The pain after the gain

The world’s stock markets took a big hit in the first quarter of 2001. The US markets were down at least 10%, as was the UK’s FTSE index. The world index of all stock markets measured in dollars was down 14%. The technology sectors were hit even more. The US hi-tech index, the NASDAQ, fell 26% in the first three months of this year and the UK’s Techmark index did nearly as badly. Michael Roberts looks at the relationship between the stock exchange and the business cycle and the likely effects of this collapse on the real economy.

The collapse of the stock exchange and the effects on the real economy

The world’s stock markets took a big hit in the first quarter of 2001. The US markets were down at least 10%, as was the UK’s FTSE index. The world index of all stock markets measured in dollars was down 14%. The technology sectors were hit even more. The US hi-tech index, the NASDAQ, fell 26% in the first three months of this year and the UK’s Techmark index did nearly as badly.

Each day it is announced that investors in yet another hi-tech company have lost more than 90% of the stock price value of their cash investment. For example, one high profile internet company, the online travel booking agency,, fell 22% in the last two days to join the ‘90% club’. Even more serious is that many of these companies, like Lastminute, are now worth less in the stock market than the cash they have in the bank. That means the stock market reckons they have no chance of ever making any money!

The question is: does this matter? After all, a fall in the stock market does not always herald a collapse in economic growth, investment and employment. It didn’t in 1987, when there was a much bigger and quicker fall. It may be that this is just a “correction” from the ridiculously high levels that particularly hi-tech company stocks reached just one year ago.

At that point, the US economy was motoring along at 4%-plus real growth rate and the value of the US stock market reached 181% of US annual GDP. Compare that with the start of this hugely long ‘bull market’ which started in 1982. Then US company stocks were worth only 45% of annual GDP. They gradually rose to 70% of GDP by 1995. But the rise in the last five years of the millennium was the greatest in the history of capitalism, a near tripling of stock value in relation to real production.

That must mean a stock market bubble. The values placed on US companies were way out of line and the money invested in them would not be repaid. It must be fictititous. And so it has proved. Around $4trn dollars of value in the stock market has been erased in the last year.

The bubble had to burst

Apparently, it was not obvious at the time, even to capitalism’s No.1 hero, the US Federal Reserve Bank Chairman, Alan Greenspan, that this was a bubble that had to burst. The good chairman, who was recently the subject of a best-selling adulatory biography written by the journalist who originally exposed the Nixon Watergate scandal, told the US Congress last year (before the crash started): “as I have argued previously, it is very difficult to make a judgment on whether we have a bubble except after the fact”! That Mr Greenspan could not recognise a bubble until it burst in his face perhaps explains why he delayed cutting interest rates in the US until the tech market had collapsed and economic growth in the US fell to 1%, as it did in the last quarter of 2000. Before Xmas, he told the world everything was fine. Within weeks, he made an emergency cut of ½% and followed that with more cuts adding up to 1% in interest rates. But it has done nothing to stop the stock market falling further.

Now, Mr Greenspan is not supposed to cut interest rates just because the prices of the stocks of the companies in the so-called ‘New Economy’ start to dive. His job, using the interest rate set by the Federal Reserve (the basis of all other borrowing rates), is to keep prices down, but without destroying economic growth.

But Mr Greenspan, along with most of the capitalist economic gurus of today, has been fooled. Like the investors in hi-tech companies, he seems to think that ‘this time it is different’. This time, the US and the rest of the modern capitalist economies are not going into a slump after a breakneck boom, because of the structural changes created by the new hi-tech, internet revolution.

Capitalism will keep going as long as the profitability of investment stays up with the expectations of investors. But Marx showed that each individual capitalist is in a perpetual struggle to sustain profitability by increasing investment in technology that lowers the cost of production. If a company does not invest, then competitors will and so steal their markets by undercutting in price or by making more profits to invest even more. So investment is stepped up across the board. At some point, however, profits to match increased investment will not be realized and profitability (the rate of profit) will start to fall. This can be avoided for some time. The main way is by increasing the productivity of the labour force so much that the rate of surplus value extracted from the labour force rises even faster than the increase in the cost of investment in new technology.

Mr Greenspan and many of capitalism’s economic gurus are convinced that this time, in the new economy, productivity growth is so fast that it will sustain US growth for the foreseeable future. And it would appear that productivity growth has shifted up in the US. Between 1889-1917, US productivity grew at 1.7% annual rate. Between 1917-27, just before the Great Depression of 1929-33, productivity grew a tremendous 3.7% a year. From 1927-48, it rose around 1.8% a year. Then, in so-called ‘golden years’ of world capitalism, US productivity managed 2.7% a year. In the terrible years for capitalism of inflation and booms and slumps, from 1973-95, US productivity growth slumped to new lows of just 1.4% a year. But in the hi-tech years of the end of century, it rose 2.8% a year, surpassing the golden years.

And there is no reason why this won’t continue, so Greenspan and co argue, thus putting a floor on US economic growth and avoiding a slump. As he said: “ the key factor in driving (the economy) has been the extraordinary pick-up in the growth of labour productivity experienced in this country since the mid-1990s”.

Real productivity gains

But is this apparent upshift in productivity levels real? The startling truth is that the figures are almost entirely due to an unacceptable change in the way productivity is being measured. It is only in the US that this method of measurement has been adopted. And it is only in the US that we have seen an apparent upshift in productivity growth. In the UK and Europe, productivity growth languishes at 1980s levels.

Let me explain. In the last quarter of 2000, the US annual rate of investment in computers and hi-tech items reached $118bn in money terms. But the US statisticians have ‘corrected’ that figure to measure the ‘real’ value of hi-tech investment, adjusting it for faster processing speed and hard drive capacity. In other words, a machine may cost $1000 the same as last year, but because it is also faster than last year’s machine, the ‘real’ value should be boosted. The statisticians argue that, just as the price of strawberries should be quoted by the weight and not by the box, so the value of a computer should be measured by its power and not by its price as a box. And they impute just such an improvement.

So by how much more is this improvement worth? By a whacking near three times! The real annual value of hi-tech investment is calculated not at $118bn, but at $329bn! So whereas, US money investment in computers has risen 10% a year since 1995, the statisticians estimated the ‘real’ increase at 45% a year. Undoubtedly, if capitalists invest in new technology and the price of those investments falls, that cheapening represents extra real value. Since 1995, the price of computers has fallen 7.7% a year, but under the government’s adjustments, they calculate the ‘real’ fall in the price of 33% a year!

At the same time, the government’s statisticians have decided that investment in software should no longer be considered a business expense, but as an investment like buying a computer. The result is that ‘investment’ in hi-tech goods and software has been bumped up to $676bn, or around 8% of annual GDP! So by a sleight of hand, billions of dollars have been added to US production without any extra effort. No wonder US productivity has jumped up and Mr Greenspan has been fooled.

This addition to national product and productivity is largely fictititious. And remember all this investment has brought in little profit to the investors. It has been a huge expense that had to be made by each capitalist because competitors would do it otherwise. And yet it has not produced the returns claimed by the statisticians. No wonder the bubble has burst and the economy has slowed as company after company begins to realize that it ‘over-invested’ in this productivity-giving new technology.

Effects on the real economy

This time the capitalist economic cycle will be different - but not in the way Mr Greenspan thinks. This time, the fall in the stock markets of the world will have a material effect on the real capitalist economy. The money wasted in hi-tech internet stocks is the hard-earned, borrowed and saved money of millions of American households who have been sucked into the stock market boom, particularly over the last five years. Now over one-third of all American household own shares and their retirement pension funds are also heavily invested in the markets. Americans continue to spend well beyond their means. The latest figures show that the household savings rate is at its lowest since records began in 1933, at -1.3%. In other words, Americans are borrowing more than they earn to spend because they remain confident that their existing savings invested in the stock market will look after them in the future.

The stock market boom, particularly of the five years up to March 2000, fuelled the economic boom and vice versa. As internet-related stocks shot up in price, internet companies were flush with cash, which they spent on advertising with the likes of Yahoo (the only profitable internet company). Yahoo’s revenues rose sharply and this increased the expectations of investors for the whole of the market. So the most important boost to Yahoo’s profits was the stock market itself. But now the process is in reverse.

Of course, the capitalist optimists remain. Stock prices have slumped, so now they are cheap, the optimists argue. Once investors realize that, they will start buying again. The market will rally and ‘confidence’ will return. It’s true that stock prices are down, although they are still way higher than they were in 1995. But profits are also going down. US company absolute profits declined nearly 5% in last quarter of 2000. And profit rates have been falling since the end of 1997.

The huge boom in the stock market since 1997 has been fostered by all kinds of fakery and trickery - the buying back of shares by companies with their cash to keep prices up; the hiding of the true profit position by excluding the cost of stock options to top executives; the adding in of the profits of companies taken over without including all the costs of debt incurred to buy them, and so on.

But it is all going to end in tears. For the moment, the news that current chief executive of America’s biggest bank, Citigroup, took home $28.6m plus an additional $196m in exercised share options last year does not produce a murmur of complaint. Or that the chief executives of top five investment banks in the US ‘earned’ $154m between them last year. But once investors realize that they have lost the bulk of their money forever, once the stream of bad profit announcements turn into a river (it’s already beginning to happen), and once employees, not just at internet companies, but also at the likes of Marks & Spencer, Procter & Gamble and Boeing, start to get the redundancy notices, then the mood of complacency will turn. Then Mr Greenspan won’t be seen as the most popular person in the US today.