Socialism Today            Socialist Party magazine

What’s wrong with the world economy?

Reasons for the ‘revival’

Profound problems

Japan’s debt mountain

THIS YEAR THE World Economic Forum, which usually meets in the exclusive Swiss ski resort at Davos, convened in New York to show solidarity after September 11. Three thousand elite politicians, bankers and big tycoons, along with a sprinkling of ideologues, altogether spent over $100 million on hotels, ballrooms and restaurants, according to the New York City Tourism Board. In five days in New York, each WEF participant spent on average what the average US worker makes in a year, 14 times the average income in India, and 74 times what the average person makes in a year in Sierra Leone.

Buoyed up by glittering parties and champagne bubbles, most of the US speakers on the global economy panel struck an upbeat note. "My role is to spread a little glee", Gail Fosler, chief economist at the NY Conference Board, told the session: "The recovery has already begun in the United States". They were apparently undaunted by the downturn in the US, Europe, most of Asia and much of Latin America, the first simultaneous worldwide slump since the end of the second world war.

"I see a significant US recovery in the second half of 2002, and this will pull with it the rest of the world", said Jacob Frenkel, president of Merrill Lynch UK. "The story of the world this year will be the story of the United States. It is the engine of the world".

Undoubtedly, it is only the US economy, which accounts for about a third of world output, which can lead an international recovery. Europe will experience very weak growth this year. The biggest European economy, Germany, grew by only 0.6% last year, and is likely to have zero growth this year. France grew by 2% overall in 2001, but there was a 0.1% contraction in the fourth quarter, the first absolute fall for five years. "There was a sharp draw down in inventories and a stagnation in investment", commented the chief economist of the French statistics office: "It’s a reaction by business to the slowdown in the United States and the events of September 11". Japan, the world’s second-largest economy, remains stagnant, paralysed by deflation and a huge mountain of debt.

But can US capitalism act as an engine of world growth? Is it on the verge of a recovery? One of the few realistic comments came from Stephen Roach, chief economist of Morgan Stanley: "It is premature to declare recovery", he said, warning that the US might slip back into trouble again this spring.

Most Wall Street wizards, however, are now claiming that there is a recovery, seizing on the 0.2% growth in the last quarter of 2001. This followed a 1.3% drop in the third quarter, and was a better figure than most expected. Alan Blinder, former vice-chair of the US Federal Reserve, pictured the US economy as a ‘crouching tiger’, predicting 3.5% growth for 2002 (compared to 1.1% for 2001). This appears absurdly optimistic on the basis of an analysis of the underlying trends.

Reasons for the ‘revival’

CERTAINLY, CONSUMER EXPENDITURE has so far remained unusually resilient for the recessionary phase of the business cycle. This is based on a number of factors that are unlikely to continue for very much longer.

Lower interest rates (base rate down from 6.5% in 2001 to 1.75% in 2002) have meant cheap consumer credit and mortgages. Families continue to re-finance their mortgages to supplement their incomes. Many households received tax rebates (totalling $40bn last year), the first instalment of Bush’s tax cuts which will subsequently go overwhelmingly to the super-rich. Oil prices have fallen. Carmakers, who account for a big share of the consumer market, have been pushing cheap deals, with zero-interest credit and cash-back inducements. Retailers generally slashed prices (one of the causes of the bankruptcy of K-Mart, one of the country’s biggest retail chains).

Another effect behind the fourth quarter ‘revival’ was the running down of manufacturers’ and retailers’ inventories of stocks. According to the rules of national accounting, these show up as GDP growth when they are sold. The sharp decline in inventories ($120bn, October-December 2001) therefore translated into growth at the end of last year, averting a further decline. It is far from certain, however, that inventories will be rebuilt to previous levels, thus creating renewed demand.

The other trends supporting consumer spending, moreover, may be short-lived. Over 1.4 million workers have lost their jobs since the official beginning of the recession last March. This will inevitably impact on consumer spending. The decline of manufacturing is continuing, and this will mean further job losses that will not be recouped very soon. Despite low interest rates, unprecedented levels of debt must set a limit on further spending. Personal sector debt has now reached 120% of disposable income.

From the fractional ‘upturn’ at the turn of the year, it is absurd to herald a generalised recovery. Really, it is a case of cheap credit and low prices stirring the embers of the late 1990s consumer boom. This could continue for a little longer. Deeper recessionary trends, however, continue to operate.

Corporate profits and investment are the decisive factors for the direction of the economy. Wealthy investors are still raking it in from one deal or another. Nevertheless, the fall in big-business profits after the last year or so is the biggest drop since the Great Depression of the 1930s. Last year profits fell to 7% of GDP, down from the peak of just over 10% four years’ earlier. Undistributed company profits (profits remaining after dividend payments) turned negative last year for the first time in 40 years – making companies more dependent on loans than ever before.

With profits plummeting, big business is not likely to undertake new investment. Last year investment in equipment and software fell by 7.6% and is predicted to fall by 15% in 2002. (Business Week, 21 January) Capacity utilisation has fallen to 75%, the lowest level for 18 years. This reflects the massive overcapacity in many sectors of the economy, both in the US and internationally. What is the point in investing if there is already too much capacity? Intense competition, both nationally and internationally, is forcing down the price of manufactured goods – further squeezing profits.

Big business, like the household sector, is weighed down by a mountain range of debts. Private-sector debt (households and business combined) has risen to an unprecedented 170% of disposable income. Last year, business debt rose to eight times the annual flow of undistributed profits, far higher than the previous debt levels at the end of the 1980s boom. While nominal interest rates are low, price deflation makes the debt burden harder to bear, threatening the US with the deflationary problems now paralysing Japan.

Profound problems

WHAT ARE THE possible sources for renewed growth in the US? Capital spending is depressed and consumer spending is likely to decline. Bush’s proposed budget will, if passed by Congress, lead to a renewed growth of the federal deficit. Compared to Reagan’s arms-dominated budgets in the 1980s, during a period of growth, however, Bush’s deficit will not provide much stimulus to the economy. During the next year or so it will only create extra demand equivalent to 1% of GDP, compared to the 5-6% stimulus under Reagan. Bush’s weapons programme will undoubtedly boost the profits of the arms manufacturers, but at the same time deep social cuts will undermine the spending power of large sections of the population.

These are the trends operating in the US economy. It is never possible to predict precisely the course of the economy, or foresee every possible variant. Timescale is especially problematic. Some commentators acknowledge that the present apparent ‘revival’ may be short-lived, giving rise to a ‘double-dip’ recession. Whatever the short-term prospects, the continuing decline of profits and investment would appear to rule out an early, broad-based recovery. The debt overhang from the 1990s is even heavier than the 1980s overhang, which conditioned a very slow US recovery after the 1990-91 recession. At best, a new upturn is likely to be slow and patchy, and will be even more ‘joyless’ than the early 1990s, with unemployment continuing to rise for some time.

Trends are one thing, moreover, but what about the possibility of ‘shocks’? The full effects of the Enron scandal, the biggest corporate bankruptcy in history, have yet to be felt. In immediate terms, the Enron collapse does not appear to threaten the viability of the whole financial system, as the failure of Long Term Capital Management did in 1998. Nevertheless, the exposure of Enron’s fraudulent accounting practises has obliged a whole range of other firms to ‘write-down’ profits previously reported, which has led to a sharp fall in their shares. The fact that Enron shares, once valued at $90 each, are now worthless pieces of paper has hit pension funds and mutual funds, which will cut the investment income and pensions of many workers and retirees.

When corporate profits in general fail to match the over-optimistic expectations of investors, share prices are likely to fall even further. Despite the ‘correction’ of the last year or so, shares are still significantly overvalued in relation to corporate assets and profits. The movement of stock exchanges is the most unpredictable element in the capitalist economy. But against a background of worldwide slump, a financial crash certainly cannot be ruled out.

If overseas investors begin selling-off US stocks, and also reducing their investment in the US economy, the US would face increasing problems in financing its foreign debt. This would make the huge trade and current payments deficit unsupportable, leading to a decline of the dollar. A big fall in the value of the dollar could trigger a flight of capital from the US.

Japan’s debt mountain

ANOTHER SOURCE OF shocks to the US and world economy could well be Japan. The world’s second-largest economy has been stagnant for over a decade. Huge government spending programmes, mainly benefiting the big construction companies, failed to revive growth. Persistent price deflation, which pushes up the real burden of debt, now threatens Japanese capitalism with a meltdown. Japan is squashed under a Himalaya of debt.

The national debt is around 140% of GDP and rising. The bad debts of the banks, acknowledged to be unrecoverable, are the equivalent of 25% of GDP. Over the last three years, the banks (with government assistance) only managed to write-off debts equivalent to 8% of GDP. The Japanese capitalists have just suffered the indignity of having the credit rating of their government bonds downgraded by Moody’s: they now have a lower rating than Botswana. This has drawn a lot of humorous comment in the capitalist press. Nevertheless, the bourgeois strategists are terrified at the prospect of a meltdown, which could precipitate a fall of the dollar (a large slice of Japan’s trade surplus is held in US dollars) and a crash of the world financial system. Even now, the decline in the value of the yen is causing growing problems for China and other South-East Asian exporters, threatening another round of competitive devaluations in the region.

Most of the speakers at the World Economic Forum acted more like capitalist cheerleaders than serious strategists. One or two adopted a more serious stance. Robert Hormats, vice-chair of Goldman Sachs International, commented: "I think when historians look at the 1990s, they will look at it as a period of irrational exuberance in many respects. The Cold War was over. Western economies grew at a rapid rate. Stock markets were doing extremely well. And there was a feeling almost of invulnerability. A new sense of realism has descended on us, and we realise we’re all in peril".

This was not only an acknowledgement of the impact of September 11, but a recognition that the triumphalism of the 1990s is over. The ‘irrational exuberance’ affected not only financial markets (as Federal Reserve chair, Alan Greenspan, admitted), but the whole mentality of bourgeois leaders. Emboldened by the collapse of the Soviet Union and its satellites, intoxicated by the super-profits of the 1990s boom, capitalist leaders believed they could throw off all restraints. They strove to claw back the concessions they had made to the working class during the long post-war upswing, and hacked away all controls on the brutal logic of the market. The unprecedented enrichment of super-rich capitalists was the counterpart of intensified exploitation and impoverishment of workers, peasants, and dispossessed people throughout the world.

In their different ways, September 11, the Enron collapse, and the Argentinian uprising are all effects of that process. There was some acknowledgement of that at the WEF. Even the US secretary of state, Colin Powell, acknowledged the link between terrorism and poverty: "Terrorism really flourishes in areas of poverty, despair and hopelessness, where people see no future". The US government, however, rejected the call from Kofi Annan and World Bank president, James Wolfensohn, for a doubling of rich country aid to poor countries from $50 billion to $100 billion.

Among capitalist leaders, it seems, the ‘new sense of realism’ only goes so far. In contrast, those participating in the ‘anti-WEF’, the World Social Forum, in Porto Alegre, Brazil, voiced the anger of millions of people around the world suffering from the catastrophic effects of globalisation and neo-liberal policies.

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