'More than a recession: An economic model unravels'

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Wahome, Kimamo (WAHOMEK@uwec.edu)
Mon, 17 Mar 2008 08:28:39 -0500



From: "Wahome, Kimamo" <WAHOMEK@uwec.edu>
Date: Mon, 17 Mar 2008 08:28:39 -0500
Subject: 'More than a recession: An economic model unravels'
Message-ID: <E3F0E607B3CF71418CE725F002B5F604415A56D027@CHERRYPEPSI.uwec.edu>

ISR Issue 58, March-April 2008
________________________________ More than a recession: An economic model unravels JOEL GEIER argues that this recession reflects a crisis of capitalism that goes deeper than the regular boom-bust cycle WE ARE at an important turning point. The recession now unfolding marks the
 end of the 25-year long period of economic growth based on the neoliberal model-a model that was for years a great boon to capital but a great misery
 for the working class. Neoliberal measures were enacted a generation ago-a fter the long post-World War Two boom and the onset of crisis in the 1970s- to restore capitalist profitability. Those policies involved something call ed supply-side economics, which included tax cuts for the rich, economic de regulation and privatization, cuts in social welfare, union-busting, and wa ge-cutting. These policies led to a tremendous buildup of debt. Monetarism subsumed fiscal policy, and cheap credit came to be seen as the solution to
 economic downturns. These policies have now produced an economic disaster- first for working people, but now for the capitalist system itself. The des tructive consequences of neoliberalism will require a reorganizing of the c redit system and the banks, and a readjustment of the imbalances of the glo bal trade system. This crisis is deeper than a standard business-cycle rece ssion-it will entail long, painful years of crisis and restructuring. The c apitalist program to carry this out is still undefined, but what is unmista kable is that we are entering a new period, economically and politically, w hich will reshape the balance of power between the world's leading nations. A year ago, it became clear the U.S. was headed for slowdown and recession.
 The business cycle peaked and the overproduction of housing produced stagn ant and then declining home prices as the subprime housing market unravelle d. This stil-ongoing collapse of the housing bubble initiated an equally sl ow unravelling of the credit bubble, what the Economist some years ago labe led the world's greatest financial bubble. The impact of failing mortgages sent the first shock waves through the highly leveraged debt structure of t he financial system. The massive losses on bad debt destroyed banks' profit s, constricted their ability to provide credit, and were clearly leading to
 a credit crisis and severe recession. It was initially impossible to know how long it would take for this to work
 its way through the economy, although we assumed it would be one to two ye ars. The world was still at the height of its biggest boom since the early 1970s. Profits were very high in the U.S., and banking profit rates were th e best since the 1920s. Nor could we guess what actions the government woul d take to slow down the recessionary process or lessen its effects. In 1998, when the Asian crisis spilled into the global financial system, Al an Greenspan, head of the Federal Reserve Bank, decided on the hitherto unt ried approach of stimulating an ongoing economic boom. Recession in the U.S
. was successfully held back for over two years. The cost was high: The dot
-com bubble led to a stock market implosion, and huge trade deficits and fo reign debt built up as the U.S. became Asia's "buyer of last resort." Again
 when the recession finally hit the U.S. in 2001 with the biggest drop in p rofits since the 1930s, its full effects were cushioned by the largest stim ulus package since World War Two. The $250 billion government budget surplu s was transformed into a $300 billion deficit; $1 trillion in tax cuts for the rich and war spending were used to moderate the effects of the crisis. Interest rates were cut to between 1 and 2 percent for three years in order
 to lower business costs and restore profitability. The result was the weak est business recovery since World War Two, and the ultimate price was the h ousing and debt bubbles, whose collapse brought on the current crisis. The economy is now in recession or entering one. As at every turning point,
 the economic indices still give off conflicting signals. Parts of the econ omy are visibly in recession; in construction, auto, finance, and retail, f or example, job creation has stopped. Credit collapses have erupted in what
 were the most stable areas of the financial system. Yet some indices give the illusion that the economy is not in a recession, but only in a slowdown
, or that the recession will be mild or short, with growth restored in six months' time as lower interest rates and the $150 billion fiscal stimulus p lan restore consumer spending. Some analysts predict that manufacturing tie d to exports will keep the economy afloat. But exports, which had grown by 19 percent in the third quarter, only grew by 3.9 percent in the fourth qua rter, despite the cheapness of the dollar. The slowdown in export growth is
 a sign of economic weakness spreading internationally. The case for a mild recession is based on the expectation that profits will
 quickly recover. While profits declined dramatically in the fourth quarter
-down 20 percent from the year before-the decline was due to the large writ e-offs in the banking system, which will continue. In the rest of the econo my profits seemed to be holding up, particularly in oil, raw materials, and
 high tech, all benefiting from the world boom. Profits for the S&P 500-the
 500 largest public corporations-grew 11 percent for the year. But a majori ty of those profits came from international operations. There are not yet r eliable figures on profits from domestic operations, which have been weaken ing for a year. Every day there is new data of economic distress. The biggest shock was the
 staggering collapse of the service economy (the Institute for Supply Manag ement reported its index of service sector business activity declined to 41
.9 in January from 54.4 in December-below 50 indicates a recession). Meanwh ile, despite massive injections of liquidity-central banks pouring money in to the banks to prevent a paralyzing credit crunch-new areas of credit beco me dysfunctional. The Wall Street Journal recently reported that "credit-ca rd pinch leads to pullback in spending," and it indicates that 7.6 percent of credit card loans were either at least sixty days in default or in forec losure. The failure of "auction-rated" debt, supposedly the safest of credi ts, has pushed up municipal interest rates. Credit for student loans is dry ing up, and credit-tightening for business as well as for consumers intensi fies. Global dimensions

The downturn is now becoming global. The recession began and is centered in
 the United States, but there is a slowdown throughout Europe and in Japan.
 Italy seems to be in recession. The housing bubble has burst in Britain, I reland, and Spain, with others, including China, expected to follow. Europe an banks have begun to report similar difficulties as the American banks. I n January, there was an international stock market crash, during the three- week period from January 2 to 23, affecting the United States, Canada, Japa n, Britain, France, and Germany, as well as the emerging markets (Brazil, R ussia, India, and China). Stock markets plunged between 15 percent and 20 p ercent. More than $7 trillion of stock values were wiped out. The theory th at the world economy had decoupled from the United States, that the world b oom would continue in the face of an American recession, collapsed in an in ternational stock market panic. The U.S. share of the world economy has declined dramatically in the last f ew years, from 30 percent to under 25 percent of world GDP, but it is still
 the center of the international capitalist system. Fifty-five percent of a ll goods produced in Asia are exported, two-thirds of them to the United St ates and the other advanced industrial countries. The consumer market in th e U.S. is $9.5 trillion. In China and India together it's $1.6 trillion. As ian manufacturers are dependant upon the American market for the sale of th eir commodities-without it they have a crisis of overproduction. Therefore as the U.S. market goes into decline, it will have a dire impact on the res t of the world economy. Increasingly it looks as though the whole world may enter recession togethe r. There has not been a coordinated international recession since 1973. Sin ce then, when some countries were in recession, others were booming-maintai ning export markets to ease the downturn for countries in recession. If all
 go into crisis together, export markets constrict everywhere, deepening th e recession even further. This slump is also a crisis of finance capital, beginning in the U.S. but s preading to the banking system internationally. The banking system is both key to capitalist production and distribution, which cannot function withou t credit-and also one of the main ways in which American imperialism has do minated the world, through its international banking system. A year ago when the slowdown began, most aspects of the credit system were hidden from public view. There was no public knowledge of structural invest ment vehicles (SIVs), of conduits, of collateralized debt obligations, of c ollateralized loan obligations, or asset-backed commercial paper, etc.-all the off-the-book operations used to keep capital reserves down and inflate profits-and of the massive fraud, corruption, and toxic debt at the center of the financial system. The banks are being crippled by losses originating in the housing bubble. S o far they have taken $160 billion in write-offs from subprime mortgages (a
 third of that at just three banks-Citicorp, Merrill Lynch, and UBS), and t hey're expected to take a total hit of $300 billion to $400 billion on subp rime mortgages. The housing market has not yet bottomed out-and if house pr ices decline further (they have dropped 10 percent and are expected to fall
 another 10 to 20 percent in the next few years), the banks will have even bigger losses. Homeowners will lose between $4 trillion and $6 trillion, wi th a third of households saddled with mortgages greater than the value of t heir homes. Losses sustained in the subprime market are leading to the contraction of $ 2 trillion worth of credit. Total credit contraction may eventually be much
 greater. Commercial real estate markets, in boom a few months ago, are now
 collapsing. Their estimated losses may be as large as subprime losses. Oth er credit problems are growing, too, from commercialized loan obligations b acked by credit card debt and auto loans to corporate mergers and buyouts f inanced by junk bonds. Corporate bonds were financed in packages similar to the subprime mess. Bon ds were divided into slices and sold as tiers; the worst, riskiest parts ha d the highest interest rates. In this pyramid scheme, if one part defaults,
 it devalues the rest. Moreover, bonds of heavily indebted corporations wer e popular because holders could buy insurance against default in the form o f credit derivative swaps. Swaps are a totally unregulated market of $45 tr illion, with lax lending standards; they are constantly traded, so no one k nows who holds the insurance and whether they have the resources to make go od on defaulted bonds. What is certain is that with credit tightening and r ecession, a large number of corporations will not have the cash flow to mak e payments on high levels of debt. They will go bankrupt and default, a pro cess only just starting, and which will pick up momentum in the next two ye ars. Due to the lack of transparency and swindle involved, there is no hard
 information on how big this problem can become.

A neoliberal crisis

This mounting debt debacle results from neoliberal policies of bank deregul ation that began with Reagan's "free market reforms" of the 1980s, includin g allowing the banks to set up off-balance-sheet operations, à la Enron. Banks could leverage their loan books to increase their profits by taking o n enormous risk, without putting up capital reserves if the loans turned ba d. Clinton and Bush tax laws encouraged off-the-book operations by taxing b ank salaries and profits from them as "carried interest," a tax loophole fo r the capitalist class to keep their highest tax rate at 15 percent, which Congressional Democrats still preserve. Under Clinton the neoliberal gift to the banks was the repeal of the Depres sion-era Glass-Steagall banking law, ending the separation of investment an d commercial banking. It was the investment banks that originated the corpo rate debt packages. The bond rating agencies (Moody's, Standard & Poor's, F itch) were paid by bond originators to provide AAA ratings so that they cou ld be held by pension funds and insurance companies. Goldman Sachs, the lar gest originator of this lethal debt, made large fees selling these bonds to
 its clients, while at the same time making billions by speculating against
 these bonds they understood were headed for default and bankruptcy. There are some winners amid the misery-the "smart money," or "sophisticated inves tors"-inside traders and swindlers. Behind the financial crisis of the banking systems stands the consumer debt
 crisis. The principal reason for the explosion of bad consumer debt is the
 enormous class inequality fueled by neoliberal free-market union-busting p olicies. The U.S. economy has almost tripled since 1973, but all the growth
 has gone to capital, to the employers, to the owners, none to labor. Real wages are lower today than they were in 1973, thirty-five years ago. The on ly way to keep up living standards was through working longer hours, and tw o-income families. Even that wasn't enough; real family income is lower tod ay than what it was ten years ago. To maintain their standard of living, wo rking people fell deeper into debt. The last, and worst debt was to borrow against their only savings, the rise in the value of their houses. From 200 4 through the first half of 2007, homeowners took $800 billion a year throu gh refinancing their housing loans and through home equity loans. Thirty-fo ur-million American households-almost a third of the population-borrowed ag ainst their houses. Together, they had a net savings rate last year of minu s 13 percent. They were literally living off their homes. When the housing bubble popped and mortgage rates went up, large numbers of
 workers couldn't make their housing payments, contributing to the spiralin g decline of housing values, and precipitating the banking crisis. It has a lso effectively put a stop to consumer spending based on people borrowing a gainst the rise in the value of their homes. This in turn is producing a sq ueeze on producers of consumer products, especially the makers of "big-tick et" items like cars and appliances, and is now radiating throughout retail.
 Naturally, since the U.S. became after the 1997 Asian crisis the "buyer of
 last resort," this collapse of consumer spending will have an internationa l impact on countries that depend on the U.S. as a key export market. Since the panic of 1907 and the creation of the Federal Reserve system in 1 913, this is the third American financial crisis. The first was in the 1930 s when the interimperialist relations that led to the First and Second Worl d Wars produced between the wars the international banking collapse that ma de the 1930s Depression intractable. In that period there was no deposit in surance, and the crisis led to a run on the banks, as people tried to withd raw their savings. The resulting panic led to the failure of thousands of b anks. The second financial disaster was the savings and loan crisis in the 1980s confined to mortgage lenders. It was a $180 billion loss that was soc ialized through a taxpayer bailout, with the assets sold by the Resolution Trust Company at fire-sale prices for enormous profit to investors. There w as a credit squeeze, but it was not intense enough to impact most of the ec onomy for long. This third crisis is much deeper than the second; in its opening stage it i s already outstripping the size of the S&L crisis. There is still no accura te picture of how bad it will be. Yet the banks are being crippled even wit h just a part of the subprime mortgage loss. They had to raise capital by s elling parts of banks to Abu Dhabi, Singapore, and various other sovereign wealth funds-in effect to be partially controlled by foreign governments. When Japan's housing and stock market bubbles collapsed in 1990, the Japane se banks that held the debt were crippled by bad loans. Japan suffered more
 than a decadelong period of recession and stagnation, despite interest rat es that were cut to almost zero. Japan was only recently pulled out of rece ssion by the Asian boom. This banking crisis could very well be worse than Japan's, because of the number of banks all over the world that the creatio n of the unregulated credit derivatives markets and off-book banking has af fected. Its global impact will be greater because unlike the American banks
, the Japanese banks were not at the center of the world financial system. Accumulated contradictions

This financial crisis is potentially more dangerous because it comes up aga inst the profound contradictions of the neoliberal period. The global trade
 system took a peculiar form after the 1997-8 Asian crisis and the Greenspa n Fed's response to that crisis. The U.S. became the buyer of last resort, importing cheaper Asian goods, as well as outsourcing manufacturing facilit ies to Asia, particularly China. The U.S. lost its competitive position on the world market. The U.S. trade deficit ballooned to $700 billion to $800 billion annually in recent years, paid for through $3.5 trillion of foreign
 borrowing-80 percent of world savings financed this deficit. In this busin ess cycle the American corporations have not invested in the creation of ne w plant and equipment, i.e., in expanding the means of production. There ar e fewer factories in the U.S. today than there were at the start of the rec overy six years ago. There are three million fewer industrial workers than there were five years ago. Meanwhile U.S. corporations have invested heavil y in new factories in China and Southeast Asia, the majority of whose produ ction goes to exports, in circular fashion, much of it to the United States
. This global trading system, with huge U.S. trade deficits financed by the A sian central banks, could not be sustained. Yet it went on for so long that
 it became an accepted part of global trade and finance. But the trade defi cit becomes unsustainable as it comes up against the credit/debt crisis and
 the declining value of the dollar. The U.S., now the world's largest debto r, borrowed $3.5 trillion from foreigners, and then refused to defend its c urrency. It allowed (and encouraged for export reasons) the dollar to be de valued by 30 percent since 2000. The foreign holders of U.S. debt have as a
 result lost $1 trillion by the dollar's decline, the greatest debt default
 in history. There is therefore a greater reluctance on the part of foreign
 banks and investors to continue to finance the U.S. debt by increasing the ir dollar reserves, as the dollar continues to decline because of debt prob lems, interest-rate cuts, weak American profits, and the trade and governme nt budget deficits. The painful restructuring of the American economy includes a painful intern ational trade readjustment. Countries dependent on exporting to the U.S. ma rket will be caught up in this crisis. Chinese domestic consumption is only
 35 percent of GDP; with slumping exports, China is faced with overproducti on in most industries. Chinese overproduction has been floated by trade-deb t relations that have now become increasingly untenable. The Chinese govern ment holds $1.5 trillion in foreign currency reserves, the bulk of which is
 in American government debt. Unsustainable conditions, even if they go on for years, eventually are not sustained. This crisis will bring that to a h ead. The war economy also increases the depth of this crisis. In 2000, military spending was $299 billion; now it is over $800 billion-having grown by half
 a trillion dollars in seven years. From the end of the Vietnam War until 2 007, arms spending was 3 to 4 percent of the economy, except for a few year s of the Reagan second Cold War arms buildup. The right wing is demanding that the military be expanded and that arms spe nding be raised-they claim it's 4 percent of GNP, using the figure of $515 billion. When the supplements for Iraq and Afghanistan are included, as wel l as homeland security, the CIA, the nuclear weapons part of the energy bud get, and additional veterans' health costs, it is well over $800 billion, o r 6 percent of GNP. At the end of the permanent arms economy with the U.S. defeat in Vietnam, t he U.S. could no longer afford a level of military spending of 6 percent or
 more of GNP. It was only affordable when the U.S. totally dominated the wo rld market. Once the U.S. had competitors by the end of the 1960s-rebuilt G ermany and Japan-it could not maintain a permanent arms economy of that siz e. History repeats itself. With weak American competitiveness on the world market, an enormous trade deficit, and now dependency on foreign borrowing,
 the U.S. has problems affording the levels of war spending necessary to ma intain its position as the world's superpower. Weakened by its unending mil itary and political disaster in Iraq and Afghanistan, American imperialism now has huge economic problems undermining its power and changing the balan ce of power internationally. The government budget deficit this year will range upwards from $4 billion to $500 billion, much of it borrowed from the rest of the world. The Democr ats will blame it on the Bush tax cuts and overlook the $500 billion rise i n war spending that they voted for. For the reasons enumerated above, what we are witnessing now is more than t he onset of a recession, but a turning point similar to when the postwar bo om ended in 1970-73. At that time, the contradictions of the permanent arms
 economy-the U.S. losing its competitive edge on the world economy-led to a
 deep crisis of profitability, followed by a major restructuring of America n capitalism. In the twelve years from 1970 to 1982 there were four recessi ons. The United States was forced to abandon the Bretton-Woods Agreement, e nd fixed currencies, and float the dollar. In the 1970s the U.S. still had the highest wages and lowest productivity compared to its chief competitors
. By the end of the 1980s it had lower wages and higher productivity than i ts main rivals. This enormous restructuring was accomplished under the ideological rubric o f neoliberalism. Keynesianism had been the accepted capitalist economic ort hodoxy since the 1930s depression. Keynesian stimulus spending, aimed at bo osting consumer demand to fight downturns, was held responsible for inflati on, and it had no answers for the 1970s stagflation crisis of simultaneous inflation and slow growth. The new economic model of neoliberalism marked a return to "free market" co nditions before the 1930s rise of unions, the welfare state, and government
 regulation. The mantra was that the privatization and deregulation of indu stry would restore competition, lower costs, and curb inflation. Neoliberal s also championed "supply-side economics": replacing state spending aimed a t boosting consumer demand with tax cuts for capitalists who, the theory we nt, would invest it back into the economy, thus boosting growth. The argume nt was that handing money to the capitalists would lead to a "trickle-down"
 effect benefiting all sectors of society. In the first years of the 1970s crisis, the working class Left was on the rise internationally; by the end there was a total rout of the working class. The balance of class forces he re and internationally shifted. Capital and its conservative right-wing coa lition won. Its total victory in the 1990s was aided by the collapse of Sta linism, giving rise to the ideological triumphalism of the free market as t he only alternative. What we are now coming up against are the limits of neoliberalism. Mortgage
 and banking deregulation cannot be allowed to produce another crisis like this anytime soon. The banks are going to be re-regulated. Northern Rock Ba nk in England, a casualty of the mortgage crisis, was just nationalized, th e first such nationalization in decades. Further tax cuts for the rich, the
 unifying idea of the Republican Party, can no longer be afforded; top marg inal tax rates will be raised no matter who is elected. The bipartisan $150
 billion stimulus program, however inadequate, already repudiates neolibera lism. It is in essence a Keynesian package aimed at stimulating consumer de mand. It is limited to people expected to spend it, to people who make less
 than $150,000 a year. Call it what you will, but it is not tax cuts for th e rich. Neoliberalism has now exhausted itself as an economic strategy for capital.
 It was always a failure for workers. But whereas in 1982 the stock market was at 750, in 2007 it peaked at 14,000, reflecting the success of the mode l in restoring profits on the back of the working class. Capitalists loved neoliberalism because it made them fantastically rich; they are reluctant t o give it up and will fight to keep as much of it as possible. Neoliberalis m will not disappear until the ruling class replaces it with an alternative
 strategy, but what has changed is that the capitalist class has to confron t and solve the failures of its own neoliberal policies, and this will not occur without political struggle and ideological crisis brought on by the f ailures of the free market. There have to be new economic policies developed. This won't happen over ni ght. At the beginning of the crisis of the 1970s, the conservative Nixon sa id, "We're all Keynesians." By the end, there weren't even many liberals de fending Keynesianism. The ruling class hasn't yet devised a new strategy; i t has no game plan. It is still in denial, hoping the world boom will save it, narrowly focused on immediate bailouts. There will be attempts to softe n the spiraling of mortgage defaults, to retain municipal bond insurance, t o keep student loans afloat. But at this stage only piecemeal efforts are b eing proposed, not a new economic strategy. It should also be clear that an y new strategy, whatever name it is given, will involve a continued, if not
 intensified, offensive by the ruling classes to cut wages and benefits and
 increase productivity. Yet no new strategies

"Politics is concentrated economics," Lenin was fond of saying. This econom ic crisis will produce new political programs and remedies. Neoliberalism i s destined to follow neoconservative foreign policy into the ideological wi lderness. Defeat clarifies the mind; failures force new options to develop.
 But consciousness lags behind experience. The Right is in disarray and ret reat, correctly held responsible for the mounting military and economic mes s, condemned for its blindness, incompetence, and corruption. But the Right
 is too strong, too tied to capital to disappear. The right wing program wi ll change; it can no longer credibly hope to win on tax cuts for the rich, deregulation, and small government by cutting social welfare. There will be
 a different Right, perhaps along the lines of Lou Dobbs-a right-wing popul ism that attacks immigrants and supports protectionism-or conceivably an ev en nastier right wing. Perhaps a major electoral defeat in the upcoming ele ctions will start the process of conservative readjustment, but the ideas f or a new capitalist Right are still too inchoate and reactive to predict th eir longer-term coherence. As the economic crisis has unfolded over the last few months the liberals, however hesitantly, have shifted leftward, if only in rhetoric. The mass re sponse to Obama's vague call for change has indicated to them the popular a ppeal of leftward motion, and a bidding war between Obama and Hillary Clint on over working-class support has characterized the primaries from Iowa onw ard. In December John Edwards came out with a stimulus plan of $70 billion; and in January Clinton came out for $110 billion; Obama said $120 billion, yet even Bush topped them at $150 billion. Beyond these immediate responses, mo re important is how liberalism will define itself for the new period ahead.
 There will be various attempts to raise Keynesian or regulatory ideas, to present a mortgage bailout and foreclosure relief by the government, since private capital is proving incapable of solving its own problems. But there
 is yet no fundamental liberal program to deal with American capitalism's c risis-only immediate, narrow responses to constantly moving targets. In recent months, the Democrats have made many promises-mostly vague; but t hey have raised people's expectations and hopes for improvements in their l ives. The Democrats have their best chance in decades to sweep the election s. The Right has been discredited. How the liberals handle the problems of both war and recession, and how they handle the disillusionment with them w hen they fail to carry through on many of their promises, will shape the po litical context of the next period. We have gone through thirty years of reaction, of the politics of the neoli beral free market, and of the ideology of TINA (There Is No Alternative), w hich most people have more or less accepted. Even the Left after 1991 came to the conclusion that a planned economy doesn't work and that the free mar ket is the only efficient way for the economy to function. What has held back the development of the socialist movement is the general
 acceptance of the free market as the only alternative, coupled to the idea
 that the working class can't change society. The ideological crisis born o f the failures of the free market do not automatically lead to a rejection of it. But from believing that the free market was a positive good, there c an develop, out of its impact on workers, the belief that the free market a nd its workings have horrible consequences. Though we cannot yet predict the impact the crisis will have on levels of w orking-class struggle, we can say that the accompanying ideological crisis of neoliberalism creates bigger openings for winning people to the necessit y of an alternative to capitalism.
________________________________ Joel Geier is associate editor of the ISR. This is a revised version of a s peech he delivered to a conference of the International Socialist Organizat ion in February 2008.



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