However, the official and mainstream media of the United States insisted that economic situation is still optimistic, and GDP, employment and stock market still have a satisfactory growth trend. This misleads all the countries in the world to believe that only some regions have local problems and it is difficult to take consistent measures to respond to the global recession just like 2008 (Snyder 2015).

It is worth noting that the website of the well-known CNBC (Consumer News and Business Channel) under the Public Broadcasting Service (PBS) of the United States published an article titled “Slump of Oil Price Will Incur a Financial Crisis Severer than Subprime Mortgage Crisis.” The article describes that the shale oil and gas exploitation fever is similar to the subprime mortgage fever in those years, banks on the Wall Street have injected huge loans with loose conditions, and bor­rowers have fragile financial positions, all of which have aroused the inflation of financial derivatives relating to price and credit default risks. People cannot esti­mate the specific scale of risks, but experts claim that risks are surely great. After three years’ plummet by 60%, the housing prices in the United States then aroused the subprime mortgage crisis. The plummet of the oil price by 70% in the recent two years means greater risks. The slump of housing prices and the oil price may trigger the bursting of bubble of financial derivatives in the United States, and arouse a financial economic and financial crisis combining overproduction and the bursting of virtual bubble. All the countries in the world should make clear of potential risks and discuss effective countermeasures the soonest possible (Harrington 2016).

Financial Derivatives, Subprime Mortgage Crisis and New Market Failure

The new market failure theories may be applied to effectively analyze why finan­cial derivative hedging products are not essentially hedging instruments but bombs of financial bubble. Now stocks, commodities, foreign exchanges, loans, bonds and so on have financial derivative hedging instruments, whose transaction amounts far exceed the scale of various insured assets. This means that economic risks have become objects of gambles of financial speculations. For example, the amount of fire insurance derived by houses far exceeds the value of house proper­ties, and people unrelated to houses purchase a lot of fire insurances of houses. This means that fire insurance market has become the place for the gambles of house fire. The more there are such insurances, the riskier the house properties are. This is because many people have a strong motivation to set on fire so as to swin­dle huge insurance compensation for house fire. The financial derivatives going short stock index futures to gamble the drop of the stock market are similar to the gambles of fire insurances for house fire, and have played an important role in this stock market crash in China.

According to the new market failure theories about bubble economy, if the market of financial derivatives is really aimed to avoid risks, the market scale thereof will be naturally restricted by insured properties. For example, fire insur­ances are restricted by the scale of insured house properties, the scale of stock index futures is constrained by insured stock amounts, the scale of derivative hedging products of subprime mortgage default is limited by insured subprime mortgage amount, and the scale of market supply-demand gap is limited and is not expanded without limitation. However, if hedging financial derivative instruments become gamble tools satisfying speculative greed, market demands of making profits by gambles and supply-demand gap can be expanded without limitation, which means that the negative effects of financial derivative bubble and market failure can be expanded without limitation. The subprime mortgage of hundreds of billions of USD derived the subprime mortgage default insurance amounting to tens of trillions of USD, indicating that the subprime mortgage changed into a financial war weapon of artificial financial crisis and pillage. The subprime mort­gage crisis in the United States incurring the global wealth loss up to trillions of USD is an authentic example.

Insurers do not allow the apparent fraudulent conducts of repeated purchase of fire insurances, but similar financial derivative hedging products cannot be blocked in reality. If any person repeatedly purchases the house fire insurances on the insurance market and then sets on fire to claim insurance proceeds, he will be prosecuted for fraud and be prisoned. However, Goldman Sachs was found to intentionally sell subprime mortgage bonds in the condition of knowing risks of subprime mortgage crisis and purchase a huge amount of default derivative hedg­ing products to go short subprime mortgage bonds, but the Federal Reserve helped the insurance fraud behaviors of Goldman Sachs by providing huge capital to rescue the insurance market. Even after concrete evidences of intentional insur­ance fraud of Goldman Sachs were found, nobody was sentenced, and Goldman Sachs only paid a fine of US$5 billion, equivalent to a small percentage of illegal revenue.

While elaborating the limited active effects of speculations, textbooks of Western economics describe that speculations of agricultural product futures are favorable for avoiding price fluctuation risks, do not state harms of speculations on many occasions, misleading people to believe that speculations naturally have active effects, and ignore that speculations have hedging effects, only when they are limited to special conditions. According to long-term practices of agricultural product futures transaction market of Chicago, the hedging effects of speculations of futures transactions are on the premise that the futures exchange must strictly restrict the quantity, qualifications, etc., of speculators to ensure the match of speculation scale with the hedging demand scale of agricultural products. After the United States eliminated financial regulation, the number of speculators and transaction scale increased largely, making prices of agricultural products separate from actual market supply demands. The significant rise of prices due to manipu­lation by speculators incurred global social fluctuations, verifying that the indul­gence of speculation greed inevitably results in an excessive supply-demand gap and market failure and new market failure theories are correct in dialectically ana­lyzing and avoiding risks.

It is worth pointing out that financial derivatives were not innovations of finan­cial capitalism of the United States and Europe in the 21st century, but were inno­vated in the early phase of financial capitalism in the 20th century. However, owing to bad effects of financial derivatives during the Great Depression in 1929, they were clearly forbidden under regulations on consolidation of financial regulation in the Roosevelt times. Not all financial derivatives were forbidden in the Roosevelt times. A minority of financial derivatives like agricultural product futures with advantages outweighing disadvantages were retained. However, it was clearly restricted that the futures transaction scale should match with hedging demands of agricultural products, avoiding the price fluctuations of agricultural products acting as gamble objects and the induction of large-scale gamble speculations far in excess of hedging demands of agricultural products. Regulations were formulated in the Roosevelt times to forbid transactions of financial derivatives of other types, for it was difficult to avoid risks on many occasions and such transactions might change into financial gambles and frauds. In those years, stocks, commodities, loans and real estate market had lots of speculation risks. Financial derivatives were difficult to avoid risks but might aggravate speculative gambles. The rule of “no gamble, no fraud” would inevitably result in frauds during financial gambles, further impelling the widespread and disastrous financial frauds that were serious in those years. After making exorbitant profits, various frauds would result in the rapid inflation of speculative demands, leading to greater supply-demand gap, market failures and more serious economic risks. These are reasons why transactions of financial deriv­atives in the United States and Europe reached an astronomical scale and far exceeded the global economic scale by dozens of times.

In the Roosevelt times, consolidated government regulation and macro inter­ventions were adopted to avoid risks. For example, as agricultural product futures could not eliminate price risks arising from severe overproduction, the govern­ment adopted agricultural protection prices and food stamps to reduce agricultural surplus; as bank deposits and purchase of stocks and financing of real estate had huge risks, it was forbidden to avoid such risks through financial derivatives, regu­lations were formulated to prohibit banks from support stock market and real estate speculations by virtue of deposits, federal deposit insurance company was established and a lot of financial fraud criminals were arrested, and it was strictly to forbid leveraged speculation financing to restrict the supply-demand gap and market failure, effectively guaranteeing the safety of bank deposits and loans and avoiding economic risks. According to historical practices, the financial regula­tion and provisions in the Roosevelt times and the social reform period effectively avoided risks which cannot be avoided by financial derivatives in those years and at present. For example, control over capital accounts, interest rates and exchange rates strictly restricted various speculations, and avoided volatile fluctuations in the oil price, exchange rate and so on which are difficult to be avoided by financial derivatives today. There were no financial crises impacting steady economic growth over decades of years after the World War II. Now, although having pur­chased derivative hedging instruments, petroleum enterprises in the United States and Europe are still caught in recession dilemma.

International financial syndicates forced all the countries to open different financial markets and interest rates and exchange rates, for the purpose of manipu­lating the sudden rise and fall of the markets to make exorbitant profits and artifi­cially generate risks, and thereby inducing and forcing enterprises and banks of other countries to purchase financial derivative hedging instruments thereof. Then, they artificially manipulated unexpected changes in share prices, interest rates, exchange rates, etc.; manipulated governments and central banks to release infor­mation giving rise to unexpected market fluctuations; and even suddenly changed policies, such as not rescuing Lehman Brothers, to intentionally burst bubble and arouse a financial crisis, so as to ensure numerous enterprises and banks hoping to avoid risks become gamble loses. In this way, they could make astronomical prof­its by virtue of derivative hedging instruments on different markets. Many enter­prises, which purchased hedging instruments on the markets of petroleum, stocks, capital and foreign exchange, could not avoid risks of changes in the oil price, share prices, interest rates and exchange rates, and suffered heavy losses in the gambles with syndicates on Wall Street including Goldman Sachs. This was because all the markets and derivative hedging instruments thereof were manipu­lated by monopolistic syndicates. The manipulation scandal of LIBOR (London Inter Bank Offered Rate) and the scandal of premeditated going short of subprime mortgage derivatives of Goldman Sachs indicated that the opening of interests and exchange rates would realize the manipulation by syndicates rather than marketization.

The Western economics now ignores the market failure of bubble economy and is widely used by contemporary financial capitalism of the United States and Europe to make exorbitant profits through speculations. The said financial capital­ism features the artificial generation of supply-demand gap and manipulation of sudden rise and slump of prices, and threatened promotion of financial derivative hedging instruments by virtue of volatile price fluctuation risks. Financial deriva­tives far exceeded primary risks in respect of scale, becoming gamble and insur­ance fraud instruments, generated the assets bubble inflation of commodity futures, stock market, real estate market and foreign exchange market, and formed the rapidly inflating and great financial derivatives bubble on that basis. Capital was withdrawal at an appropriate time to go short market and the bubble was intentionally burst, and a panic atmosphere was created to form chain reactions of financial crisis to make exorbitant going short profits. Financial derivative hedg­ing claims dozens of times of primary risks were extorted by virtue of the crisis. The financial crisis and forced bailout became financial war pillage weapons. Bad debts from financial gambles were transferred by all manner of means to govern­ments and the public. The wealth of taxpayers was pillaged through huge-amount bailout of governments, forming the sovereign debt crisis, and the wealth was plundered hiddenly through the quantitative, loose and abusive issuance of money by the central banks.

In recent years, international financial capital owners have been quietly consid­ered and passed a series of financial regulations, have been making preparations to make bank deposits and pensions of the public become new pillage objects in the condition that the huge-amount bailout of the governments is increasingly unpop­ular. When more bank off-balance sheet toxic assets return to the balance sheet, they will create greater financial panic atmosphere and take the opportunity to plunder deposits and pensions of the public. Apparently, China’s financial reform should not imitate the financial model of the United States absolutely, but should apply new market failure theories to establish a powerful financial firewall. In this way, China can not only create a more efficient new financial market model, but also effectively resist the shock of financial turbulence of the United States and Europe to maintain interests of the public. It is radically wrong to apply neoliberal­ism theories to conduct top-level design of stock market and financial reform. The correct practice should be based on the Marxist theories of finance serving the real economy, create new market failure theories about the bubble economy to guide reform practices of socialist stock market. Only in this way can different financial reforms of the stock market and so on serve the public rather than the financial speculation capital.