Issue 93 of INTERNATIONAL SOCIALISM JOURNAL Published Winter 2001 Copyright © International Socialism
The US is in the early stages of a recession which could be as deep and intractable as any since the Second World War, with serious consequences for the rest of the world.
So wrote the dissident mainstream economist Wynne Godley in October.1 Godley was one of the few economists predicting recession back in the giddy heights of the US stock exchange boom two years ago. But the forebodings are shared by many of a more conventional aspect. As Godley notes, 'Everyone agrees that the US now is in recession.'
Among those who agree is The Economist. Back in January it insisted that all the US faced was what it called a 'slowdown' or a 'correction'.2 Now it says that 'there are good reasons to expect America's recession to be deeper and longer-lasting than most people expect... Indeed, it is possible that the world economy as a whole may be about to suffer its deepest downturn since the 1930s'.3
What has caused the turn around in opinion? And what is really happening to the world economy?
The crisis began well before the suicide hijack attack on the World Trade Centre on 11 September. The week before the attack the Financial Times had felt able to carry a three-part article on the crisis in the telecommunications industry which said, 'A $1,000 billion bonfire of wealth has brought the world to the brink of recession'.4 The Economist was just as pessimistic:
The sharp slowdown in America has already caused a recession, maybe not at home, but in Mexico, Singapore, Taiwan and elsewhere. In more and more countries around the world output is now stalling, if not falling. Total world output probably fell in the second quarter for the first time in two decades. Many commentators argue that America can still avoid recession, so long as consumer spending does not collapse. But 1982 suggests otherwise: America then had its deepest recession since the 1930s, yet consumer spending continued to grow, offset by plunging investment and exports.5
I analysed the major elements in the US economy leading to recession in articles I wrote for this journal earlier this year,6 and in Socialist Review early in 2000.7 I only have room here to summarise the main points.
The 'new economy', centred upon microchip-driven devices and telecommunications, did not alter the basic trajectory of the US economy. It increased productivity in certain sectors, but much less than the hype then suggested, and it could no more keep the boom going indefinitely than could the greater revolutionisation of production that had occurred in the 'new era' of the 'roaring' 1920s.
A recent report from the management research consultants McKinsey Global Institute confirms that:
In most sectors of the economy large increases in IT investment did not produce any improvement in productivity... Nearly all the post-1995 jump in productivity was in six sectors--retail, wholesale, securities, telecoms, semiconductors and industrial machinery and equipment (mainly computers)...in the six sectors a number of factors contributed to the improvement--of which information technology was just one.8
The real driving force of the boom was a large-scale rationalisation of industry in response to the Japanese competitive challenge of the 1980s, combined with and based upon a massive increase in the rate of exploitation. Holding down wages and increasing working hours enabled the US ruling class to restore the rate of profit to roughly what it had been in the mid-1970s--although not to the higher level it had been at through the long boom from the 1940s to the 1970s.
The relatively rapid growth of the US economy compared with its major competitors attracted investable funds from all over the world. Stock exchange levels were driven ever higher, losing all contact with the real level of profitability in the economy. The ratio of share prices to dividends rose to more than twice its average over the previous 50 years. At the same time, this inflow of funds made it possible for both firms and consumers to borrow on a massive scale, until total spending in the US exceeded total income by some 6 percent.
The boom had reached the point where it could only keep going if two contradictory things happened simultaneously--if profits were raised so as to justify share values, which meant further increasing the rate of exploitation, while wages were raised so as to sustain the level of consumption, which meant lowering the rate of exploitation. This underlying truth might be covered up for a period of months, but at some point the balloon was bound to be punctured. 'Capitalists...are so carried away by their own hype that they think the profits are magically going to rise. When these illusions are not fulfilled, the stock exchange, and probably the economy as whole, can only crash disastrously'.9
In fact, the situation was even worse than this. This runaway boom had led many firms to inflate their profits massively, so as to push up their share prices:
Spectacular growth in profits during the 1990s was partly due to dodgy accounting... According to Bob Barbera of Hoenig, an investment bank, the stated operating profits of the S&P 500 companies rose at a much faster rate than the share of profits measured in the national accounts... Thus, in the 1990s, profits at S&P 500 companies tripled, but profits recorded in the national accounts merely doubled.
Whether technology-industry profits actually grew as fast in recent years as they appeared to do is increasingly being questioned. A recent study by Gary Schieneman, Steven Milunovich and Lisa Liu, all analysts at Merrill Lynch, examined 37 leading technology companies. The study found that accounting properly for options and non-operating expenses reduced the firms' profits by 25 percent on average.10
This suggests that profitability through the economy as a whole in the late 1990s was, in fact, considerably less than that of the pre-crisis years of the early 1970s and closer to the considerably lower levels of the 1980s.11
A boom of sorts did keep going through the first nine months of 2001 on both sides of the Atlantic. It was a boom in consumption even while core industries began to sack workers and to announce falls in profits, leading to a slow but cumulatively sizeable fall in share prices. Hence the talk in the summer of 'two economies'--still booming service and personal consumption sectors, and increasingly depressed manufacturing and industrial sectors.
The economic importance of 11 September was that, at least in the US, it burst the consumption balloon. It also provided industrial firms with a smokescreen behind which they could massively speed up their announcements about poor profits and their sacking of workers.
Both these things would have happened anyway. As The Observer reported on 23 September:
It was clear from the hundreds of profits warnings that corporate America has decided to announce all of its bad news at once. Honeywell International third-quarter profits would be between 43 cents and 45 cents a share, compared with 76 cents last year. The company is now considering cutting 12,000 jobs... Eastman Kodak said that third-quarter profits would be a third below estimates. Levis said it was cutting production as sales had fallen on last year. American Express saw its share price fall to its lowest level since the Asian crisis.
Analysts predict more bad news. 'We're looking at something more than a 20 percent decline in earnings for the S&P 500 compared with the same quarter last year,' said Chuck Hill, a director of Thomson Financial, the research company that tracks corporate profits.12
The Guardian repeated the same point some days later:
Companies are now taking long-overdue action to reduce their costs and boost their earnings, which they are doing by taking advantage of the terrorist attacks to sack their employees in droves. A study conducted by leading economists in the US has found that the airline and hotel industries have laid off tens of thousands of workers since 11 September.
Professor Christopher Thornberg, of the University of California, Los Angeles, said airlines had been bleeding red, losing money hand over fist. They needed to get rid of employees... Now the airlines say 'the devil made me do it. Bin Laden-he's the one who made me lay off these people'.
He added that the tourist trade was also in trouble before the attacks. Occupancy rates had fallen from 63 percent to 55 percent during the summer, he said. Now they had an excuse to lay off workers without fearing any industrial difficulties.13
By late October the Financial Times could report:
The terrorist attacks have had less impact on companies' costs and strategy than expected, according to the chief executives of the biggest US companies. But big business is reeling from the effects of a recession that most executives believe was already under way.14
This is an important point, because many supporters of capitalism have attempted to blame each recession of the last 27 years on extraneous events. For instance, there are frequent claims (in The Guardian and elsewhere) that the recession of the early 1990s was caused by an increase in the price of oil resulting from the Gulf War. In fact the average price of oil through the years 1990 and 1991 was no higher than it had been previously. It shot up for a month or two and then fell just as sharply. The recession followed from the internal dynamics of capitalism, particularly in the industrial countries, not from some external factor. The same is true of the present recession.
The most dramatic effects of the destruction of the twin towers was on the level of US share prices. The Dow Jones industrial average fell 684.81 points on the first day stock exchanges reopened.15 Two days later the Financial Times spoke of:
...one of the worst bear markets in history. In early trading yesterday, the Dow Jones Industrial Average had fallen 31 percent from its January 2000 peak, one of the worst ten declines the US market has experienced since the First World War. In Germany, the DAX index has more than halved since the peak in March 2000; in London, the FTSE 100 has fallen 36 percent since its peak in December 1999.16
Stock exchange levels are of central importance to whole sections of the capitalist class. They determine the cash value of the shares they own and the stock options that come with directorships of companies. But the exchanges do not play anything like the same central role in terms of the dynamics of the system such people preside over. Relatively little new investment is raised through stock exchanges. Their main function is in providing a market place for the buying and selling of shares in already-existing companies. They are, in fact, secondhand markets, whose relationship with the main business of capitalism--the accumulation of surplus value through exploitation at the point of production--is somewhat analogous to that of used car dealers to the activities of the giant car manufacturers.
A collapse of stock exchange levels sometimes indicates something fundamentally wrong with the system as whole, and a rise in the levels sometimes suggests the system is enjoying better health. What is more, a sudden collapse in the share values of some companies can do a lot of damage to the balance sheets of other companies and financial institutions that have tried to raise their own profitability by gambling on them. But there is no automatic correlation between the ups and downs of the stock markets and the ups and downs of the real economy. So, for instance, the Dow fell 40 percent between 1939 and 1942, in the early stages of the Second World War--just as US capitalism was entering one of the biggest booms it had known.
This time round the lack of direct correlation between the stock markets and the real economy was shown within a matter of a couple of weeks. For, while the real economy continued heading into recession, with mass sacking and more reports of low profits, the US and British stock exchanges started rising!
The Guardian reported:
There was a whiff of the good times returning to Wall Street yesterday with share prices ending back to where they were before September 11.
After the massive falls in share prices in the immediate aftermath of the devastation in New York and Washington, markets have roared back on both sides of the Atlantic. London's FTSE 100 index is now higher than it was before 11 September, and at one point yesterday the technology rich Nasdaq was within five points of its levels before 11 September...while the price earnings ratio for the S&P 500 is back to its levels before the hi-tech crash 18 months ago.17
It is a proof of how short-sighted capitalists can be that they celebrated such a return to the old ratio of share prices to dividends. That ratio, as we have seen, was twice its historic average and was based on completely unfulfillable expectations about massive increases in profit levels. It was nonsensical then. It is even more nonsensical now, with virtually every company looking at reduced profit levels.
In fact the damage the recession was causing to the real economy was escalating all the time. Two days after this report The Guardian told:
Bethlehem (the steel corporation) filed for protection against its creditors yesterday in the US. This is the company that brought us much of the raw material for the Empire State Building. One cannot help but notice how many iconic names of America's corporate past are now tumbling into insolvency courts. Last week saw Polaroid file under America's Chapter 11. Bethlehem Steel will not be the last great American name to go to the wall before the year is out.18
Ten days later:
Investors sold stocks and the dollar after disastrous data from the US... Orders for durable goods, which most economists expected to show a small decline, sank 8.5 percent in September. The weekly totals of new claims for jobless benefits in the US rose to 504,000, the four-week moving average hitting its highest since the depths of the recession in 1991.19
Numerous companies--in Britain as well as in the US--borrowed frenetically in an attempt to cash in on the boom two to three years ago. Now many are very close to going bust, with profits which barely cover their debt repayments. They only have to miss one payment for their creditworthiness to collapse, other firms to call in their debts and the receivers to come knocking on the door--quite likely in the company of the fraud squad. This is what happened to such celebrated business figures as Robert Maxwell and Asil Nadir in the recession of the early 1990s. It could happen to any one of a number of big names this time round.
The most obviously overstretched firms are those that rushed into the new technology sector associated with microchips, computers, telecoms and the internet. In Britain the one time engineering giant Marconi-GEC has only just survived a meltdown in its value. It is common knowledge that the cable firms Telewest and NTL are in a very tight situation and that the terrestrial television companies of the ITV network are doing very badly. But the damage is not confined to these sectors as the following list of most indebted British companies suggests:20
A sudden decline in advertising has already hit the magazine publishing sector very hard, while the travel industry was in trouble even before the collapse of US tourism after 11 September. The troubles of the airlines (Virgin and BA) and aero manufacturers were rooted as much as those of the internet companies in the mania of the boom years. And in other sectors many managing directors will be trying to bluff it out, knowing that one small push could knock them over.
The transition from boom to recession is never a smooth, evenly balanced decline. There are always some firms that gamble more heavily than others during the boom. There are always some industries hit disproportionately hard by the downturn. So periods of apparently smooth decline are always interspersed with sudden crises when giant firms and even whole industries are suddenly on the verge of collapse. And as quantity turns into quality, so economic collapse can suddenly cause political eruptions. Governments find it difficult to do nothing as they are faced with the desperate demands of giant capitalists and the sudden bitterness of large numbers of workers. But whatever they do--even if they do nothing--brings to the surface considerations about the whole direction of society.
Through the early autumn 11 September and then the war against Afghanistan diverted people's attention from the harm the recession was doing. This is unlikely to continue as the winter wears on.
Some of the problems are already coming to the surface in the US. The Bush administration rushed to pump in government money to deal with the immediate shock caused by the destruction of the twin towers.
The Financial Times reports:
This week, with little ceremony, President George W Bush quietly brought to a close more than a decade of US economic policy orthodoxy. By signalling support for lower taxes and higher public spending in the next year that could reach as high as $130bn--1.3 percent of gross domestic product--he threw the US administration's weight behind the proposition that a temporary deficiency in aggregate demand should be met by a shift in government finances from surplus to deficit.
This argument, the simplest distillation of the teachings of John Maynard Keynes, has been out of favour in much of the industrialised world for ten years or more. But with the world's three largest economies--the US, Japan and Germany--all in recession or close to it, the conventional wisdom is up for reassessment.
In the US, the intellectual climate has shifted decisively in favour of just such an activist policy. In the rest of the world, however, a revival of Keynesianism is still viewed with suspicion.
The conversion of Mr Bush and his Republican Party to the cause of fiscal stimulus has been going on for some months. But it has taken the tragedies of 11 September and their potentially devastating economic consequences to complete the process.21
Even the Federal Reserve has joined in the calls for an activist fiscal policy [with] Alan Greenspan telling members of Congress that a total stimulus of about 1 percent of gross domestic product would be prudent.22
This revival of Keynesian methods of state intervention is being greeted in some quarters as a welcome move that can see off the crisis. It can correct, it is said, the damage done by reliance on free market capitalism and even represent the end of neo-liberalism. Such, for instance, is the tone of some of the coverage in The Guardian.
But Keynesian methods cannot deal with the fundamental imbalances in the US economy that developed in the boom of the late 1990s. Investment in key industries far outstripped any increase in the source of profits. The current fall in profit rates is the inevitable consequence.
The rate of profit cannot be restored without, on the one hand, further massive restructuring of industry through large numbers of firms going to the wall and, on the other, a huge increase in the rate of exploitation by slashing workforces and cutting wages--as is already happening in the airline, aerospace and hotel industries. But in the short term such measures can only lead to a deepening of the crisis and a further fall in consumption, with ricochet effects right across the economy. Firms and private consumers will be under pressure to cut back desperately in order to try to get out of debt (or to end their 'negative saving' as some economists describe it). But it was precisely their borrowing that kept the US economy from sinking completely before 11 September.
Wynne Godley describes the likely consequences of them ending their indebtedness:
If private net saving reverts to its historic norm over the next two years this would remove a gigantic chunk of demand equal to about 7 to 8 percent of GDP, or $750bn, from the circular flow of income. Such a deficiency would swamp all the announced expansionary fiscal measures, which can hardly exceed $100- 200bn per annum at the outside.23
In other words the recession is bringing to an end the orgy of borrowing that has kept consumption and investment flowing until recently. The resulting decline in markets is likely to be between four and eight times greater than any stimulus to the market coming from changes in US government policy so far.
Yet there are already doubts in the US ruling class as to whether even that level of stimulus is desirable. The stimulus is meant to come from an excess of government expenditure over tax revenues. The Republicans want to achieve this by further tax cuts. The Democrats in Congress are arguing that this will lead to an excessive demand for funds from money markets, so leading to such a rise in long term interest rates as to further reduce private investment:
Democrats argue, the damage to the economy from such a fiscal policy is not confined to the effect on interest rates, says Robert Rubin, the former Treasury secretary, 'The more important factor is confidence. Once you lose control of your fiscal affairs it creates a general loss of confidence in economic management'.24
Some of the Democrats are simply using the argument as a way of pushing their preferred stimulus to the economy, through increased public spending, as an alternative to the Republicans' tax cuts. But, whatever their motives, they are pointing to the central problem from a capitalist point of view. Even the limited Keynesian budgetary measures proposed so far will run into serious problems in the medium term. Any improvement in profits due to their effect in expanding the demand for goods is going to be countered by the effect on profits and capitalist confidence of the government borrowing that provides for that demand. What they gain on the swings they are likely to lose on the roundabouts.
This was exactly the problem Keynes himself confronted--and ran away from--in the 1930s. Every proposal he made, notes Skidelsky in his biography, was tailored, 'taking into account the psychology of the business community. In practice he was very cautious indeed'.25 In practice neither the British nor the US governments intervened on the scale needed to deal with that crisis until they established a centrally directed war economy. Despite the tone of the bellicose rhetoric coming from sections of the Bush administration we are not going to see that in the near future. The US state will take measures to protect giant US firms. US governments have usually been careful not to let the neo-liberal ideology they propagate through the rest of the world hurt domestic businesses too much and have been quite happy to use the state to bolster and restructure US capitalism. But there is no sign of a stimulus on anything like the scale pessimists such as Wynne Godley see as necessary.
The official prognosis is that the British economy is strong enough to escape virtually unharmed from the world recession, since interest rates are low, inflation is low and projected increases in government spending should compensate for any reduction in foreign markets. Such glib optimism ignores a few elementary points. The British economy, like the US economy until recently, has been kept afloat by consumer spending. Overall borrowing by households rose by 10 percent last year, the highest level since 1991. It is doubtful whether that rise will continue if the surge of redundancies we've seen in recent months continues. And more redundancies are likely, since 'company profitability has fallen to its lowest level in five and a half years, raising fears that businesses are set to shed more jobs and cut investment to claw back disappearing margins'.26
At the same time, the other side of the consumer boom has been an increasing excess of imports over exports. This can be sustained so long as the belief persists that British capitalism is doing better than its European, US and Japanese competitors, leading to an inflow of international funds. But should any doubts begin to rise about this, the flow could reverse overnight, suddenly creating a great sense of crisis. A couple of years back there was a strong current of mainstream opinion arguing for a reduction in the value of the pound against the euro, on the grounds that this would increase the competitiveness of manufacturing industry. But when the value of the pound began, briefly, to fall in the summer there were sudden worries that this would be counterproductive. A lower pound would not succeed in raising the volume of exports as much as necessary should world trade stagnate (and some estimates suggest it will only grow by about 2 percent in the coming year),27 but would reduce the sterling value of each item sold: 'The decline in sterling against the dollar and the Euro could hammer manufacturers further. Economists said slack global demand may negate any competitive advantage from a weaker pound'.28
New Labour has had a fair degree of economic luck over the last four years. It is unlikely to be enough to stop Britain being sucked into the global recession. And, although this is unlikely to worry born again Blairites all that much, the avalanche of jobs losses is likely to get worse.
The effects of the US's resort to war have been contradictory. On the one hand, the US military has been able to pump money into certain industries and provide them with a floor below which markets will not fall-especially as Bush is finding it easier to push the Son of Star Wars programme through. On the other hand, the sense of instability can further damage the confidence of businesses and consumers.
What is important here is not, in the main, what happens on the military front--although what happens next in Afghanistan, and any extension to the war elsewhere (for instance in Iraq), will make a difference. Most significant will be whatever happens in the wide region stretching from the Nile to the Indus.
War often leads to political instability culminating in revolutions. But it is not often that the potential for revolutionary upheaval affecting their vital interests worries rulers when a war is only a few weeks old. But that has been a constraining factor on the US administration's conduct of its military operations. Media commentators talk openly of the possibility of revolutionary upheavals in countries such as Saudi Arabia and Egypt, and they fear the impact of the war on Afghanistan on the festering conflict between India and Pakistan over Kashmir.
But there are powerful currents within the administration which are dismissive of such fears as they push to broaden the military actions so as to achieve wider US global objectives. It is impossible to tell who will win out, or how close to revolutionary upheaval places like Saudi Arabia really are. But there can be no doubting the devastating impact on the US economy if a widening of the war were to result in the sweeping away of any of the regimes that guard the US's oil supplies.
Meanwhile, the deepening of the recession will increase instability in many different parts of the world. In Europe it is likely to accentuate the trend we saw in the early 1990s and summed up as 'the 1930s in slow motion'--a polarisation away from the centre towards the forces both of the far right and of a revived left. The important change since the early 1990s is the growth of the anti-capitalist movement, usually now central in the anti-war movements. It can provide a focus for the sudden bitterness created by the crisis in a way which was hardly possible a decade ago.
In parts of the Third World we may well see 'the 1930s in fast motion'--economic crisis on such a scale as to destabilise old political formations and states that depend on them.
'Private capital flows to emerging economies will fall sharply, producing the toughest financial conditions for these countries since the debt crises of the 1980s', warned the Institute of International Finance, a body representing global banks and asset managers, in September. It expected developing country exports to decline by 2 percent this year after growing by 22 percent in 2000.29
How desperate things could get was shown in Argentina long before 11 September. The government was thrown into crisis in the spring as it attempted to make massive cuts to the educational budget after three years of recession. It bought time for itself by giving the economic portfolio to Domingo Cavallo, who had been economics minister for the government thrown out at the previous election. He was briefly hailed in the media as the nation's saviour. By the summer he was having to push through his own even more savage package of cuts in return for an $8 billion IMF loan. Yet the economy continued sliding:
Argentina's economic recession, now in its fourth year, seems to be deepening. Construction activity fell 11 percent in August compared with the previous year while industrial production fell almost 6 percent.
September car production sagged 47 percent compared with a year ago. Consumer confidence is now close to historic lows. The immediate consequence is that tax collection plummeted 14 percent in September, forcing the government into yet another of round of spending cuts to meet its zero-deficit target.30
The government, not surprisingly, received a thrashing in provincial elections in October. In Buenos Aires, where a huge chunk of the electorate cast blank votes, the opposition Peronists got a majority of seats, but a quarter of votes went to the various parties of the far left. Against such a background it is hardly surprising that most commentators think it can only be a matter of time before the government is forced to devalue its currency and default on some of its debts.
Such a course might bring some revival to the Argentinian economy. But its impact internationally could be devastating. The country 'accounts for more than 20 percent of the emerging market bond index'.31 Default would damage those (mainly US) banks which have lent to Argentina--and would lead others to withdraw funds from other countries, so pushing them to the brink of bankruptcy. Some are in the zone subject to all the aftershocks of the Afghan war. Turkey has vied with Argentina for a year as the state which most worries the financiers. Egypt is deep in debt, despite some writing off of what it owed ten years ago as a bribe for backing the US war against Iraq. Pakistan owes $37 billion, but the debt relief bribe on offer so far is meagre. At present no less than 60 percent of Pakistan government revenues go on servicing its debt--under the proposed rescheduling scheme this would only fall to 50 percent.32 And all these countries' exports will be hit by the downturn in American, Japanese and European economies.
This definitely means increased poverty for very large numbers of people. It remains to be seen whether that will translate into the eruption of mass bitterness on the streets and the toppling of governments. But it certainly shortens the odds on this happening.
The official prognosis from apologists for the world's ruling classes is that a short recession will 'correct' the excesses of the boom years, and that a quick military victory will dispose of the threat to the US's client regimes in the Middle East.
If this is how things turn out, they will be very lucky indeed. Bush and Blair have unleashed war that can have all sorts of unpredictable consequences in a region that is full of highly combustible material at a time when their economies are skidding all over the place.