IN THE last five years the world economy has grown at almost 5 percent a year, its fastest rate since the end of the long post-Second World War boom in 1973. The boom has been centered in the “emerging economies” of China, India, Brazil, and Russia. That boom is now threatened by the bursting of the housing and financial bubbles in the advanced countries, particularly the United States, where a recession now looms.
To pull out of the last recession, the central banks of the advanced industrial countries drastically lowered interest rates to stimulate business activity and restore corporate profitability. The unintended consequence of cheap credit was an international housing boom that the Economist some years ago correctly labeled the world’s biggest financial bubble, and that now threatens to bring about a new recession, much more severe, long lasting, and global.
The Federal Reserve Bank (the U.S. central bank) kept short-term rates to 1–2 percent from 2002–04, stimulating a runaway housing market, that was responsible for 40 percent of growth and job creation and giving the appearance of a stronger recovery. Housing prices soared on the basis of low mortgage rates, producing large profits for builders, developers, mortgage brokers, and banks. To keep production up, “exotic” mortgages were invented, with no down payments, and low monthly contributions based on inexpensive “teaser” rates for an initial period of two years that were then offset by drastically higher rates of 9–11 percent for the remaining twenty-eight years. Buyers were assured they could avoid these higher rates. Since home prices were rising rapidly, they would acquire tremendous value in their houses, and with good credit derived from their monthly payments, they would be able to refinance at lower rates.
The investment banks bundled hundreds of these mortgages into securities, or bonds, which were sold to commercial banks, their off-balance-sheet subsidiaries, pension funds, insurance companies, hedge funds, and international financial institutions.
The enormous profits from this arrangement produced the typical capitalist cyclical outcome—an overproduction of houses, which could not be sold at the usual profit. A year ago construction activity and housing prices stagnated and then fell, coincidentally just as the resetting of mortgage rates began. People found that with falling home prices they could not refinance, and were now stuck with these higher, unaffordable rates. Within a few months, half a million families couldn’t make their mortgage payments and lost their homes. It is estimated that if the economy doesn’t get worse (which no one now believes) an additional two million families will lose their homes in the next two years as mortgage rates rise beyond their ability to pay.
Beyond the human tragedy, this will add to the large inventory of unsold houses, further depressing prices. Many mortgages will be greater than the house is worth, which in turn will lead more people to walk away from homes with inflated prices, producing even more forecloses, and further price declines. And of course the banks are now refusing to make mortgages in declining or unstable markets, narrowing the pool of potential buyers. It is the mad logic of the capitalist market in crisis spiraling downward and producing the worst housing depression since the 1930s.
As the housing industry contracts there is less demand for furniture, appliances, home decorating and improvement goods, etc. Manufacturing orders are falling. Construction, financial, and industrial workers are starting to be laid off.
The decline in housing prices has started to hit retail sales. Family income has never recovered from the last recession. Neoliberal economic policies channeled all the growth in wealth to the top 10 percent; everyone else’s income is less than it was in 1999. As wages stagnated or declined, consumption was only maintained through the growth of debt. Homeowners borrowed against the rising value of their homes, at a rate of $800 billion a year for the last three years. Debt levels rose and the savings rate became negative for the first time since the grim 1930s. Now that housing prices are falling, increasing house debt as the vehicle to maintain living standards is over, and retail sales to working-class families are sliding.
All of this is cutting into profits, the dynamic that drives the capitalist engine. In the last quarter, profits fell by 8 percent from a year ago, the first decline in the mass of profits since the last recession. With less profit, business spending for capital goods is being cut back. All the elements of a recession have been slowly unfolding for months. But this is more than an ordinary recession, it is also the opening of an international financial crisis unlike any in the post-Second World War period.
The massive build-up of toxic debt is threatening the functioning of the international financial system. The banks have been forced in the last two months to write down $80 billion of bad mortgage debt. Conservative estimates are that they will have to take losses of $300–400 billion in the next year—if the economy doesn’t go into recession. Citibank, the largest American bank, had to take a $6 billion loss in November, and is expected to take between $10–15 billion more in the next three months, on its worst subprime mortgages alone. Like other banks it also has severe problems with its corporate debt book, and its off-balance-sheet subsidiaries, which it did not put up capital reserves for. The most important international bank may face a capital crisis because it does not have adequate reserves to cover all of its bad loans.
These are the conditions that are producing an international credit crunch, in which banks are reluctant to lend money to corporations or other banks because they are afraid they will not be repaid, or because of the necessity to preserve capital to deal with the bad debts on their books or those of their off-balance-sheet subsidiaries. It is estimated that the subprime crisis alone may cause a contraction of the banks’ ability to lend $2 trillion, further deepening a recession. Already, a few banks in Germany and England have had to be rescued from bankruptcy by state bailouts. Many of the large European and Asian banks have suffered substantial losses from the U.S. mortgage meltdown. And that is before the bursting of the housing bubbles in other countries, in many of which housing prices were even more inflated than in the United States. The Swiss bank UBS was forced to take a $10 billion writedown in December, and it also received an $11.5 billion capital infusion from Singapore’s state investment arm and a Middle East investor.
Yet this crisis is centered in the contradictions of U.S. capitalist economics, the central axis and new weak link of the world system. The financial bust in America threatens to produce massive international crises as it finally bursts the limits of the long, unsustainable, structural imbalances of the global trading system.
Ever since the Asian recession of 1997–98, the U.S. has been “the buyer of last resort,” sucking in imports which couldn’t be profitably absorbed in domestic Asian markets. This produced a tremendous imbalance in world trade, with growth in many countries dependent on exporting to the American market, with the U.S. building up an untenable balance of payments deficit financed by foreign borrowing, often from countries exporting to it. That has produced a trade deficit of $700–800 billion a year. To cover this deficit the U.S. has borrowed $2.5 trillion dollars from the rest of the world in the last three years, sucking up 80 percent of world savings. Now foreign capitalists are reluctant to lend to a maxed-out, credit-risk United States.
While the U.S. is still dependent on borrowing $50–60 billion a month to pay for its trade deficit, capital has been fleeing the U.S. since the mortgage crisis came to a head in August. The outflow of foreign capital has produced a sharp dollar crisis. The decline of the dollar is stoking inflationary pressures as it has forced up the price of oil, gold, and other commodities. Meanwhile, the endless wars in Iraq and Afghanistan contribute to the intractable nature of the crisis by having raised arms and war spending from $299 billion in 2000, to between $700 billion and $800 billion this year, much of it dependent on foreign credit.
Now even optimistic economists are predicting zero to 2 percent growth next year, and many are expecting a recession. Indeed, parts of the economy are already in recession—construction, real estate, finance, and the big-three automakers. Some states, including Florida, Nevada, and Michigan, are also already in recession. The rest of the economy—retail, transport, capital spending—is slowing down rapidly. The only thing that is going well at this point is exports, which have risen by 18 percent in the last year, as a result of the decline in the value of the dollar. But as the Wall Street Journal reported on December 10, “The downdraft in the U.S. economy is now overwhelming those benefits, economists say.”
The deterioration of the mortgage market and other credit markets has meant that the banks are in a worse position now than they were even during the panic of last August, pushing up some interest rates, including some mortgage rates, despite the Fed’s two rate cuts. And this is before a recession, at which time the corporate debt market will also come under question. Large numbers of corporations have debt levels that are much greater than anything in the past. They were ratcheted up by private equity and leveraged buyout deals in which corporations were bought not at the usual price of six to eight times cash flow but at ten to fifteen times their cash flow. These inflated prices were paid for by massive debt through the issuing of “junk” bonds. For other corporations, bad debt was piled on to finance share buybacks to push up stock prices. It is similar to the toxic debt waste in the mortgage market; there are no defaults yet, but when a recession comes, this level of corporate debt cannot be sustained and there will be major bankruptcies that will put large numbers of people out of work.
In the last five years, with the trade deficit and the war debt, the dollar had declined by 30 percent—the lowest it has ever been. The mortgage/financial crisis setting off the capital outflow has caused the dollar to drop an additional 10 percent since August and has raised the threat of a deeper, international dollar crisis. A number of other currencies are pegged to the dollar, and as it declines, it produces inflationary pressures in countries that are still in boom, for example the Gulf oil states, all of which have their currencies tied to the dollar. Some of them are now discussing breaking their peg to the dollar. Also open for question is the use of the dollar as the international reserve currency. For the first time there are serious discussions in financial circles about the creation of other international reserve currencies, including the Chinese yuan. It is an indication of the enormous shift in the world balance of power that has gone on in just the last five years that there would be this thought of the Chinese yuan, along with the dollar and the euro, becoming an international reserve currency. The decline of the dollar is really a metaphor for the lack of competitiveness of U.S. capital on the world market and the weakening of American imperialism since the Iraq War debacle.
The shift in the world balance of power also means that many of the countries that loaned money to the U.S. and have built up enormous reserves of dollars are now using those dollars to buy American assets on the cheap. For example, Abu Dhabi, the richest city in the world and capital of the United Arab Emirates, recently bought 4.9 percent of Citigroup for $7.5 billion through preferred stock that pays 11 percent interest. But this development reflects a bigger shift in the world distribution of wealth. The United States, which five years ago was producing 30 percent of world GDP, is now down to 25 percent: it’s the biggest shift in world wealth in decades.
The coming recession will be worse than the recessions of the last generation not only because of the scale of the debt problem, but also because the U.S. appears to have fewer options in dealing with the crisis than it did in the last two recessions, having used them up to postpone dealing with its economic weaknesses in the past. From running a budget surplus of $250 billion in 2000, the U.S. has been running deficits of $200–300 billion a year since then. It made a huge tax cut for the rich; it can’t afford to do that now, especially given the costs of Iraq and Afghanistan. Until the 1990s it was the world’s leading creditor, whereas it is now the world’s leading debtor and cannot cut interests rates as unilaterally and deeply as it formerly did without risking the loss of needed foreign capital. Moreover, interest rate cuts now threaten inflation both here and internationally. Domestic inflation is now 3.5 percent; if we were using the indexes that were used in the 1980s, it would be 6–10 percent. And for working-class families, real inflation is even higher than that, because the biggest price increases have been in food, fuel, housing, and health costs. Finally, the U.S. can no longer rely on consumer spending to buoy the economy because the mortgage crisis has squeezed consumer spending.
There is some talk that the economic boom in China and the developing world will keep the U.S. out of crisis. The problem with this scenario is that these economies are dependent on exports to the U.S., Europe, and Japan for their booms. If countries like China, India, and other developing nations are dependent on the most advanced countries for their markets, then a recession in the U.S., Japan, and Europe will also drag them down.
The last time the United States went into a deep crisis was in the period between 1973 and 1982, when there were three recessions. The standard of living was cut dramatically, and since then wages have never recovered; they’re lower today in real terms than in 1973. Household income since then has only been kept up by people working longer hours and by more two-income families. Profitability was restored by an enormous shift in wealth from labor to capital. The average CEO made 30 times what a worker did then; now he or she makes 500 times what a worker makes. On the heels of a boom that barely filtered down to the working class, millions of people now stand to lose their jobs, and millions stand to lose their homes.
So far the measures taken to deal with the prospect of a long, deep recession have been ineffectual—flooding the banks with money, cutting interest rates, freezing mortgage rates for a limited number of mortgages. While American capital’s options have become limited, we should not preclude stronger, so far unforeseen, measures to contain the damage. But no matter what policies are finally adopted, we can be sure there will be a ruling-class attempt to make the working class pay for the mess that capital has created. The enormous pay cut recently established in the auto industry, in which new hires will make half what workers made before, should be a warning of how capital will try to solve its crisis.
All of the policies producing this crisis come out of neoliberal free-market measures; deregulation of banking, cheap credit as the way to fight recession, and the “supply side” shift of wealth using tax policies favoring the wealthy as the means to stimulate the economy—all at the expense of working-class living standards and consumer demand. They are the grand results of the “triumph of the free market,” and “there is no alternative”—the neoliberal policies that emerged out of the last deep capitalist crisis, which blamed the welfare state, trade unions, and high wages for the system’s woes. These policies, which have had hegemony in both capitalist parties since then, are responsible for the looming disaster today.
As a result, the coming crisis will lead to a questioning of the free market. The response to the coming recession has to challenge these policies, asking how and for whom the really existing “free market” functions. We will have to prepare for a dramatic rise in economic and political instability—and sharper class attacks by the employers. There will have to be organized efforts to defend workers against layoffs, evictions, wage and benefit cuts, deportations of immigrant workers, and the rest of the reactionary program that capital will attempt to use to solve its crisis.
Joel Geier is an associate editor of theISR.
