Is the world recession over?

The US has just suffered the steepest decline in economic growth ever - from a breakneck pace of 4.1% annually in the years 1998-2000 to a negative 1.1% in the third quarter of 2001. But now most capitalist economists forecast the US is on course for what they characterise as a V-shaped recovery, and along with it, the end of the world recession of 2001-02. Our Economics Correspondent Michael Roberts looks at this theory.

The US has just suffered the steepest decline in economic growth ever - from a breakneck pace of 4.1% annually in the years 1998-2000 to a negative 1.1% in the third quarter of 2001. But now most capitalist economists forecast the US is on course for what they characterise as a V-shaped recovery, and along with it, the end of the world recession of 2001-02.

There are some signs of an improvement. In the US, consumer confidence is up significantly. New home sales are still running at a strong pace and productivity rose by an astounding 3.5% in the fourth quarter of last year, although this was due to a reduction in the number of hours worked by all Americans as overtime was cut back and workers were laid off, not by an increase in output.

The US Purchasing Manager's Index is made up from comments collected from purchasing managers across the US. They announce what is actually being bought and sold in the manufacturing world. A PMI reading above 50% indicates that the manufacturing economy is generally expanding; below 50%, that it is generally declining. From a ten-year low of 39.5 in October last year, it has climbed back up to 49.9.

The National Association of Business Economics supposedly houses the cream of the crop in predicting the US economy. They think that it will grow at 3.5% in the second half of this year. Of course, these are the same guys that told us that we would see a second-half recovery in 2001. And the NABE has never predicted a recession until there was one!

Ironically, the US government is less sanguine that the economists about the economy. They see the economy as growing at a slow 0.7% pace this year. And neither is the world's richest man, Bill Gates confident. Speaking at the World Economic Forum, the annual gathering of the rich and powerful, the founder of Microsoft said "I don't see any big uptick this year. Japan certainly won't be and the US won't be."

Stephen Roach, chief economist at US investment bankers Morgan Stanley, expresses a minority view among capitalist economists. But his words are chilling for the prospects of recovery: "I remain convinced that the US economy is only in the early stages of what could turn out to be a protracted post-asset-bubble shakeout - low saving, high debt, excess capacity and a massive current account deficit. As a consequence, vigorous growth will be much harder to come by in the years ahead than it was in the Roaring 1990s."

He reckons the world will go into another recession very quickly after a mild recovery - a double-dip, as in 1980-82. And there is evidence he can point to. European economic growth is now likely to be less than 1% for the year. Argentina has imploded. Japan is clearly in an economic deflationary spiral. World growth is slow to non-existent.

So who is right? A proper science of society can only draw out the trends and fundamental shifts. It cannot predict every change in a global economy that is the sum total of every single decision of six billion people on the planet. Nevertheless, we must try to draw on the trend of developments and the cycle of change and offer the most likely scenario of what is going to happen.

The most startling figure about the state of the US economy is capacity utilisation in industry. This is the measure of how much use is being made of plant and machinery. Economists usually associate a number above 80 as a signal of a healthy US industrial sector. Even in the 1991 recession, capacity utilisation did not go below 78. The figure has been dropping for the last 19 months - no brief upticks, no false starts, just straight down to 74%. It's now at levels only seen since records first began in 1868!

That means two things. First, businesses usually do not start to spend money to expand capacity when they have excess capacity. And second, when there is too much excess capacity, it is hard for businesses to raise prices and thus increase profits.

In January, the yearly rate of inflation was down to 1.1%. And that number does not tell the whole tale. The entire amount of inflation over the last 12 months was in the first four months of that period. Over 1% of the inflation was in the first three months. For the last 8 months we have been in outright deflation! And Producer Price Inflation (PPI), which best describes manufacturing pricing power, fell 2.6% last year, the biggest drop in 50 years! PPI is a leading indicator of CPI direction - and it is saying: outright deflation.

Deflation gives no pricing power to businesses. In the second quarter of 2000, pre-tax corporate profits for US non-financial firms reached a peak of $577bn. The latest figure is $415bn - the sharpest decline since the Great Depression. For a rapidly increasing number of companies, profit margins are toast.

Now accounting scandals are exposing the true state of US corporate profits. The New York Times commented on the Enron scandal: "Until Enron's implosion, many investors, both individual and professional, ignored accounting issues. Wall Street's conventional wisdom held that, while a few companies might be inflating their profits, the market as a whole was essentially honest. That is now in doubt."

"Maybe I'm naive," writes Morgan Stanley's Stephen Roach again, "but I must confess to being amazed at how little we know about the possibility of more Enrons. There can be no mistaking the broader excesses of corporate leverage in the system. While that doesn't guarantee that there will be more Enrons to come, it does speak of a business culture replete with risk."

"The same can be said of household sector leverage in the US," Roach continues. "Total consumer indebtedness currently stands at a record 73% of GDP. This, in my view, is an unmistakable legacy of the asset bubble. First stocks, now homes, American households have been unusually aggressive in borrowing to support lifestyles. In doing so, of course, they have depleted traditional saving balances and relied increasingly on readily available credit to extract newfound income from inflated asset values. The overhang of excess debt, however, remains a troubling aspect of the post-bubble hangover. Should income continue to weaken, or interest rates suddenly increase, it would be exceedingly difficult for the household sector at large to keep servicing this debt. The problem, of course, would be even more acute if the US were ever to experience a whiff of deflation. The debt-deflation trap is one of the most intractable dilemmas for any economy. Just ask Japan."

US companies are swamped with debt to the tune of 156% of GDP. That's 44% more than a decade ago. It's also bigger than the debt load Japan faced before their stock market bubble busted back in 1990. Back in 1989, one-time charges to earnings among the top 500 US companies totalled around $10bn. That was considered pretty big in those days. In 2001, extraordinary charges reached $360bn, or 36 times more than 1989! And some of the largest write-offs have been the prelude to major bankruptcies. In July 2001, Bethlehem Steel took a $1bn charge to earnings to write off the value of a deferred tax asset. Three months later, it filed for bankruptcy. Excite@Home, a provider of high-speed Internet access, took a $4.63bn charge against earnings at the end of 2000. Nine months later it was in bankruptcy court.

By the time Enron went belly-up late last year, its stock price had cratered from $90 to just $0.26 a share. Over $66bn in capital and almost every single penny invested by 58,920 investors was wiped out. It was the largest bankruptcy in US history. When Argentina announced in the last days of 2001 that it was officially defaulting on its $155bn in debts, it devastated the assets of hundreds of banks and tens of thousands of investors around the world. It was the largest debt default in the history of the world. Now, despite all this, Wall Street is saying that a recovery is around the corner.

At best, US GDP will grow less than 1% this year, if at all. Corporate profits will show some growth in the second half, but overall growth will be in the small single digits, if we see any. The US may "technically" be out of economic recession by the summer, but it won't feel like it. This recovery is more of an L than a V. I reckon world capitalism is entering a 10-15 year period of slower than trend growth. This will just be the first of the recessions we see in this decade.

So if the US is going to have a tepid and short-lived economic recovery characterised by low economic growth, rising unemployment and deflation, what does that mean for the world?

Well, nearly every nation is on the verge of a debt-and-deflation blow-up, threatening to drive its economy into the gutter. For every dollar of GDP, the 12 nations of the European Union have piled up $1.82 in public and private debt. Corporate profits are sinking. Industrial production has fallen 4.1% in a year. Unemployment in the Eurozone is 8.4% and headed for double digits.

The entire Japanese financial sector is on the edge of bankruptcy. The government says banks have Y43trn ($320bn) in non-performing loans on the books. That's four times the size of Enron. Private estimates put the figure closer Y237trn ($1.7trn). That's the equivalent of 20 Enrons! Company failures will close in on 20,000 cases this year, a level reached only once before, in 1984. "We are very afraid of Japan becoming another Argentina," says Taiichi Sakaiya, who was Japan's economics minister until recently.

At the same time, deflation rules in Japan. Consumer prices in Japan are dropping at 4% a year. "We are already in a deflationary spiral," says Takatoshi Ito, professor of economics at Hitotsubashi University. "This makes debtors' balance sheets much more difficult to manage so they join the ranks of non-performing-loan companies. They lay off workers further depressing aggregate demand, thus creating more deflation and so on."

The Nippon government has tried to spend its way out of the problem, Keynesian-style, to no avail. Instead, total government debt in Japan has risen 140% of GDP, the highest in the OECD and an astounding 465% of government revenues.

The only answer appears to be to let the Japanese currency collapse so that Japan can revive by selling more goods abroad by lowering their prices. But if the yen falls sharply, Japan will cause competitive devaluations from currencies throughout Asia. That could lead to further deflation pressures in the US and a prolonged stagnant world economy. The land of cheap electronics and Godzilla movies is leading the world to the brink of disaster.