World Economy: Back from the Edge of Depression but facing Stagnation
As the world economy faces up to fresh turmoil Raphie de Santos looks at why tough times lie ahead and what the working class needs to do.
The financial crisis which started nearly three years ago rooted in loans to very poor Americans that led to the worst Global recession since the 1930s depression is far from over. Only a massive bailout out amounting to several trillions of dollars at the expense of the tax payer stopped the global economy from going into a depression – a decline of 10% wealth accumulated over several years.
We saw that post the current peak in the financial crisis after Lehmans went bankrupt that the decline in industrial production, trade and stock markets matched or exceeded their equivalent falls after the 1929 Wall Street crash which led to the great depression₁.
But to avoid a second great depression global governments put up $10 trillion of borrowed money to save the banking system and prop up private housing. Additional trillions have been spent on the car industries and on infrastructure projects. About $2 trillion of the $10 trillion has been spent up front; the rest represents guarantees against future possible losses.
This $2 trillion is the biggest contributor to the deficits that governments have been running up for the last three years. The other significant contributor to this deficit has been the recession that was induced by the crisis of the financial system that manifested itself in the real economy by the drying up of credit to individuals and corporations. The recession has led to reduced tax revenues and increased social security expenditure on the tens of millions of people who have been made unemployed.
Governments essentially bailed out global financial capitalism at our expense and as the International Monetary Fund have stated there will be ten years of severe cuts in public services and rises in taxes to pay for it. The financial sector is still sitting on $600 trillion of unregulated derivatives and hundreds of trillions of dollars of loans to individuals, corporations and governments which are still turning sour. This means that the banks will hang on to their capital (cash) and not lend it to individuals, corporations or governments. The Chinese have spent trillions trying to keep their economy afloat but have only succeeded in creating a property and stock market bubble. Governments around the world having averted the depression have decided to withdraw the stimulus programmes. In the developed western economies that is because the cost of them is too great in terms of the further cuts to spending and rises in taxes that would be required to sustain it and their doubts about being able to borrow on the financial markets. In China the concern is about inflation and the bubble that their stimulus spending has created.
We will take a survey of the key epicentres of the global economy: the global financial system; and the US, Chinese, Japanese, and European economies with a focus on the implications for the UK economy. Our conclusion is that having averted a depression we will endure a decade long slump of stagnation or slow negative growth.
The Financial System
|US Government Agencies`
(Freddie Mae and Fanny Mac)
The immediate cause of this great economic crisis that we are living through was a crisis in the financial system and the banking system in particular. We have written about this relationship extensively in the past₂ and what we want to do here is examine the current state of that system to see if it will be an aid or lead brick around the global economy. Table one shows how the cumulative current losses are spread over the financial sector. All the numbers are in billions of US dollars.
Bloomberg have estimated that an incredible £1.7 trillion US dollars has been lost across the financial sector since the onset of the credit crunch in August 2007 till the start of 2010. The media would have us believe that this money was all lost in transactions involving sub-prime debt (CDOs) and derivatives such as credit default swaps (CDS). If you break the losses down by category as Bloomberg have done, a very different picture emerges as table 2 below shows. Again the numbers are in billions of US dollars
|1 Mortgages/Consumer debt/CDOs||613|
|2 Corporate loans/commercial
mortgage backed loans/ Trading losses
The overwhelmingly majority have come from credit exposure to the real economy – trading losses amount to less than 2% of the total losses. We can conclude from this that there was massive bubble of credit which kept the economy going from individuals to large corporations. The derivatives and CDOs were the last layer of this giant credit bubble as other more conventional channels of creating credit reached full capacity even with the very liberal lending practices that existed.
The bulk of this credit bubble is still out there and a further downturn in property values and a prolonged recession or stagnation will mean that these losses will start to mount up again. This means two things ; first that banks and other institutions will hang on to what liquid cash they have (capital) to cover themselves for further losses and second governments will almost certainly have to step in again with further bailouts of billions of dollars.
As the bank of International Settlements have estimated, sitting on top of this mountain of credit sits a time bomb waiting to go off again: 600 trillion notional of unregulated derivatives. This has actually increased by 50 trillion since the Lehmans bankruptcy. The value of this derivative stockpile is driven by factors such as interest rates, stock market and currency movements and expectations about the economy. At the height of the Lehmans crisis it was worth about 35 trillion dollars this fell to 20 trillion at the start of 2010 as the financial markets calmed down. This 20 trillion figure means that a whole group of institutions own another group 20 trillion. The value of this derivative mountain has moved up over the last two months as financial markets start to move around dramatically – no official figures are yet available. This means that if we see even sharper market movements then some institutions will start to experience huge derivative losses similar to October 2008. It was these losses that pushed Lehmans, AIG and effectively Merrill Lynch into bankruptcy and caused the complete freezing of credit that led to such a deep recession. A similar scenario could quite easily unfold again.
The Global Economy
Table three shows a summary of the global economy in early June 2010. What the table does not show are that there are significant imbalances in the world economy between countries export and imports. Some countries are running a surplus – China and Germany for example while others are running deficit – notably the US and Britain.
This is actually the opposite situation of what the US wants. The strength of the US dollar is forcing it to be a net importer of goods and the surplus economies are financing the deficit. But as we have seen the US financial system is still crippled by “toxic” loans and credit to US consumers is still being fed through at very low levels. Also, unemployment and particularly long-term unemployment remains at very high levels. This is the so called “jobless” recovery. But the recovery itself is very moderate and the US hope of it becoming a net exporter is not happening while at the same time there is not the consumer credit to drive a sustained export led recoveries in countries such China. We see this in both ways by the still very low levels of “real” jobs being created in the US and falls in US retail sales in May. The US remains the largest economy and its dual problems will not help itself or the countries who have been net exporters. The net effect will to act as a drag on world economy as a whole
China has survived this economic recession by the biggest application of Keynesian polices on record. While its exports declined in 2008 and 2009 on the back of the drying up of demand for its products in its main export markets – millions were made unemployed in Chinese manufacturing , 20 million alone amongst Chinese migrant workers – it pumped trillions of dollars into own economy. It has done this in two ways: first it allocated $650 billion to infrastructure projects such as road building; and second it pumped $1.5 trillion into the banking system for loans to individuals and companies. The Chinese government effectively created an import recovery for its economy. This had the effect of sucking in resources – mainly coal and iron ore – which benefited countries such as Australia and Canada and this helped pull their economies out of recession together with their less polluted financial systems and machinery from Japan and Germany. But the massive amount of credit has created a dual bubble in the stock market and the house building market. The stock market bubble has now partly burst and while property prices continue to rise sales have declined and there are recent reports of towns of unoccupied new build homes₃. The bubble has created inflation which the Chinese government have tried to quell by raising interest rates.
At the same time Chinese manufacturing exports have recovered in late 2009 and 2010 but to not the pre-recession levels. They have been the major winners of the modest upturn in world consumer demand. China has much lower wage rates, higher levels of exploitation and larger amounts of human labour in the production process. This makes the rate of profit much higher for Chinese production than in the mature developed economies of the west. At the same time the Chinese government has kept its currency artificially low giving it a further competitive advantage over the US in particular.
But if as we believe demand will fall in credit and unemployment stricken US and Europe and this coincides with the bursting of China’s stock market and property bubble then China’s economy will stall.
Japan has been in a decade long stagnant defilation after its property and stock market bubble burst at the start of 1990s. It suffered sharp declines in its export driven economy in 2008 and 2009 and faces sharp competition from China. It has massive levels of public debt which is it has used to fund a weak domestic economy. It has only been able to service this debt by the earnings from its export manufacturing industries. But this is unlikely to be unsustainable for much longer and Japan could soon be faced by big cuts in public spending. The strength of the Yen as a “safe haven” has made its exports less competitive and much of these in the last year have been driven by Chinese infrastructure spending which cannot be sustained for much longer.
Continental Europe (excluding the UK whom we discuss below) has had a stagnant recovery and is faced with a growing government debt problem to cover growing economic deficits. This has the potential to break up the single European currency and the European Union itself and see a trade war between its former members. At the root of the crisis is the financial crisis in the banking system, the resultant recession and weak economies on the periphery which have used public spending to prop up their economies. All this has resulted in huge public spending deficits which the weak economies are finding hard to finance and services with their decling economies. The situation is particularly bad in the Greece, Portugal, Spain and Italy. The solution is to impose huge cuts in public spending, wages and jobs while raising taxes. This will have the effect of pushing these economies into another recession. Most mainstream economists are predicting negative growth for Greece, Spain, Portugal and Italy over the next two years because of these austerity measures. This will push these economies into a spiral of more cuts because their economies are not strong enough to service the level of public debts they are carrying.
At the same time the large economies – Germany and France – are being asked to put hundreds of billions into funds to support the weak periphery economies of Europe. Of course this means cuts for these economies – Germany has just announced 80 Euro billion of cuts in public spending with 15,000 job losses. This highlights the tension within Europe that may pull it apart. The Euro currency has weakened considerably on this crisis making European government debt very unattractive to Chinese and Japanese governments. This means that the rate of interest that will have to be offered to investors will have to be much higher to offset the risk of default and further currency devaluation. This will of course dampen economic growth. The risk of default by European governments has sparked a fresh credit crisis in the banking system but not yet at the level of 2007/2008 as banks start to charge a premium to lend to each other for fear of each other’s exposure to European government debt.
The likely outcome of all this is that in the short term Europe will go into another recession affecting its main trading partners – the US, UK and China.
The UK faces a situation similar to Europe but its economy is marked by a small and weak manufacturing sector, higher levels of personal debt and a polluted banking system which could still require further bailouts. We have recently seen a decline in manufacturing and retail sales in April 2010 and the proposed public spending cuts which will be on scale never seen before in Britain – most economists are predicting cuts of 20% a year for five years from 2011/2012. A recession in Europe will badly affect the economy as Europe is the UK’s largest trading partner. The decline in April 2010’s manufacturing clearly shows this to be already happening. With public spending supporting a structurally weak economy based on credit, banking and services which have all collapsed, the proposed cuts in public services will see a decade long period of austerity, stagnation and recession. Capital Economics the respected city economic consultancy are predicting 750,000 jobs losses in the public sector alone over the next five years. This would equate to about 100,000 jobs going in the public sector in Scotland.
In Summary we conclude that world economy will remain subdued and stagnant for a generation with the possibility of this scenario turning into a long depression. We believe this is the case for the following reasons:
- Huge public sector cuts, jobs losses and wage cuts
- Public debt overhang particularly in Europe
- An imbalance in the world trade that can’t be sustained by the US economy
- Removal of stimulus policies that have supported the housing and car industries
- Continued paralysis of the financial system with bad loans and unregulated derivatives will mean that there is less credit available for consumers and private corporations
- Higher medium and longer term interest rates as government loans (bonds) have to offer investors higher rates to compensate for the higher risk of defaults on payments
There is no doubt there will be big struggles against the austerity measures which global capitalism will try to impose on the majority of the world’s population. Socialists will help build this defensive fight against these measures. But at the same time they must give hope and reason to these struggles. The task we believe is to put forward an alternative to the crisis which solves the crisis in the interests of the majority and not private profit and the rich. An outline of this alternative is:
- Take the banks under common control and ownership and defuse their toxic loans and derivatives
- Cancellation of government debt
- Cancellation of government and private debt to the developing world
- A massive repatriation programmes of development aid and skills from the rich north to the poor south to compensate them for centuries of exploitation
- Use the banks resources of capital and assets to fund a programme of useful job creation which would include amongst others:
o An integrated public transport system
o Regeneration and conversion of buildings for social housing
o A house insulation programme
o Renewable energy programme
o Building of schools, hospitals, leisure and cultural facilities
o Apprenticeship training schemes for our millions of unemployed young people
- Take the global production, distribution and sale of food under common ownership and control
- A one off wealth tax on the super rich
- A progressive taxation system that redistributes from the wealthiest to low and middle income earners
- An increase in corporation taxation
- A reduction in arms and military spending
- A clampdown on tax avoidance
It is an alternative that can unite the workers and poor across the world in the fight for a rational society based on meeting human needs and not the needs of private profit.
Raphie de Santos is a derivative financial analyst, a member of the SSP and supporter of the Fourth International
₃ABC News Australia May 2010