Issue 231 of SOCIALIST REVIEW Published June 1999 Copyright © Socialist Review
What has happened to the economic crisis that seemed to be looming across the world last October? For the last few months the crisis has been off the front pages of the serious newspapers as the US stock market has reached ever new records, breaking through the Dow Jones 10,000 mark and apparently heading even higher.
Much of the world economy remains in dire straits, with serious and intractable recessions in the Far East, including the world's second largest economy, Japan, economic meltdown in Russia and mounting recession in Latin America. But the US economy seems to have taken all this in its stride, continuing to boast remarkable rates of growth by recent standards (the latest figures suggest the economy is growing at 4 percent) with little sign of the re-emergence of inflation. And that economic strength has placed some limits on the economic crisis elsewhere as the US has become the 'importer of last resort'. The 'Goldilocks' scenario, the economy growing neither too fast to rekindle inflation nor too slowly, thereby creating unemployment, is showing remarkable resilience.
This has been possible for a number of reasons. The first is that the US economy is relatively insulated in terms of its real economy from the downturn in the world economy. International trade only accounts for some 10 or 11 percent of US economic activity, so providing domestic investment and spending remains strong, export problems will only have localised effects in the short term.
Investment and consumer spending have also remained very strong as the irrepressible rise of the stock market has provided growing paper wealth ('collateral') against which companies and consumers have been able to expand their debt. Unemployment has fallen to very low levels which has boosted the income available for spending by the working class and greater job security which has increased consumer confidence to take on more debt.
In addition there have been signs of increasing wage costs as the bosses compete to attract and retain labour in increasingly tight labour markets. However, price rises (inflation) seem to have been repressed through a combination of falling commodity and oil prices internationally and a rising value of the dollar, which has made imports cheaper and put pressure on domestic producers to keep prices lower. The value of the dollar has risen because of the weakness of economies elsewhere, and the continuing strength of the US economy and of Wall Street which has made the US an attractive venue for international finance. Although the US financial markets suffered a shock last October in the aftermath of the Russian devaluation and default giving rise to fears of a more general financial collapse, three quick interest rate cuts by the US central bank, the Federal Reserve, and the bail out of the hedge fund Long Term Capital Management (LTCM) restored financial confidence.
The resilience of the US economy has given rise to the claim that the economy has entered a 'new paradigm' in which it can operate at much higher levels of growth than before because of a productivity revolution based upon a shift to 'post-industrial global information technology' in which US companies are market leaders. This revolution will, it is supposed, generate much higher profits thus justifying the stratospheric levels to which Wall Street has risen. If this were true, current US economic growth would not just be a product of short term factors which could disappear, but would be evidence for longer term ruling class confidence that they had overcome the sources of instability which have beset the US economy for the last 25 years or so.
However, there is little evidence to back up these claims. It is true that the US working class has suffered a significantly increased rate of exploitation since the early 1970s as average wage rates have stagnated and declined. There has been some restructuring and investment to raise productivity. But this does not add up to a decisive shift in favour of sustainably higher profits and growth. Alan Greenspan, the current chairman of the Federal Reserve, has admitted that the information revolution has been 'less important than technological revolutions at the turn of the century' (Financial Times, 13 May 1999). Apart from anything else the proportion of the economy in value terms devoted to information technology remains limited. Moreover, Greenspan notes that 'the average annual growth of business output per hour in the post-1992 business cycle has been less than in the years between 1954 and 1975'. Even more significantly, there is every reason to believe that not only is current US economic growth unsustainable, but that the slowdown when it comes will be severe both for the US and the world economy.
The US is now beginning to incur a record excess of imports over exports--a balance of payments deficit. This can be financed for as long as the rest of the world is effectively willing to lend the US money, but sooner or later that willingness is likely to run out if the deficit continues to grow. At that point the dollar will fall in value. A fall in the value of the dollar will make imports more expensive, potentially pushing up inflation. Inflationary pressure is already evident with the recent rise in oil prices following the oil producing (OPEC) countries' decision to cut back production. And it is impossible to believe that if very low levels of unemployment continue this will not lead to rising wage costs.
If inflation re-emerges as a threat the Federal Reserve will feel obliged to reverse the interest rate cuts which have helped to sustain economic growth, and if interest rates rise this will make the already grossly inflated share prices on Wall Street much more unattractive. Already, long term interest rates, set by the interest rate on government debt (bonds), have risen by 1 percent in the last few weeks on the basis of inflation fears. Wall Street clearly remains very vulnerable. As Samuel Brittan, leading Financial Times columnist, recently put it: 'Just as there are optimists today who talk about the Dow Jones Industrial Average rising from 11,000 to 20,000 or 30,000, their forebears in the 1920s spoke about a new era of everlasting prosperity. The rise in the Dow Jones between 1924 and 1929 was very similar to the rise from 1994 to date.' A collapse on Wall Street, if and when it comes, will not of itself precipitate wider economic problems. This is, after all, notional rather than real wealth. However, it is likely to have wider and very serious ramifications.
The increasingly unregulated, globalised and anarchic financial markets have led to an explosion of complex financial deals involving major financial institutions--and indeed industrial corporations--on the future movement of share prices, interest rates and currency values. These complex deals can produce huge profits if the speculators bet correctly and huge losses if, for example, there were a big fall on Wall Street. Speculators can find themselves running out of cash and credit, as LTCM did last October. As the financial panic spreads, lending can seize up in a credit crunch.
This will very seriously affect the primary motor of US economic growth over the last few years--the growth of debt. But even if the problems do not originate with the collapse of the stock market bubble, it is difficult to see debt growth continuing to be the primary source of US growth. A recent study by Wynne Godley and Bill Martin reveals that:
The willingness of corporations and consumers to increase their debt burden has a variety of causes, but one very important reason is the apparent increase in wealth generated by the enormous increases in share values. Godley and Martin estimate that to generate the required boost to spending over the next five years to sustain economic growth at its long term average, stock prices might need to increase in real terms by nearly 40 percent a year. At today's price level, such a rise would push the Dow Jones Industrial Average to well over 40,000 in five years time. But the probability that the Dow Jones could be more than four times as high in 2003 than it is with today's bloated price level is virtually zero. The current US boom bears certain similarities to the Lawson boom of 1988 when the UK private sector overspent its income by 6 percent of GDP. Sooner or later the US private sector will seek to reduce rather than increase its debt 1evels dramatically (as the UK private sector did after the Lawson boom peaked) with dire consequences for the US economy. No one knows exactly when this will happen or what will trigger it, but that it will happen is a near certainty.
Should spending in the US economy begin to decline, the state is not without measures it could take to try to stem the decline. The Federal Reserve could drive short term interest rates down, reducing the cost of repaying debt, improving the attractiveness of investing on the stock market and making borrowing more attractive. However, inflation is virtually zero and any downturn in economic activity is likely to see the general level of prices falling as too many goods chase a shrinking market. This is deflation and it is what has been happening in Japan. In these circumstances lowering interest rates can be much less effective in reviving growth.
The US government has eliminated the chronic budget deficits of the 1980s when government spending far outstripped government revenues. It is now running a budget surplus. There is still a very large national debt but it has been declining as a percentage of GDP. A slowdown in the economy will reduce tax revenue and probably push up government spending. Even the most avowed monetarists accept that governments have to run budget deficits when the economy is in recession. Attempts to reduce the deficit in these circumstances would simply exacerbate the recession by further reducing spending and this would ultimately make the deficit worse by cutting tax revenues and forcing up welfare spending. With the US government currently running a surplus it should be in a position to give the economy a positive boost by consciously increasing spending and cutting taxes. However, the prevailing orthodoxy on Capitol Hill and in the White House will be to move extremely cautiously in this regard and, if Japan is anything to go by, the deflationary and recessionary forces may be so great that government action will be too slow and too cautious to prevent a descent into recession.
US economic growth and the Wall Street boom on which it has been based have been remarkable in the context of the instability of the world economy, but it is the result of a fortuitous conjunction of circumstances. As time goes on, the chances of the economy suffering a serious downturn grow, with unpredictable but serious consequences for world capitalism as a whole.