It's still getting worse

The last time Michael Roberts commented on the state of the US and world economy was in May. The piece was called: "The worst is yet to come". Now things are getting worse for world capitalism. The US economy is in "recession" and there is little doubt that the third quarter figures will confirm the end of the long boom. Michael Roberts updates our analysis of the present economic situation.

The last time I commented on the state of the US and world economy was in May. The piece was called: "The worst is yet to come".

It's holiday time in the northern hemisphere and things are getting worse for world capitalism. The US economy is now in "recession", which capitalist economists define as two consecutive three-month periods when national output (gross domestic product) falls. The official figures have not been released yet. We know that in the second quarter of this year, GDP was down by 0.1% over last year. But we must wait for the third quarter figures, not released until October, to know for certain that the long boom of US capitalism, which started back in 1992, is officially over.

There is little doubt that the third quarter figures will confirm the end of the long boom. For a start, US industrial production has been down for eight months in a row. That's more than in the great world recession of 1973-74 or in the terrible industrial slumps of 1981-2 or 1990-1. The utilization of industrial plant and equipment has fallen to its lowest reading since 1983 and the productivity of American workers had its largest drop in eight years, falling at an annual rate of 1.8%. At the same time, more than 3 million Americans filed for jobless benefits in July. That's higher than any figure since 1992. And in the US, increases in unemployment usually precede a recession by about seven months. That means the downturn should begin in the third quarter (and that's where we are now).

What's been different about the end of the long boom this time is that, while US industrial production has collapsed, the rest of the economy has apparently continued on its merry way (until now). That's partly because industry (as defined by the official figures) is now only a small part of the economy and so has less of an impact on the rest. While the manufacturing sector has lost 785,000 jobs in the last year, the so-called service sector has put on jobs (at least until the last month).

The other main reason why the boom has extended beyond the collapse in industry has been the huge credit and borrowing binge that US households and corporations have been engaged in, with the connivance of the monetary authorities represented by the Federal Reserve Bank and its chairman, Alan Greenspan.

American households, incited by very low interest rates provided by Mr Greenspan (interest rates are now down 3% since the beginning of the year, the quickest set of cuts ever), have slipped deeper and deeper into debt to sustain their spending spree. In June, consumer credit reached a record 22% of personal income levels, way higher than before the last busts of 1980 and 1990.

This spending spree has kept up demand for cars, electronics gadgets and other retail items. But above all, it has fuelled a property boom. Last year, house prices rose by over 8% and home sales continue at an annual rate of 6 million.

But this binge is coming to an end. That's because the productive sectors of the US economy have now fallen to their knees and the final blow to the chin is about to hit them. The reason is clear. The great hi-tech revolution of the internet that supposedly created a 'permanent boom' has been exposed as a fraud and the huge bubble of investment pumped into this sector has not produced great profits, but the opposite, huge losses. As a result, US company profits are now down 25% on last year and investment in all sectors of the economy are in free fall.

The optimists about US capitalism remain in the ascendancy, however. Since its peak in March 2000, the American stock exchange that sets the prices of the shares of US manufacturing and technology companies, the NASDAQ, has fallen 60%. Yet in June, Americans ploughed another $11bn into the hands of stockbrokers to invest in NASDAQ shares. The majority are still expecting a quick recovery in the US economy and therefore in the stock market. Recession, profits slump, rising unemployment, further collapse in share prices - it's not going to happen!

Americans are reassured in this belief by Fed Chairman Greenspan himself. Recently, he was asked a question in the US Senate: "If this is a bust, the boom was sure as hell worth it. You agree?" Alan replied: "Certainly". The hope and belief is that the US economy will have a V-shaped recovery, a quick turn up again, probably before the end of this year.

But following the advice of Alan Greenspan may not be the best thing for Americans to do. Back in March 2000, orders for high-tech goods were rising at over 25% a year. Greenspan waxed lyrical: "When historians look back at the latter half of the 1990s, they will conclude that we are now living through a pivotal period in American history...the essential contribution of IT is the expansion of knowledge and the reduction in uncertainty. The benefits of new technology can be realized only if they are embodied in capital investment and for these investments to be made, the prospective rate of return must exceed the cost of capital. Lofty equity values and declining prices of high-tech equipment have reduced the cost of capital. The fact that the capital spending boom is still going strong indicates that businesses continue to find a wide array of high rate of return, productivity-enhancing investments. And I see nothing to suggest that these opportunities will peter out any time soon."

Well, one year later, orders for high-tech goods are falling at a record 31% annual rate; big high-tech companies have been writing off huge amounts of excess equipment that they can't sell (Cisco Systems wrote off $2.25bn in the last quarter alone). Companies like Lucent, Nortel, Corning, at the heart of the 'New Economy', have written off their purchases of other internet and high-tech companies that are now worthless to the tune of $100bn! That's greater than the GDP of Ireland, another global high-tech casualty.

Last month, the real story about the New Economy was revealed. The US authorities announced revisions of the figures for productivity growth in the last five years, the period of the great internet revolution. They show that productivity did not grow at 4%-plus as previously thought, but by an average of just 2.5% a year. That's good. But it's not nearly as good as the rate of growth achieved in that famous industrial boom of the 1920-27, when productivity rose 3.8% a year, or in the golden age of capitalism of 1948-73, when recessions were slight and booms long. Then productivity grew at 2.8% a year.

The truth is that the long boom of the 1990s has not been as productive as some previous booms, all of which ended in a massive slump. The boom and bust cycle of capitalism is still alive and roaring, despite the soothing words of Mr Greenspan. It's just that the underlying slowdown in profits and productivity have been hidden under a deluge of cheap credit and inflated share prices. Now that this tide of credit has ebbed, the rocks of capitalist crisis are being revealed underneath.

Having failed to recognise a bubble as a bubble, Mr Greenspan, along with the US government and most American stock market 'experts', have failed to see a bust as a bust.

Last February, Mr Greenspan commented on the US economic slowdown that was then becoming more visible: "Although recent short-term business profits have softened considerably, most corporate managers have not altered their optimism about the future returns from new technology... at least this is what I glean from equity analysts, who, one must presume, obtain most of their insights from corporate managers. According to one thousand of them, earnings forecasts for company profits remain at a high level. That bodes well for continued strength in capital accumulation and sustained elevated growth in structural productivity."

Many other Americans relied on the advice and forecasts of these 'equity analysts'. Now with corporate profits falling off a cliff, productivity slumping and the stock market down 60%, many investors are taking legal action against these analysts. Investors are going to court, saying they were misled by these 'experts', who had a vested interest in recommending shares that their companies were selling. What happened to the latest court decision on that? The investors' case was thrown out on the grounds that investing is a risky business! Welcome to the capitalist world!

What now? The US recession is now with us. It just hasn't been declared official yet. The question is whether it will be short and shallow with a quick recovery. The majority of capitalist experts say yes. But then before, they said there would not be a recession.

The size of this credit bubble and the extent of the expansion in speculative (fictitious) capital are unprecedented. This is a bigger bubble than the famous Tulip bubble of the 17th century or the South Sea bubble of the 18th century. It's bigger than the consumer credit boom of the 1920s when the productive foundations of growth were better than in the 1990s.

The US economy continues to live on borrowed time and borrowed money. US corporations and households have been spending about 6% of GDP more than they have in incomes. They have borrowed the difference, mainly from investors abroad. The US economy runs a trade deficit of 4% of GDP with the rest of the world and US corporations invest hugely abroad in the great process of 'globalisation'. They finance all this by attracting foreign investors to buy US companies or US shares and bonds. Indeed, up to now, the US economic boom has attracted so much money that the US dollar has appreciated against all other currencies.

But now the boom is over. Foreigners are becoming more reluctant to buy US assets. The dollar has started to slip in the last month. If the slip accelerates, it will put Mr Greenspan in a major dilemma. He wants to cut interest rates to stimulate the credit bubble. But if he keeps cutting, then foreigners will get less for holding dollars. So they may stop buying dollar assets. Even worse, they may start selling them.

Then Mr Greenspan cannot cut interest rates because he must protect the value of the dollar. If he stops cutting, then American investors and corporations will realize that the cost of investment is not going to fall any more and yet profits are diving. They will cut back on investment and jobs even more, while a falling dollar will start to drive up the cost of importing goods from abroad. Inflation will rear its ugly head. The great enemy of capitalism in the 1970s and 1980s - stagflation (rising inflation and falling output) - will reappear.

The rest of the world is no position to take up the slack if the US founders. Japan remains in recession. This year, national output there will fall by 1% and probably by the same amount next year. Unemployment is a record levels. The new government under the nationalist, 'Mr Hairdo', Junichiro Koizumi, is pledged to reduce government spending even if it makes the economic recession worse!

Germany is slowing down fast. Industry is recession and the economy will be lucky to grow more than 1% this year. The rest of Europe looks little better. The UK's property bubble and borrowing binge (similar to the US) is keeping the economy above the water line, but only at the expense of a sharply rising trade deficit and low productivity and profits. It cannot last. And places like Ireland are about to be decimated by the huge job cuts that global hi-tech firms are now making to get their balance sheets back in order.

Asia is diving. Taiwan's national output is falling by 8% a year, Singapore's by 10%. Only China continues to grow, relying on its low wages to export and government-directed stimulation of the domestic economy.

As the world slips into recession and the dollar devalues, that will increase the danger of protectionism as governments put up walls to defend themselves from the contagion of slump. Of course, as in the 1930s, that will only make things worse. Already China has imposed punitive tariffs on Japanese cars, mobile phones and air conditioners in retaliation for Japan's ban on Chinese food products. The US and Europe have a major dispute over $4bn worth of help that the US government gives to its exporters in contravention of world trade rules. And the Bush administration is pledged to help its steel producers with action against foreign imports. Export growth has plunged worldwide from 11% rise in 200 to just 4% this year.

The world recession next year will mean a rise in the misery index for everybody. We've talked of this index before (the level of inflation plus unemployment rate). In the US, it fell to a low of 5.9% in mid-1998. Since then, it has been on an inexorable rise. Now it's 7.8%. That's still low by historic standards. But with unemployment rising at its fastest pace since 1992 and inflation likely to blip up if the dollar slides, we can expect double figures next year pretty quick. Then American households will start to fell the pinch in a big way. And when the US catches a cold, the rest of the world gets pneumonia.