Issue 233 of SOCIALIST REVIEW Published September 1999 Copyright © Socialist Review
Just one year ago panic swept the markets. The world's financial system appeared to be on the brink of meltdown, and the immediate crisis was precipitated by a run on the Russian rouble, its devaluation, and the announcement by the Russian government that it was prepared to default on its debts. The Brazilian currency then came under attack and a US hedge fund, Long Term Capital Management (LTCM), with massive speculative commitments and relatively little capital was unable to make its repayments. Clinton announced that the world was facing its most serious crisis since the Second World War.
A year later it seems as though there had never been a crisis. The bail out of LTCM organised by the US central bank, the Federal Reserve, and three interest rate cuts in the US restored confidence to the financial markets. The US economy has continued to grow strongly, acting as buyer of last resort for the rest of the world economy, in what has become the longest US postwar expansion. Optimistic reports have also appeared about recovery in Asia.
The reality is that things are much more precarious than the 'optimists' suggest. August, in particular, has seen signs of growing problems for the apparently virtuous circle that has been powering the US expansion.
This, which has been key to recovery in the world economy over the last year, has been fuelled by ever increasing amounts of debt based spending by both companies and consumers. This spending boom has been supported by the US stock market, which has continued to rise to even more bizarre heights. The stock market has risen more than 10 percent since the end of 1998, and estimates put the Dow Jones index of share values at anything from 25 to 50 percent above its historic average. Early signs of trouble ahead were seen with the recent fall in the value of hi-tech shares, including internet shares. The balance of payments deficit is likely to exceed $300 billion this year, its highest level ever.
The long US expansion has created serious labour shortages, forcing US bosses to increase wages (and therefore costs) to attract and retain labour. These increased costs have been absorbed so far by rapidly rising productivity, largely explicable not in terms of a productivity revolution based on hi-tech information technology (the 'new paradigm') but on hitherto excess and idle productive capacity being brought into play in response to strong demand. Now the US economy appears to be slowing, with growth in the second quarter of 1999 falling to 2.3 percent from 4.3 percent in the first quarter. The productivity gains which restrained inflation are beginning to fizzle out, increasing inflationary pressure.
But things are even more fragile than this. The rise in the stock market and the balance of payments deficit have been financed so far by speculative international finance flooding into the US as a safe haven and in pursuit of making a profit out of the stock market bubble. The very modest signs of recovery in some other parts of the world have provided alternative ports of call for international speculative capital. Money, for example, has been flooding into Japan, pushing up the value of the yen (and thereby threatening to snuff out the incipient Japanese recovery) and pushing down the dollar. Commodity prices have been rising and oil has doubled in price over the last year.
A significant fall in the dollar, which would push up US import prices, combined with increased international commodity prices, further threatens to reignite inflation in the US. This could encourage a flight of capital causing a crash in the stock market and a collapse of the dollar on the international markets.
The Federal Reserve is under increasing pressure to increase interest rates to try and cool the economy down, and preserve the value of the dollar. The recent rise was the second in eight weeks. But there are also fears that a significant rate increase will cause a stock market crash.
The speculation which threatened to produce serious financial crisis last August has continued and, if anything, grown over the last year. Already there have been persistent rumours of another LTCM type collapse. Major financial institutions have enormous speculative exposures which are susceptible to shocks coming not only from within the US but from other parts of the world, where things remain very unstable.
China, for example, is continuing to suffer a deflationary crisis, rampant corruption and severe economic restructuring and dislocation. The devaluation of the Chinese currency to alleviate some of these problems is a growing possibility, which could further destabilise the south east Asian economies. Even here, although there has been very modest economic growth following the catastrophic falls in production in 1998, the 'restructuring' demanded by the international financial community has proceeded very modestly. The break up of the heavily indebted Daewoo, which accounts for some 5 percent of South Korean production, shows how much further some 'Tiger' economies have to go to stabilise the situation.
And although Japan has boasted some economic growth in the first half of this year on the back of enormous government spending (and therefore debt), no one believes this is sustainable against the very strong deflationary forces still at work in the Japanese economy.
Last time round Alan Greenspan, the chairman of the Federal Reserve, won a breathing space for the US economy more through luck than judgement, by organising a bail out and reducing interest rates. Next time inflationary pressure and dollar difficulties will make this option much more problematic. All the signs are that the US and the world's financial and economic system are in a state of relative calm before more severe storms.