HANNAH SELL assesses prospects for the global economy after the recent US interest rate cut.
On 18 September, the US central bank, ‘the Fed’, cut interest rates by 0.5%, the first cut in four and a half years. The US stock markets, already frothy, responded by surging to record new highs, taking it as an indication that the US economy is heading towards ‘a soft landing’.
Central bankers are also hoping that they might have pulled off a miracle. As Christian Lagarde, President of the European Central Bank, put it, recent years have been a “severe stress test” for capitalism, with “the worst pandemic since the 1920s, the worst conflict in Europe since the 1940s and the worst energy shock since the 1970s”. Now the bankers hopes are rising that they might have successfully weathered those storms.
The introduction to the Bank of International Settlements (BIS) annual report (June 2024), for example, was headlined “so far so good”. The report’s summary declares that, “The world economy appears to be finally leaving behind the legacy of the pandemic and the commodity price shock of the war in Ukraine. The worst fears did not materialise. On balance, globally, inflation is continuing to decline towards targets, economic activity and the financial system have proved remarkably resilient, and both professional forecasters and financial market participants see a smooth landing ahead. This was by no means a given a year ago. It is a great outcome”.
Relief from the representatives of capitalism is inevitable, given that the world economy has not yet been plunged into a new deep global crisis despite numerous hazards, and the US has managed better than expected growth figures of 2.5% in 2023. Those figures are not, however, a true reflection of the experience of the working class. Polls show that anxiety over ‘making ends meet’ has increased markedly. Biden’s policy wonks have been publicly scratching their heads over why this is so, but the answer is obvious; millions of working and middle-class Americans’ living standards are still being squeezed. Meanwhile the US banks have pocketed a $1 trillion windfall from higher interest rates.
Workers’ pain will get worse as the US economy slows down, even if there is the hoped for ‘soft landing’. Mohamed El-Erian, President of Queen’s College Cambridge, was one of many commentators to ruminate on the issue in a Financial Times article (13 September, 2024). He pointed out the reasons why it was very far from certain: “While US economic growth has repeatedly proved to be much more robust than many expected, the potential for continued ‘economic exceptionalism’ must be weighed against the intensifying pressures felt by lower income households. Many have exhausted their pandemic savings and incurred more debt, including maxing out their credit card”. He concluded that there is no agreement on whether “weakness will remain concentrated at the bottom of the income ladder or migrate up”. In other words, increased suffering for the ‘bottom of the ladder’ is a certainty, even if the most optimistic capitalist commentators are right on the character of the next downturn.
El-Erien is correct, however, to warn that it could be much more severe. The financial markets are buoyed up by huge speculative bubbles, especially in the US – focused on the big tech companies and the AI frenzy. Only twice before has the gap between the value of global financial assets and the value of actual goods and services produced increased to such gargantuan proportions, both before serious financial crashes.
Even the BIS Report, after its relatively optimistic opening, strikes a more downbeat note about the difficulties of pushing inflation out of the system without triggering a major crisis. It argues that the problems are far greater than was case “during the Great Inflation era of the 1970s” because then there were nowhere near the same “vulnerabilities” in the world financial system. Today, they correctly say, the levels of “vulnerabilities” is unprecedented. Chief among them are the already record levels of debt in the world economy. In 2022 the combined debts of corporations, states and individuals were equal to more than three-and-a-half times global GDP.
The report makes the correct point that the banking crises in March 2023 were as a result of the ‘materialisation of interest rates risk’ alone, but that the ‘the materialisation of credit risk’ is still to come. Even with interest rates coming down, a lot of debt agreements made in the days of ultra-low interest rates will be more expensive when they are refinanced. On the slowing US economy, it points out, “savings buffers are dwindling. Debts will have to be refinanced. Within this broad picture, specific pressure points abound”. They point in particular to commercial real estate and the “burgeoning private credit markets”, along with “other vulnerabilities we know far less about”, any of which could be a trigger for a new global financial crisis.
The BIS report is a little more optimistic about the state of US banks, even though they are heavily invested in commercial real estate, with non-performing loans in the sector doubling in 2023. However, its optimism is partly based on the Fed’s plans for beefed-up regulation after the 2023 banking crisis. Yet, since their report was published, the wolves of Wall Street have, in the words of the Financial Times, forced the Fed into “complete capitulation” on its attempts to increase regulation.
Clearly there are multiple possible financial shocks that could trigger a new economic crisis, as could new or escalating wars or other geo-political events. More fundamentally, regardless of immediate economic perspectives, none of the fault-lines in the world economy that triggered the Great Recession have been overcome. On the contrary, each emergency measure to ‘keep the show on the road’ has deepened the contradictions.
The period of the ‘Great Moderation’, with prolonged ultra-low interest rates and low inflation has gone forever. It was a product of the era of globalisation after the collapse of Stalinism, where the US was briefly – in historical terms – a hyper-power able to set the framework for the world economy, and where China was willing to act as a cheap labour assembly plant for Western capitalist powers.
That era is gone, and the multi-polar world we are in today makes it much harder for the different capitalist classes to co-ordinate their responses to the inevitable financial and economic crises.
Keeping the show going
Right now central bankers have their fingers crossed that they might just have managed to end the ‘era of cheap money’ without triggering a catastrophic disaster. During the pandemic, in order to stave off disaster, central banks introduced stimulus packages on an unprecedented scale, even compared to the years of ‘quantitative easing’ and loose monetary policy that preceded Covid. In 2020 the US Fed pumped more than $3 trillion into the economy. One fifth of all the dollars in existence, physically and electronically, were created that year. But it was not just the US. The ratio of ‘broad money’ to GDP rose by almost as much in the Eurozone, by more in Japan, and most of all in Britain.
Only now, after two years of ‘quantitative tightening’, and the pain of an inflation surge and a brutal cost-of-living squeeze for the working and middle classes, are ratios back to broadly pre-pandemic levels. However, central banks are having to ‘tighten’ with extreme caution. When the US saw the second and third biggest bank collapses in its history, in March 2023, the Fed quickly intervened and guaranteed all deposits in order to limit contagion. The IMF summed up the reality when it said that doing so raised a real question of moral hazard and threats to public sector balance sheets, but that there was nonetheless no choice, but to do “whatever it takes”.
Without doubt, even though new rounds of quantitative easing would have both a more limited effect and potentially more damaging consequences than in the past, that will not prevent the major capitalist powers reversing course and attempting such measures in order to try and ‘keep the show on the road’ when faced with a new crisis.
And even while central banks have to some extent ‘turned off the taps’, governments have increased intervention in the economy. Above all that is true of the US: Biden’s Inflation Reduction Act (IRA), Chip Act and other measures, aim to boost US capitalism against its rivals, especially China. Some have pointed to the undoubted increase in military expenditure, of a record 6.8% in 2023 – $166 billion globally, as a factor in stimulating economic growth. However, that is dwarfed by the IRA, which alone agreed to put $891 billion into the US economy, mainly via subsidies to manufacturing. It is true that this hasn’t all been realised. Around 40% of new manufacturing planned as a result of the IRA has already been delayed or cancelled. In reality, even with high tariffs, the US solar panel industry, for example, can’t compete against cheaper Chinese panels that have saturated the world market. At the same time, the highly-automated character of most new manufacturing means limited new jobs even where plants reach completion. And, of course, increased tariffs are adding to the cost-of-living squeeze facing US workers.
Nonetheless, US manufacturing employment has increased by 700,000 over the last three years, and foreign direct investment (FDI) into the US has increased by over a $1 trillion as Japanese and German companies in particular rush to take advantage of subsidies. Of course, even for the US, state intervention on this scale comes expensive. The US debt to GDP ratio is already 122% and heading higher. US government debt servicing costs are already 12% of total government outlays and a third, $9 trillion, of government bonds must be refinanced in the next year alone.
US capitalism has more room to manoeuvre than others. It is in relative decline, but is still the strongest economic power. The dollar remains the global reserve currency. However, this does not prevent big sections of the US capitalist class worrying about the potential consequences of the size of the debt. Some also recognise that it is utopian to try to rebuild American manufacturing, which cannot be competitive in the global market against China.
But despite the problems Biden was compelled to take this path in order try to protect US industry from the consequences of China’s drive to claw its way up the value chain and become an advanced manufacturing economy. On this question there is no fundamental difference between the approach of the Biden and Trump administrations. Biden kept most of Trump’s tariffs and added subsidies to US-based industry. Trump rails against the IRA but it is an open question as to how much he would repeal if he was elected, particularly given that a large part of the new manufacturing is in red states.
The biggest single disruptor to the world economy in the last two years has been ‘Bidenomics’. The rest of the world has been forced to attempt to follow suit, but with far less ability to do so. The IMF estimates that last year2,500 new ‘industrial policies’ were introduced worldwide, 71% of which it considered to be “trade distorting”. This compares to virtually none a decade before. China is facing its own serious economic difficulties. Its domestic market is still limited and it is therefore badly effected by US and other tariffs. It is compelled to respond to the US in kind with, for example, increased restrictions of sales of rare minerals used in semi-conductors. Even in the past, at ‘peak globalisation’, capitalism remained based on nation states. Now, however, the constant conflict between the world market and the nation state – present from the dawn of capitalism – is tipping towards increasing national barriers and protectionist measures.
The trend in that direction is clear, but the world economy still remains highly integrated. In the period after the collapse of Stalinism up until the 2008 Great Recession world trade grew dramatically from 39% as a percentage of global GDP in 1990 to 61% by 2008, with – of course – two-thirds of the profits growth (to 2013) being captured by Western companies. Since 2008 world trade has not regained that peak but has still remained at a higher level than the early 2000s, or any previous period of history. This year World Trade Organisation economists divided the world into two geo-political blocs centred on the US and China and looked at the difference between trade within the ‘blocs’ and between them since the invasion of Ukraine. They found that goods trade between the blocs had grown by only 4.2% less than it had within them.
In reality, this indicates that there aren’t two defined blocs, but rather different national capitalist classes attempting to defend their own interests, often balancing between the big players. Nonetheless, the increasingly multipolar and conflict-ridden character of world capitalism is going to make it far harder to achieve effective global cooperation to limit the consequences of the next major economic crisis whenever it comes. In 2008 it was cooperation between the US and China which was central to limiting the effect of the Great Recession. That is not going to take place again.