10.08.2011

Stock market panics and the danger of another recession

The loss of its triple A credit rating is symbolic of the decline of US hegemony and therefore of capitalism as a system, argues Eddie Ford

Obviously, the decision by Standard and Poor’s on August 6 to issue a “negative” outlook on the United States government and hence downgrade its credit rating by one notch from triple-AAA to AA+ status was a political humiliation for the Obama administration. A humiliation doubtlessly compounded by the finger-wagging it received from the Chinese bureaucracy, which hypocritically lectured the US about its “debt addiction” - a bit like a drug-dealer scolding a user for having a bad habit.

This was the first time, of course, that S&P has ever made such a judgement since it first began rating the credit-worthiness of US railroad bonds in 1860 and it has indicated that another downgrade is possible within the next 12-18 months. Which would trigger another around of economic and political panic as sure as night follows day. There is also the real possibility that other credit rating agencies will follow suit.

Explaining its decision, S&P stated that the “political brinkmanship” in Congress over the debt deal had made the ability of the US government to manage its finances “less stable, less effective and less predictable”. Meaning that there is now a chance, however tiny, that the US government could default on its debt obligations - enough to induce anxiety in investors. Furthermore, S&P declared, and not without logic, that the $2.1 trillion debt reduction plan (ie, vicious austerity) frantically scrambled together last week “fell short” of what was necessary to get the country out of its hole. Therefore, it had no choice but to downgrade the US due to the fact that the “majority of Republicans” continue to “resist any measure that would raise revenues” - a stance, it argues, that has been “reinforced”, not alleviated, by the passing of the Budget Control Act. Growth is needed, not just an endless round of cuts, cuts, cuts.

Frankly, communists find it hard to disagree with S&P’s assessment of last week’s deal. That is, by effectively adopting the Republican programme, which rules out any economic stimulus measures such as tax rises on the wealthy or ‘quantitative easing’, Barack Obama has taken the country to the brink of a possible double-dip recession or far worse - and perhaps damaged his chances of winning next year’s presidential election by alienating his electoral/political base (working class, blacks, Hispanics, etc). Whether it was an act of cowardice or suicide will be for future historians to debate.

Naturally, at the very start of the week the markets plunged in reaction to S&P’s damning judgement, and that was on top of the estimated $3 trillion that had been wiped off the value of world shares the week before. Indeed, on August 8 the stock market had one of its worst days since Lehman Brothers collapsed in 2008, triggering off the ‘credit crunch’ and the near collapse of the global financial/banking system. Only what had previously been derided as ‘socialist’ state interventionism and a package of emergency Keynesian measures, also regarded as hopelessly outmoded, salvaged the day for capitalism. But now, of course, the ideological orthodoxy from Washington to London is austerity and ‘balancing the books’, begging the question of what measures the ruling class will deploy if faced by Credit Crunch 2.

Anyhow, in the ensuing bloodbath Royal Bank of Scotland and Lloyds - both bailed out by the government, of course - lost about a third of their value, creating a £35 billion loss for the taxpayer (and continued job losses, needless to say, for ordinary bank workers). The price of oil slumped in the New York futures markets as dealers, quite logically, anticipated lower demand from a stuttering global economy. There was a triple-point fall in the FTSE 100 index over August 8-9 - marking the first time in the 27-year history of the blue chip index that the market had lost 100 points or more on four consecutive days. In fact, being down more than 20% since its July peak, the FTSE 100 index ‘officially’ entered the bear market - generally defined as when there is a price decline of 20% or more over at least a two-month period - by this measure there have been 10 previous bear markets in stocks during the last half-century. The investment group, Vanguard, urges its clients to stay calm and remember that even in a bear market “you may be better served by adhering to your long-term investment plan”.^[1] Fat chance.

Gold spiked to an all-time high at $1,771 an ounce, as investors took refuge in the relatively safe haven - for now - of gold, with other ports of call being the Swiss franc and Japanese yen; to the point, indeed, that these suddenly “massively overvalued” currencies were “coming like a hammer” against their respective economies (potentially crippling exports, etc) and as a consequence had to be devalued virtually overnight.^[2] The law of unintended, but quite logical and foreseeable, consequences under capitalism.

In another crisis-management step, the US federal reserve issued a statement saying it will keep interest rates near zero until at least mid-2013 - previously, it had talked more vaguely about keeping borrowing costs low for an “extended period”. But the Titanic is still heading towards the iceberg. Needless to say, the federal reserve did not announce that there would be a third round of quantitative easing - which over the last two and a half years saw $2 trillion pumped into the US banking system. Do nothing and wait for that magical Harry Potter moment that will somehow make everything all right again - that seems to be the message.

Euro panic

Feeding into this generalised panic was the continued crisis in the euro zone. Specifically, the well grounded fear that debt contagion was spreading inexorably from the periphery to the core, with Italy stepping into the firing line, closely followed by Spain. In the case of Italy, the interest rate yields on government bonds (the amount needed to service public debt) had reached a crippling 6%, so that the country was having to run faster and faster to stand still. Clearly an unsustainable position, inviting default and bankruptcy, and the nightmare scenario of the European Union finding itself having to bailout the euro zone’s third largest economy and the eighth largest in the world - an impossible-seeming task, given the near intractable problems posed by the Greek bailout. Or just let Italy go under, hence destroying the euro zone project - also unthinkable. Too big to fail or too big to bail out?

Therefore, the European Central Bank mounted a desperate rescue mission on August 8 and purchased a so far undisclosed amount of Italian and Spanish government bonds - having the effect that the rise in demand lifted their prices. Most think that the initial ECB bond-buying operation came to about €5 billion - a drop in the ocean of toxic debt, of course. However, RBS economists estimate that the ECB and its bailout fund, the European Financial Stability Facility mechanism, will eventually have to own at least €850 billion-worth of Spanish and Italian bonds in order to safeguard - relatively speaking - those countries; thereby transferring significant risks to the balance sheet of a highly conservative organisation that has traditionally stuck to its remit of controlling inflation.

Even then, the ECB’s ‘rescue’ operation is at best a short-term fix - a little finger jammed into the huge fiscal dam. Yes, Italy’s 10-year bond yield fell to around 5.3% and Spain’s fell even further to 5.15%. But no-one thinks that these falls will last for long. Sooner rather than later the yield rates will start to creep up again, vulnerable to any economic/political instability in either the euro zone or the US.

Under the terms of an agreement struck after last month’s emergency summit in Brussels, the ECB’s bond-buying powers are meant to be assumed by a reformed and beefed-up EFSF mechanism - something like a EU version of the International Monetary Fund. But its powers have yet to be ratified by the European parliament and member-states - a tortuously long process that could take months, if it happens at all. Given the dire and extenuating circumstances then, it was judged that the ECB should ‘override’ the EFSF and call the bond-buying shots for now.

Unsurprisingly, this ‘unconstitutional’ decision revealed deep frictions within the euro-establishment - Germany’s Bundesbank, and the German government as a whole, was opposed to measure, unhappy that the ECB had chosen to considerably extend its powers and remit. But desperate times require desperate measures. That was certainly the view of ECB president Jean-Claude Trichet, who declared that Europe faced its worst crisis since the war.

However, the Italian job - or bailout - comes at a heavy price for the working class. According to the Italian daily, Corriere della Sera, Trichet sent a letter to prime minister Silvio Berlusconi at the end of last week dictating the terms on which the ECB was prepared to buy Italy’s increasingly costly debt, the slight dip in bond rates notwithstanding. The measures demanded by the ECB include more privatisations, including those of companies currently owned by local authorities, which must be set in train immediately, and, of course, sweeping ‘reforms’ of the labour market. In other words, the ECB seeks to drive down the living conditions and standards of Italian workers.

Following the statement from the US federal reserve and the ECB intervention, August 10 saw a market rally. But this will almost certainly turn out to be short-lived - watch this space. Indeed, in many respects, the indications are that we are witnessing a near classic bear market rally, also known in the trade as a “dead cat bounce”.^[3]The Japanese Nikkei 225 has been typified by a number of bear market rallies since the late 1980s, but this had not affected the long-term stagnation that has characterised its economy.

After all, one of the key reasons behind the massive sell-off over the past few days has been the fear that the US - the world’s biggest economy - may be falling into recession. Something confirmed in the federal reserve statement, which expected “a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting” (though it attributed some of the slowdown to “temporary factors”). The fed added that economic conditions were “likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013” and had looked at a “range of policy tools” to promote a “stronger low-inflation recovery”. These unnamed tools would be employed “as appropriate” in the light of “fresh information” on the economy - more steady-as-she sails complacency, in other words. But the facts speak for themselves. The US economy grew at its slowest pace in the first half of 2011 since the recession ended in June 2009. The manufacturing and services industries barely grew in July. The unemployment rate remains above 9% percent, despite the 154,000 jobs added in the private sector in July.

The reality is that the US economy is scraping along the bottom, flirting with a double-dip recession - maybe a slump of calamitous proportions. Ditto, to some degree, the UK. Forecasts for GDP growth have been steadily falling since data showing the economy grew by just 0.2% in the second quarter - with UK manufacturing experiencing in June a 0.4% decline in production, and the trade gap rising to £8.87 billion. Delivering a further blow to George ‘fiscal genius’ Osborne’s plans for recovery, on August 10 the Bank of England downgraded its UK growth forecast for 2011 from 1.8% to about 1.5% - wildly optimistic in and of itself. Meanwhile, Osborne insists - like a man in total denial - that the government’s austerity measures are “working” because the UK has retained its triple-AAA credit unlike the US.

What is to be done? Many mainstream economists are saying that the ECB “must go nuclear to save Europe” - as opposed to weakly staggering from one emergency stop-gap measure to another. Take action. The EFSF’s current €440 billion budget needs to hiked to as much as €2.5 trillion, even the setting up of an additional “anti-speculation stabilisation fund”. Then, for instance, the ECB needs to launch quantitative easing on a “massive scale” to head off a wholesale euro zone debacle - if necessary purchasing half the entire stock of Italian and Spanish debt at one fell swoop. For Stephen King, the HSBC’s chief economist (not the horror novelist), the ECB should forthwith drop its “ideological opposition” to quantitative easing and embrace “easy money” in “exactly the same” way as the US federal reserve apparently does. In the view of King, the euro zone will have to embrace closer fiscal and political union in the end or face the same sort of “fiscal anarchy leading to financial implosion.” A stark message indeed.

Yet all these half-baked schemas, self-evidently, are totally inadequate - even the sad fantasies of deluded people. The EU/euro zone is too fractured a body, riven with antagonistic contradictions as it is, to ever organise anything on the scale suggested above - let alone provide a real solution to the crisis.

New hegemon

Some have argued, both on the left and right, that the US downgrading is meaningless - just a storm in a teacup. We think this is a profoundly mistaken view. No, the downgrading is symbolic of the economic decline of the US. The prestige of US imperialism has taken a severe denting. There is idle talk of a new reserve currency to replace the dollar, maybe the Chinese yuan. Just forget it - it is not going to happen, simple as that. The US emerged as the strongest country on earth after World War II, with half of the world’s industrial production and the nexus of political connections - sheer clout - to get what it wanted. And behind that, of course, it had the armed force to enforce those political decisions if necessary. It remains the world’s sole military superpower.

What country or bloc could rival or replace the US as the global hegemon? China is a non-starter, especially given the fact that it has massively lent to the US and hence has absolutely no interest in a US recession - which would have a disastrous impact on its own economy, and in turn pose a possible threat to the political supremacy of the misnamed Communist Party of China. Despite the claims to the Morning Star’s Communist Party of Britain, Socialist Action and other Stalinites, the CPC party-state machine is incredibly fragile and could easily fall to pieces. If its economy slowed down, or went into reverse, then the Chinese bureaucracy would find extreme difficulty in subjugating the masses and maintaining its own cohesion - an essential requirement if it is to successfully function as the sweatshop of the world capitalist economy, into which it is inextricably locked. And the signs of Chinese slowdown are there - industrial output grew at a slower pace in July, while inflation unexpectedly quickened, putting the central bank in a bind as it tries to keep prices in check without dragging down an economy facing increasing threats from abroad.^[4]China to the rescue of capitalism? It just goes to show that the leaders of the capitalist world have no viable strategy. How about the EU ‘taking on’ US imperialism as a new contender? To ask the question is to get the answer - only with a new Napoleon would that be a possibility.

Only the working class can provide an alternative to capital’s irrationality and horrors - no other force can replace the US as the world’s hegemon. Our class must come to power if we are to chart a course to a new civilisation, and only if that occurs first on a continental scale will that power be able to survive - a workers’ Europe being the most feasible candidate.

Notes