The International Monetary Fund meeting to be held in Washington over the weekend takes place amid what is arguably developing into the most serious crisis of the global capitalist economy in the post-war era. It is not just that growth rates have been revised down, following claims of a recovery earlier this year. There is also a growing sense that a series of financial and economic problems are coming together.
The growth figures in themselves are bad enough. According to the IMF’s World Economic Report, world growth for 2002 is projected at just 2.8 percent, barely above the 2.5 percent level considered by many economists to be bordering on recession. Moreover, the growth estimate for 2003 has been marked down to 3.7 percent, compared to the 4 percent that was predicted last April.
Summing up the report, the Reuters correspondent said it had painted “a picture of a global economy stacked precariously like a house of cards, waiting for a hit from just one more morsel of economic misery to bring on a global recession”.
Even more significant than the overall outlook are the growth predictions for the major capitalist economies. US growth is predicted to be 2.2 percent for 2002 and 2.6 percent next year, compared to the prediction five months ago of 3.4 percent.
For the euro zone the growth rate prediction for this year is just 0.9 percent and 2.3 percent next year, with no marked increase likely in the near future. According to IMF economic director Kenneth Rogoff: “The main short-term concern in Europe is that domestic demand is extremely weak and insufficient to fuel the recovery.”
The Japanese economy is in an even worse state. Growth for this year is projected to be minus 0.5 percent, rising to 1.1 percent next year. Having passed through a decade of stagnation, there is no guarantee, according to Rogoff, against a similar bad decade in the absence of a determined effort to “address the nation’s core economic problems, the need for profound bank and corporate restructuring, together with decisive steps to finally end a period of deflation unprecedented among industrialised countries since World War II.”
But Rogoff’s remarks could well be seen simply as a case of “rounding up the usual suspects” for no one, either in the IMF or the Japanese government, has a viable plan for resolving the country’s worsening economic problems.
Indeed, if the events of the past two weeks are anything to go by the situation is becoming more desperate. Ten days ago the Bank of Japan (BoJ) announced that it intended to buy shares from major banks in order to try to sustain their asset base. This proposal—unprecedented in the history of central banking—was widely criticised as dangerous. Now it appears that it may have been a ploy to pressure the Japanese government to intervene itself—a desperate attempt by the BoJ for someone to take seriously its warnings of the need for decisive restructuring of the banking and financial system.
From the standpoint of the stability of the world economy as a whole, it is hard to know which of the two alternatives is the more serious—the BoJ share bailout plan, or the fact that it feels the need to resort to “shock therapy” proposals to force the government’s hand.
The problems confronting the world economy go beyond the low levels of growth and Japanese deflation—serious as they are in themselves.
The Japanese financial disaster was regarded as the exception. But it may turn out to be the rule, for there is a growing fear that the continued slide in world stock markets and the heavy involvement of banks and other financial institutions with companies that have incurred heavy losses—especially in the telecommunications and high-tech industries—could lead to a major financial crisis.
In an editorial published on September 26, entitled “The bear starts to show its teeth”, the Financial Times pointed out that two significant rallies in the stock market—the first in the immediate aftermath of September 11 last year and the second in the late (northern) summer—have proved to be “false dawns”.
The editorial pointed out that the longer the bear market continued the more serious became its consequences for the workings of the economy and the financial system. One of the greatest problems concerned life insurance companies that gave guarantees to investors based on what were believed to be conservative assumptions about equity returns but which may not be met if markets keep falling. “It will be a disaster for everyone,” the editorial concluded, “if the insurance sector produces its own Barings or Long-Term Capital Management.”
Across the Atlantic, the Wall Street Journal has also been warning of the flow-on effects for US banks from the losses incurred in European telecom companies. Following an announcement by J.P. Morgan Chase that it would need $1.4 billion to cover “soured loans”, an article in the WSJ noted that because of the practice of syndication, in which banks sell their loans to other banks and big investors in order to spread the risk, the problems could extend across the financial sector.
“[W]hile syndication has helped shield individual banks from trouble, it also means when problems arise, they quickly cascade across the balance sheets of other banks. What frustrates investors now is that no one knows for sure all of the loans that tripped up J.P. Morgan—and which other banks could be left holding the bag.”
The worsening situation is starting to create policy dilemmas for those in charge of regulating the economy.
This week the US Federal Reserve decided to leave the federal funds rate stationary even while it pointed to “considerable uncertainty” as to the extent and timing of the “expected pickup in production and employment” and while warning that risks were “weighted mainly towards conditions that may generate weakness”.
In something of a departure from the norm, the decision was not unanimous, with two members of the Federal Open Market Committee calling for an interest rate cut.
While the deliberations have not been made public, one can surmise that one consideration was that with a base rate of only 1.75 percent, a further cut would not leave much in reserve in the event that a major cut is needed if even more serious problems emerge.
No doubt the IMF meeting will try to put the best face on a worsening situation and issue a reassuring communiqué, even as the problems are discussed behind closed doors. But no policy decisions will be put on the table to halt the gathering crisis.
As the Financial Times commentator Gerard Baker pointed out, labelling the IMF meeting as a “gathering of incompetents,” it was a “delusion” to believe that “the people gathering in Washington have the inclination, let alone the ability, to control global economic activity”.
An editorial published in the Guardian warned that “the world economy is looking increasingly vulnerable to something really nasty happening”. America could move back into recession at any time, Japan was still locked into an asset price deflation “that is showing no signs of ending and which the government has no policy to deal with” while the Europe Union was “in no mood to help out by unilaterally stimulating growth”.
In the face of this situation, the only policy it could come up with
was a European interest rate cut. But the deepening problems of the world
economy—to which the editorial itself pointed—have gone well beyond anything
that could be resolved by so-called fine tuning.
As stock markets continue to fall and financial problems start to spread, a discussion has broken out in sections of the financial press over whether the global economy is entering an era of deflation of a kind not seen since the Great Depression.
An article in the Economist of October 10, for example, headlined “Of debt, deflation and denial” warned that the risk of falling prices was greater than at any time since the 1930s. Deflation could be a serious threat in America, Europe as well as Japan. This could prove “particularly awkward” given the increase in borrowing, especially in the United States. This is because while in an inflationary environment the borrower tends to benefit as loans are repaid in a devalued currency, under deflationary conditions debt burdens increase.
If prices continue to fall for any length of time this leads to major problems when the value of assets drops below the loans taken out to purchase them. This is the situation now facing many banks and financial institutions in Japan and is one of the main reasons why, despite bank bailout efforts, the mass of bad loans within the financial system keeps on rising. Now it seems that these problems may be starting to spread to the rest of the world.
In another article published in the same edition, the Economist drew attention to a remark by American economist J. K. Galbraith that “inflation rescues firms from the errors of optimism and stupidity” noting that over the past three decades “indebted companies and individuals have often been bailed out by inflation, which has eroded the real burden of their debt.”
But while in both America and Europe private sector debt in the late 1990s rose more sharply in relation to gross domestic product than at any time in the past, with much of this borrowing assuming unrealistic growth in incomes, profits and share prices, “inflation can no longer rescue bosses and consumers from their folly.”
The Financial Times has also taken up the deflation debate. On October 9 it published a comment by Glenn Hubbard, chairman of the US president’s council of economic advisers, denying that the US was in danger of deflation. According to Hubbard the “basic features of the US economy look quite good” and data showing that increases in productivity which began in 1995 are continuing unabated. Consumers, he claimed, could look forward to real incomes that grow more quickly than they have in the past 30 years. All in all, Hubbard insisted, “the economic fundamentals are sound.”
This optimistic outlook was not shared by Morgan Stanley chief economist Stephen Roach who contributed a comment to the Financial Times four days later. He claimed that the view of most economists that, despite the build up of deflationary pressures there would not be an overall fall in prices, was mistaken as it was based on the assumption that services, unlike goods, would not experience deflation.
Roach noted that services inflation was running at an annual rate of 3 percent at the end of 2000, the last peak in the business cycle, but since then had fallen by 0.8 of a percentage point. This contrasted with the experience over six previous recessions when services inflation increased on average by 0.2 of a percentage point over the six quarters following the business cycle peak.
The figures for the goods sector showed even more clearly the deflationary pressures at work. Goods inflation which was running at an annual rate of 0.7 percent at the last business cycle peak slipped into outright deflation of 0.8 percent in the second quarter of this year. “This swing,” Roach noted, “is three times the average change that occurred over the same 18-month period in the previous six business cycles.” The deflationary pressures in the goods-producing sector of the economy have been more intense than in previous business cycles, but this time they have not been offset by price increases in the services sector.
An article by the Guardian’s economics correspondent Larry Elliott, published on Monday under the headline “Deflation is a bigger threat than Saddam”, reported that the financial firm Lehmann Brothers had encountered a “litany of worries” in its discussions with central banks, hedge funds and equity fund managers. These include: that the impact of last year’s interest rate cuts is fading, that the US and Europe are on course to emulate Japan’s “lost decade” and that shares on Wall Street still have another 40 percent to fall.
The significance of deflation lies not only in the fact that it indicates downward pressure on profit rates, forcing firms to continually cut costs if they are selling in a market where prices are falling, but also that there is significant excess capacity throughout the economy. Back in 1999, the Economist estimated that the output gap—the difference between potential GDP and actual GDP—was at its highest level since the 1930s. There seems to be little improvement since then, and the situation may even have got worse with the US economy, operating at near capacity three years ago, now estimated to be running at 1 percent below its potential.
Deflationary pressures, falling profits, and declining share prices are also playing havoc in financial markets, with pressures building up on major banks and insurance companies as investments turn sour. The plight of the Japanese banks has been widely reported but now, according to an article in the October 13 edition of the Financial Times, it appears that a major financial crisis is building up in Germany.
“It has become fashionable to argue,” the article began, “that the world economy will survive corporate scandal and market upheaval without the kind of systemic banking crisis typical of previous bear markets. Look at Germany, though, and you have to wonder.
“German banking is in turmoil. As the Dax index of leading shares slides remorselessly, credit rating agencies are issuing stark warnings about lenders’ financial health. Bank shares have tumbled and credit spreads [the difference between the most secure and the most risky investments] have ballooned. Rumours of liquidity problems swirl through the markets. Despite hot denials from regulators and banks, twitchy investors are beginning to fear the worst: that, somewhere, a big bank failure is waiting to happen.”
The article pointed out that in terms of share values in dollar terms, German banks in the past year have performed worse than those of any country except Argentina and Brazil. European Central Bank chief economist Otmar Issing has claimed that while the German banking system was not “in crisis” the situation was “dramatic”. In London, bankers believe that the Bank of England is becoming concerned about the state of German banks and the risks their weakness poses to the whole financial system.
Serious strains are already starting to appear. According to the Economist, pessimism in international credit markets is unsettling equity markets and vice versa. Last week, it noted, five-year bonds issued by the Ford Motor Company were quoted at just 89 percent of their face value—reducing them to “junk” status, despite assurances from both major credit rating agencies, Moody’s and Standard and Poor’s, that they had no plans to downgrade the company’s debt rating.
It seems that Ford bonds were overwhelmed by general market trends. So far this year 50 companies have had their investment-graded bonds downgraded to “junk” status, only seven short of last year’s total and the level of defaults in the corporate bond market has reached $140 billion, already more than the total for 2001. The Economist noted that according to Moody’s “the creditworthiness of American companies has now deteriorated for 18 consecutive quarters, one short of a record.”
Taken together these processes severely undermine the reassurances by Hubbard and the Bush administration in general that all will be well in the US, and, by implication in the global economy, because productivity is still rising.
Hubbard asserts that incomes will rise because workers are more productive. But this is a false analysis because the driving force of the capitalist economy is not productivity, as such, but the rate of profit. And here is to be found one of the peculiarities of the present situation.
In the past rising productivity did tend to indicate rising profits. But since 1995, when, according to Hubbard and others, US productivity started to sharply increase, the opposite has been the case. National accounts data for the US show that overall profit rates began to fall from 1997 onwards. Individual companies, however, still continued to report profit increases above the growth rate in the economy. These results were only achieved by the kind of “creative accounting” and outright fraud and swindling for which Enron and WorldCom have become by-words.
That increased productivity has been accompanied by falling, rather than rising, profit rates, leading to overcapacity and deflation and the attendant problems these processes create in financial markets, is of considerable significance. It shows that the global economy is being wracked by the emergence of contradictions located in the very heart of the capitalist profit system.
The close of 2002 has seen the prospects for the long-term expansion of the global capitalist economy become increasingly problematic. Accounting for more than 70 percent of world production, the three main regions—the US, European Union and Japan—determine the future direction of the global economy. But it is here that the main problems reside.
The Japanese economy shows no sign of breaking out of the stagnation that has gripped it since the collapse of the share market bubble at the beginning of the 1990s. The eurozone is faring little better and is being dragged back by near-recession conditions in its largest economy, Germany, while the US economy is experiencing a series of fits and starts. After growing at an annual rate of 4 percent in the July-September quarter, the economy is expected to expand by only 1.4 percent for the last three months of the year.
Overall, the Organisation for Economic Co-operation and Development expects that the world economy will grow by only 2.2 percent next year after growth of 1.5 percent this year. A world growth rate of less than 2.5 percent is regarded by many economists as marking the onset of a recession.
A breakdown of the figures reveals some of the growing structural imbalances within the world economy. The OECD estimates that while the US accounts for 31 percent of world production, it will generate 52 percent of the increase in world demand for 2002. Total domestic demand is estimated to have grown 2.8 percent in the US, 0.7 percent in the EU and minus 1.4 percent in Japan.
In other words, with capital spending in Europe showing no signs of an increase after falling for the past seven quarters and Japanese consumption and investment spending continuing to stagnate, the limited growth in the world economy is becoming ever-more dependent on the expansion of the US economy.
But with little or no growth in the rest of the world, the only way the US economy can continue to expand, even at the lower growth rates of the past two years, is by a further increase in debt, both externally and internally.
Already US spending is 5 percent greater than its income—the difference being reflected in the balance of payments deficit. At present this deficit requires an inflow of $1.4 billion per day from the rest of the world to finance it, but this could rise to $2 billion if present trends continue. And if the payments deficit continues at its present rate of around 5 percent of gross domestic product (GDP), the net external liabilities of the US, at present over 20 percent of GDP, will climb to 50 percent within five years.
What this means is that in the absence of any prospects for economic expansion in Europe and Japan, growth in the world economy is dependent on processes in the US that are unsustainable in the long term.
Precisely how these processes unravel remains to be seen. But already the depressed state of the world economy as a whole and the lack of any sustained recovery in the US are prompting fears that Japan’s decade of stagnation may not be an exception but could turn out to be the rule.
After the November decision of the US Federal Reserve Board to cut interest rates by a further 0.5 percentage points, these concerns were reflected in the speech delivered by Fed chairman Alan Greenspan to the Economic Club in New York on December 19.
Greenspan began by pointing out that the central issue in most major economies in the post-war period was the emergence of and then battle against inflation while “concerns about deflation, one of the banes of an earlier century, seldom surfaced.” However this has now changed.
“The recent experience of Japan,” Greenspan continued, “has certainly refocused attention on the possibility that an unanticipated fall in the general price level would convert the otherwise relatively manageable level of nominal debt held by households and businesses into a corrosive rising level of real debt and real debt service costs.”
Greenspan pointed out that recent experience had “stimulated policymakers worldwide to refocus on deflation and its consequences, decades after dismissing it as a possibility so remote that it no longer warranted serious attention.”
While hastening to offer the reassurance that the US is “nowhere close to sliding into a pernicious deflation,” he did acknowledge that even though the US economy had largely escaped any deflation since World War II, “there are some well-founded reasons to presume that deflation is more of a threat to economic growth than is inflation.”
It is a measure of the turn in the economic situation that deflation, which only a relatively short time ago was regarded as a result of some of the peculiarities of the Japanese economy, should now be regarded as a threat to the US. That the once unthinkable has become a reality is a result of the events of the past two and a half years—the collapse of the share market bubble; the revelations of widespread false accounting, not to speak of outright looting; the contraction in investment and the emergence of over-capacity in all sections of the US and world economy; and the failure of record interest rate cuts to have any significant impact on economic growth—to name a few.
Greenspan did not hold out any great hope for an upturn in US economic prospects in the immediate future. While new orders for capital goods—a central component any sustained expansion—had stabilised, this did not signify the beginning of a vigorous recovery.
“In the end, capital investment will be most dependent on the outlook for profits and the resolution of the uncertainties surrounding the business outlook and the geopolitical situation. These considerations at present impose a rather formidable barrier to new investment. Profit margins have been running a little higher this year than last, aided importantly by strong growth in labour productivity. But lack of pricing power remains evident for most corporations. A more vigorous and broad-based pickup in capital spending will almost surely require further gains in corporate profits and cash flows.”
There is little evidence that either of these events will take place.
Moreover, the Federal Reserve Board is running out of room to manoeuvre.
Having already cut interest rates to just 1.25 percent, it could soon be
facing some of the same problems that have confronted the Bank of Japan where
close-to-zero interest rates have left it with few policy options to combat