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From International Socialist Review, Issue 6, Winter 1999.
Downloaded with thanks from the ISR Archive Website.
Marked up by Einde O’Callaghan for the Encyclopaedia of Trotskyism On-Line (ETOL).
SINCE THE start of the economic crisis in Asia that began in the summer of 1997, many economic experts and media pundits have argued that the U.S. economy, barring some minor irritations, has been largely insulated from the crisis that now covers over 40 percent of the world. The popular wisdom was that the U.S. with its miracle “Goldilocks” economy would weather the storm. Then, from August to October 1998, it seemed that the U.S. was headed for a serious economic recession. Suddenly the U.S. stock market began gyrating and plummeting along with world stock markets, and a financial panic spread through U.S. banks and investors. This was the third market catastrophe in a year, and this time it was hitting the world’s largest economy.
The socialist explanation that world capitalism was in its worst economic crisis since the 1930s became trendy media wisdom. This was best exemplified by Newsweek’s October 12, 1998 cover title, The Crash of 1999? Inside, the lead article by Robert J. Samuelson read in part:
Americans have been lulled into a false sense of security, and it is hard to overlook the eerie parallels with the late 1920s. Then as now, Americans had experienced an exhilarating stock-market boom; then as now, they had enjoyed the pleasures of new technologies ...; then as now, they thought they had embarked on a period of endless prosperity. No doubt, the American economy has done better in the past three years than hardly anyone expected at the start of the 1990s. But the very surprising nature of its performance ought to remind us that the mood of the moment-pessimistic at the start of the decade, optimistic now-is rarely a reliable guide to the future. The United States is the last great domino propping up the world economy. If it falls, woe to us all.
But when a measure of stability was restored and the stock market made an impressive recovery, rampant ruling-class panic gave way to recovered self-confidence. The government economic reports indicated continuing, strong economic and job growth. The media, in an abrupt somersault, proclaimed the crisis over. The U.S. had miraculously stepped back from the abyss, due mainly to Federal Reserve Chairman Alan Greenspan’s brilliant intervention to prop up a collapsing hedge fund that threatened to topple the entire financial system, along with interest rate curs to stimulate the economy. The strength of U.S. consumer spending, it was argued, would buoy the U.S. even when other economies were stagnating or sinking.
This article argues that what passes for analysis in the media and among the bourgeois economic “experts”-an analysis that goes up and down literally with every swing of the stock market-is a superficial spin. To understand what is happening to the U.S. economy and the world economy it is necessary to look at what is happening to the underlying structure of the economy. A closer inspection reveals deep fissures and cracks-contradictions that will lead to further destabilization and crisis. This article will argue that while the Fed’s intervention has had an impact on the economy, it cannot overcome the fundamental problems facing the U.S. economy.
The last market debacle was the third, most serious stage of global crisis since the summer of 1997. Each of the three successive legs ot this crisis followed a similar script: a real economic disaster acted as a catalyst to a market panic, a government rescue program provided temporary stabilization, and stock markers then surged on the belief that the worst had passed and catastrophe had been avoided. But after periods of seeming stability, the two previous rescue programs failed and the crisis progressed to another, even worse phase. Each stock market recovery has been more speculative than the last, more disconnected from the real economy. In the U.S., the real economy-the production and circulation of goods and services – cannot remain indefinitely so far out of alignment with what is a massively overint1ated stock market. The warning signs of recession in the U.S. – of overcapacity and overproduction in manufacturing that have already led to manufacturing layoffs, and in the farm sector that have caused widespread farm foreclosures – are already appearing. We remain in the early stages of a prolonged, deep international capitalist crisis from which the U.S. cannot escape.
The disruption of capitalist stability began with a minor event-currency devaluation in Thailand in July 1997. In the next two months currency and economic meltdowns swept through Malaysia, the Philippines and Indonesia. The standard wisdom is that these events “caused” the ensuing global crisis, in the same way that a flu virus spreads from one village to another. But these economies are much too small to have caused the ensuing world havoc. Southeast Asia proved to be the weakest link in the world economy. and so crisis appeared there first. But they were an expression of an underlying problem that affects the world economy as a whole-a classic crisis of overproduction.
Southeast Asia had for years been the poster child of free market capitalism. The “Asian miracle”-high growth rates fueled by export-led growth and massive investment and loans from foreign capital-was being touted as capitalism’s greatest success just weeks before the onset of crisis. Billions of dollars in investment poured into the region over the last two decades, in expectations of high profit rates. Everyone believed that the boom could keep going. So productive capacity increased, and the investments and loans kept coming in, masking for a time the growing gap between the amount of goods being churned out and each company’s ability to sell them on the world market. Government and private debt piled up.
The rapid rise of China tipped the scales. Chinese wages, even lower than those in other parts of Southeast Asia, heightened competition and pressured profit rates, while China’s industrial growth triggered overcapacity. On the surface, the financial boom ballooned, while down below, factories from China to Korea were operating at capacities of between 60 and 75 percent. The markets were unable to absorb the additional production at rates of profit which could justify the capital investment that created the new capacity. Falling exports and rapidly declining profit rates throughout Asia combined to undermine loan payments on the debt incurred for these investments. As this pressured banking systems and currencies, the crisis in production also became a crisis of the financial system, triggered by the collapse of Southeast Asian currencies. As international investors began withdrawing money just as fast as they had previously shoveled it in, demanding debt repayment in dollars, the financial panic spread-declining currencies made the debts far too expensive to pay back. The regional crisis became a global one in October, 1997 when it spread to major Asian economies, with the crash of the Hong Kong stock market (a surrogate for China) and the implosion of the Korean economy, whose chaebols, or conglomerates, with their low profits, were the weak link of global overproduction.
The International Monetary Fund (IMF) – a wholly owned subsidiary of U.S. capitalism – attempted to stabilize this first phase of the crisis through the infusion of a multi-billion dollar rescue package to Thailand, Indonesia and South Korea. The IMF plan was capitalism’s “old time religion.” In return for loans, the IMF demanded austerity measures – cuts in government spending, devaluation of the currency to boost exports and high interest rates to stem the tide of investment flight. The bailout aimed not to alleviate the effects of the crisis on the region’s people, but to protect the investments of U.S. and European capital. More ominously, U.S Secretary of the Treasury Robert Rubin vetoed an alternative $100 billion bailout proposal by Japan. The U.S. wanted a bailout, but not one that shifted the balance of forces in Asia against it.
The IMF argued that the crisis was caused by the peculiar character of Asian capitalism, which lacked the open, deregulated, transparent markets of the West where efficient corporations succeeded while less profitable firms were ruthlessly weeded out. The IMF contended that this was violated in Asia by corrupt, secretive, government regulation of the economy and the banks in order to protect powerful cronies from the rigors of competitive failure, which then resulted in overextended debt precipitating financial crisis.
The IMF claimed that its program would keep the Asian “flu” from spreading. Southeast Asia’s problems would be solved by increased foreign investments in newly deregulated markets, and the world would absorb Asia’s increased exports. American banks and corporations gloated over the fire sale buying opportunity the Asian crisis afforded them.
By April and May of 1998 it became clear that every aspect of the U.S.-IMF bailout package had failed. Currency devaluation aggravated the crushing debt burden, which was denominated in increasingly expensive dollars. Export-led growth was utopian in a global crisis of overproduction. Exports, despite devaluation, continued to fall. Foreign capital, rather than coming back in with new investments, continued to flee the area. The result was severe in some countries, catastrophic in others. South Korea, Thailand and Malaysia’s economies have all contracted by more than 5 percent over the last year.
The Indonesian economy was hit hardest. Economists are projecting that Indonesia’s economy contracted by 15–20 percent in 1998. The Suharto regime was overthrown attempting to fulfill IMF loan conditions to cut working-class living standards. Unable to buy food, tens of millions of people were thrown into hunger. Cutting consumption in a crisis of overproduction corroded the economic and political position of local ruling classes unfortunate enough to become wards of the IMF brand of crackpot capitalism. They now had to face the risk of revived class struggle or, in Indonesia, of revolution.
Around this time it became apparent that the Japanese economy, the second largest in the world, and 65 percent of the Asian economy, had moved from years of anemic growth and miserable profits – into a deep recession. The Japanese banking system was unable to provide adequate loan capital, creating a credit crunch throughout Asia. The value of the yen took a nosedive, making Southeast Asian exports less competitive against Japan. To prevent further currency chaos, Southeast Asian governments raised interest rates, another blow to production.
The failure of the IMF’s containment strategy spooked world stock markets. An international run began on the currencies and debt of emerging countries in Latin America, Eastern Europe and Africa. Many of these countries are commodity producers whose national revenues had sunk as world recession cut demand and commodity prices collapsed. The immediate, weak link became Russia, most of whose exports are commodities – oil, natural gas and minerals.
To stabilize this second round of market chaos a new IMF plan centered on a loan of $21 billion for Russia arranged in June and July of 1998. The IMF also came up with additional money for Indonesia and scrapped the austerity conditions that had triggered the mass upheaval against Suharto. The Japanese government promised to rescue its banking system, but political paralysis delayed action. These measures temporarily calmed currency and capital markets. But the Asian “flu” had spread, so that now a quarter of the world was suffering from economic recession. The calm, therefore, could not last.
The IMF insisted that Russia had basically sound economic fundamentals, and that its problems arose from the transition to a market economy. The IMF encouraged Western financial institutions to make loans and float bonds for the gangsters that ran the Russian banks. The latter, understanding Russian fundamentals far more realistically than the IMF and its Clinton administration handlers, promptly shifted their assets out of Russia. The IMF loans were the vehicle to finance the capital flight that led to the Russian meltdown. It was a repeat of what Indonesia’s largest capitalists, Suharto and his cronies, had pioneered a few months earlier.
The second stabilization plan collapsed more quickly and catastrophically than the first. In August, within a month of the IMF bailout, the Russian ruble disintegrated, there was a run on Russian banks, and the Russian government repudiated payments on the national debt. This debt default, the first by any country since the 1930s, set off the greatest market panic since the Second World War. Western banks were estimated to have lost $200 billion, or 14 percent of their capital. Some financial institutions hemorrhaged, while others went bankrupt – the most notorious of which was an obscure hedge fund called Long-Term Capital Management (LTCM).
Stocks markets globally crashed. A world credit crunch drained capital markets as banks demanded higher collateral, higher interest rates, refused to make new loans and called in old ones. The markets for initial public offerings for new companies, high yield bonds, for real-estate development and for the debt of Latin American corporations and countries, among others, all but shut down. Money disappeared from all risky markets and flowed into the safety of U.S. or European treasury securities, a situation described as a liquidity crisis.
As capital fled Latin America, Brazil, Mexico, Chile and Argentina raised interest rates to between 20 and 50 percent, ensuring a devastating regional recession. Even more shocking was the collapse of the safe haven, the American dollar, against the Japanese yen, by almost 20 percent on October 7–8.
The fear that then swept through world financial markets was best expressed by George Soros. the international currency speculator, who testified to Congress that “the global capitalist system ... is coming apart at the seams.” Yet once again the worst was overcome, and markets were to soar to new heights by the end of 1998.
The third attempt at stabilization, for a more serious crisis and one which directly threatened the U.S. economy, required a more far-reaching and expensive approach. Crisis management shifted from the IMF to the U.S. Federal Reserve and Treasury. A two-pronged strategy was adopted. The first prong was to stop immediate financial panic by saving LTCM, preventing a Brazilian crackup and pressuring the Japanese government to act on its banking disaster. The second prong was to lower interest rates to take pressure off capital markets and to reflate the American economy as a way to ease the slide into recession.
The Bailout of Long-Term Capital. The misnamed Long-Term Capital Management (LTCM) is a hedge fund, a speculative investment pool that required a $10 million minimum per investor. The fund used its $5 billion of investor capital to borrow between $100-200 billion, often at concessionary interest rates, from banks whose officers were LTCM investors. These loans bought bond and stock positions, which were used as collateral for a $1.2 trillion portfolio of derivative trades (futures, swaps, mortgage securities, etc). LTCM’s trading profits on its leveraged borrowing were pathetic, but calculated on its investor base of $5 billion, the return was lush, with participants making profits of over 40 percent a year. This free-market extravaganza of leveraged profits, with virtually no government control, was presented as the American model of deregulated capital market efficiency.
LTCM proved to have less market sense then an average Russian gangster. It bought the Russian bonds the latter were dumping, and sold U.S. treasury bonds against them on the “sophisticated” theory that all interest rates tend to converge. It was a strategy that informed the trading of most other hedge funds and Western banks. When LTCM went belly up in the Russian debacle, the Federal Reserve Bank arranged for a consortium of stronger American and European banks and stock houses to rescue LTCM and its creditors-at a cost of $3.5 billion.
The justification for the rescue was that the bankruptcy of LTCM, with the forced liquidation of its portfolio, would cause such turmoil in international markets that it would lead to more bankruptcies and threaten the entire U.S. and international banking system. This assessment may have been too severe, but it indicated the seriousness of the Fed’s appraisal of the crisis and fragility of capital markets, in contrast to propaganda releases about unending expansion.
The self-righteous explanation that the crisis was caused by overextended Asian borrowers gave way to the recognition that this is a crisis of overextended Western lenders. Another casualty was the arrogant American free-market mantra-meant for other countries suffering from crisis-that inefficient and unprofitable firms must be allowed to go under in order to restore economic health. For years the Americans have charged that the key to Japan’s problems was the convoy system in which stronger banks were forced to rescue insolvent ones. The rescue of LTCM showed that the Feds employ the same method when the losing speculation of super-rich American crooks, cronies and so-called financial wizards threaten the U.S. banking system.
After a few large banks (Union Bank of Switzerland and the Bank of America) fired their CEO’s for losing hundred of millions of dollars in investments and unsecured loans to LTCM, the veil of secrecy that shrouds the inner workings of Western banking was restored. The truth is that LTCM was not a rogue outfit. Its practices are fairly standard operating procedure for hedge funds, and also for the proprietary trading desks of the large American and European banks and brokerage houses, which derive a major part of their profit from unregulated derivative speculation.
The truth is, many have portfolios with greater potential for economic chaos than LTCM, which is a relatively minor player compared to the international banks. The LTCM bailout eliminated the threat of immediate financial system collapse. But none of the problems that caused a previously unknown, minor financial fund to threaten the whole system have been solved. The uncontrolled derivatives time bomb continues to tick away until the next bankruptcy rocks a strained financial system.
From Asia to Latin America – The Turn of Brazil. As the Asian crisis unfolded and panic spread to Russia, Brazil was waiting in the wings. The Brazilian economy is the eighth largest in the world and dominates the Latin-American market. Its currency, the real is highly overvalued, sucking in cheaper foreign imports, producing an unsustainable large balance of trade deficit. When Russia unraveled, capital fled Brazil, expecting its currency to collapse. In August, foreign currency reserves, needed to conduct international business, fell from $70 billion to $40 billion, making it difficult to defend the currency. The fear was that the collapse of the Brazilian real would bring other Latin currencies down with it and touch off a new round of Asian devaluations, plunging another part of the world into a deep recession.
To stabilize the situation, the IMF loaned Brazil $41.5 billion in November, but with many of the same austerity conditions that were an unmitigated disaster for Asia. The Brazilian government, with an economy already sliding into recession, was instructed to further restrict consumption by $84 billion in the next three years by cutting government spending, mainly on social services, and by raising taxes.
The results of the bailout to date are not positive-either in terms of the Brazilian economy, or in terms of social conditions the austerity is creating. In an attempt to stem the fall in value of the real and the panic flight of capital, the government has raised interest rates to a crushing 30 percent and higher. The bulk of the huge government deficit, which is 8 percent of Gross Domestic Product (GDP), goes for high interest rates on its $300 billion of debt. Interest rates for private corporations are higher, and for consumer loans the lowest bank rate is 6 percent a month. The lowest credit card rate is 10 percent a month. These rates fatten the profits of the banks and credit card companies, but strangle the Brazilian economy. Capital spending has fallen to half the rate it was in the 1980s. Auto production has dropped 40 percent in the last few months, and industrial production has fallen 9 percent on the year. São Paulo’s unemployment has skyrocketed to 17 percent.
Nor are the IMF loan provisions, with all the hardships they impose, even a guarantee that the real can hold its current exchange rate. In December, after IMF aid, $5 billion in currency reserves fled the country, and the chances of a devaluation grow greater with each passing month. Continued capital flight limits interest rate cuts, insuring a worse recession.
The impact of Brazil’s crisis will be large. Its GDP is greater than the combined GDP of the four Southeast Asian countries that initiated the global disaster. With roughly 45 percent of Latin-American GDP, Brazil’s crisis will severely drag down growth in the whole region. Already in Columbia industrial production has dropped by 7.6 percent; in Venezuela, GDP fell 4.8 percent; and Chile is beginning to slide downward. Interest rates from Argentina to Mexico have jumped, with consumer loan rates jumping from 20 percent to 50 percent.
A recession in Latin America will have a greater impact on the U.S. economy than the Asian crisis did. The U.S. exports more to Latin America than it does to Asia, and U.S. corporations and banks invest and loan more heavily there. The IMF money may temporarily steady the Brazilian situation, but at the cost of deeper recession throughout the region.
Japan’s $500 Billion Stimulus Package. The Japanese “bubble economy” burst in the early 1990s, wiping out $10 trillion of inflated stock and real-estate values. The banks were left holding hundreds of billions of bad loans, later increased by large loan losses from the Asian crisis, now estimated to be $1 trillion. Japan is the major creditor nation in the world with an asset balance of over $1 trillion in loans and investments to foreign corporations and governments, including $300 billion in U.S. treasuries. The failure of important Japanese banks would threaten the entire international banking system. Japan’s weak banks have been unable to extend adequate business credit, which has deepened the crisis in Japan and Asia. The Japanese government has been too paralyzed to solve the problem. It was politically risky to use tax revenue to cover bank losses at at a time when the public has lost much of its savings in a stock market and housing market that have lost 50 percent of their value.
Overwhelming pressure was placed on Japan to bailout its banks, no matter what the financial or political cost. In October, the government pushed through a $500 billion bank restructuring which nationalizes the weakest banks and recapitalizes the stronger banks. The cost is triple the American S&L scandal, financed by taxes and government deficit spending. The government budget deficit is $500 billion, or 9.8 percent of GDP. To raise the money, the government issued bonds that are effectively crowding private loans out of the credit markets. The socialization of banks’ losses, therefore, comes through a drain of the productive economy. The game plan is for the banks to be restored to health as a first step, with the economy to follow, in some years. Since Japan is the engine for the Asian economies, this will prolong the crisis throughout the region.
The U.S. Fed’s Monetary Stimulus. To prevent a recession, the second prong of U.S. strategy was implemented-to lower interest rates and rapidly pour money into the financial markets. It was essentially the same policy that Greenspan employed successfully to protect the real economy from the effects of the stock market crash of 1987. In September, the Fed cut interest rates by a quarter point to relieve gridlocked capital markets. When this proved to be insufficient, two additional rate cuts followed in October. After some initial resistance, Germany and Europe also agreed to interest rate cuts, giving Asian and Latin countries room to trim their rates. Thirty-three Central Banks followed the Fed, and cut interest rates a total of 66 times from October to December 1998. This lowered the cost of loans for capital, eased mortgage and consumer debt, provided cash for consumer spending and restored liquidity to markets.
The Fed’s monetary stimulus was an even stronger boost to prop up spending and the economy. From 1992 to 1997, the money supply grew at an annual rate of 4.7 percent, in line with nominal growth of GDP (real growth plus inflation). This summer the Fed began to raise the rate of money expansion to double or triple GDP. In the second half of 1998, broad money supply, or M-2, increased by $278 billion, a 13.3 percent annual rate. In the last three months, this accelerated to a 15.4 percent annual rate of growth. The broadest measure of money supply, M3, grew by $420 billion, or a rate of 15 percent, in the second half of 1998.
This flood of dollars into the economy was designed to immediately stimulate demand and growth, the theory being that more money will mean more spending. If those were its only results, every government threatened with recession would print money without limit. This stop-gap gamble is unsustainable as policy, because of its unforeseen, uncontrollable consequences. Among other things, it opens up the dangers of a severe decline in the value of the dollar and a growth of inflation. In addition, it can lead to an even larger trade deficit, and an inflation of assets. This may eventually create the need to rein this in eventually with higher interest rates. It is a form of economic adrenaline whose repeated use would threaten economic collapse. Financial markets assume that when immediate danger passes, the policy will be replaced by its opposite-a prolonged period of subnormal money growth, with subnormal economic stimulus and growth.
This combination of pouring $420 billion of new money into the U.S. economy, $180 billion in IMF loans, and the collapse of oil prices (which is equivalent to a $300 billion tax cut to non-oil producing economies) is a stimulative package greater than any Keynesian deficit financing this side of the Second World War. Its immediate impact is to check the downward spiral, mainly by stimulating stronger consumer spending. The aim is to prevent a crash, a “hard landing,” and to ease the economy slowly into recession to achieve what economists call a “soft landing.” The Fed has tried soft-landing strategies in the past, but has never been able to achieve one.
Federal intervention may have temporarily stabilized the markets in the U.S., but does that mean that the U.S. economy has now resumed its “Goldilocks” expansion? Put another way, as 1998, the year of the Asia crisis, gives way to 1999, the year of the Latin-American crisis, will the U.S. economy avoid recession as an isolated island of growth?
There are a number of reasons to answer this question with a “no.” This first is that the world crisis has already had an impact on the U.S. economy – in the form of a crisis in commodities and farm production, the beginning of a decline in manufacturing and a decline in profits. The second reason, related to the first, is that the yawning gap between the value of stock market trading and the condition of the real economy – the production of goods and services – means that the stock market “bubble,” similar to Japan’s real-estate bubble in the early 1990s, will inevitably either burst or slowly deflate.
Commodity and Farm Recession. World demand for raw materials has collapsed because of industrial overproduction. The result has been a global, deflationary commodity recession. The U.S. alone among advanced industrial countries is an important commodity producer of oil, metals, lumber, grains, meats, etc. While stock markets are reaching record highs, commodity markets are close to record lows. The index of commodity prices has fallen to its lowest level since 1977. Commodity prices are continuing to fall, despite monetary stimulus as world demand continues to weaken more than is generally perceived. Copper for one, has fallen from a high a year ago of $1.27 to 67 cents a pound, adjusted for inflation – its lowest price since 1935.
Oil prices, which in 1977 averaged $20 a barrel, have plummeted to $11-12 a barrel today. At $20 a barrel, the industry generated $2 billion a day in revenue, which is now down to $1 billion a day, a year’s loss of $365 billion. Cheaper oil prices may help stimulate growth in some parts of the world economy, but at a severe cost and at the expense of oil producing countries and companies. The collapse of oil prices has thrown Venezuela, Saudi Arabia and Russia, among others, into recession.
The fall in oil prices is also a disaster for the American companies who dominate the world oil markets. The profits of oil companies declined 40–50 percent in 1998. Earnings of small oil exploration companies fell 88 percent. These enormous hits to profits are behind the mega-mergers of Exxon and Mobil, and of British Petroleum and Amoco. The mergers are a survival strategy to overcome poor profits through layoffs and cuts in capital spending, not a sign of economic health.
The U.S. farm economy is already in deep recession. The loss of export markets in Asia and Russia, as food consumption has declined there, has cut farm exports and prices. Corn prices are down 60 percent from 1996, soybeans by 35 percent and wheat by 50 percent. Farm income has declined by 16 percent this year, a figure similar to Asia’s income drop. The value of land is declining drastically, affecting farmers’ ability to get loans for spring planting. A study by Iowa State University indicates that one third of Iowa farms won’t survive another two years of these conditions.
The farm recession has had a devastating impact on farm equipment manufacturers. To take one example, Case sales dropped 10 percent in 1998, and another 10 percent drop is expected this year. Its profits fell by 60 percent in 1998. Case has announced plans to layoff a total of 3,400 workers – 19 percent of its labor force.
The Manufacturing Recession. The global crisis has started to impact manufacturing. While the boom in services continues, the production of goods-which accounts for 50 percent of the U.S. economy-has been stagnant for half a year. Manufacturing is being hammered by the world glut in steel, auto, electronics, semiconductors and petrochemicals. Manufacturing exports are falling, and imports are rising. Exports of U.S. goods and services in the 1990s accounted for one-third of growth. In 1997 exports rose 13 percent, while in first quarter of 1998 real exports fell by 2.8 percent, by 7.7 percent in the second quarter and by 2.8 in the third quarter.
The U.S. trade deficit expanded to a record $150 billion in the first nine months of 1998, and may hit $300 billion in 1999, as markets for American goods dry up, and as cheaper imports take a greater share of the U.S. domestic market. Steel imports that until a year ago took 20 percent of the American market are now taking 35 percent. As a result, the capacity utilization of the industry has gone from 90 percent to 75 percent in the last year, with profits falling and layoffs mounting.
Deflationary pricing pressures are now spreading from raw materials to manufactured goods. Petrochemical prices fell 10 percent, polyethylene plastics by 25 percent. The world automobile industry produced 60 million cars last year, with capacity to build 80 million cars. The price of an Acura in 1998 was $42,000; in 1999 it will be $35,000, and the prices and profits of other car makers will be under pressure.
The dynamic of capital in a boom is to accumulate, to expand production. Spending for plant and equipment in the last few years grew three times as fast as the economy. The result was that manufacturing capacity – which grew 2 percent annually in the 1980s and early 1990s – expanded at 3.5 percent in 1995, 4 percent in 1996, and 5 percent in 1997 and the first half of 1998. With capacity growing and industrial production slowing, capacity utilization in manufacturing, the operating rate for plant and equipment, now stands at 79 percent, its lowest rate since the end of the last recession.
Falling profits and the decline in productive investment. The most celebrated achievement of the “miracle economy” was the rise in profits, which averaged a 15 percent a year gain through 1997. Although this decline may be temporarily reversed by monetary stimulus, profits were already falling when growth was strong, and as the economy slows down they will fall more sharply. The profit picture is mixed, with strong, growing profits in still-booming high-tech, services and consumer goods, and weak, declining profits in raw materials, farm goods, and manufacturing. The peak of this business cycle’s manufacturing profits was $228.9 billion in the third quarter of 1997. Profits for manufacturing corporations have fallen every quarter since. In the third quarter of 1998, they totaled $196 billion, down $33 billion or 13.5 percent for the year.
To protect profits, capital spending is being sliced and workers laid off. New orders for capital goods rose 7 percent in the 1980s and early 1990s, was up 12 percent in 1997 and another 17 percent in the first half of 1998. By the third quarter of 1998, they were negative.
The capital goods sector – the sector that produces means of production – will be the next to go into recession. Over two thirds of large corporations have announced plans to trim capital spending in 1999, an expected cut of 35 percent of capital spending. Spending on construction of new plant and equipment fell 32 percent in August and 9 percent in September. Exports, manufacturing and capital spending were the main pillars of the 1990s expansion in the U.S. economy. All have fallen victim of the global crisis and are all winding down.
Manufacturers have cut jobs every month for the last eight months. So far a rather modest total of 250,000 jobs, out of a 25.3 million workforce, have disappeared in the goods-producing sector. The biggest layoffs have been in steel, farm equipment, oil and semi-conductors. But the announcements of planned layoffs for 1999 have been mounting. The biggest is Boeing’s plan to sack 48,000 workers. The number of layoffs, which in 1998 totaled 677,000, surpassed the record 615,000 layoffs in 1993, which occurred at the end of the corporate restructuring of the last slump. These layoffs occurred despite the strength of a growing economy; as it slows down in 1999, they will accelerate.
The Stock Market Bubble. The Fed’s monetary stimulus is accelerating the powerful stock-market bubble. The lackluster performance of the productive economy means available cash will be spent on stock-market speculation rather than in new investments in plant and equipment. Typically every boom-bust cycle ends in an orgy of speculation. In the late stages of a business cycle, capital augmented by accumulation during the boom, but confronted by declining profit rates, moves to where it can find the profits that productive investments previously afforded, but that now only come through speculation.
A speculative stock-market bubble has been growing for some time. At the start of 1999, the U.S. stock markets were capitalized at $13 trillion, or 150 percent of GDP. Until three years ago, stock valuation never exceeded 80 percent of GDP, except for 1929, when it reached an historic high of 81 percent. On the eve of the 1929 crash, stocks traded at 20 times companies’ real earnings. Today, they trade at 27 times earnings. In 1990, the NASDAQ market capitalization was $265 billion with corporate earnings of $14 billion. By early 1998, profits rose to $29.8 billion, while NASDAQ valuation was $2 trillion. In other words, while profits doubled, the value of stocks went up seven-fold. That was prior to the Internet craze, where stocks of Yahoo, Amazon and AOL have in the last year risen 4 to 10 times. This is a speculative mania completely divorced from rational valuations or investing. Yahoo, the week this was written, had a market capitalization of $41 billion-greater than Boeing, Monsanto or Colgate-Palmolive.
The market bubble, though disconnected from reality, impacts the real economy. As stocks rise, so has the paper wealth of the upper classes. The rich have a greater percentage of their assets in stocks than at any time since 1929. The consumer boom is also propelled by the spending of a part of these stock market gains. Stock wealth has replaced savings. Savings that in the 1990s averaged a low 5 percent of incomes, have dropped to zero. In September, for the first time since 1933, the savings rate went negative. Meanwhile, credit card debt has hit record levels and housing debt as a percent of housing value rose to the highest on record. When the bubble bursts, and the well-off are forced to restore their savings and credit balances, consumption will drop more drastically than in a normal slump, producing a deeper recession.
The stock market, like debt spending, can act as a spur to economic growth, as capitalists and states are allowed to play with a pool of capital much larger than any could individually generate. But that same overextension also makes the crisis deeper and more dangerous when the market becomes too overvalued. The money on the stock market is in the end merely the shifting around of the existing surplus value created by workers in the real economy; a shifting around that creates market winners and losers, but does not itself add one iota to the pool of surplus value created. As Alex Callinicos writes:
Speculators profits may derive from changes in the prices of financial assets, but these prices in turn depend on expectations about the profits generated in production. When the stock market develops ahead of productive capital for too long, a crash is inevitable.
The Fed is now confronted with the same poor choices the Japanese Central Bank faced in the beginning of the 1990s, when a continued cheap-money policy ignited a runaway stock market to an inevitable crash. Yet if the money supply stops growing so fast, or if the Fed is forced to raise interest rates, it threatens to burst the bubble, as occurred in Japan, and risk a prolonged period of stagnation or recession.
The world is faced with a severe economic crisis. In parts of Asia this deepening crisis has taken on depression-like characteristics. Consumer income has been slashed by $550 billion. Industrial production is down 8–12 percent in Japan, Russia and Korea. Exports fell by over 10 percent in Taiwan, Thailand, Korea and China in October. In Malaysia and Thailand, GDP has fallen 8 to 10 percent, in Indonesia by 18 percent. Unemployment in Indonesia is 22 percent with the number living in poverty climbing from 20 million two years ago to 130 million today.
Between 35 and 40 percent of the world is now in recession. To Southeast Asia, Korea and Japan must be added Russia, the Czech Republic, South Africa, Saudi Arabia and Brazil – and the rest of Latin America is about to join them.
The hope is that the U.S. and Western Europe, which together account for half of the world’s output, will continue to expand. But these remaining healthy areas of the global economy are – despite massive stimulus – being overcome by global overproduction, overcapacity and falling profit rates. The four large economies of Europe – Germany, France, Britain and Italy – are all experiencing a slowdown in manufacturing and stagnant, if not rising. unemployment. In Germany, the largest economy in Europe, unemployment is 9.5 percent; in France it is over 12 percent. The optimists among economists expect growth in these countries to slow to between 0 and 2 percent in the next six months.
The third stage of crisis last fall dispelled the illusion that America was exceptional, isolated from the dynamics of the global economy. The apparent contradiction between the Asian bust and the American boom has been replaced by an internal contradiction between sectors, some still booming (high tech, consumers goods, services, construction) with other sectors stagnant or sapped by world overproduction (commodities, farm products. exports and manufacturing).
The logic of capital in a situation of widening recession and weakening profits is to slash expenses, cut investments and cut costs through layoffs and speed-ups. It is a dynamic that spreads: Reducing capital spending triggers of workers in the capital goods sector. These laid-off workers hold back buying consumer goods and this in turn means weaker profits and more cuts as we spiral downward in the mad logic of the periodic market busts that have produced three previous recessions in the last 25 years.
But this specific global recession takes place in the context of the end of an investment boom, in which there is not just overproduction of goods that has to be worked off, but a glut of factories, office buildings, plant and equipment. It is a situation that is producing the longest, most severe recession since the Second World War.
The Fed has bought time with its monetary program, postponing but not resolving the crisis. The stimulus might put a deceptive glow on the economy and markets for months, but its significance is not greater than the ruddy cheeks of a heart attack victim. The argument now being sold be economic pundits – that the world economy can be held up by a “shop-until-you-drop” American consumer, whose continued buying is predicated on unsustainable monetary growth, an ever-rising stock market and ever-greater debt – is the last illusion of a system without fundamental answers to the widening global crisis.
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Last updated: 26 August 2021