The upswing since 2001 has been one of the most lopsided in the history of capitalism. It has been powered by the American consumer, referred to by some economists as ‘the consumer of last resort,' so important are they conceived to be to the functioning of the world economy. Though comprising less than 5% of the world's people American consumers' demand has been responsible for an incredible 19% of the growth of the world economy in recent years. How is this possible?
After all American workers' incomes (and most American consumers have to work for a living) have not risen in real terms for three decades. Yet they have more money in their pockets to spend, and to buoy up a world economy of six billion souls in the process.
The answer to this question is because of what is called the wealth effect. House prices have been going up so Americans have felt richer. Consumers have been able to borrow against the rising value of their houses. In effect they have been using their homes as ATMs, spending like there's no tomorrow. Now tomorrow has arrived.
I'm forever blowing bubbles
For years Socialist Appeal has warned that the rising price of real estate in Britain, the USA and other advanced capitalist countries is a classic bubble. House prices have more than doubled in Britain and the States over the last ten years for no real reason - that is no reason founded in the real economy. A bubble means that prices are going up because people are buying; and people are buying because prices are going up. Figure that out! Bubbles can burst. When bubbles burst, prices fall because people are selling; and people are selling because prices are falling. That is what is happening now - in Britain, Ireland, Spain and most of all in the USA.
House prices have already fallen by 8% from their peak in the States. A speculative boom produces its own illusions. The most dangerous words in economic prediction are ‘this time it's different.' That's what they were saying in 1929 before the Wall Street stock exchange crash. Read any reputable history, such as the chapter ‘In Goldman, Sachs we trust' in Galbraith's The Great Crash 1929, to recognise the same smug complacency we encounter now. They were saying it in 2000 before the dot.com dive when the ‘new economy' shares went down. They were probably saying ‘this time it's different' in Holland in the 1630s at the height of tulipomania.
The dot.com collapse in 2000 is interesting since it shows how ‘contagion', once it has taken hold, can wreak damage far beyond its real significance to the economy. Actually IT shares were worth only 6% of the total but their collapse sent waves of fear through finance capital, and share prices as a whole halved over three years. It is argued that the share crash was the trigger for the US recession in 2001. Houses are more important to capitalism than IT shares, affecting 72% of the US economy. So who knows what will happen now the bubble has burst?
Everyone now knows that it was stupid to pay more for a tulip bulb than a farm, as people did in the 1630s. But as long as you can sell the tulip on to ‘the greater fool' for more than you paid for it, what's the problem? Why is it any less stupid to treat a house as an appreciating asset rather than bricks and mortar to keep the rain off your head?
But the story gets murkier. People buy houses on tick, by taking out mortgages. In the States the financiers have been hurling mortgages at people with no income, no job and no assets. They have left the problem to be sorted out by ‘the greater fool', just as the speculators did in 1929. But there's something new in the financial firmament. Money men talk about financial innovation. What on earth do they mean? The process is called securitisation, an ugly expression. It means your mortgage and a lot of other liabilities will be bundled up onto a piece of paper and sold on as an asset. After all you ought to be paying back your mortgage over twenty years or whatever. So what for you is a financial liability can be an asset for someone else, providing them with a steady income stream.
Instead of a mortgage sitting in the bank, as most people expect to happen, they have been bundled up and sold on as financial instruments. They're called structured investment vehicles (SIVs). They are passed from hand to hand. Because they count as a financial asset, they will usually end up in the vaults of a financial institution and used as backing for a further round of lending.
There's just one fly in the ointment. The SIV's a financial asset (it's worth something to someone else) just as long as you keep up the payments on the mortgage. But mortgages were handed out to people who could not possibly pay back. These are known as sub-prime mortgages. And through the ‘sophisticated' financial system these toxic little packages have been passed all round the world.
How bad is the sub-prime mortgage crisis? Nobody has any idea. Ben Bernanke, head of the Fed, the US Central Bank, reckons there may be $150 billion of dodgy debts floating around out there. Others fear it's more like $400 billion. So some bits of paper are actually worthless, but nobody knows to look at them which are any good and which are not.
Credit crunch hits Northern Rock
This in turn has caused the credit crunch. Financial institutions have become very reluctant to lend to each other in case they get caught out with a worthless piece of paper. So, if they do lend to other banks, they demand a much bigger risk premium than they wanted a few months ago. Libor (the London Inter-Bank Offered Rate) was regarded as an obscure piece of bankers' jargon a few months ago. Now it has soared, and we realise how important it is. Formerly it was controlled by Official Bank Rate, as it is now called - the rate at which the Bank of England lends to commercial banks. In this way the Bank of England could control interest rates throughout the economy. Now Libor is out of control, and so is economy, so far as the Bank of England is concerned.
The financial panic may sound esoteric, but it will have real effects on the real living standards of real people. And it could really hurt. The first victim of the credit crunch in Britain was Northern Rock, or rather its investors. So far as we know the Rock didn't have a single sub-prime mortgage on its books. But its business plan was to borrow from financial institutions in order to lend to house buyers. In banking parlance, this is called borrowing short (running out every three months to roll over the loan) and lending long (for twenty years or so). It's risky. And suddenly the financial institutions stopped playing ball with Northern Rock. So we saw the first run on a bank in Britain since the 1860s.
Blowback on Britain
We haven't really felt the pain here yet. But 130,000 are likely to declare bankruptcy or surrender their financial affairs to an Individual Voluntary Agreement this year, up from 111,000 last year. New mortgage approvals are down by 44%. That means housebuilding will take a hit. And 2008 is a year when millions of fixed rate mortgages are due to be reassessed. All the signs are set to stormy.
And there is no reason to suppose the American financiers were uniquely unscrupulous in lending to people who couldn't repay. A Panorama programme recorded the sordid tale of operators from call centres who target postal districts where economic distress is widespread and carefully groom potential suckers to take out sub-prime mortgages, and pocket their bonus for doing so. The real extent of British sub-prime mortgages is yet to be revealed. Is the iceberg £15 billion or £150 billion?
Bankers in pain!
The pain is hurting all over the world. Billions have been written off by the banks. Just to take two examples. US bank Merrill Lynch has admitted to losing between $8 and $12 billion. HSBC has writen off $10.5 billion in the States. We don't know how far the panic will spread. Marx pointed out that under capitalism we are all tied up together in a vast global division of labour. But the division of labour imposed by the law of value is like the force of gravity. We don't know it exists till the house falls down about our ears.
House prices have already fallen in the US, in Ireland and Spain, and they're beginning to fall in Britain. They have further to fall. The crash in house prices has already brought a halt to the construction industry in the States, with knock-on effects on the manufacturers of building supplies and other reverberations throughout the economy. Repossessions will impoverish millions of people. Unemployed workers cut back on their spending, so yet more people find themselves out of a job. And the daisy chain of credit has decisively snapped.
The central Banks of the world are on the case. In December they made $110 billion available to the commercial banks on account of the credit crunch. But it's the old question for bankers: is it a liquidity crisis (a temporary cash flow problem)? Or is it a solvency crisis (more liabilities than assets - in which case you'll be headed for the Poorhouse? At the moment nobody knows what it is. If it's a liquidity crisis, and the central banks know what they're doing then they should be able to sort it out eventually. They can identify the toxic packages with sub-prime mortgages in them over time, gradually ease them out of the financial system and ‘recapitalise' it. But if there are too non-performing SIVs, then they have a solvency crisis - and so do the rest of us. Then it is inevitable that part of the financial edifice will slide into the abyss with huge consequences for the capitalist system.
Even if they sort it for now, what will they have achieved? Ian Harwood, economist at Dresdener Kleinwort, explains that previous action to stave off the dot.com crash simply replaced the bubble in the stock market at the end of the 1990s with a bubble in the housing market. "We never did have a recession in the 2000s because everyone went on to party again," he says. We can't party for ever.
End of the line
Since the last recession in 2001 the world economy has been growing faster than any time since the golden years of the post-War boom from 1948-74, at about 5%. You wouldn't know that in Britain. Our economy has been booming quite fast by its own miserable standards, at 2.8% last year. The trend rate of growth for British capitalism is reckoned at about 2¼ %. The extra spurt in recent years is probably provided by mass migration, particularly from eastern Europe.
The US, Japanese and western European economies have also not been performing any faster than usual in recent years. But the reason for the fast growth worldwide is because of the supercharged performance of the ‘emerging economies' Last year China grew at an incredible 11% a year, India at 9% and Russia at 7%.
The USA is forecast to grow at 2% or even less in 2008. And that projection takes no account of the fall-out from the sub-prime mortgage crisis. So we don't know what the real growth figure will be, but it will be lower. Now even a growth rate of 2% is not enough to prevent unemployment rising. Whatever happens, America will be in a ‘growth recession.' And that is the most favourable possibility! One thing is for sure. No longer can American consumers provide a market for the whole world by spending money they haven't got on the basis of soaring paper prices for their homes.
The US has been running a deficit with other countries of about 6% of its national income. That means for every $100 they earn at home Americans spend $106. They buy twice as much from foreigners as foreigners buy from them.
How do they get away with it? Foreigners lend them the money to buy their goods. Think about it. If I keep lending you money, you can keep on buying my goods. Clearly this can't go on! In particular the Chinese have been running a huge surplus with the USA. When the Chinese earn all these extra dollars, they use them to buy US Treasury Bills, thus recycling their purchasing power back into America.
The USA is a mass of contradictions. As a result, the world economy is as unbalanced as a wonky old bike. Not only have US consumers been having a free lunch at the expense of the rest of the world for the past few years, but the government has been spending money it hasn't got like there's no tomorrow. Not only have Americans notched up record debts with the rest of the world, but their government has ratcheted up a national debt of £4.4 trillion. This is set to rise to £4.8 trn, which George W. Bush will leave to the American people as a little farewell gift when he leaves office. And that debt will swallow up more and more interest payments.
Bush has been inspired by the economic policies of Ronald Reagan, policies that Bush's own father correctly denounced as voodoo economics in the 1980s. Rather than balancing the budget, Bush junior's strategy has been to let rip, not on social projects but on arms spending and tax handouts to the rich. So Americans have simply stopped saving. Instead they let the rest of the world do it for them. This is a clear sign that the period of US hegemony in the world economy is drawing to a close.
The dollar takes a dive
Given the parlous state of the US balance of payments, it's a wonder the dollar has stayed up so long. But now it's on its way down. And foreigners will dump it if they think it will no longer act as a store of value. So that'll make the collapse worse.
It is argued that a cheaper dollar, and cheaper US exports, are just what the doctor ordered for the American economy. That is how the price mechanism is supposed to work after all. But imports into the USA will become more expensive. That will appear to consumers as inflation, hurting Americans' standard of living.
The Fed could stop the dollar's fall by nailing it to its perch with sky-high interest rates like a dead parrot. But Americans wouldn't like that either since higher interest rates would radiate throughout the economy. Now it's true that the condition of capitalism means that US consumers need to cure their addiction to debt, but that would really be going cold turkey. Whatever happens, 2008 is not going to be pleasant for the American people
Decoupling is the latest economic buzzword. All economists realise that the whole world economy can't be powered by US consumption any more. So they're looking to a different world champion. In 2006 India, China and Russia were responsible for a half of all the world's growth. Some argue that, since China and India are developing so fast, they can pull the rest of the world behind them. This raises the question: are these ‘emerging economies' dependent on growth in the rest of the world or are they an independent factor in global economic growth? Can they decouple?
Certainly the International Monetary Fund realises that in the case of eastern Europe, its relatively rapid growth rate of 5% in 2006 (from a starting point of complete economic collapse with the collapse of Stalinism) is dependent on exports to western Europe. "The Directors welcomed the strong growth in emerging Europe, noting that its expansion is likely to moderate in 2007 in response to the slower growth in western Europe" (Spillovers and cycles in the global economy: world economic outlook April 2007 p. 195). The IMF also understands that the growth in Russia is entirely dependent on soaring commodity prices, particularly now oil has hit $100 per barrel.
But what about China, a land of 1.3 billion people? China now produces 26% of the world's steel; by comparison Europe manufactures less than 20% and the USA less than 10%. China's explosive growth has made it the second biggest importer of oil. All over the world commodity prices are bouncing up and producer countries are booming because of Chinese demand. China is actually the third biggest trading economy in the world. Its extraordinary rates of growth are export-led. For ‘developing Asia' as a whole more than 45% of growth is accounted for by exports now compared with less than 20% in 1980. By comparison, over the same period, the role of domestic consumption in stimulating development fell from 67% to 50%. This suggests that these nations are still dependent on demand from the advanced capitalist countries.
Economists have pointed to the expansion of inter-regional trade in east Asia, where countries like Japan and Korea supply more capital-intensive goods for China to make consumer goods for esport. In fact the whole of east Asia is like a vast factory with a division of labour between countries in the way a factorty has different plants. But the whole effort acted as a supply chain where the end of the chain was the Amercian consumer. That period has now come decisively to an end.
The dropping away of US demand for Chinese goods will not cause recession in China. Domestic demand will ensure that the economic continues to grow rapidly, perhaps at 8%. But China is at present dependent on the world economy for its export-led growth. It can maintain the demand for raw materials in the countries that produce them, but its imports cannot sustain output growth in the advanced countries that remain the heartland of capitalism. The Asian Development Bank agrees with us. It can find ‘no evidence' of decoupling.
It is the demand from China and other ‘emerging economies' that is powering the price of commodities, in particular oil, upwards. Rising food prices are already causing hardship to the poor and riots in poor countries. Oil is now hitting $100 a barrel. The oil price hike is going to hurt all the oil-consuming countries, which is nearly everyone. The worst recessions since the Second World War were in 1974 and 1979. They were the worst because they coincided with sharp oil price rises. The 1970s was a decade of ‘stagflation,' of mass unemployment plus inflation. As readers must have noticed - inflation is raising its ugly head again. Policy makers are confronted with a dilemma. Should they fight inflation with higher interest rates and so make the recession worse? Or try to ease the recession and so feed inflation?
Whatever the immediate outcome of this financial crisis, the world is entering a new and immensely unstable period. Welcome to a world of capitalist crisis! This crisis can only be understood with Marxist analysis. It can only be overcome with Marxist solutions.