THE NEXT CRASH IS BREWING

The hopeful announcement of the end of the crisis hides the fact that the bills cannot be paid with a little upswing

By Laurent Cordonnier

[This article published in: Le Monde diplomatique 9/11/2009 is translated from the German on the Internet, www.monde-diplomatique.de/pm/2009/09/11.mondeText.artikel,a0206.idx,8.
Laurent Cordonnier is an economist at the University of Lille.]

The disastrous consequences of the economic and financial crisis that has kept the world in suspense since the fall of 2008 have not disappeared. For several months, every weak sign of growth was acclaimed: the slight and very uncertain rise of stock prices, the rising prices for raw materials and fossil energy, the somewhat slowed increase of unemployment in the US, the encouraging growth forecasts of the US Fed (Federal Reserve) and the slightly brightened assumptions of the International Monetary Fund for a worldwide economic upswing, the more favorable predictions of the French Central Bank, the growth course of German industry, the “narrowly positive” balance sheet of the French Societe Generale for the second quarter, the hefty profits of the Goldman Sachs investment bank in the first half of 2009 and the early repayment of state assistance by US banks.

When we put aside the limited shelf life of these predictions, the question remains whether the famous light at the end of the tunnel is not the light of a train speeding to us. Even if the most optimistic scenarios prove true [1], the unemployment figures will continuously increase through 2010. For the year 2010, we in the Euro-zone must expect an official average unemployment rate of 11.5 percent. At the beginning of 2008, it was still 7.5 percent. For France alone, French unemployment insurance (Unedic) announced the loss of 501,000 jobs. In the US where 7 million workers have already lost their jobs, the figures for the first half of 2009 (with a monthly loss of 600,000 jobs) indicate an unemployment rate of 10 percent f4or the whole year, which is also expected for 2010.

According to estimates of the International Labor Organization (ILO), the economic and financial crisis could saddle state budgets worldwide with an additional 39 to 59 million unemployed. In addition, around 200 million workers earn less than two dollars a day.

In any case the unpaid bills of the crisis cannot be removed with the prospect of a slight economic growth forecast by nearly all research institutes. Even if the optimists are right, it would be careless to exclude a crisis-laden relapse. More time bombs are planted in the system. We do not know either the length of the fuse or the power of the explosive charge. Thus the number of credits that cannot be repaid (from private households and businesses) in a continued overcast economic situation could increase by leaps and bounds, which could ring in a new round of crises for the banks. According to a forecast of the European Central Bank, financial institutions today must expect new losses of 284 billion euro. They will probably only survive this because they can rely again on generous state relief.

In this stage of the crisis, a crash on the bond market cannot be excluded – triggered for example by the growing mistrust of “investors” in public instruments for enforcing debt payment. In truth, it involves mistrust of “persons of independent means” who gain wealth from their savings (and thus do everything but “invest”). These private creditors fear – rightly or wrongly –firstly that the astronomic sums states must borrow to finance their deficits could lead to higher interest-rates and secondly that if the state cannot erase its debts, they could gradually withdraw from the market of state bonds.

This would depress the prices of bonds, which will automatically lead to higher interest rates. This would bring states to the edge of bankruptcy because the interest burdens would rise the moment when public debts explode. If this should happen, the great alternative is: either politicians rediscover the virtue of taxing high incomes and central banks declare their readiness to refinance state debts at zero interest or the bill must be paid by “those below” since a dismantling of public services and state social spending threatens. [2] The second solution would not contribute to a demand-based upswing.

These problems are clearly foreseeable. Where more time bombs may be hidden is less clear. Is it the certain bankruptcy of the state of California that is so clammy on account of political conditions where a two-thirds majority is necessary for raising tax rates so the state “pays” its suppliers with homemade “promissory notes.”?

Or is it the threatening financial debacle with the pension funds of the public services of New Jersey, California or Illinois, caused by a political class that has never paid its legal share so these funds were under-financed and plundered for over two decades? [3]

Or is it the house of cards from promissory notes built up in the market of derivatives? These securities should serve the goal of ensuring economic actors against risks (in changes of exchange rates and interest rates and the insolvency of business partners) but were transformed – through silent agreements between financial actors – into play markers for the casino of speculation. If this house of cards should collapse in the course of a new financial tremor, losses could come to $3.5 trillion – the same amount as in the original mortgage crisis.

We like to calm ourselves that the US and Europe are developing rules for their financial markets, creating monitoring- and regulatory authorities and introducing a binding authority for compensation claims. But these would be very similar institutions as exist today, which did not prevent the sub prime crisis or the balance sheet scandals and frauds on the scale of Enron, WorldCom or Madoff. The Securities and Exchange Commission (SEC), the US stock exchange police, unsuccessfully scrutinized the dubious business practices of Bernard Madoff (1992, 2005 and 2007). From time to time, this venerable institution that was regarded as a model for an effective regulatory and monitoring authority even utilized the services of Madoff who gained his intimate knowledge of Wall Street financial markets as head of Nasdaq. [4] Even if obliquely, the SEC its financial and personnel resources according to the absurd motto “the greater the failure, the more chances of success in the future!” [5]

THE CHINESE SAVE TOO MUCH

This absurdity is the by-product of another maxim that is the cornerstone in the system of liberal theory: “We allow barbeques in the forest and increase the number of fire stations.” According to this rule, the ingenious “financial innovations” do not need to be preventively restrained. The world again expects new wonders from these “financial innovations.”

Fed chairman Ben Bernanke also invoked this principle when he feared Congress would not share his aversion to strong regulation. “We may not succumb to the temptation to impose great restrictions on potential creditors that could hinder the future development of new (financial) products and services.”

If one asks in amazement why such new products are good, Bernanke says “the financial innovations facilitate access to credits lowering costs and increasing elective possibilities.” Bernanke made this bold statement eight months after the outbreak of the crisis. Whenever such pyromaniacs have the say, dealing with future time bombs must be really frightening.

Seriously doubting whether “developed” economies will create a new upswing in the near future is in no way paranoid. Many bottlenecks in the past crisis on the plane of the macro-economy were not overcome. Rather they prove so stubborn that they should not be trivialized as “business cycle” bottlenecks.

The height of state indebtedness is far removed from the historical all-time high of the immediate postwar period according to the analysis of the International Monetary Fund. In countries like the US, Great Britain, France and Belgium, indebtedness could reach or surpass the mark of 90 percent (of the annual gross domestic product) by 2014 and even break the 200 percent mark in the case of Japan. This development results from several factors, state revenues declining on account of the recession, the politically conditioned low tax rates and the restrained inflation. The indebtedness of private households that supported demand for consumer goods in the last 20 years – as a substitute for stagnating or falling real income of employees – will reach an all-time record high.

Thus we cannot rely on state spending and private consumption, the two supporting pillars of global economic demand, in the coming years. With the slightest sign of an economic recovery, foreign demand inhibited anyway in euro-lands by an over-rated common currency acts like a mechanical brake because the raw material- and energy-prices will immediately shoot up again.

This is very true for the energy realm where easy and cheap deposits draw to an end. Rising prices result from the high profits expected from investments in the exploration, exploitation and reprocessing of fossil energy. Since speculation raged intensely on these raw material markets in the last years, energy prices could rapidly increase again – irrespective of the hope for an economic recovery that normally triggers a rise in prices. A vicious circle threatens. The “rich” countries and their energy-guzzling economies will hardly succeed in compensating the expenses for their elixir of life in the short-term through revenues from foreign demand starting from countries producing oil and raw materials. In 2004 the International Energy Agency (IEA) predicted that a constantly high oil price of 25 to 35 dollars per barrel could reduce the annual economic growth of OECD states around 0.4 percent and 0.45 percent for EU countries. In the case of France, this 0.4 percent could eat up the positive effect of the state economic program. A price increase from $60 to $150 per barrel would be debilitating. Similar questions are raised in relation to the gigantic trade surpluses gained by China over against the US and Europe. The core problem is that the Chinese “save too much,” not that the US soaks up the savings of the rest of the world to finance its impressive balance of payments deficit. This can be partly explained through the higher personal savings rate, which has structural causes. The main factor is that the new industrial businesses – with their orientation in export or substitution of imported goods – in which the surplus of the Chinese balance of trade more than tripled from 3 to 10 percent of the GDP, have made gigantic profits. The greatly expanded sale of goods has inflated profits in the industrial sector so that the aggregate savings rate of firms has risen 7 percent since the beginning of 2000.

Since business profits “restrained” in China did not flow in the worldwide demand, they contributed – along with private savings – to the trade deficits of partner countries, which the same China gladly finances. For the world economy – in the phase of a first hesitant recovery -, this strategy represents a gigantic demand gap of 168 billion euro over against the EU and 268 billion dollars over against the US.

Given the fact that macro-economic crisis pressures inhibit effective demand worldwide, state pressures can hardly be classified as “business cycle problems.” The “influencing factors” that for more than a quarter century have characterized what Paul Krugman calls “Depression Economics” [6] are: an economy that only drags on with difficulty because it is pressed down by the burden of liberal economic globalization and the rule of finance (finance capital) over businesses and labor.

However the attribute “structural” remains vague while the problems in the crisis have become more clearly visible. With this term, the new regime of capital accumulation established in the 1980s under the governments of Reagan and Thatcher is inexactly described. This new regime was by no means “strong” in releasing a special dynamic of real investments (not in the core countries of the OECD) but in its effects, growing inequality, social-political restrictions at the expense of wage earners and lasting damage of the environment. For a long while, this neoliberal regime maintained in principle and growth (and more than growth) will be further impacted.

This finance-driven accumulation regime is ensured by the new power of shareholders over big businesses on the stock exchange. The comeback of the shareholder occurred in the 1980s. The enormous growth in power of big institutional investors involved in more than 50 percent of business shares listed on the stock exchange should be emphasized. Property investment funds, pension funds and insurance companies are now big actors. Through their new investment strategies and firms (like Private Equity funds), they influence the top management of businesses and assume the role of a “stock market police.” They punish the businesses that do not make shareholder value into the center of all decisions and conversely reward those who gain the famous 15 or 25 percent profit on their own capital. Obviously extravagant profit expectations neither strengthen future investments nor the consumer power of employees. - investments and only pursue projects where the new financial profits can be amassed. On the other side, the demanded profit margins are at the expense of wages, salaries and jobs so the consumer power of the gainful working population declines again.

That domestic demand, a main support of the economy, continuou9sly weakened in developed countries was one of the reasons “western” businesses increasingly sought their new sales paradises in other world regions.

Where do those magical self-healing powers of crisis originate in view of a slack upswing of the global demand in which an economy groaning under the dictate of stock profits suddenly becomes stakeholder capitalism that functions for the well being of “claimant groups”? [7] Or changed in a public interest oriented economic system that could obligate businesses to the well being of employees, consumers and the social and natural environment?

KEYNESIAN HIGH SPIRITS

Great doubt should be raised around questions of a liberalization of international trade and capital markets in the framework of the General Agreement on Trade and Tariffs (GATT) and the World Trade Organization (WTO) negotiated for 20 years. The traditional rule of “free competition” enables organizing production processes and investment projects in value-creation chains that cover the whole world and play off different groups of employees against one another. This development has transformed the multitude of wage earners in developing countries into a gigantic reserve army enabling the capital-side to force down wages and salaries everywhere in the long run.

Identifying the forces that can stop or even reverse this disastrous development in the short-term is not enough. In the present recession, there is a growing danger that the constant pressure on wages could accelerate the fall of incomes. This is not a long-term hypothesis but a very real process particularly in the US where weekly wages have already hit an all-time low – on account of the weak negotiating power of employees and shriveling weekly working hours.

What about Europe? The EU supposedly created a uniform economic realm that is not a realm (with rules for foreign trade and monetary policy), an economy (with common minimum taxation of businesses and minimum wages adjusted to specific countries) or a unity (with transfer benefits compensating regionally unequal developmental changes). The policy of dumping wages in this Europe still appears to have a bright future.

The economic way of thinking enforced for a quarter of a century is one of the structural factors that helped this “economy of depression” breakthrough. This dominant doctrine persistently denies the role of demand and concentrates instead on the problems limiting the supply of goods and services (produced by free enterprise). The usual suspects here are high wage costs, the inflexible labor market, capital taxation stylized as an expropriation, bureaucracy, the poor motivation of people to seek new work and so on. These academic agents who only invoke the long-term development of potential growth can untiringly propagate their alleged “structural” strategy with the goal of control of wage earners, formation of “human capital” and technical progress. These academic ideas contributed to the present crisis. Paul Krugman refers to one of the most influential doctrines. “The flimsy working model titled `supply economy’ is basically only a crazy doctrine. It would hardly have had a great influence had it not appealed so successfully to the prejudices and social instincts of the rich dominant in the media.”

This crazy doctrine could become the prevailing doctrine again after the “Keynesian high spirits” heard in this carnival of economic debates die away. This should certainly be feared. At his monthly press conference in July 2009, Jean-Claude Trichet, the intrepid president of the European Central Bank, admitted his macro-economic ideas were nourished from old sources of inspiration. “Regarding structural policy, we must intensify our efforts to support potential growth in the euro-zone.”

Then he demanded “necessary structural reforms.” “We especially need reforms of the commodity markets to strengthen competition and advance restructuring and productivity growth. In addition, labor market reforms must encourage more appropriate wages and a mobility of workers spilling over sectors and regions. At the same time, many recent political measures supporting certain economic segments should be discontinued in a fixed period of time. We should concentrate on strengthening the adaptability and flexibility of the economy of the euro-zone – in harmony with the principles of an open market economy and free competition.”

That is not a light at the end of the tunnel.

FOOTNOTES

(1) Die Rückkehr zu weltweitem Wirtschaftswachstum prognostizieren IWF und Fed für die zweite Jahreshälfte 2010, die OECD schon für Anfang 2010.
(2) Eine entsprechende Empfehlung richtet die OECD an die USA: Die sollten ihre öffentlichen Finanzen dadurch stabilisieren, dass sie "das Problem der sich aufblähenden Sozialausgaben angehen". Siehe OECD-Bericht Nr. 85 vom Juni 2009.
(3) Den Rest besorgte der Börsencrash von 2008, der die Aktiva der Pensionsfonds um 30 Prozent reduziert hat.
(4) Diese Börsenaufsicht ist allerdings keine staatliche Institution, sondern wird von der Vereinigung der Börsenmakler (National Association of Security Dealers oder NASD) organisiert, an deren Spitze Madoff einige Zeit stand.
(5) In der gleichnamigen Zeichentrickserie sind die "Shadoks" vogelähnliche Wesen, die streng hierarchisch organisiert sind und auf eine logisch verstörende Weise miteinander kommunizieren.
(6) Paul Krugman, "Die große Rezession", Frankfurt am Main (Campus) 2001.
(7) Als "Stakeholder" gelten, im Gegensatz zum Konzept des reinen "Shareholder"-Kapitalismus, Individuen, Gruppen und Organisationen, die gegenüber den privaten Unternehmen materielle, soziale, ökologische und politische Interessen geltend machen. Wichtige Stakeholderinteressen gegenüber den Unternehmen vertreten z. B. die Beschäftigten und ihre Organisationen, die Kunden und Konsumenten, der Staat sowie die vielfältigen zivilgesellschaftlichen Gruppen und Organisationen (NGOs etc.).