Dark Clouds Ahead for World Economy – but Happy Christmas Everyone!

Paying particular attention to the US, European and Chinese economies, Michael Roberts analyses the real state of the world economy. As we head into the Christmas season, things are not looking so merry for world capitalism.

As we approach Christmas yet again, the decorations, jingles, lights and bunting appear ever earlier on the streets of America, Europe and much of Asia. The retailers tell the media that it is going to be a bumper season for sales and optimism always reigns in the financial world, particularly the stock market.

Indeed, since the lows of the summer, the world’s stock markets have entered yet another rally in prices. They remain well below the peaks reached at the end of the great dot-com bubble. Then the Dow, the price index of the top 30 companies in the US, reached 11,500. In the subsequent slump through to mid-2002, the index fell back to 7,500. A series of rallies and slips (snakes and ladders-style) since then have taken the index back to 10,500. That’s a sizeable gain for those speculators who bought at the bottom in 2002. But, just as in the casino or the lottery, very few did. Most punters, and that includes the pension and retirement accounts of the millions of workers in the US and the UK, are still nursing losses and can expect a meagre return on their hard-earned money.

But now all is sunshine. President Bush has been re-elected with the promise to maintain the tax cuts for the rich and for the big corporations. He is even hinting at extending those cuts and introducing legislation to hand over the social security budget to private companies to run. That would be a bonanza for the financial sector (and of course disaster for the recipients of pensions and benefits in the future).

The US economy seems to have recovered from its ‘soft patch’ when it slowed down in the summer. Economic growth is tripping along at 3-4% a year. Jobs are coming back. Households seem to be spending still and house prices are holding up – at least so far.

But here is the rub. The whole boom seen since the very mild recession of 2001 has been based on cheap money pumped in by the Federal Reserve Bank and for that matter the Bank of England and the European Central Bank. Households in America and the UK have borrowed that money, spent some of it and speculated the rest on buying homes. The property market dominates the discussion of the middle classes at their dinner tables and even concerns the many layers of the working class as they see house prices rocket beyond their means.

As a result household debt has reached astronomical proportions, well over 100% of annual household income after tax in the US, the UK and many other countries. So far, the cost of financing this debt has been manageable for most. With interest rates very low, mortgage payments have been no higher than 20-25% of most people’s available income. But now interest rates are on the rise. The Bank of England drove up interest rates sharply during 2004 and now the Federal Reserve has started to hike rates from all-time low levels.

And these are just some signs that the great housing boom of the 1990s and early 2000s is coming to an end – perhaps with a bang rather than a whimper. All the talk is of a fall in house prices in most of Britain in the last few months. In Australia, there has already been a 15% fall. The US is still reasonably buoyant but in the hot spots of California, Las Vegas and Florida, prices are cooling off. Significantly, mortgage borrowing has fallen away.

And that is the first danger for the growth of the US economy. Americans have spent heavily in the shops by borrowing. For most Americans take-home pay has not expanded in the last few years and for many it has fallen. The main reason is the huge rise in benefit contributions to pay for medical care, education and transport costs.

If house prices now start to fall, then expect Americans, Brits and even Europeans to cut back on their spending in a big way. That spells slowdown and even recession. Already, there are muted mumblings that Christmas is going to be tough for the retailers in the high streets and malls.

There is nothing coming from the big corporations that will keep the US economy rolling. The big companies in Europe, Japan and the US have dramatically improved their profit levels since they bottomed back in 2001. In the US, profit margins are nearly back to the levels of the height of hi-tech boom in 1997. But they have done this not by investment in new technology or through innovative marketing etc. It is almost all the result of huge job cuts. President Bush is the first US president since Herbert Hoover in the 1930s to serve a term of office where there were less people working at the end of his four years than there were when it began. American workers have paid for the boom in profits by lower benefits, wage cuts and job losses.

Despite huge tax incentives, job cuts and easy credit, US corporations have not used their massive profits to invest productively. Most of the profit has gone to extravagant salary packages for the top bosses, rising dividend payments to the shareholders and even buy backs of shares in the market. Net investment after money spent on replacing old plants and equipment is at an all-time low! Only investment in arms, missiles and ‘security’ is rising.

The great productivity boom of the 1990s in the US was the result of huge investment in new technology. Indeed, there was massive over-investment, a chronic fault in a capitalist system where there is no planning, that finally led to the bust in 2000. After that productivity growth was sustained only by cutting the jobs of the workforce. But now productivity growth is slowing fast. Whereas last year, productivity per worker per hour was rising at over 5%, now it is creeping along at under 2% and will slow even further.

That suggests the US cannot maintain its 3-4% growth rate much longer. And there is another dark cloud ahead – the dollar. US prosperity has been based on borrowing: borrowing to buy houses and also borrowing from abroad to pay for cheap imports from China and Asia. Most of the consumer gadgets, clothes and appliances bought this Christmas and most of the cars sold on the extremely easy credit terms are imported from overseas. America increasingly makes less, borrows more and buys from abroad. The US has been able to get away with this because the dollar has been supreme, the currency for world trade and savings. Asian exporters have recycled their dollars back into investments in US stocks and shares or bonds or even to buy US companies.

That process has been going on for over a decade. Now the US owes over 25% of annual income in debt abroad. But the inevitable demise is fast approaching. The dollar has started to slide. The slide began back in 2002 and then things seemed to stabilise this year. But now the run on the dollar has resumed. Foreign investors are asking themselves why they should buy all these US shares and bonds if their value is going to slip because the value of the dollar does. It is self-enforcing. Once confidence in the dollar goes, all will fall down.

If the US slows, there will be little help from Europe or Japan to take up the slack. Germany is hardly growing at all. The economy is still shedding jobs, shop sales are terrible and there is growing gloom at the failure of the government to turn the economy around. And now the euro currency is strengthening so much that it threatens to hit severely the export sales of European companies. Japan appeared to have been making an economic recovery in the last year. But since its great financial and housing bubble burst back in 1989, there have been several false dawns for the economy. It stayed stagnant throughout the 1990s and the current recovery is now showing signs of exhaustion. Industrial production is down, prices in the shops are still falling and house prices remain dormant. Exports to China are booming, as the only saving grace.

And here is the next danger for the world economy. Outside of the US, China has been the main support for world growth and demand for commodities and equipment in this decade. The economy has been racing along at over 10% a year. With a no-holds-barred-approach by the bureaucracy, capitalist businesses have been allowed to expand, without environmental control, paying very low wages and providing terrible working conditions – just as in the days of the industrial revolution of the early 19th century Britain.

This capitalist expansion within the confines of an authoritarian Stalinist regime and under-invested ageing state sector has created huge distortions in the economy. Manufacturing trade booms and China sells huge amounts abroad. Corruption, inequality and, above all, unplanned over-investment have rocketed to new heights.

Now the great boom seems to be heading for a bust. Take car sales for example. Last year car sales were rising 100%. Now they are falling by 3%. There are now 600,000 unsold cars and manufacturers with new plants and workers are getting worried. The same thing is happening in the new gadget industries. There are 315 million mobile phone users in China! That provides sales of about 90 million units year, up 50% from 2003. This is already reaching the point of saturation. Unsold mobile phones have already reached 60 million, or nearly two thirds of yearly sales. Then there is housing. Property speculation has been unprecedented. Property investment is now 50% of annual output!

This great investment boom is heading for a classic capitalist bust. Sure, because China still has 60% of its investment in state hands, the impact can still be controlled. But it will still mean a sizeable slowdown in the economy in 2005.

And China is no longer unimportant in the world economy. If you exclude the effect of currency exchange, then China’s economy is now 60% of the size of the US, or the second largest in the world. Between 1990 and now, it contributed 28% of world growth compared to just 19% from the US! And that figure was probably closer to 50% since 2000.

To sum up, the US is probably heading for a slowdown. The UK will follow the US, as always. Europe is already expanding weakly. Japan’s recovery could stall again, particularly if China slows. And that great manufacturing powerhouse of the globe could well be heading for a capitalist bust.

All this suggests that global capitalist slump is not far away. And with productivity growth slowing and oil prices still high, inflation may return at the same time to deliver the worst of all possible capitalist worlds – stagflation (stagnation and inflation). Happy Christmas!