False Optimism

Stock markets in the US and Europe have bounced up during August. Indeed, after reaching a new low on July 24, they've now recovered by 20%. It seems that there is some renewed optimism that capitalism is not going to slip into recession after all, but can make a steady recovery. But beneath all the hype the cruel realities of the economic data in America, Europe and Japan remain unchanged.

Stock markets in the US and Europe have bounced up during August. Indeed, after reaching a new low on July 24, they've now recovered by 20%. It seems that there is some renewed optimism that capitalism is not going to slip into recession after all, but can make a steady recovery over the next 18 months.

Why the new optimism? Well, it can't be the summer weather in Europe where rain and flooding has been unprecedented for 200 years! It's true that much of the US seems have had hot weather. But there are more serious arguments presented by the representatives of capital.

First, the Bush administration claims to have acted against the fraudsters of corporate America. After the scandals of Enron, WorldCom and Tyco, and after much cajoling, the US government agreed to new laws designed to tighten up corporate accounting. It's a case of the stable doors being closed after the horses have bolted.

While "insiders", as they are called, sold their shares before the stock prices collapsed, middle America, with much of their savings for retirement invested in stock market portfolios, took a huge hit. The net wealth held by American households (including shares, bonds and property) has fallen over 20% in the last two years, since the "bear market" in world stocks started in March 2000. Many hard-working Americans (who have the longest working year in the OECD) are now contemplating postponing their richly deserved retirement and working a few more years to make up the losses in their retirement portfolios. So they are angry and demanded action to deal with the swindlers and accounting fraudsters that run America's biggest corporations.

The gruesome irony is that among these insiders is the President himself. When Bush was governor of Texas, he was on the board of Harkin Energy (formerly Bush Exploration). Just a few months before the stock price of that company collapsed, he sold thousands of shares, making a tidy profit. It seems he knew in advance that the company would have to announce poor profit results. But of course, he has been exonerated in an inquiry.

But no worries, the president and congress have now acted and there will be no more scandals. Indeed, on August 14, nearly all the chief executives of the top 1000 US companies signed affidavits declaring that their accounts were true and correct. Stock markets breathed a sigh of summer relief and rocketed up.

The other big reason for new optimism is the increasing belief that the Federal Reserve bank, led by the new Knight of the British Empire (honorary), Alan Greenspan, is going to cut interest-rates to record lows and so revive the economy from its doldrums. Several US banks are predicting sharp reductions before the end of the year. Investors loved this news and stock market prices rose.

But all this optimism is summer silliness. Beneath all the hype the cruel realities of the economic data in America, Europe and Japan remain unchanged. The world economy is still slipping down. Take the US. Throughout July and August, every new figure on the economy was worse than before. Much is made of the need for the US consumer, namely the average American family, to go on spending. It is almost a patriotic duty to borrow more or use up more savings to spend in the shopping malls in order to keep the economy going. Indeed, US auto companies continue to offer zero-interest financing if Americans buy new cars.

Despite the rebounding stock market, consumer confidence is sliding. The Conference Board's July index of consumer confidence tumbled from 106.4 to 97.1, its lowest level since February. Consumers' expectations about the future took an even steeper turn for the worse. The future expectations reading plummeted to 95.7 from 107.2.

At the same time, sales in the shops are falling off. Indexes that measure confidence among US manufacturers have also weakened and manufacturing output is dropping back towards recession levels after a limited revival in the early part of this year.

Most significant, the figures for real gross domestic product in the US for the second quarter of this year showed a rise of just 1.1% and previous quarters were revised down to confirm that indeed in 2001 the US economy had fallen into recession and only recovered briefly in the first quarter of this year. Business investment fell for the seventh straight quarter. Meanwhile, the pace of consumer spending slowed to a crawl, advancing just 1.9% after growing 3.1% in the first quarter. Only government spending shot up. And of course, at least for the moment, with interest rates so low the property boom continues, as it does in the UK, Australia and many other OECD countries.

And the other ghastly reality for US capitalism is that profits are not improving. The top 500 US companies recently reported their second quarter earnings. Let's be generous and assume that we can believe the accountants and the company reports as reflecting a true record of profitability (some chance!) But even on that basis, profits were up just 1% compared to the same time last year, when they were terrible.

The real story is that unless US companies go in for another huge binge of job cuts (and in the last year over 2 million American jobs have been lost), they won't get profits up and so they won't resume investing. But of course, if they sack loads more workers, the unemployed won't be able to buy goods in the shops and those still employed will be so scared that they might lose their livelihoods that they will cut back on spending and start to save. The result will be economic recession. Such is the capitalist dilemma, when profit rules production.

And it is no better in Europe. Most of European countries have reported economic growth figures for the second quarter of this year. Only there was little or no growth! Germany was up 0.3% and Italy was up 0.1%. Britain was best at just 0.7%. And with manufacturing faltering and sales in the shops of Europe and Britain also dropping off, the prospects look bleak in the second half of this year.

As for Japan, it's the same old story. National output is falling by 0.5-1.0% a year. Deflation remains the order of the day with prices falling. Even the services sector is continuing to slide as unemployment hits post-war highs. The government is paralysed about what to do after 12 years of recession. Public debt just keeps mounting.

And there are lots of nasty rocks in the world's economic ocean that could sink a few more capitalist ships over the next few months. The economic and political chaos in Argentina continues with no sign of escape. Similarly, despite huge dollops of IMF money, the Turkish capitalist politicians continue to squabble, threatening to drive this key ally for the US in its so-called War on Terror into economic depression. And elections are imminent in Brazil with the likelihood of a massive defeat for the government candidate. The presidency of the largest country in Latin America is now likely to be held by the Workers' Party leader Lula or the Workers' Front leader Ciro Gomes. It's not a pretty thought for capitalist investors and they are taking their money out of Brazil like there was no tomorrow.

And then there is Iraq. The Bush administration is preparing a huge armed force to take out Saddam Hussein, probably some time this winter, whatever the European governments and the UN say. But that is going to drive up oil prices even if the war goes well and it could seriously damage the world economy if the Bush adventure goes pear-shaped.

And there are two bubbles still to burst in world capitalism. The first is the strength of the US dollar. It has weakened a little in the last year but there is much room yet to go down further. Foreigners hold $9 trillion of dollar assets, while the US runs a trade deficit of $37 billion per month. Those foreign investors are facing even bigger losses than their American counterparts. For on top of the stock market losses, they have currency losses of another 10-15%. When they begin to sell in big numbers, the buyers will disappear and the dollar will fall far more than most people expect.

The second great bubble still to burst is the property sector. US and UK consumers have gone on spending because they are relying on the rising value of their houses. But 10% a year price rises in America and 20% in Britain are not sustainable. Already there are signs of exhaustion in house prices in London and New York. If the housing market stutters, people will stop spending a big way, dragging down the economy further.

All this makes a mockery of that talk about a New Economy for capitalism based on hi-tech, the internet and deregulation of controls over business. Economic growth in this great era of laissez-faire capitalism has been much weaker than in the immediate post-war decades. In the US, from 1942 to 1966, the average annual real GDP growth rate was 4.5%. From 1975 through 1999, it was only 3.2%. The average annual gain in industrial production from 1942 to 1966 was 5.3%. From 1975 through 1999 it was only 3.4%. At same time, consumer debt rose from 64% of annual disposable personal income in 1966 to 97% in 1999.

And yet the US authorities and Alan Greenspan in particular, continue to spout optimism in every statement. Recently, Greenspan commented: "The mildness and brevity of the downturn are a testament to the notable improvement in the resilience and the flexibility of the economy. The fundamentals are in place for a return to sustained healthy growth: imbalances in inventories and capital goods appear largely to have been worked off; inflation is quite low and is expected to remain so; and productivity growth has been remarkably strong, implying considerable underlying support to household and business spending as well as potential relief from cost and price pressures."

The reality is much more as Morgan Stanley's chief economist, Stephen Roach described it: "This business cycle has little in common with those of the recent past. Unfortunately, it does have a lot in common with the pre-World War II boom-bust cycles triggered by speculative bubbles in financial markets. History tells us that the 19 peacetime cycles from 1854 to 1945 had recessions with an average duration of 21 months - essentially double the 11-month duration of post-1945 recessions. Post-bubble shakeouts are long and painful. Why should this one, following on the heels of the mother of all bubbles, be any different?"

A PS on the World Economy

The perspectives outlined by our economics correspondent Michael Roberts in his article that we published yesterday received dramatic confirmation within 24 hours with steep falls on international stock markets.

More than £36 billion was wiped off the value of British shares yesterday, when the FTSE 100 index of blue-chip companies ended the day nearly 4 percent or 152 points, lower. At one stage it crashed through the psychologically important 4,000 barrier. The fall in share prices threatens to force a number of household names, including British Airways, out of the FTSE 100 index of top shares.

In Japan the Nikkei index fell to its lowest level since 1983. In New York, the Dow Jones Industrial Average fell by more than 350 points.

"The US market is setting the agenda and Europe is slavishly following," said John Hatherley of the UK fund managers M&G. "All the indications are
that the US economy is slowing down. The question is whether there is enough ammunition to push the markets into a new bear phase." (The Independent, September 4, 2002)

Dealers said the slide had been prompted by "persistent economic uncertainty in America and the prospect of Britain joining an attack on Iraq." Fund
managers and equity strategists said the rally that had seen the FTSE 100 rise by almost a fifth in August appeared to be over.

Most economists now agree that the United States faces a so-called "double dip" recession. This confirms what In Defence of Marxism has consistently maintained: the rally that occurred earlier this year was only the prelude to a further and steeper decline in the world economy. The present falls on the world stock markets are merely the tip of the iceberg.

Alan Woods
September 4, 2002