"It is economics that decide, but only in the last analysis. Of more direct significance are those political-psychological processes that are now taking place in the German proletariat and which likewise have a logic of their own." (Leon Trotsky, The First Five Years of the Communist International, Introduction to the 1924 edition.)
Economic perspectives are of great importance but must not be taken in isolation from the general situation of world capitalism. Marxists are not economic determinists but dialectical materialists. A scientific perspective always takes all sides of the equation into account. A dialectical analysis deals with action, reaction and interaction of all factors, both economic and superstructural (political, military, diplomatic, etc.).
Economic crises play an important role, as we saw in Asia, Russia and Argentina in the crises of 1997-2001, which had serious social and political repercussions. But in the present situation of world capitalism, where contradictions are piling up at every level, any external shock can have profound consequences, whether it originates in the world economy or from other factors.
The economic cycle is important, but it does not exhaust the question of class consciousness or revolutionary perspectives. It is also a political question. For example, the effects of the instability in the Middle East, the invasions of Afghanistan and Iraq, have had a big political impact in Italy and Spain. Also in the USA there is a serious political crisis over Iraq. At the other end of the world Pakistan has been totally destabilized by events in Afghanistan.
The fall of the Aznar government in Spain was a sudden and radical turn in the situation that was rooted in the world crisis of capitalism but not directly related to economics. In the period in which we live sudden shocks of this sort are rooted in the general situation. This is equally applicable to economics, which remains the ultimately determining factor of world history.
The most decisive factor in current history is the crushing domination of the world economy, which was predicted long ago by Marx and is now a reality. No nation, no matter how strong, can resist the powerful magnetic pull of the world economy. Neither the USSR nor China - both mighty sub-continental economies - could resist this force, much less the pygmy states of Europe.
The fall of the Soviet Union and the subsequent incorporation of almost two billion people from India, China, and the former USSR into the world economy has given a powerful stimulus to world trade and acted as an oxygen balloon for capitalism. The intensification of the international division of labour, and the opening up of new markets and fields of investment has provided the opportunity for super-profits and plunder.
However, none of this means that the fundamental contradictions of capitalism have been overcome. They have merely been reproduced on a far vaster scale than at any time in history. The bourgeois economists, proceeding in an empirical manner, once more fell into the delusion that the economic cycle had been vanquished and that crises were a thing of the past. They wrote about the so-called New Economic Paradigm.
Now nobody talks about this any more. The Internet crisis of 2000 burst the bubble and although they recovered for a few years they are now all talking nervously about the prospects for a slowdown of the world economy or even a recession in 2008. The old confidence and "irrational exuberance" has vanished and has been replaced by a deep sense of anxiety.
Every economic cycle begins with a boom and ends in a slump. It is impossible, however, to be precise about the timing of the cycle. All the ingredients are present for a downward slide, particularly in the all-important US economy. The bursting of the technology bubble in 2000 led to a recession, but it was a relatively mild affair. But there is no guarantee that the next one will be the same. In economics the past is no guide to the future. The present crisis in the money markets has raised the prospect of a recession in the wider economy. The dollar, despite everything, remains the world's "reserve currency". A further fall in its value could destabilize the global economy.
For the last five years the world economy grew at an average of almost 5% a year, close to its fastest pace ever. For the advanced capitalist countries that growth has been only moderate at 2.8% p.a. It is the "emerging" economies that ramp the figures up with growth figures of 7.8%. China has been growing at 11% and India at 9%. This is a new phenomenon, but the world economy's prospects are still dependent on the performance of the advanced capitalist countries, particularly the USA.
Though growth figures of 5% a year are like those of the post-War boom era of 1948-73, we remain in a new and less optimistic age for capitalism. Moreover, there are clear indications that these levels of growth will not be maintained. The crisis in the summer of 2007, which began in the US sub-prime market and rapidly spread to other countries, was a warning that the boom in the USA is moving to its end. The chaos on world stock markets in the summer of 2007 was a manifestation of the general turbulence that is the most prominent feature of the present epoch.
The reason the US Federal Reserve's board decided to cut interest rates after the crisis of the summer of 2007 was to prevent "contagion" - that is to say, to prevent the crisis in the sub-prime sector from spreading to the rest of the economy and tipping the USA into a full-blown recession. This showed that the bourgeois see the risk of a recession looming, and it is fear of a recession that lies behind the present nervousness in money markets.
Finance and the real economy
The boom in the USA has largely been a consumer boom, fed by credit. As Marx explains, credit is a way of expanding the market beyond its natural confines. But this has its limits and these have now been reached. If the capitalists cannot find markets for their commodities, no surplus value will be realized and a crisis of overproduction will ensue.
The financial crisis of the summer of 2007 was a turning point. It may or may not signify that the critical point has been reached when the world economy begins a slide into recession. That is a possibility. But the laws governing the conduct of the money markets are not the same as those that govern the capitalist cycle. A stock market crisis may be the spark that ignites a general crisis, as happened in 1929. But if the underlying process is still on an upwards curve such a crisis can serve to squeeze out fictitious capital from the system, preparing the way for a further period (longer or shorter) of economic growth, as in 1987.
A fall in house prices will depress Americans' spending by much more than the stock market crisis in 2001. The immediate effect of the sub-prime crisis has been a fall in house prices and credit conditions. As a result, households can no longer borrow against rising house prices to support their spending. One widely watched index of consumer confidence fell for the third month in a row in October, to its lowest level in two years.
One of the main motor forces of the boom in the USA was the boom in construction. This was related to rising house prices. But the housing market is now in decline. Experts said that house prices could never fall in the USA. But they have fallen by 5% in the past 12 months. Residential investment has collapsed. A glut of unsold homes means that prices will drop much further.
This will affect the US economy in a number of ways. The falling demand caused by overproduction in the housing sector is causing a slump in the construction industry. This will have a knock-on effect in industrial sectors (steel, cement, etc.). On the other hand it will have a negative effect on credit and consumption, reducing demand, which must also have an effect on production.
If Americans slow their spending sharply, as is certain to happen, it will drag the economy down. Consumption in the USA has been the locomotive of growth since the 2001-2 recession. This growth has not been based on rising incomes, since workers' incomes have been stagnant in the United States for decades. It is based on a ‘wealth effect' of consumers borrowing against the rising price of their homes. This house price increase was, of course, a bubble. The bubble has now burst.
The rising price of oil (notwithstanding episodic fluctuations in crude prices) will further reduce purchasing power. It is for these objective reasons that "consumer confidence" has fallen sharply. If people have less money, credit is tight, prices are rising and you fear losing your job, it is natural that you will not rush to the shops to buy things. It cannot be long before the consumer boom in the USA exhausts itself. And if there is no market in which to sell things, this will sooner or later affect companies' profits, leading to a fall in productive investment.
Financial crises and credit squeezes are not the cause of economic crisis but its effect. However, dialectically, cause becomes effect and effect becomes cause. The capitalist cycle of boom and slump has more profound causes. As long as the capitalists are making profits from the extraction of surplus value, there is "trust" and "confidence" and credit is lax and easy to get. But when the cycle is reaching its limits and there are indications that the good times will not continue, this "confidence" evaporates.
Marx mentions in Capital that there are two sorts of financial crisis in capitalism. There are financial panics that are a direct reflection of crisis in the real economy, and serve to make the crisis worse. Then there are financial crises sparked off by apparently accidental factors that go on to have a backwash effect on the economy. It is not yet clear what effect the present credit crunch will have on the ‘real economy'. It is clear that the American economy, and with it the world, is due to dip into recession.
Financial crises are not the cause of depressions, which are the consequence of the anarchy of capitalist production. But they can certainly exacerbate crises by injecting huge quantities of fictitious capital into the system during the upswing. This happened in the period before the Great Crash of 1929 and it is happening on an even bigger scale now.
The increase in the cost of credit does not only affect consumers and house-owners, it also eats into the rate of profit of the capitalists. This can affect investment at a certain stage, especially if it is combined with rising prices of raw materials like oil.
The Fed contributed mightily to America's bubbles and its debt addiction. By holding rates too low for too long, it encouraged the credit boom, preparing the way for the present crisis. For much of the period from 2002 to early 2006, "real" rates were actually negative. People were punished for not taking on debt. Greenspan now says: "The human race has never found a way to confront bubbles". He admits he was caught off guard by the sub-prime madness that ensued. That is true of most of the economists and the bourgeoisie in general.
The levels of speculation and fictitious capital injected into the economy in the last period are like a poison that must be squeezed out. But in attempting to do this, they can easily puncture the bubble and drive the whole thing down. At this point creditors begin to demand repayment of debt and are no longer so keen to lend money. They demand a higher rate of interest. This cuts into the rate of profit and reduces demand. What was effect now becomes cause, driving the whole cycle down in an uncontrollable spiral.
At the peak of the boom there can be a crisis of the stock markets that serves to squeeze out the large quantities of fictitious capital that have been injected into the system during the upswing. This is now referred to as a "correction" and is supposed to have the same beneficial effects that bleeding (removing excess blood from a patient) was thought to have in the Middle Ages. But as we know, the loss of too much blood all at once can have disastrous consequences.
This is what both the British and American bourgeois are afraid of. That is why both the Fed and now (reluctantly) the Bank of England are injecting more inflation into the economy. By so doing they may postpone the evil day a little longer, but only at the cost of causing an even sharper and deeper collapse later on.
The inflation in the stock market was already staggering before the sub-prime crisis. The market capitalization of all US stocks grew from $5.3 trillion at the end of 1994 to $17.7 trillion at the end of 1999 to $35 trillion at the end of 2006, generating a geometric increase in price earnings ratios. This was not the result of an expansion of productive activity but because of a massive increase in fictitious capital: more dollars chasing the same number of securities.
The result of repeated interest rate cuts is a country living far beyond its means (the bankers call this moral hazard). From the biggest world creditor America has been transformed into the world's biggest debtor, with net external liabilities of $3,000bn. The savings rate has fallen below zero for the first time since the Depression. The US has been running a current account deficit of 6.5% of GDP for year after year, and yet the Fed looked complacently on as on America's shoppers merrily went on spending and accumulating ever-greater debts. As a result Asia, and particularly China, have accumulated huge reserves of currency at America's expense.
The recent crisis has revealed to what extent big US banks are involved in speculation. Particularly distasteful was the practice of the buying and selling of debt. During the recent boom, banks and finance houses were willing to offer credit and mortgages to many people who could not afford it. As long as interest rates were low (for a time even negative) this seemed like a good deal. Many poor working class people were tempted to buy houses on this basis. Moreover, the banks actually sold packages of this debt to other banks, which were eager to buy.
"Structured finance" is the term they use for a system allegedly designed to distribute capital more efficiently by allowing other market participants to fulfil a role that used to be considered the exclusive preserve of the banks. In practice, it is a gigantic swindle. Insecure mortgage loans and other liabilities were magically transformed into assets (securities) by so-called securitization. It was the financial equivalent of the alchemists who claimed to transform lead into gold. This system relies on investors to provide the funding for mortgage loans that are pooled and sold as collateralized debt obligations or CDOs.
This means that the bourgeois were buying and selling debt. Huge fortunes have been made out of this vast swindle. It was all very nice while it lasted. But all good things must come to an end. The panic in US credit markets was sparked off in May 2007 when Bear Stearns revealed huge losses in two of its hedge funds. One of the two funds was allowed to collapse, while the bank bailed the other out. By August 2007 new CDO sales plunged by 73%.
The economists say the sub-prime lending crisis in the USA was the cause. But as Hegel explained long ago, necessity expresses itself through accident: if it wasn't the sub-prime, it would have been something else. The sub-prime in the US was the weak link in the chain. As Greenspan admits: "If we had gotten past that and we hadn't broken the overall fever it would have been something different, but it would have happened one way or the other".
In its youth the bourgeoisie, driven by greed for profit and insatiable thirst for surplus value (the unpaid labour of the working class), developed the productive forces. But in the period of its senile decay it plays no progressive role whatsoever. Marx explained that the real ideal of the bourgeois is to make money from money, without having any need to resort to the painful process of production. The bourgeoisie has now been infected with a disease that has no known cure.
In the past capitalism played a relatively progressive role in developing the productive forces and thus creating the material base for a new society - socialism. But today this is no longer the case. With the exception of China (and some other Asian economies) the bourgeoisie has not been developing the productive forces. This is a symptom of the terminal sickness of capitalism.
Now they are close to realizing the old dream of making money from money. In Britain, the US and many other countries there has been a steep decline of manufacturing and huge rise of the parasitic finance and services sector. The so-called private equity firms are involved in a speculative orgy of takeovers that do not entail any productive activity but rather, closures, sackings and the hollowing out of industry for the sake of profiteering.
The sums spent on so-called leveraged buy-outs are enormous. For $32.6 billion in cash and the transfer of $15.9 billion in debt, Bell Canada Enterprises (BCE), owner of the largest telephone company in Canada, has agreed to be taken over by an Ontario pension fund and two American private equity firms. If it is completed, the takeover would not only be the largest in Canada's history but the biggest leveraged buyout anywhere. It puts into the shade the news in Britain that a private-equity firm may buy Virgin Media, a pay-TV, internet and telephony group, for a mere $11 billion or so.
The entire banking system is now up to its neck in fraud and swindles of all sorts. This was always the case. In a boom, when production is in full swing and there is plenty of money to be made there is a frantic scramble for credit. An excess of money and credit at this stage in the economic cycle plays a positive role in oiling the system and providing much-needed liquidity.
There is always an element of speculation in this, as Marx explains. When everybody is making money, nobody is concerned about looking too closely at where the money is coming from - or even if it is real money at all. The English economist Gilbart, as early as 1834 wrote:
"Whatever gives facilities to trade gives facilities to speculation. Trade and speculation are in some cases so nearly allied, that it is impossible to say at what precise point trade ends and speculation begins."
In Marx's day it was estimated that possibly
"nine-tenths of all the deposits in the United Kingdom may have no existence beyond their record in the books of the bankers who are respectively accountable for them."(The Currency Theory Reviewed, etc., pp. 62-63)
In this merry carnival of moneymaking everybody is too intoxicated with the spectre of enrichment to worry about the fine print. "Eat, drink and be merry, for tomorrow we die!" That is the motto of the bourgeoisie in a period of boom. However, as the boom runs out of steam, these fraudulent schemes and swindles are being exposed. Bank failures are inevitable in the future.
The only difference between the present period and the past is the scale of the orgy of swindling and speculation. In the recent period vast quantities of fictitious capital have been injected into the system through the stock exchange boom, the housing bubble and the endless extension of credit and debt to unheard-of levels. This is merely one reflection of the senile decay of capitalism.
Bankruptcy of bourgeois economics
capitalism crises are inevitable. If you accept capitalism then you must accept
the laws of capitalism: that is to say, you must accept booms and slumps (now
referred to in polite circles as "corrections"). The reformists and
Keynesians who advocate tinkering with the system to "smooth out the
cycle" by state intervention, deficit financing, pump-priming and the
like, may succeed in postponing a slump for a time, but only at the cost of
preparing an even more serious crisis in the future.
The bourgeois economists are incapable of understanding crises, which are an inescapable result of capitalism. They are perplexed and at a loss to explain what is happening. All their predictions have proved worthless. That is not new. In 1929, days after the stock market crash, the Harvard Economic Society reassured its subscribers: "A severe depression is outside the range of probability". In a survey in March 2001, 95% of American economists said there would not be a recession, even though a recession had already started.
The general opinion of the bourgeois economists is that central bankers and governments can manipulate the economy so that slumps can be avoided. Most of them agree that a repetition of the crash of 1929 and the Great Depression is impossible. They assume that because for the last twenty or so years there have only been two recessions and both of them were relatively mild, that they have finally managed to find a magic recipe for avoiding slumps as in the past. This is an entirely erroneous assumption. In fact every economic cycle has its own peculiarities. These have to be sought in the specific factors of capitalist development in time and place. The mildness of recent recessions is no indicator of a new era for capitalism.
The Northern Rock crisis in Britain showed precisely that all the instruments for solving a crisis and avoiding panic are useless. In the moment of truth people were gripped by a herd instinct. They moved en masse like a herd of wildebeest frightened into a stampede by the mere scent of a lion. Many commentators have spoken scornfully about this "irrational" conduct. If it was irrational, then it is the same irrationality that is the heart and soul of the capitalist market economy.
The government and the Bank of England were powerless either to prevent a major banking crisis or to calm the nerves of depositors and investors. In the end they only succeeded in preventing a total collapse by giving a promise of unlimited funds to the bankers, paid for out of the taxpayers' pockets. This has temporarily halted the downward slide, but only at the cost of preparing the way for even steeper falls in the future.
For the bourgeois, crises (and economics in general) are always explained in subjective terms. In the same way as all consumers are assumed to possess a universal knowledge of commodities, so all crises are caused either by the mistaken decisions of governments or central banks, or, as in the latest version of former chairman of the US Federal Reserve, Alan Greenspan, human nature:
"Human nature moves from euphoria to fear," he informs us. "It is this sense of fear that modern economists are failing to take account of when they make forecasts, he adds. "The old habit of boom-and-bust cycles has not died in recent years - it has merely been dormant."
Today, the bourgeois are trying to console themselves with optimistic predictions. These remind one of the incantations of a primitive shaman who tries to make it rain by constant chanting (the governor of Arizona recently did just that). They operate on the supposition that booms and slumps are caused by subjective psychological factors ("confidence") on the part of consumers or investors. In reality the capitalist boom-slump cycle is determined by objective factors that are outside the control of governments and central bankers.
The "confidence" of investors is based on very real material considerations. As long as the US economy was going forward, even though the fundamentals were unsound, the bourgeois of other countries were prepared to invest in it. They paid no attention to the colossal levels of debt and the huge deficits, including a current account deficit of around $800 billion a year. The US needs to raise at least $70 billion every month just to cover this shortfall.
Most economists do not forecast a recession in America, but the facts suggest that the United States is probably heading for one. US GDP grew by 3.9%, at an annual rate, in the third quarter of 2007. But there are signs that the economy could stall in 2008, with output and jobs shrinking. Most commentators agree that the US economy will grow at less than 2% next year. This takes no account of the effects of the sub-prime mortgage panic. Greenspan, the Organisation for Economic Co-operation and Development (OECD) and others have suggested that it is fifty-fifty whether the American economy goes into recession in 2008.
Instead of raising interest rates to combat inflation, the Federal Reserve gave financial markets what they wanted: it cut the federal funds rate. This action, irresponsible from a capitalist point of view, was dictated by fear of the social and political effects of a recession. They clearly judged that there was such a risk of recession that it warranted cheaper money.
To please Wall Street, the central bankers are underestimating the dangers from inflation, although there are plenty of warning signals. Inflation is increasing, a fact not adequately reflected in government statistics. In 2000, when Bush took office, gold was $273 per ounce, oil was $22 per barrel and the euro was worth $0.87 per dollar. Currently, gold is over $700 per ounce, oil is over $80 per barrel, and the euro is nearly $1.50 per dollar.[*] Some economists are talking about oil at $125 per barrel by next spring. The recent cut in interest rates will pour fuel on the flames.
The benign core inflation figures may be understating price pressures, particularly given the falling dollar and record oil prices. By its actions, The Fed has confirmed the belief of the financial markets that investors' expectations determine the central bankers' decisions: if Wall Street demands a rate cut, the Fed will deliver.
There has been relative stability of inflation over the past 15 years. This is due to a combination of globalization and the entry into the labour force of millions of low-paid workers that exercises a downward pressure on wages and prices. The capitalists and economists have become blasé about this. As a result the central banks have allowed monetary policy to become extremely lax, building up problems for the future in the form of an even bigger credit bubble.
In the future all the chickens will come home to roost. We will see a global crisis of overproduction aggravated by a sharp contraction of credit and a collapse of house and stock market prices. All the factors that drove the market up will combine to drive it down.
Consequences for the world economy
Walker, comptroller general of the USA
has been drawing parallels between the crisis facing the USA and the end of the Roman
Empire. He has warned there are "striking similarities" between America's current situation and the factors that
brought down Rome,
including "declining moral values and political civility at home, an
over-confident and over-extended military in foreign lands and fiscal
irresponsibility by the central government". This tells us a lot about the
current psychology of the strategists of Capital.
An American recession must have serious consequences for the rest of the world.
The bourgeois economists try to argue that the economies of Europe and Japan, which grew strongly in the third quarter of 2007, will pull the world out of recession. But many economists predict that this growth will not be maintained. Even if they maintain some degree of growth, it will not be sufficient to compensate for a recession in the American market. The falling dollar will hurt exporters in both Europe and Japan, pushing up their currencies and making their goods less competitive. Moreover, in Europe the crisis in the housing sector mirrors that of the USA, with similar results. Some European banks have been damaged by America's sub-prime crisis.
This is the other face of globalization. The argument that the rest of the world could remain aloof from a US recession is childish in the extreme and contradicts everything the economists said in the past about globalization. A crisis in any major sector of the world economy must affect every other sector. That was clearly shown by the crisis of 1997, which began in Asia and rapidly spread to Turkey, Poland, Hungary, Russia, Brazil and Argentina. The same thing can happen again at any time.
Faced with the clear evidence of an impending recession in the USA, the economists are placing all their hopes on emerging economies. This is ironical in the extreme. A decade ago, the thought that the entire world economy much depended on these crisis-prone places would have terrified the Americans and Europeans. Yet now they look to China and the rest of Asia for salvation. This fact is a graphic expression of the impasse of capitalism and the growing desperation of the bourgeoisie on a world scale.
Prospects for Asia
Prospects for the world economy are dependent on continuing strong growth in Asia. Commentators hope for a de-coupling of economic growth from the demand of American consumers that they know will fade away next year.
On the surface there might appear to be grounds for this optimism. The Asian economies recovered from the crisis of 1997-2000 and now their annual growth rate has surged to around 7%. In 2007 they contributed no less than half of the globe's GDP growth, measured at market exchange rates, over three times as much as America. However, depending on "emerging markets" the capitalists are leaning on a broken reed. These economies are heavily dependent on exports and the growth of world trade. Most are dependent on the US market, which has been sucking in their exports at a dizzying rate. That was because the USA was living beyond its means. But that phase is already past.
The relative growth of the importance of these countries in the world market is not so much an expression of their strength (except China) but of America's weakness. America's importance as an engine of global growth has declined. Since 2000 its share of world imports has dropped from 19% to 14%. Emerging economies will not grow fast enough to make up for the whole of a fall in America's output. Most of them will slow in the next period. A recession in America would reduce emerging economies' exports.
It is true that domestic demand in emerging economies has grown. In the first half of 2007 the increase in consumer spending (in actual dollar terms) in China and India added more to global GDP growth than that in America.
It is also true that the Japanese economy is reviving. Big Japanese manufacturers now report insufficient production capacity for the first time since 1991 and plan to increase capital spending by 17% in the year to March.
Although America takes only 23% of Japan's exports, down from almost 40% in the late 1980s, this understates Japan's total exposure. Japanese firms (like those in South Korea and Taiwan) send a lot of components to China for assembly into goods, which are then exported to America as finished products. On top of this, if a sinking American economy pulled the dollar even further down with it, this would further squeeze Asian exporters. Moreover, Japan has a massive public debt and therefore is not in a position to "spend its way out of a crisis" by deficit financing. Taiwan, where domestic demand is weak, is also constrained by a large budget deficit.
There are therefore no serious grounds for believing that Asian economies can "decouple" from an American downturn. Although China's exports to America have fallen from 34% of its total exports in 1999 to 25% now (adjusting for the re-exports which are made through Hong Kong), a sharp fall in demand in the USA would still have serious consequences for China.
Slower American growth will hurt China, India and Japan and it will hit the smaller Asian economies, such as Singapore, Taiwan and Hong Kong, that are more dependent on foreign demand, still harder. But all Asia is interconnected and the crash of 1997 showed how once a crisis starts it will leapfrog from one country to another.
Ten years ago, on July 2nd 1997, Thailand's central bank floated the baht after failing to protect the currency from speculative attack. The move triggered a financial and economic collapse that quickly spread to other economies in the region, causing GDP growth rates to contract precipitously, bankrupting companies that had overexposed themselves to foreign-currency risk, and ultimately necessitating costly and politically humiliating IMF-led bailouts in the worst-affected countries. That precipitated the Asian financial crisis of 1997-98. They are now congratulating themselves on coming out of that crisis but it can easily be repeated on an even bigger scale.
The Chinese economy has been roaring ahead at eleven percent per annum, although it has recently slowed to "only" ten percent. Unlike the USA, which has experienced a consumer boom based on debt, China has seen a colossal development of the productive forces. As Marxists, we welcome this because it serves to develop and strengthen the mighty Chinese proletariat.
China overtook the USA in 2004 as an exporter of hi-tech goods. It is estimated that by 2015 China will have more scientists and engineers than the rest of the world put together. By 2020, if present trends are maintained, it will be spending more on research and development than the EU. It is already the biggest market for integrated circuits in the world. These enter into the production of laptops, telephones, refrigerators, air conditioners, computers, etc.
The world bourgeoisie has derived considerable benefits from its involvement in China, which occupied the position that Russia was intended to have played after the collapse of Stalinism. They invested massively in new plant and machinery and thus created a powerful modern industry in China, where the advantages of cheap and plentiful labour combined with the latest technology imported from the USA, Europe and Japan to produce a formidable productive capacity. This has big implications for the world economy as does the launching of Chinese satellites, which has both an economic and a military significance.
The problem is that all these modern factories in Guandong and Shanghai would inevitably produce a mass of commodities - televisions, computers, DVDs, mobile phones, microchips and now cars - that have to find a market. It is true that the extraction of surplus value takes place in the workplace, but whether the capitalists can realize the surplus value extracted from the labour of the workers depends on their ability to sell the commodities produced.
It is true that the Chinese domestic market has expanded considerably in recent years. Yet China remains heavily dependent on world markets, and above all the US market. A sharp contraction of demand in the USA would hit the Chinese economy hard. This would have a severe knock-on effect in places like Taiwan, Korea and the rest of Asia, which exports goods to China where they can be cheaply assembled and then re-exported to the USA and Europe.
In participating in world markets China has benefited enormously, but it is also creating new contradictions, importing problems like inflation that did not previously exist. Inflation is now around 6.5%, a very high figure for China. There have been strikes protesting low wages. Recently an increase in oil prices sparked off rioting. The government, alarmed, instructed the state owned oil companies to bring more oil to market but, in the words of The Economist, the companies are "slaves to the market".
In the long run China will be an economic power to match the USA, but predictions that this is imminent are mistaken. The bourgeois economists made the same mistake in relation to Japan in the 1980s on the basis of the same false method of extrapolating the future on past trends. The Japanese economy collapsed and was in a state of recession for over ten years from which it is only now painfully extracting itself. The same can happen to China.
The strength of China is uneven. It has many weaknesses. Chinese iron and steel foundries can only satisfy a small percentage of demand. The majority of the population still lives in conditions of extreme poverty in the rural areas and have a very small purchasing power. There are at least 150 million unemployed in the cities. The Economist recently remarked: "China is where electronic goods are made, not where much of the value is added."
Let us take one example. The Apple iPod 30-gigabyte video version is made in China by a Taiwanese company. It has no fewer than 424 parts and costs $224 (in 2005). Out of these 424 parts, 300 cost one cent or less. But the display module that costs $30 was made in Japan. Chinese labour that assembled this product added only $3.70 to its value. As for the internal market, this is restricted by the low living standards of the great majority. Only about 15% of the electronic and information goods produced in China are sold on the home market.
Chinese industry is producing vast quantities of goods every year. But in the end the contradiction remains: the goods have to be sold. A recession in the all-important US market will hit China's exports hard - not only the direct exports to the USA, but the exports and imports to and from the rest of Asia.
Stephen Roach has estimated that since 1980 the export share of growth has gone from 20% to 45%. Over the same period the share of domestic consumption in growth has fallen from 67% to less than 50% today. The Chinese economy might maintain a rate of growth of 8% without the stimulus of exports to the USA. But it could not take over as the engine of world economic growth. The United States remains decisive in that respect.
The decline of the dollar
At the peak of a boom one expects to see rising production and employment, rising profits and wages and also rising prices. The present boom has been characterized by stagnant wages, record profits and relatively low inflation. This is mainly due to the effects of globalization, with huge numbers of low paid workers entering the world labour markets and also producing goods at very low prices that enter world markets, either directly as commodities, or indirectly as component parts (of cars, televisions, computers, etc.).
This intensified participation in world trade has boosted production, opened new markets and provided new and profitable fields of investment. It has also exercised a downwards pressure on wages and prices, keeping inflation lower than could be expected at this stage of the cycle. This, in turn, has permitted the bankers to keep a low level of interest rates, thus fuelling a credit boom. It has also produced the biggest speculative bubble in history: the housing boom in the USA and Europe, which has spread to every other continent. This is an element of colossal instability.
This has now reached its limits. Prices are starting to rise, particularly oil prices, which have risen mainly because of strong demand in China and other emerging economies. They have accounted for as much as four-fifths of the total increase in oil consumption in the past five years. In past American recessions the oil price usually fell. This time it may hold up, which will further reduce demand in the USA and Europe. The world economy will be faced with a combination of inflation and economic slowdown, or stagflation, as it used to be called.
The US bourgeois tried to get out of a crisis by allowing the dollar to fall. In theory a weak dollar will boost exports, and lift the US economy at the expense of its rivals. But exports now only account for 12% of US GDP. This is too small to make up for a weakening of consumer spending, which accounts for 70% of GDP. Interest rate cuts will be at best a temporary palliative. They will not revive the housing market. That carnival is over. The banks, having burnt their fingers, are tightening lending standards and the housing inventory is larger than any time since records began. The resulting fall in house prices will affect consumer spending, bringing about a contraction of demand. The real effect of the interest cut will be an increase in inflation.
The dollar has continued to fall to the level of $1.50 to the euro. Without enormous purchases by central banks in Asia it would fall still further. This support cannot be maintained indefinitely. The US economy is sick and completely unsound. If any other country were to show the same level of private, public and corporate debt, or have a similar current account deficit, the World Bank and IMF would be knocking at the door demanding cuts and austerity. Since these organisms of international capitalism are controlled by Washington, this will not happen. But sooner or later the "invisible hand of the market" will extract its revenge on profligate US capitalism.
In reality the falling dollar amounts to the biggest default in history. It is a gigantic fraud, which has already wiped far more off the value of foreigners' assets than any emerging market has ever done. As the reality of the weakening of America's economic power gradually dawns on international investors, they will ask why they are holding the lion's share of their wealth in dollars.
China and others are already moving out of the American currency. Asian and Middle Eastern countries with currencies linked to the dollar are facing rising inflation, but falling American interest rates make it harder to tighten their own monetary policy. They will eventually be forced to let their currencies rise against the enfeebled dollar. That means they will buy fewer dollars.
The US economy is defying the laws of gravity. It is so unsound that it is unthinkable that the present situation should last for long. Eventually foreigners will worry that the dollars and bonds they are holding will not be worth the paper they are written on. And why should they want to lend money at low rates in a currency that is declining in value when they can take these same funds and lend them at high rates in a currency that is gaining in value?
Slowdown or slump?
Even in the most optimistic scenario for capitalism, the growth of the world economy will slow. In the worst case scenario we will be facing a global slump. Emerging economies, especially in Asia, have large foreign-exchange reserves-no less than three-quarters of the global total. This is mainly because of the huge US deficit. At present China and other Asian countries hold huge stocks of dollars and US bonds. It is not in their interest to provoke an economic collapse in the USA, and the Americans are banking on this. But there are limits to all things. Sooner or later the unsound nature of the US economy will provoke an international run on the dollar. Lower interest rates will not bring money back into the markets, but they will further undermine the dollar.
By lowering interest rates the Federal Reserve is entering onto very dangerous ground. The rest of the world will not be willing forever to finance the United States' tendency to consume far more than it produces. There are already signs of this. Paradoxically, it seems that the first ones to panic are the Saudis, the main allies of Washington in the Arab World, who have huge investments in the USA. Saudi Arabia has refused to cut interest rates in step with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg. This move risks setting off a stampede out of the dollar across the Middle East.
For its part, the Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation. Henry Paulson, the US Treasury Secretary, said any such sanctions would undermine American authority and "could trigger a global cycle of protectionist legislation". This indicates the real dangers that now face the USA and the whole world economy. What really turned the slump of 1929 into the Great Depression that lasted ten years till the outbreak of the Second World War was the protectionism, trade wars and competitive devaluations that undermined world trade.
The falling dollar puts pressure on the EU, which has seen its competitive position worsen, not only against the USA but also against China and other Asian countries whose currencies are linked to the dollar and are therefore also falling. This has led to howls of protest from the European capitalists, who are threatening retaliation against China unless it takes action to revalue the yuan. All this is an anticipation of more serious protectionist tendencies that will inevitably gather force with the onset of recession.
Future shocks inevitable
The economists like to present the weakening of the dollar as a necessary "correction". They say the same thing about the falling house prices, the collapse of the US sub-prime market, the crisis of Northern Rock in Britain and so on. All are presented as "corrections", which will sooner or later sort themselves out. In fact, these are symptoms, like the symptoms of an underlying disease or the tremors that precede an earthquake.
An earthquake can also be presented as a necessary "correction", which merely re-adjusts the earth's crust. Eventually, it all settles down and life goes on as before. But this comforting analysis leaves out of account the terrible trail of damage caused by the earthquake: the villages wiped off the face of the earth, the trees uprooted, the crops destroyed, the thousands killed and injured. Moreover, normal life is not so easily restored after every earthquake. Some can be so devastating and leave such a trail of destruction that the effects can be felt for many years.
The crisis has not been avoided. It is only just beginning. From now on, after years of low inflation and low interest rates and easy credit, we will see a tightening of credit and rising interest rates. This will have a number of effects. On the one hand, dearer and scarcer credit will reduce demand by cutting into the purchasing power of consumers, both in Europe and the USA. On the other hand, together with the inevitable rise in inflation (oil prices recently hit a new high), it will negatively affect the profits of the capitalists, which will lead to a slowing of production, and eventually a recession.
To begin with, a fall in the profits of the banks must lead to job cuts in the financial sector, which must affect property prices. This will lead to a further contraction of demand, unemployment and bankruptcies in the construction industry. This in turn will affect demand for steel, cement, bricks and other commodities, leading to a further downturn in industry. The dizzying rise of share prices and house prices is preparing the way for an equally steep fall in the future. There will be repossessions, losses, bankruptcies and defaults, despite the actions of the Fed.
The investment banks are hoping that cuts in interest rates will send the stock market soaring again. But a cut in the interest rate does not solve the fundamental problems. It does not eliminate insolvency among homeowners, mortgage lenders, hedge funds and banks. Far from solving the problem, it will ultimately make it worse.
The US market is already awash with liquidity as the result of the antics of Alan Greenspan, which produced the present housing bubble - the biggest speculative boom in history. By reducing the cost of borrowing, the Fed is only creating a further extension of credit and indebtedness at all levels. It will prolong and exacerbate the housing and the credit bubbles.
Already in the USA over a million homes are in danger of or have already been repossessed. So millions of poor Americans find themselves homeless, while millions of others are struggling to pay the mortgages on homes that are no longer worth as much as they paid for them. One writer recently predicted the emergence of a sub-class of mortgage slaves in the USA.
The American worker is now producing on average thirty percent more now than ten years ago, yet wages have stagnated for the last six years. Rising prices signify a cut in real wages. The same is true for pensioners and others on a fixed income. Even without a recession the American people will see an erosion of their standard of living. Many poor Americans are already struggling just to make ends meet. Now millions will be threatened with the loss of their jobs and homes. This will eventually provoke an upsurge in strikes and class conflict such as the USA has not seen since the 1930s.
The international crisis that began with the crisis in Asian money markets in 1997 caused a wave of turbulence that spread across the entire world. It was not confined to economics but had profound political consequences in places like Russia and particularly Latin America. The after-shocks of this crisis caused the collapse of the Argentine economy in 2001, which had revolutionary consequences. The same thing can happen again.
Even without a slump, the best that the capitalists can hope for is a period of slower growth, which will create new social and political tensions. The present boom has nothing in common with the economic upswing of 1948-73. That was characterized (at least in the developed capitalist countries of Western Europe, the USA and Japan) by full employment, rising living standards, reforms and an amelioration of the class struggle. That is not the case now.
Pressure on workers
This is a boom at the expense of the working class. Companies have benefited from an expansion in the global labour supply, prompted by the integration of India and China into the global economy, and that this has kept the lid on wage claims. Everywhere wages have been kept down and profits have risen at the expense of wages.
Eventually, however, demand must suffer from such a scenario. So far, consumers have managed to keep financing their lifestyles by borrowing. But this is bread today and hunger tomorrow. Eventually, it must lead to a global crisis of over-production. The relative weakness of consumer stocks is making investors move into commodities like metals that used to be considered "old fashioned".
The boom was based on an intensification of exploitation, cuts and attacks on workers' rights. Everywhere we see the same phenomena. High rates of growth and rising profits are not expressed in rising living standards and reforms, but constant and remorseless pressure on the workers and systematic plunder of the underdeveloped world. Inequality has reached levels unprecedented in recent times. The richest 2% of adults in the world own more than half of all household wealth, according to a new study by a United Nations research institute.
The report, from the World Institute for Development Economics Research at the UN University, points out that the poorer half of the world's population own barely 1% of global wealth. This is a striking confirmation of what Marx wrote in Capital: "Accumulation of wealth at one pole is, therefore, at the same time accumulation of misery, agony of toil, slavery, ignorance, brutality, moral degradation, at the opposite pole."
The rich get ever richer and the poorer, poorer. The grandiose promises to make poverty history stand exposed as an empty slogan. According to the figures of the UN, 1.8 billion people are living in poverty. Of these, eight million die every year because they do not have enough money to stay alive. Millions of children die each year from preventable diseases like diarrhoea caused by the lack of clean drinking water.
In Latin America there have been high rates of growth in the last period. This has led to a huge rise in profits and obscene wealth at one end of society and rising poverty, exploitation and despair at the other extreme - just as Marx predicted. The richest man in the world is not the American Bill Gates but the Mexican Carlos Slim. Everywhere in the world we see the same extreme inequality and polarization between the classes. In Latin America this is producing revolutionary explosions. But Latin America only shows the future of the rest of the world as in a mirror. This is the main thing to be kept in mind.
In the next period a deep slump is not ruled out. All the conditions for this are maturing on a world scale. Such a development might have the immediate effect of paralyzing the class. Under conditions of mass unemployment economic strikes make little sense. The bosses would just close the factories. However, this can lead to a wave of factory occupations. This has already occurred not only in Latin America but in Canada, even before a recession.
Above all, a slump will have the effect of transforming the psychology of the masses. Workers will begin to draw revolutionary conclusions and this will find an expression on the political plane and within the mass organizations of the class.
Economics is not a precise science and it is not possible to be precise about timing. All we can do is to explain the fundamental tendencies and arm and prepare the cadres of Marxism. The main thing to bear in mind is that sudden shocks and crises are implicit in the whole situation. A crisis can erupt at any time in any part of the globe without warning, like a thunderbolt from a clear blue sky. The important thing is that we are prepared, that we are able to explain these events to the advanced workers and youth and that we take advantage of every opportunity that presents itself to build the Marxist tendency.
Our purpose is to analyze the general crisis of capitalism in order to intervene. And in order to intervene we require the forces. We must build those forces. In the past we were often mostly spectators. For example during the Allende period in Chile we had an absolutely correct analysis but we were only onlookers, not active participants in events. Today in Pakistan we are a force. In Venezuela we have a growing force that has built important points of support. In Mexico we have an outstanding group that is intervening very effectively in the mass movement. This affects the whole nature of our discussions.
[*] These figures are from when the document was first drafted (November 2007). Since then, oil has reached $100 and gold $900. We can expect them to rise further in the next few months.
- World Perspectives 2008 draft - Part Two (January 15, 2008)
- Alan Woods on world perspectives 2008 – Part One by Alan Woods (January 13, 2008)
- Alan Woods on world perspectives 2008 – Part Two by Alan Woods (January 13, 2008)
- Audio version of Alan Woods' speech