The impending global recession
Blaming China is a diversion, argues Michael Roberts. The USA is still key
As I write, the US Federal Reserve Bank’s monetary policy committee (FOMC) is meeting to review its policy interest rate. This sets the floor for all interest rates (mortgages, government bonds, foreign loans, etc) in the US and overseas, and last month the FOMC raised it from near zero to 0.5%. That was the first hike in nearly 10 years - the last was when the US and world economy was motoring along in a property and bond boom, before the global financial crash and the great recession ensued.
At the December meeting, Janet Yellen, the Fed’s chief, explained that the hike in rates was appropriate, because the US economy “is on a path of sustainable improvement.” And “we are confident in the US economy”, even if borrowing rates rise.1 So it was best to start a series of planned hikes before ‘full employment’ was reached, to stop wages rising too fast and causing inflation.
Well, as the Fed meets now, it appears to have a large amount of egg on its face. Even before its meeting last December, there were clear signs that the US economy, already decidedly sluggish in its recovery since the end of the great recession in 2009, was now slowing down again. And just before the Fed hiked its interest rate, the figures for US industrial production in November came up and they showed the worst fall since December 2009 at the end of the great recession. Since then, we have had further poor data, suggesting that US real GDP growth in the last quarter of 2015 was likely to be under 1%. Indeed, the latest Atlanta Fed estimate for US real GDP growth in the last quarter of 2015 is just a 0.7% annual rate.
If that turns out to be right (the first official estimate is out this week), then the US economy will have grown (after inflation) by just 1.8% in 2015 - down from 2.4% in 2014. In addition, both industrial production and manufacturing output have slowed to a trickle and retail sales - a measure of how much is being bought in the shops - has also slowed markedly.
JP Morgan investment bank has been very optimistic over the past few years that the US and global economy would recover to ‘normal’ levels of economic growth. But now, in the last few days, its economists have reached the following conclusion:
Over the past few weeks, it has become apparent that pace of activity in the global manufacturing sector remained anaemic into year’s end. This realization upended our previous belief, which was based on preliminary data, that production growth strengthened last quarter. As we lowered our expectations for global IP growth, we did the same for global GDP growth. Our economists have made a rapid-fire set of revisions that left GDP tracking 1.5% annualized in 4Q15, the smallest gain of the expansion.
At the beginning of the new year, ex-Goldman Sachs chief economist Gavyn Davies headlined his blog in the FT: “Global activity contradicts market pessimism.” He went on to say:
so far there is little sign of a recession starting, either in our ‘nowcasts’ or in hard data for industrial production and retail sales ... and the gradual slowdown in US growth from 2.1% last summer to only 1.5% now is an aberration, and it runs counter to the Fed’s apparent determination to continue tightening monetary policy.2
But, within two weeks, the headline was: “US slowdown is now a headache for the Fed”. Davies commented:
last week came increased fears of a persistent slowdown in the US economy, following weak activity data from the US industrial sector. The drop in growth identified by these nowcast models is therefore becoming worrying. It needs to reverse very soon if the Fed’s view, and the consensus view, of the economy is to remain valid.
He added: “the recession probability has been hovering around 15-20%, no longer an entirely negligible risk.”3 Two weeks is a long time in economics.
This change of view by the economic strategists of capital has coincided with a significant collapse in stock markets around the world within weeks of the Fed’s rate hike.
What kicked this off was apparently China. The big investors, banks and financial institutions globally are worried that China is imploding and planning to devalue its currency hugely, thus driving down the rest of the emerging economies, many of which are already in recession (Brazil, Russia, South Africa, etc) and so will pull down the rest of the world, including the major advanced economies, into a global slump.
As a result, investment banks, previously confident of economic recovery and lauding the great emerging market ‘miracle’, fell into a despond of despair. Analysts at the Royal Bank of Scotland told clients to “sell everything”, as stock markets could fall more than a fifth, while oil and other commodity prices could drop to a tenth of where they were just a year ago. RBS has noticed a “nasty cocktail” of deflation in commodity prices, emerging economies in recession, capital flight by investors and rich citizens from China and other emerging economies, and the prospect of higher dollar debt servicing costs, as the US Federal Reserve carries out a planned hike in its policy interest rate this year.
China has set off a major correction and it is going to snowball … the epicentre of global stress is China, where debt-driven expansion has reached saturation. The country now faces a surge in capital flight and needs a “dramatically lower” currency.4
Albert Edwards at Société Générale, who has been predicting a deflationary slump for the last five years of global economic recovery, was now convinced that the Chinese crisis will lead to a global slump: “The western manufacturing sector will choke under this imported deflationary tourniquet”.
But is this right? There is no question that the Chinese economy is in trouble. Economic growth has slowed from double-digit increases back in 2010-11 to under 7% on official estimates in 2015. Many reckon that this official figure is nonsense and, looking at the pace of electricity consumption and spending, economic growth is probably more like 4%, which in Chinese terms is almost a recession.
When the great recession broke, the Chinese government reacted to a serious decline in global demand for its exports by launching a major government spending programme to build bridges, cities, roads and railways.5 That kept the Chinese economy growing. Interest rates were slashed and local authorities were allowed to borrow in order to spend on housing and other projects. There was a major credit boom. As a result, Chinese non-financial debt rose from about 100% to about 250% of GDP. Total Social Financing, a broad measure of monthly credit creation, is now growing at nearly three times the rate of officially recorded money GDP growth - or more if you do not believe the official GDP data.
The government was influenced by pro-capitalist economists in their ranks who have been continually arguing that the government must ‘open up’ the economy to foreign capital and private companies.6 The government should privatise the big state-owned companies and banks, end capital controls and allow the Chinese yuan to become a freely fluctuating currency, it was argued. Indeed, just before the Chinese stock market and currency crash began, the government pushed for and got the Chinese yuan to be included in the International Monetary Fund’s international reserve currency basket for the so-called SDR (special drawing rights). In effect, the Chinese currency was now increasingly subject to the laws of the international currency markets and the economy was increasingly influenced by the law of value.
More debt, slower growth and an overvalued currency, now subject to speculation, have engendered a stock market crash; now rich Chinese and foreign investors are trying to get their money out of China or the yuan and convert it to dollars abroad. Capital flight, as it is called, is running at over $100 billion a month, or about $1.2 trillion a year. Given that Chinese dollar reserves are about $3.3 trillion and around half of that is needed to cover imports, if capital flight continues at the current rate, Chinese dollar reserves will be exhausted in about 18 months.
The Chinese authorities have been unable to handle this financial crisis. By opening up their economy to currency and financial speculation, they created a Frankenstein that is now trying to kill them. First, they tried to weaken the yuan against the dollar to boost exports. But a weaker currency only encouraged Chinese companies and rich individuals to switch even more into dollars, by legal and illegal methods. Then they tried to prop up the stock market with extra credit and by making state-owned banks buy stocks. But this only fuelled even more debt. Then they reversed these policies, causing a stock market crash and credit squeeze.
The seeming incompetence of the Chinese authorities and the continued capital flight have now convinced many western capitalist economists that China will suffer a ‘hard landing’ or economic slump, capitalist-style, and this will add to already diving emerging economies and drive the world into slump.
But does a collapse in the Chinese stock market and fall in the value of the yuan mean an economic slump in China? The power of the state remains dominant in industry, in the financial sector and in investment. Yes, the Chinese authorities have opened the economy to the forces of capitalist value, particularly in trade and capital flows, and in so doing have made China much more vulnerable to crises. This is something that I forecast back in 2012: “if the capitalist road is adopted and the law of value becomes dominant, it will expose the Chinese people to chronic economic instability (booms and slumps), insecurity of employment and income and greater inequalities.” And this has been the result of Chinese leaders succumbing to the pressures of the World Bank and others to ‘liberalise’ the financial sector and become part of the international financial ‘community’.
Yes, the world is slowing down. The long depression, as I have described it, is still operating.7 Only last month, the World Bank pointed out that developing economies grew just 3.7% in 2015, the slowest since 2001 and two percentage points below the average 6.3% growth during the boom years between 2000 and 2008. And IMF chief Christine Lagarde reckoned that developing countries face a ‘new reality’ of lower growth:
Growth rates are down, and cyclical and structural forces have undermined the traditional growth paradigm. On current forecasts, the emerging world will converge to advanced-economy income levels at less than two-thirds the pace we had predicted just a decade ago. This is cause for concern.
A 1% slowdown in emerging markets would cause already weak growth in advanced countries to slow by about 0.2 percentage points, Lagarde said.
Crude oil prices have hit a nine-year low. Demand for oil has slowed sharply and oil stocks have built up to a record three billion barrels, while oil tankers circle the waters around refineries in the US and Europe, unable to unload because there is no demand. At the same time, the prices of important raw materials like iron ore and copper hit new lows. The transport of these resources in bulk carriers has collapsed, as measured by the so-called Baltic dry index, now at a 30-year low.
As a result, the large so-called emerging economies like Russia, Brazil and South Africa, where exports are mainly energy and other raw materials for the industrial and consumer economies of the mature capitalist world, have slipped into economic recession, with their currency values collapsing. The largest consumer of these raw materials was China, but that economy has seen a significant slowdown in real GDP growth and is stockpiling its own steel, iron ore and copper, or trying to dump them abroad at low prices.
Last summer, I pinpointed this growing crisis for the previously booming ‘emerging economies’, which had taken off through the exports of raw materials and energy.8 They financed the boom by borrowing at very cheap rates in dollars from the banks of the west. But now, with the collapse of their exports and falling prices, these debts are going to become much more difficult to pay back.
Financial firms in developing economies repaid a net $15 billion of international debt in the third quarter, while non-financial companies issued just $6 billion in new debt. Both figures were the lowest since the beginning of 2009, according to a report by the Bank of International Settlements (BIS).9 Emerging market (EM) companies are starting to default more often than US borrowers, the first time that has happened in years.10
If the Fed continues with its policy of interest rate hikes, the cheap debt that the emerging economies have borrowed will get more expensive to service. The face value of dollar-denominated emerging-markets’ sovereign and corporate debt has roughly tripled since the beginning of 2009, to $1.7 trillion, according to Bank of America Merrill Lynch index data. These emerging nations are just starting to feel the weight of their mountain of debt. The BIS report reckons that the cost of borrowing in these emerging economies is very sensitive to Fed interest rates.
When in 2014 the Fed decided to end its quantitative easing (QE) measures (printing money), this caused what was called a ‘taper tantrum’ in emerging market economies (EME), where stock and bond markets plunged in value. Now the BIS says:
There have also been signs that EM local currency yields are increasingly sensitive to developments in the United States. The post-crisis era has been characterised by strong international spill-overs from US bond yields to emerging markets, even when those countries were at different stages of the business cycle. And this effect seems to have strengthened over time. A simple rolling regression of an EME bond index on US 10-year treasury yields suggests that the potential for spill-overs is larger now than it was during the taper tantrum.11
The BIS is worried that these tighter financial conditions “may also increase financial stability risks”. Average credit-to-GDP ratios in the major EMs has risen by close to 25% since 2010:
Despite low interest rates, rising debt levels have pushed debt service ratios for households and firms above their long-run averages, particularly since 2013, signalling increased risks of financial crises in EMEs. Debt service ratios will inevitably increase even further when lending rates start to rise. Any further appreciation of the dollar would additionally test the debt servicing capacity of EME corporates, many of which have borrowed heavily in US dollars in recent years.12
If emerging economies get into a debt crisis, with companies defaulting and banks going bust, the mature capitalist economies will not avoid the impact. As it is, corporate debt has risen sharply in the US and Europe, as companies there have taken advantage of cheap loans to stack on cash. But, as corporate profit growth has slowed to a trickle in the last year, corporate defaults and debt downgrades have risen, and that was before the Fed hiked its rate.
More than $1 trillion in US corporate debt has been downgraded this year, as defaults climb to post-crisis highs, underlining investor fears that the credit cycle has entered its final innings. Much of the decline in ‘fundamentals’ has been linked to the significant slide in commodity prices, with failures in the energy and metals and mining industries making up a material part of the defaults recorded thus far.
US and long depression
But will the slowdown in China and the slumps in major emerging economies bring down the world? The argument for that to happen is based partly on the claim that emerging economies are now the drivers of the world economy. Emerging economies make up 57% of world GDP and have outstripped the advanced capitalist economies, according to IMF figures.
But this is a wild exaggeration, because the IMF uses what is called a purchasing power parity (PPP) measure. This measures what you can spend or invest in local currency in any country - but that exaggerates the national output of emerging economies compared to measuring GDP in dollars, as is necessary in world trade and investment.
In dollar terms, emerging economies have only 40% of world GDP. Sure, that share has doubled since 2002, but it is still the case that just the top seven major capitalist economies, with 46%, have a greater share than all the emerging economies. And in the last two years, that share has stabilised. While China’s share of world dollar GDP has rocketed from just 4% in 2002 to 15% now, it is still much smaller than the US share of world GDP. That has fallen from 32% in 2002 to 24% now.
These figures show the tremendous expansion of the Chinese economy. But they also show that the US remains the pivotal economy for a global capitalist crisis, particularly as it dominates in the financial and technology sectors. In 1998, the emerging economies had a major economic and financial crisis, but that did not lead to a global slump. In 2008, the US had the biggest slump in its economic post-war history and it led to the global great recession. In my view, this weighting still applies.
My main theme about the global economy is that it is in a long depression that can be distinguished from a ‘normal’ capitalist economic recession, because the global economy did not return to the previous economic growth rate in the recovery from a slump. Instead, economic growth, employment and incomes grew sluggishly, well below trend, and economies slipped back into recession. Such depressions are rare; there have only been three: in the 1880s in Europe and the US; in the 1930s; and now since 2008.
The global economy is in a long depression because the profitability of capital has not recovered and because corporate and public debt remains historically high, both weighing down on investment in technology to boost productivity and growth. A combination of depressionary factors has come together, not seen since the 1930s.13 One consequence of this depression is that no amount of mainstream policies like monetary boosts (QE) or fiscal stimulus (government spending) can turn things around.14
In this environment, I have argued that there was a serious danger that the US Fed would repeat the mistake it made in 1937 during the last great depression of the 1930s.15 Then it concluded that the US economy had sufficiently recovered to enable it to start raising interest rates. Within a year, the economy was back in a severe recession, from which it did not recover until America entered the world war in 1941.
So should the Fed be hiking interest rates at this time? This question was debated at the recent annual meeting of the American Economics Association by the great and the good of mainstream economics. There were two sorts of responses to this question.
The first was to ignore the fact of the weak global and US economic recovery or argue that it did not matter. Among leading luminaries, Martin Feldstein, former economics advisor to George Bush, reckoned that the US economy was recovering well, with unemployment down and incomes rising. So there was nothing to worry about.
John Taylor, leading economist from Stanford University, took a different tack. Yes, the US economy was very weak, but this was the fault of the economic and monetary policies of the current US administration and the Federal Reserve. What was needed was to reduce regulation of the banks and large companies, so that they can grow, and for the Fed to end its cheap money policy. Let’s just get back to business as usual and things will be fine. Taylor appeared oblivious to the fact that it was the failure to regulate the banks and financial system or to stop the introduction of speculative financial instruments that contributed to the global financial crash in the first place!
But the main response of the other contributors at this mainstream meeting was to conclude that we just do not know why the economic recovery was so weak and now seems to be faltering. The vice-chair of the Fed, Stanley Fischer, offered several possible reasons, but said he did not know which was right.16 Fischer was worried that the ‘equilibrium rate of interest’ (now called R*), where savings and investment are matched with full employment and moderate inflation, looked very low, as inflation was near zero. This was another way of saying that the equilibrium rate could be ‘zero-bound’ and thus the economy was in some form of ‘secular stagnation’, as argued by Keynesians like Larry Summers.
But Olivier Blanchard, former chief economist of the IMF, and ever the optimist, offered Fischer a positive answer.17 Actually, the US economic recovery was beginning to look normal, after all. You see, the infamous Phillips curve of the 1970s - according to which, inflation would rise when unemployment fell - was still operating weakly. So, as labour markets tightened, inflation would rise and the Fed would be justified in raising its policy rate, as it had started to do.
Another view is that of the Austrian school of economics, which argues that the ‘easy money’ policy of the Fed and other central banks, including the use of QE - ie, ‘printing money’ - has only fuelled the stock market and bond boom that is now bursting and has distorted the allocation of investment into productive sectors. This malinvestment must be quashed with a strong dose of monetary tightening to get interest back into line with the Wicksellian ‘natural equilibrium’. (Johan Gustaf Knut Wicksell was a leading Swedish economist of the pre-Keynesian ‘Stockholm school’.)
This Austrian view has been promoted by the economists of the international central bankers association, the BIS. The BIS economists reject the Keynesian view of ‘secular stagnation’ that must be overcome by more monetary and fiscal stimulus. That is just making things worse, in their view. In several studies they argue that what causes crises is excessive credit, leading to malinvestment and financial bubbles that burst. Their latest study of recessions in 22 rich countries dating back to the late 1960s claims just this.18 It is not a lack of demand that ‘causes’ economic crises under capitalism, as Keynesians like Paul Krugman, Larry Summers or Brad DeLong argue, but malinvestment in the supply side of the economy, caused by too much debt.
Returning to Wicksell, the BIS economists reckon that if real interest rates (after inflation is deducted) are held too low (ie, below the ‘natural rate’ that equates savings and investment in the ‘real economy’), then credit bubbles and malinvestment ensue. And rates are too low: they are way into negative territory, last seen during the first post-war international slump of 1974-75.
The BIS reckons the Fed is right to hike interest rates, but what is wrong is that it has taken too long to do so. Now the economy will have to go through ‘cold turkey’ or ‘creative destruction’ (to use the phrase of the early 20th century Austrian economist, Joseph Schumpeter) to clear the system of excessive credit and unproductive investment. In other words, another slump.
In a way, nothing has changed since the debates of the 1930s between the Keynesians, who blame a lack of demand for the depression (with no real explanation of why demand slumped), and the austerians (Austrian school, and monetarists like Milton Friedman), who blame excessive credit and the interference of central banks and governments in the ‘natural’ workings of the market.
In my view, the cause of the great recession and subsequent depression cannot be laid at the door of the lack of demand (Keynesian) or the existence of too much debt (Austrian). Neither theory has a place for the profitability of capital in an economy that depends on a mode of production based on making a profit! Yes, in a slump, there is a lack of demand (capitalists cut investment and households stop spending). But that is a description of a slump, not an explanation. Yes, too much debt can provoke a financial crisis and weigh down on future investment. But why and when does debt or credit - a necessary part of capital accumulation - become ‘too much’?
The Marxist answer, in my view, is that debt becomes too much when it can no longer be serviced, because the profits from productive investment become insufficient to sustain it. And demand becomes inadequate when the profits from investment drop so much that capital stops employing labour, closes down companies and reduces the utilisation of plant and equipment.
So what matters is not the level of interest rates - whether they are too high or too low, relative to some ‘equilibrium natural rate of interest’ that US mainstream economists are now arguing about - but what is happening to corporate profits and investment. Investment drives employment and incomes, and thus economic growth.
Currently global corporate profits (a weighted average of US, UK, Germany, Japan and China) have turned negative and US corporate profits are now also falling (on a year-on-year basis). That suggests that US business investment, which has been expanding at only 3%, will also start to drop within a year or so. If that happens, then the US will likely head into recession. But it will not be China or emerging economies that will be decisive.
US election policy options
Eight years after the election of Barack Obama at the depth of the great recession, the economic policies of the administration and the forecasts of sustained recovery by mainstream economics have failed. Now there is a rising risk that the US could enter a new slump in 2016 or 2017 - right at the time of the election of a new president. And, whoever is elected, do they have any idea of how to avoid a new slump or get America out of it?
On the Republican side, we are offered a range of neo-conservative, pro-gun lobby, anti-abortion, anti-gay rights, anti-labour, anti-welfare, anti-tax multi-millionaires and climate-change deniers - the noisiest and most popular (among Republican Party supporters) apparently being Donald Trump.
Let us leave aside Trump’s provocations on gays, immigration, Muslims and ‘liberals’ and instead have a look at the economic policies he advocates for America. The Republican leadership represents Wall Street, the big corporate moguls and the military-industrial complex. But Republican Party activists are mostly small businessmen and older, white, ‘middle class’, male workers in America’s suburbs, who reckon, or are told, that what is wrong with America’s economy is too much government, too high taxes and too much free trade and immigration that does not protect Americans.19 This is the classic petty bourgeois (to use Marx’s phrase) view.
It is these people that the billionaire Trump appeals to. So his economic proposals boil down to cutting taxes, reducing government spending (but not the Medicare needed by his elderly supporters), taxing imports to ‘protect’ American jobs and reducing bureaucracy.
But, of course, Trump’s economic plan does not really help his base of support. He wants to cut corporate taxes and income tax for all. The biggest beneficiaries of this would be the very rich. Top billionaires would see their taxes decline from 36% to 25%, and corporations would get a cut from 35% to 15%. On average, most people would see their tax bill reduced by about 7% of their after-tax income, but savings for the top 0.1% of the wealthy would amount to $1.3 million - 19% of their income.
These tax cuts, if implemented, would, according to the Tax Policy Center, result in a loss of government revenue worth $25 trillion over the next 10 years.20 So, just to get to 2025 without increasing the deficit, government spending would have to be cut by about 20%. The biggest loophole in the Trump tax plan, according to Robertson Williams of the Tax Policy Center, is the “pass through” provision, which would allow self-employed contract workers to have their income taxed at the lower 15% rate (this again is a policy aimed at Trump’s base).
Trump says he would raise tariffs on foreign goods to help American industry and impose punitive sanctions on China and Mexico, which are America’s two largest trading partners. This would break the Nafta agreement. If the US were to impose tariffs (driving up domestic prices), retaliation would follow from trading competitors. All of this is anathema to the Republican grandees, who follow the demands of Wall Street and the big corporations for ‘free trade’. But it sounds great to the self-employed and other small businessmen, who are struggling to make ends meet, even though reduced government services would hit them too
On the Democrat side, Hillary Clinton is facing a strong challenge from Bernie Sanders, the ‘socialist’ senator from Vermont. That again is another sign that union workers, public-sector employees and active working class Democrats are fed up with the dominance of the Democrat establishment, financed by hedge funds and big business and so tied to their policy needs. Sanders has called for a living wage for all, government investment, breaking up the banks, etc.
These policies are mild in their impact on a capitalist economy in successful times, but they are unacceptable in a capitalist economy still struggling to grow after the great recession and possibly heading back into economic slump. So, for capital, it would be a disaster if Sanders won the Democrat nomination, because it would pose a new threat to the profitability of capital.
But Sanders is also opposed by supposedly liberal reformist elements on the Democrat side. Top Keynesian economist Paul Krugman has launched a series of posts against Sanders.21 Krugman is opposed to Sanders not particularly because he is against the latter’s mild measures, but because he considers them unrealistic in the face of a Republican Congress and the might of Wall Street and the media.
So we ‘liberals’ ought to settle for Hillary in order to get a few things done, as we did under Obama. As Krugman put it, “accepting half loaves as being better than none: health reform that leaves the system largely private, financial reform that seriously restricts Wall Street’s abuses without fully breaking its power, higher taxes on the rich but no full-scale assault on inequality”.22
You see, if Obama could not do much at a time when Bush and the Republicans were discredited thanks to the great recession in 2008, there is even less chance now. Of course, this argument assumes that Obama ever advocated anything radical to control the financial sector, reduce inequality or empower labour. On the contrary, Obama appointed Wall Street bankers to bail out the financial institutions, and had then Fed chief, Ben Bernanke, help the banks with mountains of cash and appointed a treasury team that aimed to curb government spending on public services and infrastructure.23
But Krugman argues that a campaign for a “radical overhaul of our institutions” is a pipe dream because the ‘broad public’ will never support it:
The point is that while idealism is fine and essential - you have to dream of a better world - it’s not a virtue unless it goes along with hard-headed realism about the means that might achieve your ends. That’s true even when, like [Franklin D Roosevelt], you ride a political tidal wave into office. It’s even more true for a modern Democrat, who will be lucky if his or her party controls even one house of Congress at any point this decade.
So there it is. The US economy is heading down again. The policies of the last eight years under Obama have not turned things around. Krugman’s response is that backing Clinton is the only thing to do - in the hope that a few crumbs will fall the people’s way, as a new recession looms.