Questions and answers about the crisis
July 26, 2002 | Pages 6 and 7
"THE FUNDAMENTALS are in place for a return to sustained healthy growth." So said Federal Reserve Chair Alan Greenspan on July 16 in testimony before the Senate Banking Committee. But Greenspan's assurances came in the midst of one of the worst-ever weeks in Wall Street history, with stock prices falling to their lowest level since 1998.
Does the decline in stocks mean that the economy will relapse into recession? Or is Greenspan correct that the recovery will gather strength? LEE SUSTAR answers your questions about the roots of the U.S.'s economic problems and the prospects for the future.
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WHY HAS the stock market declined so much and so fast? Are the corporate accounting scandals to blame?
THE SCANDALS did spook many investors into selling, and signs of this panic prompted others to follow suit, in order to cut their own losses. But the real reason that investors are dumping stocks is what some economists have called the "profitless recovery."
According to government statistics--which are more accurate than the fairy-tale balance sheets issued by Corporate America--the peak of pre-tax profit margins during the 1990s boom was about 13 percent in 1997. That number fell to less than 7 percent last year. While profits have increased since, they remained weak in the first quarter of 2002 despite the recovery.
It was the drop in profits over the past five years that led companies like Enron, WorldCom and Qwest to cook the books to keep their banks and investors happy. A favorite tactic was granting stock options worth hundreds of millions to top executives, while refusing to list them as an expense on their books.
Wall Street analysts estimate that once large companies calculate the real cost of stock options, their reported profits will be cut by 10 percent. That's why the problem can't be reduced to what George W. Bush calls a few CEO "bad actors."
There were a whole series of measures adopted by big business to keep the appearance of the boom intact well after it was over--abetted by accountants and regulators, who let them get away with anything.
BUT GOVERNMENT statistics show that the economy is growing. Why are profits so lousy?
THE BROADEST measure of the production of goods and services--gross domestic product, or GDP--did increase by 5.8 percent in the first quarter, a very rapid pace. But a closer look at the government's numbers shows the underlying weakness of the recovery.
Government spending--jacked up by Bush's military budget and post-9/11 spending, such as subsidies to airlines--boosted GDP by a full 1 percent. Most of the rest of the growth came from manufacturers suddenly gearing up to replace inventories that were liquidated at fire-sale prices during the 2001 recession.
Simply producing enough to replace inventories accounted for 3 percent of growth in GDP for the first quarter. That in turn led to an increase in manufacturing in the first half of this year, following a big decline in 2001.
Nevertheless, only 76 percent of manufacturing capacity is currently being used--compared to 84 percent at the height of the boom. Thus, the big investments in factories and machinery that seemed to guarantee profits in the 1990s are a millstone around the economy today.
Not only are there too many goods to be sold at a profit, there are too many factories to produce the goods at a decent profit. Yet profits can only be made by exploiting the labor of workers--by paying wages kept as low as possible, paying the cost of raw materials, machinery, etc., and keeping the rest for capital. That theft is the real scandal at the heart of the system. But if the prospect for profits is poor, capitalists won't invest in new production--leading to more layoffs.
Also holding down investment is corporate debt, which hit $4.9 trillion last year--equal to nearly half of GDP. As a result, what statisticians call "private fixed investment" has declined 15 months in a row--even though interest rates for borrowing money to invest are at their lowest levels in 40 years.
For once, Greenspan explained the problem in plain English: "The recent economic downturn was driven, in large measure, by the sharp falloff in the demand for capital goods that occurred when firms suddenly realized that stocks of such goods--both those already in place as well as those in inventory--were excessive."
Or as Karl Marx would say, we are in a crisis of overproduction--not just in the U.S., but on a world scale. The auto industry, for example, has enough capacity to supply the U.S. market two times over. The problem is perhaps worse in telecommunications, where only a fraction of capacity is being used, leading to a gigantic corporate debt chain of bankruptcies.
WHY DID this crisis of overproduction develop?
CAPITALISM goes into recession periodically--as part of what mainstream economists call the "business cycle." The boom starts when investment picks up to take advantage of new markets, and competitors follow suit until markets are saturated with goods that can't be sold at a decent profit. In the recession that follows, banks call in loans, and companies go bust until the excess capacity is cleared away.
But letting huge companies like Enron, WorldCom or United Airlines go bankrupt could drag down larger and healthier companies. So governments step in with bailouts and protectionism against foreign trade. But this doesn't eliminate the excess capacity.
Another factor affecting the character of the economic crisis today is that it is taking place after a long-term decline in the rate of profit. Profit margins at the high point of the 1990s boom were far below those of the 1960s boom and comparable to those of the 1970s. Meanwhile, low interest rates and easy money have only continued to create a huge financial bubble.
The New York Times reported recently that the market for derivatives--complex financial instruments that are basically bets on the price of other securities--is now $100 trillion, about twice the value of all the goods and services produced worldwide in a single year. That's a 38 percent increase since 1998, when bad derivatives trading by Long-Term Capital Management triggered a world financial panic that put leading U.S. banks at risk.
The huge growth of derivatives--a virtually unregulated, international market--has made further financial instability likely.
CAN SPENDING by consumers keep the recovery going?
"CONSUMER" is a statistical amalgamation of all social classes--workers, the middle class and the tiny group of capitalists. The working class, and especially the middle class, have taken advantage of "zero-finance" auto sales and low interest rates to buy houses or refinance mortgages. This likely helped to maintain economic growth in the second quarter, although statistics aren't yet available.
But the boom in housing prices--one area of the economy where the 1990s bubble hasn't been punctured--has added to already staggering levels of consumer debt. Mortgage payments are running as high as 42 percent of income. Home-equity loans are expected to hit an incredible $1 trillion this year--a 20 percent increase over last year. And since home-equity loans typically aren't fixed, a rise in interest rates could wipe out millions of homeowners.
Once the bubble in house prices bursts--as it inevitably will--many millions more could find themselves paying off loans worth more than their houses are worth.
In any case, consumer spending, while increasing, dropped off its fast pace of the 1990s as working people max out on debt--and if unemployment keeps rising above its current 5.9 percent, it will slow further. Savings as a percentage of disposable income is just 3.1 percent, compared to 9 percent back in 1989.
Greenspan hopes that consumers will keep spending long enough for low interest rates to finally induce business to make investments. Japan's policymakers used the same strategy when a financial bubble burst there a decade ago. They're still waiting for it to work.
CAN GOVERNMENT spending take up the slack?
BUSH'S MILITARY and "security" spending, plus last year's massive tax cut, did provide a burst of momentum for the economy. But military spending is far short of the share of GDP that it was at during the height of the Cold War, so it won't play the pivotal role it did then.
Plus, Bush's $1.35 trillion tax cut is skewed to the superrich, so it won't help ordinary people much.
WHAT WILL be the impact of the stock market dive on the overall economy?
IT'S IMPORTANT to distinguish between the stock market--part of what Marx called "fictitious capital"--and the real economy.
Marx called stocks "fictitious" capital not because of lying CEOs like Ken Lay or Bernie Ebbers, but because these "shares" in the ownership of companies themselves don't have any intrinsic value.
Changing stock prices reflect speculation on how much surplus value--the source of the bosses' profits--will be extracted from workers in the future. But there's nothing to keep stock prices in line with the underlying value of a corporation.
The 1990s technology boom provided many examples of the absurdities of speculation--like, for instance, when the total value of all the stock (or market capitalization) of an Internet travel agency turned out to be greater than the capitalization of the airlines.
The bubble began to burst in the middle of 2000. But because corporate profits have declined even more, the stock market is still inflated--and at a level comparable to the bubble that burst in 1929 during the Great Depression. Investors are finally catching on that corporate profits aren't getting better--and are therefore selling.
Sometimes, a stock market crash has little effect on the real economy. This time, though, a further fall on Wall Street, whether fast or slow, is likely to have a far-reaching impact.
First, the collapse in stock prices has wiped out the savings of millions of people who invested in 401(k) retirement plans because their employers no longer offered traditional fixed-benefit pensions. A Boston Globe journalist estimated recently that the average 401(k) plan has lost about a quarter of its value in the last two-and-a-half years. As a result, millions of people who thought that they would be able to retire soon suddenly face the prospect of working until they die.
What's more, the 1990s stock market boom attracted enormous amounts of international investment. If foreign investors keep dumping stocks, the impact will be to not only drive down share prices, but keep putting pressure on the value of the dollar relative to other currencies.
WHY IS the decline in the value of the dollar important?
THE STRONG dollar of the late 1990s benefited the U.S. and the world economy in some important ways. It helped to make the U.S. attractive to foreign investors, particularly after the East Asian and Russian financial crisis of 1997-98.
Investment from abroad seeking a safe haven greatly inflated the stock market bubble. And with the dollar strong, the U.S. could become the importer of last resort for the crisis-wracked East Asian economies.
But the stronger the dollar is compared to other currencies, the more expensive U.S. exports become on the world market. That hurt U.S. manufacturers. Meanwhile, the strong dollar made imports cheaper.
The combination of the import boom and massive financial inflows into the U.S. led to a record deficit in its current account--the total amount of foreign goods and capital owed. According to the investment bank Goldman Sachs, the U.S. current account deficit is on track to increase from $420 billion in 2001 to $730 billion in 2006--which would be equivalent to 5.9 percent of GDP.
This deficit allowed the U.S. economy to consume far more than it produced--which didn't seem to matter as long as foreign investors were willing to keep pouring money into U.S. investments. But now that the value of those dollar-denominated assets is plunging, foreign investors are bailing out.
The falling dollar could help U.S. manufacturers, but if it declines beyond a certain point, the Federal Reserve might have to raise interest rates to attract foreign investors back. Higher interest rates, in turn, could choke off the investment that the U.S. needs. And if the weak dollar persists, it could cause a sharp drop in the exports of other countries to the U.S.--which would have a devastating effect on Japan and East Asian countries.
Moreover, the main European countries are struggling with recessions and slow growth of their own. As Financial Times columnist Martin Wolf put it, "There may be a brutal adjustment in the near future, with a vicious downward spiral in U.S. and world equity prices, higher long-term interest rates, an exodus of capital and dollar weakness The true choice now may be between going over a high cliff some years from now or going over a rather low cliff quite soon."
HOW WILL the crisis be overcome?
THE EMPLOYERS have already made their solution clear: Squeeze workers even harder as companies try to work off debt and get rid of unprofitable capacity through layoffs and plant closures.
The surge in productivity in recent months is mainly the result of management increasing output while hiring very few new workers (or recalling only a few of those who were laid off).
The longer that the economy does poorly, the greater the squeeze will become. But it's far from clear that even this would prevent another slide into recession--or at least economic stagnation.
Debt and overcapacity could take years to overcome--the process has lasted 10 years in Japan, with no end in sight. Meanwhile, financial instability threatens an even greater lurch downward.
A workers' solution to the crisis has to start with defending jobs, organizing and strengthening unions, demanding relief for the unemployed and taxing the rich to make them pay.
We need to put forward a clear analysis of the system--one that explains how capitalism is based on exploitation and ruins the lives of countless numbers in each crisis. At the same time, it's important to put forward a socialist alternative--a society based on not on maximizing profits for the Enrons and the WorldComs, but meeting human needs under democratic workers' control.