Against the Current, No. 98, May/
The Empire's Endless New War
— The Editors
The Economy After the Boom
— Robert Brenner
Colombia From Peace to War Again
— Forrest Hylton
Argentina: What Kind of Revolution?
— Francisco Sobrino
The World Social Forum
— Michael Lowy
From Beijing to Porto Alegre
— Linda Ray
Palestine-Israel After Jenin
— David Finkel
Ta'ayush: Partnership for Solidarity
— Shira Robinson, Kawther Mataneh and Neve Gordon
Iraq, The Empire's Next Target
— Rae Vogeler, Allen Ruff and Mike Wunsch
Communal War in Gujarat, India
— Kunal Chattopadhyay
UAW Abandons Accuride Local
— Dianne Feeley
The Rebel Girl: Choice and the RICO Dilemma
— Catherine Sameh
Random Shots: The Kings of the World
— R.F. Kampfer
- Speaking Out Against War and Repression
Race and Class: Terrorism, Racism, Patriotism
— Malik Miah
Would Gore's War Look Any Different?
— Paul Felton
Paul Allen Anderson's Deep River
— Rachel Rubin
- Speaking Out Against War and Repression
Cracking A Closed Society
— Hunter Gray
Dan La Botz's Made in Indonesia
— Kurt Biddle
E. San Juan's After Postcolonialism
— Anne E. Lacsamana
The Relevance of the Enlightenment
— Samuel Farber
- In Memoriam
Sol Dollinger, 1920-2001
— Dianne Feeley
Dave Van Ronk, 1936-2002
— Brad Duncan
THE LONG U.S. economic expansion has ended. Whatever the outcome of the current recession, the odds are against a return to the boom conditions of the second half of 1990s. It may indeed be difficult over the medium run to avoid stagnation/slow growth, or even worse.
The reason, at the most general level, that the U.S. economy, and the world economy as a whole, appear to face relatively bleak prospects is that they failed during the 1990s to definitively transcend the long economic downturn that plagued them from the early 1970s through the early 1990s.
Overcapacity and overproduction in the international manufacturing sector — and the failure of successive attempts of governments and corporations to successfully respond to it — have been fundamentally responsible for reduced profitability and continuing stagnation on a system-wide scale, and there is as yet little evidence that the problem has been overcome.
A significant rise of the manufacturing profit rate between 1985 and 1995 did, initially, provide a real basis for the U.S. boom of the 1990s. But the rise in U.S. profitability and, eventually, U.S. economic growth, was paralleled by — and to some extent caused — falling profitability and deep recession in much of the rest of the advanced capitalist world, including Japan and western Europe, during the first half of the 1990s.
This in turn limited the U.S. surge, and, and over the second half of the 1990s the manufacturing profit rate fell significantly. Even as corporate profitability began to fall between 1995 and 2000, the stock market took off on the greatest runup in its history. At this point, the “wealth effect” of rising equity prices replaced manufacturing revival as the economy’s main engine. Corporations thus found that their overvalued stocks gave them access to almost unlimited financing. On this basis, they were able to sustain a powerful investment boom, and the 1990s expansion was enabled to continue.
Nevertheless, the growing gap between rising stock prices and falling profitability could not long persist. From the middle of 2000, one after another corporation confronted disappointing returns, and the stock market crashed. The wealth effect of rising share prices now went into reverse, as corporations found it much more difficult to raise money. But the overriding problem was the mammoth overhang of excess capacity that corporations had built up during the stock market run up. Too much capacity made for too much production, and corporations were unable to sell their output at prices that allowed them adequate (if any) profits.
Manufacturing profitability, already having fallen significantly between 1997 and 2000, now plunged, setting of the classical downward spiral in which declining investment (declining orders for means of production) makes for rising unemployment, which leads to declining consumption demand, which leads to both increased bankruptcies and rising debt defaults, which put further downward pressure on investment, and so forth.
As the U.S. recession deepened, the growth of U.S. demand fell sharply, and the rest of the world economy, profoundly dependent upon U.S. imports, followed the United States downward. As the international economy contracted, U.S. export growth fell drastically, exacerbating the U.S. downturn.
A mutually-reinforcing international downturn ensued, with the drop-off in U.S. investment and economic growth from year mid-1999-mid-2000 to the year mid-2000-mid-2001 the greatest in U.S. postwar history.
Over the course of 2001, the U.S. Federal Reserve brought down interest rates at record breaking speed and to an unprecedented extent, and very major increases in household debt and consumer spending ensued. This encouraged corporations to rapidly restore their inventories, with the result that the frightening fall of the economy was stemmed at least for the time being and GDP rose notably during the first quarter of 2002.
Nevertheless, profitability remained in the doldrums, investment failed to rise, exports continued in crisis, and — reflecting all this — the stock market was unable to launch a recovery. So the outcome remained very much in doubt.
The underlying weakness of the economy over the course of the 1990s is revealed in a variety of ways<197>especially in the declining performance of the advanced capitalist economies taken together and in the dependence of the U.S. boom on the stock market bubble.
Declining Vitality of the Global Economy
During the course of the business cycle of the 1990s, the economic performance of the advanced capitalist economies taken together was, by all of the standard measures — growth of GDP, per capita income, labor productivity and real wages, as well as level of unemployment — worse than that during the 1980s. The latter was itself less good than that of the 1970s, which did not, of course approach that of the 1960s and 1950s.
For the advanced capitalist world as a whole, wage growth during the last decade fell to its lowest level of the post-war period, unemployment hovered at or near its post-war peaks (outside of the United States), and the welfare state contracted, if at varying speeds. And this was the case despite the enormous stimulus imparted to the world economy by the U.S. boom.
The New Economy as Ideology
Of course, the standard, or official, picture of the 1990s expansion is rather different. This ignores the system as a whole, a world economy that continued to stagnate, and focuses on the supposedly unique genius of the U.S. economy. If the others would only follow the U.S. model, according to this viewpoint, problems of the world economy would vanish.
In the official version, enshrined in the Council of Economic Advisers’ Economic Report of the President 2001 (issued in early 2001!), as well as the speeches of Alan Greenspan (available at the Federal Reserve website), the U.S. economy relied on its free market financial and entrepreneurial institutions — particularly its highly developed venture capital companies, its equity markets, and its high tech startups — to launch an epoch making revolution in information technology and achieve a definitive break from the long downturn.
According to the official account, the long stagnation of the 1970s and 1980s was thus the result of a sud<->den (unexplained and unevidenced) exhaustion of innovation, which was ostensibly responsible for the long-term slowdown in productivity growth. But with the equally sudden availability of New Economy technologies in the early 1990s, firms that could mobilize the necessary “intangible capital” — in the form of inventiveness, skill, organization and so forth — were presented with unprecedented potential profits.
Venture capital companies were thus ostensibly motivated to fund very high-risk start-ups by their potential for yielding generous rewards when their shares went on sale at initial public offerings (IPOs).
Investors in turn were supposedly willing to pay astronomical prices for the equities of these, and other, information technology companies, because of the enormous profits these companies expected. For the same reason banks were willing to provide them with loans.
As Fed Chairman Greenspan never tired of explaining, the promise of the New Economy thus raised the expected rate of profit, driving up equity prices; the latter allowed corporations, especially high tech start ups, easier access to finance (“the wealth effect”), enabling investment to boom; this made possible further leaps forward in technology, enabling productivity growth to rise even higher.
The latter raised potential profits, thus equity prices, thus investment still more, issuing in what Fed Chairman Greenspan termed a “virtuous cycle” of economic expansion, centered on the stock market and venture capital.
In this narrative, the stunning return on Netscape Corporation’s Initial Public Offering in August 1995 announced the vast potential of the New Economy and thereby set off the mutually supportive stock market runup and economic boom, which produced what the Council of Economic Advisers insists on calling, in the face of overwhelming evidence to the contrary, the “extraordinary gains in performance” of 1995-2000. (Economic Report of the President 2001, 23)
In fact, U.S. economic performance during the height of the boom, from 1995 through 2000, though better than during any other five-year period since the start of the long stagnation in 1973, was anything but extraordinary. In terms once again of the usual indices, U.S. economic performance in the five years period between 1995 and 2000 did not quite match that in the twenty-five years between 1948 and 1973 — and productivity growth, supposedly the source of a U.S. economic breakthrough, was fifteen per cent lower.
Dependence of the Boom on the Bubble
The most important fact of the 1990s boom — a substantial boom, even if it was vastly overrated by publicists and politicians — is that it was, ever more dependent upon the stock market rather than vice versa. Venture capital firms did provide massive funding to high technology companies. But they did not do so until the equity price bubble was approaching its peak.
At that point they did not have to depend on these companies’ actual productive potential, but could profit from the insanely inflated returns from the initial public offerings (IPOs) of these companies’ stocks (which also failed to rise significantly until the bubble expanded.)
Equity investors more broadly did help finance some of these companies, as well as others, by buying their shares. But they did so not because these companies had delivered high profits on the basis of their powerful technologies, but rather because their stock prices were skyrocketing into the stratosphere, driven by speculation. Most E-businesses failed ever to make a profit; and even the leading technology, media, and telecommunications companies (TMT) companies at the heart of the “New Economy” could not achieve profits that remotely kept up with their equity prices.
Corporations did launch a huge investment boom and were thereby able to raise productivity growth, but they could do so only because their inflated share prices made access to capital so easy, not because the New Economy had raised profit-making possibilities.
Again, the growing gap between stock prices and profits at once defined the bubble and drove the expansion. But it also constituted the economic expansion’s fatal flaw and ultimately brought both the boom and the bubble to a screeching halt.
U.S. Revival, World Stagnation, 1985-1995
The real story runs more or less in the opposite direction to the official one. There is little evidence indicating a falloff of the rate of technological advance in the 1970s and 1980s. There is, however, irrefutable evidence in these years of continuing, deeply reduced profitability, especially in the U.S. and international manufacturing sector. The latter reflected ongoing overcapacity and overproduction — as well as the failure of successive Keynesian (in the 1970s) and Monetarist (in the 1980s) policies to provide a solution — and this goes a long way toward accounting for the long-term slowdown of capital accumulation. Slowed investment growth must bear a large part of the responsibility for the long-term system-wide slowdown of innovation and productivity growth. (For the foregoing, see my “Economics of Global Turbulence,” New Left Review 228-229, May-June 1998.)
U.S. Manufacturing Recovery
Against the background of still much-reduced rates of return and slowed growth internationally, between 1986 and 1995 the U.S. manufacturing sector, and thereby the U.S. private economy as a whole, achieved a striking recovery of profitability and ultimately, vitality.
It did so by taking a leaf from the book of its leading international rivals in Germany and Japan so as to achieve a powerful revival of international competitiveness and exports. But U.S. manufacturers did not increase their competitiveness and profitability through stepped-up investment in aid of rising productivity — at least not until the very end of the process.
They did so instead primarily by means of the classical capitalist mechanisms of industrial shake-out and redistribution of income away from both labor and their overseas rivals. In the extended cyclical downturns of the first half of the 1980s and the first third of the 1990s, U.S. corporations shed huge masses of high-cost, low-profit means of production, and especially labor.
Corporate America thereby began a revival of manufacturing productivity growth without the assistance of investment growth. Firms benefitted simultaneously by holding real wages virtually constant during the decade after 1985, and taking advantage of Reagan administration tax breaks that enabled them to sharply reduce their share of taxes in profits.
Over the same period, they were also able to profit mightily from the devaluation of the dollar by 40-60% with respect to the mark and yen. This realignment of currencies was detonated in 1985, when the U.S. obliged its main allies and rivals to agree to the Plaza Accord, which called for bringing down the dollar from the heights it had reached during the first half of the decade.
Between 1985 and 1995, the rate of profit in U.S. manufacturing increased by more than two-thirds. It thereby succeeded over this period in raising profitability for the economy as a whole above its level of 1973 for the first time in more than twenty years.
The U.S. manufacturing profitability takeoff was deeply dependent upon an extraordinary recovery of U.S. manufacturing competitiveness, and U.S. exports rose more quickly over the decade than they had during any previous ten-year period in the postwar epoch. Capital accumulation sped up and enabled productivity growth to leap forward, making for a further increase in profitability and setting off the expansion of the 1990s.
Japanese and West European Manufacturing Impasse
In an ideal world of mutually complementary specialized productions, the revitalization of the U.S. economy might have ended up propelling the world economy into a new era of growth. But before the mid-1990s, in the actual world of manufacturing overcapacity and redundant production, the U.S. recovery not only imparted little increased dynamism to the world economy, but came to a large extent at the expense of the economies of its leading competitors and trading partners, especially Japan and Germany.
This was because, right up until the end of 1993, U.S. producers secured their gains in profitability primarily by means of the falling dollar and essentially flat real wages, as well as reduced corporate taxation, but with the benefit of little increase in investment.
In what turned out to be pretty much a zero-sum game, they therefore raised their rates of return by reducing costs so as to successfully attack their rivals’ markets; but they generated in the process relatively little increase in demand, either investment demand or consumer demand, for their rivals’ products.
When the U.S. government moved in 1993 to balance the budget, the growth of U.S.-generated demand in the world market received an additional negative shock. As the opposite side of the same coin, from 1985 the manufacturing economies of Japan, Germany, and elsewhere in western Europe faced an ever intensifying squeeze. Their rising currencies, as well as their relatively fast wage growth, made for declining competitiveness, thus increased downward pressure on already reduced manufacturing profit rates and capital accumulation.
Meanwhile, the declining growth of investment, consumer and government demand growth issued in stagnating purchasing power for their goods at home and abroad, most especially in the United States. These economies thus could avoid neither intensifying problems during the second half of the 1980s, nor severe crisis during the first half of the 1990s. From 1991, they entered into their worst recessions of the post-war epoch.
The Bubble as Engine of Expansion, 1995-2000
By spring 1995, as the yen rose to seventy-nine per dollar, its highest level of the post-war epoch, Japanese manufacturers could barely make a profit, and the Japanese economy began to freeze up.
The Mexican Peso Crisis had traumatized the world economy only a few months before. The U.S. government thus felt pressed to bail out the Japanese manufacturing economy in much the same way that the Japanese and German governments had had to bail out the U.S. manufacturing economy in 1985 — viz. by engineering, in collaboration with the other G-3 powers, a new rise of its currency.
The so-called reverse Plaza Accord of summer 1995 marked a huge turning point for the world economy, as the ensuing ascent of the dollar, as well as the East Asian currencies tied to it, and parallel decline of the yen and the mark, initiated a epochal shift away from the pattern of international economic development of the previous decade.
As the dollar began to rise from the latter part of 1995, the burden of continuing international overcapacity and over-production in manufacturing shifted back to the United States. The revalued currency thus immediately cut short that extended rise of U.S. manufacturing competitiveness that had played such a big part in the profitability revival.
U.S. manufacturers were now squeezed between the intense downward pressure on prices, resulting from the surfeit of international manufacturing supply, and its own rise in relative costs resulting from the rising currency. The manufacturing profit rate fell by about 17% between 1997 and 2000, and began to depress the profit rate in the private economy as a whole.
Rising Equity Prices
Meanwhile, in 1995, under the terms of the Reverse Plaza Accord, the U.S., German, and especially the Japan<->ese government let loose a huge flood of funds onto U.S. money markets to drive up the dollar, mainly through the purchase of U.S. Treasury instruments.
As a result, U.S. long term interest rates fell sharply, at the same time as the Federal Reserve pushed down short term interest rates (to help combat the Mexican Peso crisis). The major reduction in the cost of borrowing that thus took place in 1995, as well as the rise of the dollar itself, encouraged and enabled investors to detonate the great stock market runup.
Previously — between 1980 and 1995 — U.S. equity prices had risen significantly, but no more than had corporate profits. But, henceforth, equity prices left corporate profits in the dust, and the biggest stock market bubble in U.S. history blew up.
U.S. corporations were quick to exploit the cheap money regime endowed by Alan Greenspan. Between 1995 and 2000, they increased their borrowing as a fraction of corporate GDP to record levels. This was not so much to fund expenditures on new plant and equipment, as to cover the cost of buying back their own shares.
In this way, the corporations avoided the tedious process of creating shareholder value through actually producing goods and services at a profit, and directly drove up the price of their shares for the benefit of their stockholders, as well as their corporate executives who were heavily remunerated with stock options. U.S. corporations were the largest net purchasers on the stock market between 1995 and 2000.
Wealth Effect of Rising Equity Prices
The runaway stock market allowed the U.S. expansion to continue and accelerate in the years between 1995 and 2000, at the same time as downward pressure on the manufacturing profit rate came to deprive the expansion of its initial foundation. As the paper value of their assets inflated far beyond any possible underlying economic value, corporations were endowed with vast alternative sources of cheap funding, aside from profits.
They could issue overvalued stocks; they could also gain access to endless supplies of credit by using the inflated value of their assets essentially as collateral. They were thus able to maintain, even increase, the rate of growth of their expenditures on new plant and equipment, despite the diminishing relative contribution of profits. Thanks to this wealth effect, the expansion then continued, even accelerated.
Limits to the Wealth Effect
Nevertheless, equity prices could hardly rise forever in defiance of falling profitability. The stock market was running over a cliff; but, like the proverbial cartoon character, so long as equity investors refused to look down, or refused to be concerned by the trend in profitability, it could continue to move forward. But it could not defy gravity forever. Starting in mid-1998, corporate equities did begin to fall sharply. Shortly thereafter, in the wake of the Russian default and Brazilian crisis, the U.S. economy was descending by 1998 into its most serious crisis of the post war epoch.
But if the United States went into recession, much of the rest of the world economy, dependent as it was upon the U.S. market, might be headed for depression. With global financial markets freezing up, Alan Greenspan and the Federal Reserve thus engineered their famous bailout of the LTMC hedge fund and lowered interest rates on three occasions.
They did so, in the first instance, in order to stabilize an international financial system that was heading for a crash. But Greenspan’s goal was not merely to head off a collapse. It was also to push up equity prices by assuring investors that he wanted them to rise. In this way the wealth “effect“ of the stock market’s continuing ascent might keep the U.S., and world, economy turning over.
What Greenspan was attempting might be called “stock market Keynesianism.” Whereas in traditional Keynesianism, demand was “subsidized” by means of the federal government’s incurring rising public deficits, in Greenspan’s version, demand would be increased by means of corporations and rich households taking on rising private deficits, encouraged to do so by the increased paper wealth that was represented by the increased value of their stocks.
By 1997-8, the U.S. campaign to balance the budget had reduced deficit spending to zero, and recourse to traditional Keynesian was ruled out. In order to stoke investment and consumer demand and thereby counter-balance the worsening decline in manufacturing competitiveness, exports and profitability, the Fed thus had little choice but to force up the stock market.
By virtue of his material reassurances to the equity markets, as well as his paeans to the New Economy, Alan Greenspan pretty much achieved his goals, with dramatic results: Between the end of 1998 and the middle of 2000, the stock market run-up and the U.S. economic boom entered their most fevered phase.
Technology, media, and telecommunications firms (TMT) in particular saw their equities rise into the stratosphere, enabling them to raise huge amounts of money. On this basis, they were able to finance a hugely disproportionate share of total investment in this period and, in turn, significantly increase their productivity growth.
From Bursting Bubble to Recession
The stock market was running over a cliff, but, like the proverbial cartoon character, so long as equity investors refused to look down, it could continue to move forward. Nevertheless, from summer 2000, firm after firm was hit by news of disappointing returns, and the stock market began to plummet.
A huge multitude of e-commerce firms, having never shown a profit, had already collapsed as they simply ran out of funds. But soon the crash was consuming almost all of the leading lights of the TMT sector (technology, media, telecommunications), including such stock market darlings as equipment makers Cisco, Lucent, and Nortel and components producers JDS Uniphase and Sycamore. Perhaps a third of total asset values extant at the start of 2000 went up in smoke.
As a result of the fall in equity prices, the wealth effect went into reverse. Finding the value of their on-paper assets sharply reduced, firms and households have not only found it more difficult to spend, but less attractive to do so, especially since the growing threats of bankruptcy and unemployment have led them to look to repair their overburdened balance sheets.
In turn, they naturally cut back expenditures on capital and consumer goods. But with investment growth falling, productivity growth has had to drop too, putting further downward pressure on profitability.
Above all, the economy has found itself in possession of great masses of plant, equipment and software, which could in no way be realized. The resulting over-capacity had succeeded already by the first half of 2001 in reducing absolute profits in the manufacturing sector 58% below its 1997 high point, while bringing down the profit rate in the non-financial corporate sector some 25% below its 1997 peak.
Under the impact of the reverse wealth effect and in the face of mammoth excess capacity, the growth of output and of investment fell faster than in any other comparable period since World War II, GDP growth declining from 5.2% in the year ending at mid-2000 to 0.8% (on an annualized basis) in the first half of 2001 and non-residential investment growth from 11% to minus 7.4% over the same interval.
It was the collapse of investment in the face of manufacturing overcapacity and plummeting profitability that drove the cyclical downturn. Manufacturing employment and output began to fall immediately and profoundly. But it was only from around the middle of 2001 that the U.S. economy as a whole began to fully register the profound shrinkage of its markets that had followed upon these drop-offs of growth and capital accumulation and to take the standard measures of self-preservation.
From that point, U.S. corporations in general began lopping off great swathes of their productive capacity, and in particular their labor forces, in an effort to restore competitiveness and balance sheets, placing huge pressure on their rivals to respond in kind.
The aggregate effect was a powerful downward spiral in which falling investment and consumption led to rising layoffs, bankruptcies and loan defaults, making for further sharp falls in demand, creating the pressure for deepening recession.
As the U.S. entered recession, the rest of the world followed in virtual lockstep. Itself saved by the stock market, the U.S. boom in its final phase had rescued the world economy from the international economic crisis of 1997-1998 originating in East Asia.
With equity prices and investment now collapsing, especially in high technology, the film began to run in reverse. Declining U.S. demand made for declining imports from the rest of the world and the ensuing international recession made for declining U.S. exports. A mutually reinforcing international recessionary process was in progress.
Can Expansionary Policies Stem the Tide?
To stem the economy’s frightening plunge over the course of 2001, the Federal Reserve lowered interest rates extremely sharply and extremely rapidly. The idea of course was to encourage spending by encouraging borrowing by making its real cost exceedingly cheap.
Nevertheless, it was pretty evident from the start that this policy would have little effect on corporations. They already had too much plant and equipment, so had no desire to invest. They therefore wouldn’t borrow no matter how little it cost to do so. In this sense, the Fed was, in Keynes’ famous phrase, “pushing on a string.”
The historic reduction in interest rates has been quite successful, however, in its main short-term goal — i.e. to spur consumer spending. Super-cheap credit thus has provoked an extraordinary increase of household borrowing, especially by means of the re-financing of home mortgages, even as unemployment has steadily increased.
Rising personal consumption has single-handedly saved the economy, at least for the moment. In 2001 the growth of household borrowing increased faster than at any time during the 1990s. This allowed personal consumption expenditures to grow by 3.1% in 2001, and by a whopping 6% in the fourth quarter of 2001.
In response to this increase in spending on the part of consumers, corporations have been rebuilding the inventories that they allowed to run down as the downturn deepened and GDP has responded accordingly. It is the causal chain running from the growth of household borrowing, to the growth of consumer expenditures, to the growth of inventories that has been responsible for the rapidly accelerating growth of the fourth quar<->ter 2001 and first quarter of 2002.
Nevertheless, precisely because the recovery has thus been almost solely dependent upon the rapid growth of consumer spending, and behind that, consumer debt, its foundations remain shaky.
Investment growth, the key to economic health, has been falling like a stone — from an average annual rate of 14% in the first half of 2000, to 4% in the second half of 2000, to minus 7.4% in the first half of 2001 to minus 11% in the second half of 2001 (the latest period for which there is data).
Export growth has also been collapsing — from 11% in the first half of 2000, to 3.3% in the second half of 2000, to minus 6.5% in the first half of 2001, to minus 14.9% in the second half of 2001.
The excruciating downward thrust of both investment and exports was responsible for the downward spiral that gripped the economy until late in 2001. It is now the aim of policy makers to keep consumer spending driving the economy going until investment and exports can revive, investment hopefully rising under the stimulus of rising consumer spending.
But the worry is that overhang of excess plant and equipment that was responsible for declining profits will forestall any new burst in investment. As to exports, it is just about certain that they will not rise until the economies of the rest of the world begin to recover, something which will not happen until the U.S. itself begins to expand and to pull them along.
How long reduced interest rates can drive consumer spending is itself a big question. In 2001, the growth of household borrowing as a percentage of GDP reached its highest point since 1980 (except for 1985) and household debt as a percentage of GDP hit its highest level ever, almost 25% above that in 1990.
It therefore seems likely (though hardly certain) that, especially in the face of rising unemployment, households will have to slow down their taking on of new debt and thus reduce their spending.
Meanwhile, policy makers face something of a double bind: for, were household borrowing to keep household expenditures growing and the economy expanding, interest rates would certainly rise, and that could undercut both borrowing and consumption.
Against this background of profound uncertainty, the enormous “balances” that are legacy of the bubble of the late 1990s loom like dark clouds.
i) The record ascent not only of household, but especially corporate borrowing was central to the boom. But as declining prospects and bankruptcy have loomed ever larger, corporations have felt obliged to reduce their debts to reduce their vulnerability. Should this continue to happen on a large scale, a big prop to investment will go by the wayside.
ii) Up to now, overseas investors have been more than willing to fund U.S. trade and current account deficits that have continued to break new records every year, and they did so again in 2001. They have done this by making huge direct investments in the U.S. and enormous purchases of U.S. corporate equities and U.S. corporate debt.
But if the U.S. economy continues sluggish and the stock market to languish, the rest of the world may finally come to find U.S. assets relatively less attractive. Were they to do so, the dollar would come under downward pressure.
At that point, the Fed would be faced with an excruciating choice: let the dollar fall and risk a wholesale liquidation of U.S. assets by foreign investors that would bring about a real run on the dollar; or, raise interest rates and risk pushing the economy back into recession.
iii) Equity prices have obviously fallen hugely, in response to the worsening business outlook. But paradoxically, their decline has failed to bring stock prices back into line with profits, because profits have dropped almost as fast.
Stocks thus remain highly overpriced, and the stock market may therefore have a good way further to fall. Were it to do so with the recovery still so fragile, the effect on business confidence and the economy more generally would be devastating.
The bottom line is that the rate of profit, the ultimate key to any recovery, remains very depressed, and the forces that drove it up during the 1990s are gone. In 2001, manufacturing corporate profits fell to their lowest level since 1986. At the same time, the non-financial corporate profit rate fell to its lowest level since 1981.
Yet the dollar remains high, keeping down international competitiveness, and making any manufacturing profit rate recovery exceedingly difficult. And, of course, the wealth effect of the stock market boom no longer inflates demand or makes investment nearly costless.
Even as economic growth has accelerated, the Federal Reserve has so far failed to raise interest rates, a sign that it is anything but confident that the economy is taking off and the recovery is secure. By the same token the stock market has continued to stagger, failing to rise much above its depressed levels of late 2001.
Clearly, big business has serious doubts about the consumer-led upturn. Alan Greenspan has declared the recession over. But the economy is not yet out of the woods.
from ATC 98 (May/June 2002)