There is no doubt about it: the US financial
structure is crumbling, possibly even collapsing. The collapse of a major
Wall Street bank and the enormous bailouts that are being offered to financial
institutions in the US by the US Federal Reserve are only symptomatic
of the wider crisis created by the unravelling of the real estate boom
based on dodgy lending practices.
Everyone knows that what has already come out is only the tip of the iceberg.
The financial crisis has clearly spread quite dramatically: from "sub-prime"
borrowers to "prime" borrowers; from bad mortgage debt to bad
credit card debt; and from banks to hedge funds to insurance companies.
There is no doubt that there is much more bad news to come within US markets.
And most certainly, given the sheer size of the US system and the complex
forms of financial pyramiding and entanglement with other financial structures
in different countries, the global financial system will feel the impact.
There is also little doubt that the US economy is heading into, if not
already in, a major economic recession. The economic data from the last
two quarters is poor, and the prognosis is worse. In the last quarter
of 2007, the US economy grew at only 0.6 per cent, and much of that increase
was due to higher exports rather than domestic demand. Retail sales have
declined in the first two months of 2008 compared to the previous year.
The most recent employment data show that the US lost 63,000 jobs in February
2008, following a fall of 22,000 in January. Initial claims for unemployment
have been rising and have already reached levels associated with previous
recessions in 1990 and 2001.
Indeed, such figures suggest not a mere recession but even a more substantial
depression is in the offing for the US. This is likely to intensify as
the effects of the housing foreclosures and worsening financial position
of households combine with rising unemployment to create significantly
reduced consumption demand. Investment will suffer not only because of
the reduced assessments of future market demand but also as the financial
crisis makes it harder to access finance for new investment. And so the
elements of the downward spiral are all in place.
And here too, the rest of the world will feel the impact, as the large
economy whose voracious demand for imports had fuelled the most recent
global economic expansion stops being an engine of growth. So there is
no doubt that world output growth will be adversely affected, particularly
in those countries (such as China) that had been growing rapidly on the
basis of rapid increases in exports to the US.
The collapse of the US dollar vis-à-vis other major currencies
is not only related to these troubles; it also reinforces them, while
simultaneously generating cost-push inflationary pressures within the
US by making imports more expensive. Import prices have increased by nearly
14 per cent in the year to January 2008, which is the fastest increase
since such data began to be published in the early 1980s. As a result,
there is evidence of greater inflationary pressure already at work. The
year-on-year producer price index in February rose by 7.4 per cent, making
it the biggest increase in more than 26 years. In the past three months,
the consumer price index increased at an annual rate of 6.8 per cent.
This combination of stagnant or falling output and rising prices is why
more and more economists and analysts in the US have started using the
dreaded S-word – stagflation – to forecast the immediate future of the
US economy as well as the world economy. This immediately brings to mind
analogies with the period of the 1970s, when not only the US but the entire
world economy suffered a prolonged period of income stagnation and even
decline and increased unemployment, accompanied by rising price levels.
At that time, the rise in oil and other commodity prices combined with
attempts by workers in developed countries to maintain their real wages
in the face of rising costs of living generated inflationary spirals,
and economic volatility and depressed investor expectations caused real
output and employment to stagnate.
The stagflation hypothesis appears to be reinforced because the current
period is also a time when global commodity markets are experiencing some
of the highest prices ever. Crude oil prices, at more than $111 a barrel
in the middle of March, are higher in real terms than they were at the
height of the oil shock of the 1970s. Other commodities such as metals
have been showing very high and rising prices for the past year. World
wheat prices are also at record highs, hit by falling output (because
of acreage shifts in the US to biofuels, along with bad weather conditions
in major exporting countries like Australia and Canada).
And now gold prices have hit record highs, crossing $1000 per ounce in
early March. This is something that typically happens when inflationary
expectations are high, as investors seek safety in real assets rather
than financial assets, and gold remains the most convenient of such commodities.
So does all this suggest that not only the US but the entire world economy
is heading towards stagflation? The answer may well be yes, but not for
the reasons that are generally being offered by many analysts. Several
economists have offered an essentially monetarist analysis of stagflation,
whereby it is brought about by central banks trying too hard to prevent
recession, and thereby keeping interest rates too low and monetary policy
too loose. According to them, this creates an excess of money supply,
which then generates higher inflation. Instead, they argue that if the
Fed holds its nerve and simply tightens its monetary policy in the face
of rising price levels, then inflation will be brought down even at the
cost of some temporary pain in the form of a recession.
Remember that the essence of stagflation is a prolonged combination of
stagnant income and rising prices, rather than a stagnation that has a
temporary rise in inflation followed by a more widespread deflation. While
there is no question that aggregate world incomes will grow more slowly
than they have in the recent past, whether or not there will also be rising
inflation depends not upon monetary policies and the attempt to control
money supply, but on the ability of different groups in the economy to
maintain their distributive shares.
That is because inflation in modern economies is essentially about two
forces: the fight over distributive shares in national income by different
groups, and the role of expectations about inflation. Thus, if there is
a rise in commodity prices (that would increase the relative income share
of commodity producers) then this will only lead to a rise in the general
price level if capitalists insist on maintaining their margins over costs
at the same level. If they are unable to do so for any reason, then the
rise in commodity prices need not translate into a generalised inflation.
Similarly, if the initial rise in prices pushes down real wages and workers
are not in a position to demand increases in nominal wages that would
maintain their real wages, then the inflation is controlled. Tight monetary
policies are usually a way of enforcing this by allowing greater unemployment,
so they work indirectly rather than directly to control inflation. So
inflation reflects a wider fight over income distribution.
Expectations add another dimension to this, by making different agents
behave in ways that are determined by their anticipation of future inflation.
If higher prices are anticipated, producers and retailers will set their
prices higher to absorb such expected effects, and workers will scale
up their demand for nominal wages. In this way, the expectations become
self-fulfilling and create an inflationary spiral that becomes hard to
break.
Therefore, whether or not there will be stagflation depends ultimately
on international political economy and the relative strength of different
groups in the world economy. It may be argued that working classes and
peasants have been so weakened by the onslaught of neoliberal policies
of the past two decades that they are in no position to fight to maintain
even their already significantly diminished shares of income. If this
is true, then the likelihood for the immediate future is an economic recession
with worsened conditions of living and higher unemployment across the
world, albeit with lower rates of aggregate inflation.
But if the world has changed in other ways that make further attacks on
people's livelihood more difficult in most countries, then the current
crisis may well become an opportunity. A period of stagflation and generalised
capitalist crisis could augur a different global political economy and
more creative approach to economic policy making, in which rapacious profit
making is restrained and ensuring better material conditions for the majority
becomes instead the basic policy priority.
This is not as far-fetched as it may sound. The 1970s may be remembered
with fear and loathing by finance capital, but they were also a period
in which several developing countries began the industrialisation process
that culminated in the "success stories" of east Asia and elsewhere.
And surely the destructive tendencies of the most recent phase of capitalism
require a shift in economic strategy in a more democratic direction, which
can only be enabled by the clear collapse of the existing strategy.