The U.S. Economy: From Boom to Bust

 
BY:Conrad Schuler| September 21, 2001

After growing for nearly ten years, the U.S. economy came to a standstill. In the fourth quarter of 2000 growth was merely 1.1 percent. In January 2001, Federal Reserve chairman Alan Greenspan admitted the U.S. went through a dramatic decrease with probably close to zero growth. Indeed in industrial production, the economy dipped below zero growth.

The change in the economic cycle took place in the middle of the last year. In the second quarter of 2000 growth was still
5.6 percent; in the third quarter it dropped to 2.99 percent. The primary reason for the fall was the reduction of new investments that were then tending downward, becoming rapid when private consumption sank drastically.

All parts of the economy suffered. Private consumption, which includes two-thirds of the Goss National Product (GNP) and is therefore the deciding factor for demand, sank from 7.6 percent in the first quarter of 2000 to 2.8 percent in the last quarter. Since then, consumer trust has dwindled further and arrived in January at the lowest level since 1990. In February, it dropped another 6 percent.

Corporate profits shot up in the first two quarters of 2000 at a rate of about 10 percent but have decreased since the third quarter. The former power house of the economy, the Information Technology (IT) industry, warned they would not meet their profit goals. Big corporations such as Cisco, Nortel and Hewlett-Packard had to dramatically reduce their estimates.

Second quarter 2000 investments showed a growth of 21.7 percent but dropped in the fourth quarter to minus 3.7 percent. Correspondingly, the use of industrial production between August 2000 (82.6 percent) and January 2001 (80.2 percent) sank continually. Labor hours were reduced about 6.6 percent.

The number of new jobs decreased as well. In January 2000 the unemployment rate increased to 4.2 percent from the prior month’s 4.0 percent. Even then, 316,000 people applied for unemployment benefits for the first time, 12,000 more than in November. The number of first-time applications grows monthly. In every quarter more than a million citizens become unemployed.

Recently, companies like Lucent, Motorola, DaimlerChrysler, General Motors and Ford announced the discharge of a total of 150,000 employees.

The speculation bubble at U.S. stock exchanges burst with a big bang. Nasdaq quotations have sunk about 40 percent, or .6 billion, since March 2000. At the New York Stock Exchange there was a decrease of 13 percent, or trillion. Just as the continuous rise was the motor of the previous growth, now the slump is instigating a downward dynamic.

New economy, old crisis cycle

Just as the implosion of the socialist economies made the ideologues of capitalism announce the ‘end of all history’ and the unimpeded everlasting dominance of capitalism, a decade of uninterrupted growth of the U.S. economy had them dreaming of a never-ending boom. IT, with its productivity explosions, is said to have relinquished Marx’s dictum that the profit rate’s tendency to fall is the main reason for the inevitable cyclical capitalist crises.

In light of the economic setback, Stephen S. Roach, chief economist of the investment bank Morgan Stanley, spoke of the ‘first recession in the information era.’

The long-term stock market rise could temporarily restrain the factors that induce the crisis but not abolish them. Rather the longer the rise, the greater the potential failure.

This is especially important in relation to what Marxist theory considers to be most important as an economic crisis factor: the sinking purchasing power of the masses. People’s purchasing power (demand) is not enough to consume the whole of national production. The reason: first, capitalism wants to enlarge production without limitations; second, it wants to minimize costs, especially by reducing wages as far as possible – which is nothing but the purchasing power of the masses.

This seems to be a contradiction to the unimpeded purchasing power of U.S. citizens that still grew though wages remained far behind the growth of production and productivity. From 1973 until 1996, the productivity per work hour increased 26.4 percent while the real wages only grew 1.8 percent.

This enormous purchasing power came from U.S. consumer indebtedness, which rose between 1989 and 1998 from ,200 to ,400. During the same period family income remained nearly constant, increasing from ,800 to ,300.

On the other hand, the savings rate dropped continually. When debts began to weigh people down, they started to liquidate savings.

During the rise entrepreneurs could minimize costs greatly and had no problems with sales. Many new firms gathered funds without taking bank credits just by increasing their share capital.

Demand was there. Private shareholders, confident of the everlasting boom bought on credit shares worth 0 billion, 50 percent of which was loaned by bankers and brokers. If the value of the credited share dropped more than 25 percent, the holders had to increase the loaned share holdings; otherwise the broker/bank sold off the necessary amount of shares. This way, shareholders could lose a great part of their holdings during a slump.

If one takes into account that people with a yearly income of ,000 usually have ,600 of their property in share holdings, one can imagine that the number of shareholders in this income group diminished rapidly. Anyway it mattered little: they had already done their duty financing the boom for brokers, banks and joint-stock companies.

For companies, there was not only the possibility of issuing new shares, they could easily get credit during the rise. So-called venture capital in IT expanded in the years ’98 and ’99 from billion to billion. During the same period, indebtedness of telecommunication companies increased about 85 percent to 5 billion. These branches grew annually by 25 percent, and were responsible for one-quarter of the growth of the economy. Altogether U.S. corporate investment exceeded income by 0 billion. Easily procured capital – now in a slump followed by growing financial difficulties and waves of bankruptcies – were accompanied by declining work costs, as many workers were paid a part of their wages in shares. This not only cut expenses but intensified employee motivation: their new shareholder mentality made them exploit themselves almost without limit.

But one factor remained primary – the never-ending stream of money and goods from abroad. In the last three years the foreign trade deficit grew annually more than 50 percent. The ‘rest of the world’ not only delivers goods worth 0 billion more to the U.S. than it exports, foreign investors transferred the same amount or more money into the U.S. than the U.S. invested in foreign countries.

Because these foreign investors own assets worth trillion, the U.S. can compensate foreign debts of more than .5 trillion, a deficit in the balance of trade of 5 percent and rising investments accompanied by sinking savings. Foreign investors were attracted by increasing interest rates, dollar rates and share value.

Hard landing or crash?

Though it is easy to decide if an airplane has landed or crashed, this is more difficult to determine concerning a change in a business cycle. The classic definition of a recession – that the economy is shrinking for two subsequent quarters – hasn’t been fulfilled for more than ten years. The question is: Do we face a V, a rapid slump and fast recovery, a U, a fall with a slower return, or even an L, a long period of unsure stagnation?

In the middle of 2000, leading U.S. economists calculated that the outcome would be a V. They still believed in a growth of 3.3 percent for the second quarter of the year. In fact it was less than 2 percent and now the experts are correcting themselves.

They expect for the first half of 2001 a growth of two percent and for the second half, three percent. This would be a hard landing as two percent would not be enough to stop the growth of unemployment, because the increase of productivity is larger.

Even if the U.S. economists seem pessimistic, others experts are more skeptical. The International Monetary Fund predicted in October 2000 a growth of 3.2 percent for the coming year, but altered this prognosis to 1.7 percent, expressing doubts about the rise in the second half of the year. A certain skepticism gripped the Congressional Budget Committee: its prognosis of 3.1 percent was reduced in January to 2.4.

Some prophets of a soft landing remain steadfast. Rudi Dornbusch, professor at the Massachusetts Institute of Technology and a prominent liberal spokesman said the landing and the rise can be achieved without serious problems because the Fed can provide cheap credit without producing inflation or scaring away foreign investors. He argues for so-called ‘shock absorbers’ that allow for the development of the economy.

According to Dornbusch, even after ten years of growth, there is no danger of inflation because:

a) as high-tech business decreases, there is growing competition even of highly qualified workers and the expenses for labor are lowered;

b) competition at the global market prevents an upsurge of prices for goods; and

c) the long curve of IT inventions will last another two to five years.

These factors allow for profit by lowering costs, keeping the market prices stable and give the opportunity for the Federal Reserve’s cheap credits to the market that do not ruin the value of money.

More revealing is Dornbusch’s answer to the question of why foreign investors won’t be scared off by the declining interest – there are no international alternatives. The Japanese market is dead and in Europe the interest rates would be lower than in the U.S. Shareholders don’t then fear a loss on the exchange of the dollar. A weaker dollar would support the U.S. economy and be bad for the Europeans who are dependent on the U.S. market. It would be in the interest of the Europeans to stabilize the dollar.

Until now Dornbusch’s prognoses proved right only in regard to the dollar and the behavior of foreign investors. In fact, the exchange rate of the dollar has even risen in spite of two reductions of the interest rates of about one percent in comparison to the German mark and the Japanese yen. No large amounts of capital have been withdrawn. Foreign investors have not been scared off either by the two reductions of interest rates or by further reductions in the coming months.

Other predictions of the MIT professor were refuted at the beginning of this year. The assertion that there will be no inflation is a crucial point. In spite of the stagnation in production, the inflation rate increased about 0.6 percent in January; the annual inflation rate was 3.7 percent. Producers’ prices even rose about 1.1 percent in January. On the same day the inflation rate was announced the Federal Reserve came together for an extraordinary meeting at which another reduction of the interest rates was expected. This decision was not made. Dornbusch’s confidence that the Fed could decide about interest rates without regard for inflation is already dashed.

Bush and Greenspan:
ways out of stagnation?

It was no surprise that President Bush sold his tax-reduction program and other election promises as a revival program for the economy. What was really surprising is the fact that Alan Greenspan threw overboard his previous policy of dollar stability and national debt reduction. He stated,

Never did I expect to see the day I would talk about anything else than the reduction of the debts of the government. But now I am caught in the tyranny of zero growth that is where nothing is to reduce. And now – have I changed my point of view? Yes, it has changed; but it had to be changed.

The center of the government policy is tax reform. During the election campaign Bush announced plans to reduce taxes about .3 trillion. Just after the election it was proclaimed – as if made to order – that the budget surplus in the next ten years would be much higher than expected at .6 trillion. Bush then announced in his budget the new margin: .6 trillion. Taxpayers would have 0 billion per year more at their disposal, 2.3 percent of the consumption expenditure.

The essence of the tax reduction program are benefits for the rich, decorated with a slight improvement for the very poor. The great mass of the taxpayers, the people with average income, get nothing.

So what will it be – a V, U or L?

To solve the question as to how to promote a new rise it is best to have a look at the circumstances that led to the slump. Can any improvement be expected?

The initial factor for the slump was the bursting of the speculation bubble at the stock exchange. From March to December 2000, .6 trillion were annihilated. In the first seven weeks of the new year – after two reductions of the interest rates by the Fed – the Dow Jones sagged further about 2.5 percent; the Nasdaq – the stock exchange of the ‘New Economy’ – about 10 percent. Corporate news is characterized by announcement of losses and overindebtedness, especially the IT companies, with share profits far below the bank’s interest rates. AOL Time Warner for example, have a market/profit relation of 74.8, meaning the shareholder has to pay to see one dollar profit in the company’s balance sheet. Even so, ever optimistic Dornbusch expects value losses in the next year between ’10 and 20 percent.’ Again, values amounting up to trillion would be annihilated, much more than the tax reductions planned by the government of George W. Bush for the next 10 years. The stock exchange is no part of the solution, it is part of the problem.

This leads us to the crucial factor: private consumption. The economic rule of thumb says that a reduction of the value of stock holdings about leads to a decrease of the consumption about 3 cents. If the value losses in 2001 amount to 20 percent, private consumption will decrease further about 0 during this year. Growing unemployment and the enormous pressure of competition in the labor market keep wages and thereby the purchasing power of the masses low, increased indebtedness reduces the available income and fear for the future dampens readiness to consume. It is more than questionable if Bush’s tax reductions can outweigh these factors as planned. The fact that the masses have less money to spend on consumption can only slightly be altered by such a tax reform.

The second factor influencing consumption, investments, gives no better prospects. The Bush government has worsened the costs for the companies by their aggressive international policy. Military actions against Iraq and the more open threats against China are part of a long-term strategy that will not only intensify conflicts in the world but raise the prices for raw materials and energy. Costs that enter the markets this way and threatens the whole society in the form of inflation pressure are an inevitable consequence of the long-term policy of the U.S. government. The pessimism of the managers therefore equals the pessimism of the consumers.

Regarding the third element that could potentially revive purchasing power, the consumption by the government, there is not much to be expected from the Bush administration. Although the expenses for schools, the military and the Star Wars program are to be increased, the policy is still based on Bush’s call for a ‘slim administration’ and the doctrine of the ‘autoregulation of the market.’ The budget for 2000-2001 increases only about four percent, but the biggest entry, the military budget, grows much more than the rest, while the labor budget is reduced. Therefore it is impossible to speak of a program to revive the economy.

So there only remains external factors and the behavior of foreign trading partners. In the economy, as elsewhere, the maxim that everything is not eternal but will end some day, proves true. It is impossible to carry on the enormous annual deficit in the trade balance and the equally high import of capital in the U.S. forever. These currents of trade and finances signify that the rest of the world hands over year after year a growing part of their production and capital to the U.S. This will stop when the rest of the world is no longer able or willing – because of economic or political reasons – to make this donation. It is to be doubted that this case will become acute in the immediate future. Although the miserable situation of Japanese companies leads to rumors that they will have to withdraw money out of the U.S. at the end of the business term to prevent bankruptcy or further loss of credit, they still need the U.S. market, as well as European markets, for their exports. If they let the dollar collapse they endanger the export market in the U.S. and further activate the U.S. government.

Already 10 trillion U.S. shares are in the hands of foreign investors, benefiting them as well. Capital has no fatherland – but an important home in the U.S. So the least danger for the U.S. economy arises from other countries.

So what will it be: a V, a U or an L? It cannot become a V anymore because the slump was too rapid. A U would be possible, if the U.S. economy would recover powerfully in the second half of 2001. There are few arguments for this possibility. Let us forget all symbolic discussion: The U.S. is in a recession, and it will take long to recover.

From Political Affairs Magazine – September/October, 2001

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