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?
Sub-prime world
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
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?
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.
China
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.
Oil
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.
