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Issue 56, May 2001

THE FEDERAL RESERVE'S surprise move on 18 April to cut the base interest rate by another 0.5% (to 4.5%) was an unmistakable signal that the US authorities now fear the danger of a major downturn in the US economy. This was the fourth interest rate cut this year, totalling 2.0% altogether - in reality, emergency treatment to increase liquidity in an effort to cushion the fall in share prices and soften the sharp slowdown in the real economy.

Share prices rose in response to the interest rate cut on the international exchanges. Repeated rallies, however, cannot conceal the fact that since March 2000 the trajectory has been downward. The S&P500 fell 8.2% over the last year, while Nasdaq fell by 61%. The speculative equities bubble, which was inflated to unprecedented dimensions during 1998-2000, has been remorselessly deflating - and many commentators consider that US share prices are still overvalued by between 30% and 50% in relation to corporate assets and profitability.

The fall in share prices has already seriously eroded the 'wealth effect', the translation of the stock exchange's paper gains into capital investment and consumer spending (mostly by the wealthier strata), the twin motive forces of the late 1990s boom. As yet, consumer spending (still growing at an annualised rate of between 2-3%) has apparently not been seriously undermined. This no doubt reflects recent wage increases gained by workers during the peak phase of the business cycle (in marked contrast to the wage stagnation of the 1980s and early 1990s). Consumer spending has also been held up by unprecedented levels of mortgage and consumer debt.


Capital investment, however, has collapsed in recent months, undoubtedly reflecting the marked decline of corporate profits. Investment in traditional industries, such as cars and engineering, has declined as demand fell off, stocks of unsold goods rose, and the overcapacity continued to accumulate.

Capital investment in the technology and telecommunications sector, which was fuelled by the speculative frenzy in technology stocks, has fallen even more drastically. During 1996-2000, investment in this sector accelerated by 20% a year, while in the first half of 2001 it fell by over 10%. The slump in technology investment cannot but reduce the rate of productivity growth, despite Alan Greenspan's claims that the gains of the 'new economy' will be maintained. Productivity growth rose from 1.9% pa during 1990-97 to 2.9% pa during 1997-2000 (still below the 3.3% pa average growth of the 1950-73 upswing period). New technology, combined with more intensive exploitation of workers, was undoubtedly a factor in the recent surge of productivity growth, and is unlikely to be continued during the downturn.

Some economic indicators have given mixed signals, not surprising at the beginning of a downturn. Hope springs eternal, especially with profit-crazed investors, and some seized on various reports - a positive consumer confidence survey and fractionally higher car output in March - as proof that there will only be a relatively painless pause in US growth. The underlying trend, however, is clearly towards a recession.


Over the past twelve months, US industrial output has grown by only 0.8%. Despite the slight increase in March, mainly due to increased car production, output in the first quarter fell at an annual rate of 4.7%, the biggest quarterly drop since the end of the 1990-91 recession. Reflecting the serious overcapacity of US and world manufacturing, the utilisation of plant was below 80%, hovering around an eight-year low point.

In its recent statement, moreover, the Federal Reserve referred to 'the persistent erosion' of corporate profits and profit forecasts. There is expected to be a 9% year-on-year decline in corporate profits for the first three months of the year, and the position is likely to deteriorate further. The profits of technology companies, moreover, are expected to fall by 26.4%. Unemployment rose slightly in March, with 86,000 job losses (81,000 in manufacturing), the worst since November 1991 (when 94,000 disappeared).

Many financial-market gamblers are betting on a 'second-half recovery'. Nevertheless, serious debate is beginning among capitalist strategists about the prospects for the US and the world economy. Apparently, there is a majority who still believe that the 'Maestro', Greenspan, will successfully engineer a 'soft landing', in other words, a gradual, managed slowdown that, after a year or so, will prepare the way for a renewed upturn.

A number of factors, however, appear to rule this out. The bubble-boom of the late 1990s was linked to several processes which were ultimately unsustainable. Not only that, but they have given rise to several massive structural problems which will now act as a dead weight on the US economy, as well as having drastic international repercussions.


The bubble-boom floated upwards from a mountain of debt. On the strength of stock exchange gains, wealthy speculators and corporations borrowed more and more in order to increase their gambling stake in financial markets. Corporations are even more indebted than they were in the late 1980s. At the same time, middle- and working-class families, encouraged by the apparent prospect of indefinite prosperity, increased their mortgage and consumer debt in order to improve their living standards. Altogether, the current 'debt-overhang' from the late 1990s will be far heavier than that of the late 1980s, which was largely responsible for the very slow, weak recover from the 1990-91 recession.

US capitalism lived beyond its means in the 1990s, consuming more than it produced. This has resulted in a trade deficit of over $400 billion a year, which has to be financed by a flow of capital from overseas, with foreign investors buying US companies, shares, and bonds. The accumulation of foreign debt that this entails, currently around $2 trillion, makes the trade/payments deficit unsustainable. Cutting the US deficit, however, would have a severe impact on Europe, Japan, Asia, etc, whose growth depends on exports to the US.

The stock exchange bubble is linked to a dollar bubble, with the US currency between 20% and 30% overvalued. Created by the massive inflow of capital into the US, attracted by the prospect of high profits, the overvalued dollar cheapened exports, exacerbating the trade deficit. At the moment, the dollar is still strengthening, presumably reflecting a belief on the part of international investors that the US downturn will be shallow and short lived. At some point, however, the US downturn, with a further likely collapse of share prices, will trigger a flight from the dollar. That would render the US trade deficit completely unsustainable, provoke turmoil in world currency markets, and threaten the stability of the world financial system.


Awareness of the dangers posed by these factors has led some strategists to warn of a much more serious downturn. "There is a serious risk of the slowdown getting out of control", commented the head of Credit Suisse First Boston Equity Trading (Financial Times, 19 April). Moreover, Clinton's former treasury secretary, Larry Summers, recently argued that "the country's current economic cycle is different from previous post-war cycles... This expansion, he argued, has been more like pre-war cycles, or like that in Japan in the late 1980s, that is driven by credit. The absence of rising inflation has allowed the expansion to go on for longer, but at the cost of a greater accumulation of debt". (Economist, 3 February)

The clear implication is that the US, as a result of the current downturn, could face a long period of stagnation comparable with the paralysis of Japanese capitalism during the 1990s. The situation ahead, however, may be even worse. A stagnant Japan managed to avoid a meltdown because of the world growth propelled by the boom in the US economy after 1995. What happens when the US, Japan, Europe, and the rest of the world all slip into a serious downturn?

Already, international capitalist agencies like the World Bank are revising downwards their estimates for world growth in the coming year. There are signs of a slowdown in Europe, with a spate of job losses, especially in manufacturing. In Japan, capitalist leaders are openly talking about the danger of an implosion of the economy. Since the mid-1990s, the US demand for manufactured goods and raw materials has been the locomotive of the world economy. When the US economy goes down, there is no way the rest of the world can avoid a serious downturn.


It is not only features of the current economic cycle which recall the interwar period, however, but the social situation in the US. The economic processes and ruthless neo-liberal policies from which the late-1990s bubble-boom arose have produced a profound social polarisation, a chasm between the hyper-rich and the majority of society. The divide is far more extreme than during the post-war upswing, and on a similar scale to that of 19th century capitalism or the 1920s.

The class divide reflects the fact that the 1990s boom was based primarily on the intensified exploitation of the working class, including the international working class, and especially the poor working masses of the underdeveloped countries. On the other hand, the economic gains of the US working class during the 1990s have been minimal. While such stark social inequality maybe tolerated under conditions of economic growth, it will become intolerable in a period of downturn, especially in a prolonged period of economic crisis which will see the reappearance of mass unemployment and new depths of poverty for millions.

The strategists of US capitalism have no idea of how to deal with the developing economic crisis, and no real conception of the political and social upheavals which are approaching.

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