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The stagnating US economy

Shaken by major bankruptcies and scandals, coming together with a stock-exchange crash, US capitalism now faces a period of stagnation. Recent data shows the hollowness of the promised recovery and erosion of workers’ conditions. Downturn in the US will have profound repercussions on the world economy. LYNN WALSH analyses the trends.

THERE HAS BEEN no rebound of the US economy. Last year’s recession was in fact deeper and longer than it first appeared. Weak signs of recovery at the end of last year have been cut across by the stock exchange crash, the biggest since the 1973 slump.

The share price collapse was triggered by a spate of post-Enron business scandals, involving some of the biggest corporations and finance houses, like Global Crossing, WorldCom and Merrill Lynch. Underlying the slide, however, is a slump in corporate profits and capital investment. The outlook is for a second recession, the so-called ‘double dip’, or a prolonged period of stagnation comparable with Japan’s decade-long malaise. This would have a profound effect on the whole world economy. World growth in the 1990s depended decisively on the US demand for imports from both advanced and under-developed countries. Cut this off and the whole world economy could slide into a major downturn.

In a dramatic policy reversal, the US has already been forced to sanction huge IMF support for Brazil and Uruguay to prevent economic collapse and save US banks which have made huge loans to those countries. The actions, commented USA Today (7 August), are "long-term insurance policies to contain foreign crises that could spread to the USA".

Neither Bush not Greenspan has any policy – apart from more tax cuts for the hyper-rich – to lift the US economy. The president’s economic forum at Waco, conveniently near his Texas ranch, only revealed the vacuity of the Republican right. The succession of massive corporate bankruptcies and criminal scandals exposes the rottenness of the 1990s ‘business model’ and shatters the notion of market perfection. Greenspan’s phrase, ‘infectious greed’ sums up the system.

Recent data reveals the structural weakness of the US capitalism, the vulnerability of its international position, and shows the downturn has begun to bite seriously on jobs and workers’ living standards.

The share bubble bursts

IN THE NINE weeks from mid-May to mid-July, both the Dow and S&P 500 fell by over 20%, the biggest nine-week fall since 1974, when a bear market developed during a severe recession far worse than the recent downturn. The collapse of shares was triggered by the eruption of corporate scandals affecting major corporations and finance houses. They undoubtedly undermined confidence in the accounts of major companies. Fundamentally, however, the scandals exposed the underlying rottenness, the deep erosion of productive capacity on which the vast superstructure of speculative finance capital had arisen during the late 1990s. The collapse of share prices marked the partial wiping out of the fictitious wealth created by the bubble. The S&P 500 and the Dow are almost 50% down on their 2000 peak, and Nasdaq shares have fallen even more, altogether wiping out about $7 trillion in portfolio wealth.

Since mid-July there have been some stock exchange rallies, but the markets remain extremely volatile. Optimists still abound, claiming the ‘bottom’ has been reached and there will now be a ‘rebound’. Yet with no sign of a recovery in corporate profits, share prices remain overvalued. Average price/earnings (profits) ratios are currently around 16:1 on pre-slump profits, or 20:1 on current profits. This is sharply down on the peak 2000 35:1 ratio, but still above the long-term, historic average of 14.5:1.

The rallies were partly driven by big corporations buying back their own shares in order to push up their share prices. A sustained rise in share prices would only be possible on the basis of a sustained growth of the economy, particularly a steady restoration of profitability. This appears very unlikely in the next period.

The collapse of share prices has largely cancelled out the stock exchange ‘wealth effect’, the transfer of a proportion of capital gains into consumer spending, particularly on the part of the wealthier strata. Over half of US families now own shares, but half the shareowners hold portfolios of under $25,000 (at pre-slump values). The fall in tax payments for last year indicate a loss in personal income of $200bn or more, mostly among the wealthy – and the reduction will certainly be bigger in 2002. The disappearance of the stock exchange wealth effect has to some extent been replaced by the housing bubble wealth effect, which is likely to be temporary.

Longer and deeper

THE US DOWNTURN last year was shrugged off by many commentators as a ‘brief, shallow recession’. Recent revisions of the data by the US government, however, show that the recession was longer and deeper than it appeared. The US economy shrank during the first three quarters of 2001, clearly moving into recession before 11 September. Recovering towards the end of the year, it grew by 5% (annualised rate) during the first quarter of 2002 but slowed to only 1.1% in the second quarter. This is virtually stagnation.

Productivity figures have also been revised downwards. Instead of 3.3% in 2000 and 1.9% in 2001, actual growth was 2.9% and 1.1% respectively. The trend for recent years is about 2%, better than the 1.1% of 1970-80 but still significantly below the 3.3% average growth of the 1950-73 upswing. Hardly a ‘productivity revolution’, despite the development of microelectronics and other technologies. Corporate profits and investment are also stagnant. After five consecutive quarterly declines, second-quarter profits jumped to 29.7% (compared with 2001), according to Standard and Poor. However, according to analysts at Thompson First Call, profits grew by only 0.9%, which is probably more realistic. (New York Times, 11 August)

After a huge surge of investment in machinery, computers, software and buildings during the late 1980s, there has been a slump in business investment (which accounts for about 10% of GDP). Investment has fallen for six consecutive quarters, but there is still massive overcapacity as a result of previous over-investment. In the second quarter of 2002, investment in equipment and software rose at an annual rate of 2.9%, but investment in buildings declined by around 14% – resulting in overall business investment remaining negative. Venture capitalists (VCs), finance houses that played a key role in the 1990s financing start-up technology companies prior to firms tapping the stock exchange for funds through initial public offerings (IPOs), recently returned funds to investors because of the lack of company start-ups. Seven VC funds returned $2.7bn to investors in the second quarter. About 30 VCs still have around $100bn in uninvested capital and expect to invest only around $20bn by the end of this year. (USA Today, 6 August)

Consumer spending

THE SERVICE SECTOR, which accounts for 80% of the US economy, is also slowing down, largely reflecting the stalling of the consumer spending which cushioned the downturn since 2000.

Consumer spending grew by only 1.9% in the second quarter, compared with 3.1% in the first quarter, and 6% at the end of last year. Purchases of cars have been buoyant, largely due to cut prices and cheap credit. Purchases of durable goods, like household appliances, have declined. In fact, the total value of goods and services sold in the second quarter actually declined slightly. The slight growth in the economy was entirely due to wholesalers maintaining their inventory levels after more than a year of cutting their stockpiles.

For there to be faster overall growth, consumers would have to increase their spending over coming months. A number of things will work against this, however. Worried about job security and reduced incomes, angry at corporate and political corruption, consumers are now tending to spend less on luxuries and postpone big purchases. Consumer spending is slowing under the pressure of the squeeze on jobs and wages, the burden of debt, the disappearance of the stock exchange wealth effect, and generalised uncertainty about future prospects. The bursting of the current housing bubble, moreover, could further hit consumer spending.

Household debt has continued to rise, with the ratio of non-mortgage debt to disposable income standing at a record high of 21.9%, more than three points above the peak debt ratios of the 1980s. The growth of car leasing, not counted in debt statistics but in reality the equivalent of debt, adds another 2% to consumer indebtedness.

While the wealth effect from the stock exchange bubble faded as share prices slumped, during 2000-01, the ballooning of the housing market helped sustain spending throughout the economy. Soaring house prices stimulated a spurt in residential construction, while many homeowners (through additional mortgage debt and refinancing) converted their increased equity into consumer spending. The refinancing of housing loans gave back about $100bn to household incomes in 2001 and may add another $50bn this year. Since 1995 house prices have risen 30% more than prices generally. The main reason is that more and more people see a house not merely as a place to live but as an investment for the future. Above-inflation house prices added an additional $2.6 trillion to housing wealth, or an average of $35,000 for the US’s 73 million home owners. (Dean Baker, The Run-Up in Home Prices: Is It Real or Is It Another Bubble? CEPR, August 2002)

The housing bubble cannot be sustained indefinitely. Squeezed income and the growing burden of debt will bring prices down at a certain point. A modest decline of 11% would cut housing wealth by $1.3 trillion. A sharp fall of 22% would cut $2.6 trillion. Such falls would mean a cutback in residential construction equal to between 0.6 and 1.3% of GDP. The reversal of the wealth effect from the housing bubble, which has probably given a greater boost to consumers than the stock exchange wealth effect, would probably cut consumer spending by between $80bn and $160bn.

Workers squeezed

WORKERS HAVE ALREADY been squeezed by the recession, and most are far from experiencing any ‘rebound’. As always, workers have borne the main burden of the slowdown through increased unemployment, lost wages, and intensified work effort. 1.8 million jobs were lost between March 2001 and April 2002, and only 94,000 have been recovered since then. According to official figures, unemployment remains static at around 5.9% (out of a total labour force of 130.8 million), but unless the economy grows at around 3% unemployment and under-employment will certainly rise. The biggest loss of jobs has been in manufacturing, construction and the ‘temporary help’ sector. More involuntary part-time working has been imposed on workers, with the working week cut back to 34 hours, the shortest since 1964. This has sharply reduced earnings for many workers. (Labour Data Raises Questions on Recovery of the Economy, New York Times, 3 August)

Labour Department data show that the wages of 100 million workers have stagnated for over a year. At the peak of the boom at the end of 2000, private-sector workers’ pay increased by 5% (annualised, inflation adjusted rate) adding $4.2 trillion to workers’ pay. For the next year, workers lost a total of $94bn in pay, with only $9bn recovered so far this year. The lost wages and salaries were enough to cut at least 1% from GDP growth. Apparently, facing sharply rising costs of company-sponsored health insurance, the bosses are deducting most of the additional costs off workers’ pay cheques. (Stagnant Wages Pose Added Risk to Weak Economy, New York Times, 11 August)

Productivity growth was maintained through the bosses squeezing more work effort out of workers. In the first quarter of 2002 there was an increase of production while bosses cut back on workers and hours, resulting in an 8.6% (annualised) productivity growth rate. In the second quarter, while goods and services rose by only 0.3%, productivity rose by 1.1%.

The downfall of the dollar?

WHILE THE STOCK exchange bubble has burst (and the housing bubble is still inflating), the dollar bubble appears to be on the way down. At the height of the 1980s boom, the dollar was at least 20% overvalued, pushed up by the massive tidal flow of capital into the US in search of easy profits. Foreign investment in US stocks and bonds rose from $278bn in 1998 to $522bn in 2001. Foreign direct investment (FDI) in the US (spent on acquiring or establishing companies) rose to $301bn in 2000. The worldwide demand for dollars in order to make these investments inevitably pushed up its value.

As a result, imports purchased in dollars (especially from South-East Asian economies which had devalued after 1997) became extraordinarily cheap, and US consumers bought up increasing quantities of cars, computers, electrical goods, etc. By the same token, the high dollar made US exports relatively expensive on world markets. US imports grew much faster than US exports.

This imbalance has produced an accumulated current account deficit by 2001 equal to 23% of GDP (and estimated to rise to 40% of GDP by 2006 if annual deficits continue to grow at the same rate). The current account deficit is now running at about $400bn (the difference between what the US owes foreigners for goods, services, interest and dividends over what foreigners owe the US. Financing this deficit requires an inflow into the US of $400bn).

Despite the growing foreign debt, the Bush administration says it sees no problem with the ‘super-dollar’. However, the reduced inflow of capital from abroad has begun to push the dollar in a downward direction. Since January, the dollar has fallen about 12% against the yen and the euro. (This, of course, hits exports from the euro zone and Japan, and the Bank of Japan has been attempting to support the dollar in order to prevent a big rise in the value of the yen.) Against the currencies of the US’s main trading partners, however, the dollar has fallen by only 7%, and against those of all trading partners has fallen by only 3%. So far, this has had no effect in reducing the trade deficit. In the coming months, however, the dollar will almost certainly fall significantly because of the sharp decline in overseas investment into the US.

"The one place that always seems safe for the world’s investors – America – is slowly losing its aura of invincibility", wrote one commentator. (Haven No More, New York Times, 17 July) September 11, corporate scandals, and the slump in profits have all had an effect. Foreign direct investment, capital spending by foreign-owned companies, and foreign investment in shares and bonds have all declined sharply. "The net inflow into the country fell 83%", reported the New York Times (21 August), "or $16.4bn, in the first quarter compared with figures in the period for a year earlier. Switzerland alone invested $11.1bn in the US in the first quarter of 2001, in the first quarter of this year, it withdrew $154 million worth of capital". (Weaker Dollar Yet to Spur Export Boom, New York Times, 21 August)

A controlled decline of the dollar might, in time, boost US exports, curb imports, and reduce the trade deficit. That could have a devastating effect, however, on growth throughout the world economy, which has been heavily dependent on the US demand for imports. Even more devastating, however, would be an uncontrolled collapse of the dollar, which would hit the US economy and the world economy. Goldman Sachs, for instance, estimate that to reduce the current deficit by half (from $400bn to $200bn a year) the dollar would have to fall an ‘astonishing’ 43% against the currencies of the US’s trading partners. Such a fall would undoubtedly provoke a deep and prolonged recession in the US. In order to attract foreign capital the US would have to steeply raise interest rates in order to compensate for the falling value of dollar-denominated bonds. Because of the US dependence on a range of foreign imports (many products such as TVs are no longer produced in the US) and oil, domestic US prices would shoot up. It would take many years of investment by US capitalists to expand the US industrial capacity enough to rebalance the trade balance.

A major reduction in the US trade deficit would severely hit those countries which depend on exports to the US. Many would undoubtedly respond by devaluing their own currencies (to further cheapen their exports) and/or by putting up tariff barriers against US imports. US treasury secretary Paul O’Neill glibly dismisses the current account deficit as a ‘meaningless concept’. The Economist commented that the consequences of a declining dollar would bring sleepless nights to "a treasury secretary who knew what he was talking about".

A surge in oil prices in the event of a US strike against Iraq, together with extra war expenditure (when the Federal budget is moving sharply into deficit, mainly because of Bush’s tax cuts to the rich and generally declining revenues) would be additional negative economic forces. US capitalism is burdened with huge overcapacity and mountains of debt, and the anaemic state of the world economy offers no easy way out. The US can no longer rely on its status as a ‘safe haven’ and the promise of super-profits to cream capital from every corner of the globe. Will there be a ‘double dip’? The profile of the current recession is really a secondary issue compared to the prospect of prolonged deflation and stagnation now facing US and world capitalism. No wonder Marx described (capitalist) economics as the ‘dismal science’.


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