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Issue 42, October 1999

US Economy Feels the Strain

'THE CRISIS is over and the global economy is booming again'. That has been the message of the year. The latest IMF World Economic Outlook repeats it but also admits that 'there are still strong risks of a relapse'. The IMF expects a slowdown in the US economy - it is only a question of time - and this casts a shadow over 'the sustainability of the recoveries under way'.

Bubbles burst and each recovery reaches its peak at a certain stage, thanks to the limits set by the capitalist market. But it is almost impossible to predict when the fall will come and how big it will be. As the veteran US Keynesian economist, JK Galbraith, said in a lecture at Cambridge University in July: 'The speculative crash, now called a correction, has been a basic feature of the system. Periods of speculation do come to an end'.

There are many factors, however, that point towards a slowdown in the world economy. The rosy picture painted by many commentators and politicians corresponds more to their wishful thinking than reality. It is true that the crisis-ridden economies in East Asia are recovering and that Japanese capitalism is performing better than expected. However, the recovery is extremely fragile and it is doubtful it can be sustained.

The recovery in parts of Asia, and to some extent Europe (although the Euro-zone has only experienced sluggish growth), has been based on cheap exports to the US and an increase in consumer spending. The latter is due to lower savings, and real income growth would be needed next year to sustain the same level of spending.


The fact that the US became the investment haven and buyer of last resort in 1998 made it possible to temporarily subdue the shock to the capitalist system delivered by the crisis that started in Thailand in July 1997. That crisis spread to other so-called 'emerging markets' and the world economy was on the brink in September 1998 when the Russian economy collapsed.

The threatened financial meltdown was only avoided by the bail-out of LTCM, one of the bankrupt US hedge-funds, and a series of interest rate cuts throughout the world. These actions, together with the continuation of the capital flow into the US, a drastic fall in commodity prices during 1997 and 1998 (oil prices, for example, more than halved), and a consumer boom in the US based on credit, gave a temporary breathing space to world capitalism last year. It also made it possible for the US to finance its deficits, uphold the value of the dollar, and counteract inflationary pressures.

The global crisis was postponed but new problems were added to the old ones, as the stock-market bubble expanded. The consumer boom was increasingly supported by rising share prices while, at the same time, 'virtually all the indicators on the bubble are flashing red for the US... When such bubbles burst soft landings never seem to be within reach'. (Bubble Trouble, HSBC Bank, May 1999)

Private savings in the US went negative last year for the first time since the 1930s. The current US corporate financial deficit is the largest for 20 years. The total private-sector debt is now around 130% of GDP, compared with less than 100% in 1929, just before Wall Street crashed.


The world economy became even more dependent on the US, which accounted for half of the increase in global demand in 1998. 'The world now depends on America, the American economy depends on the consumer, and the American consumer depends on Wall Street, and Wall Street depends on 50 companies, half of which have never made any profit', comments Paul Volcker, former chairman of the Federal Reserve (Times, 6 July 1999).

The new and dangerous imbalances created in global capitalism have worsened this year and are now taking their toll. The value of the dollar has started to fall. The soaring trade and current account deficits reached record highs in July, and were far worse than expected. It was the largest trade shortfall since July 1992.

The prospect of international investors fleeing the US for other markets has become a reality and is further undermining the value of the dollar, particularly against the Japanese yen. Capital has started to move away since the summer - as much as $50 billion of overseas funds may have gone into the Japanese equity market. Nowadays, capital flows determine the value of a currency and this is pushing up the value of the yen. The risk is that a strong yen could raise Japanese export prices and end the 'recovery'. In the words of US economist, Paul Krugman: 'Hopes of a recovery are starting to look like a self-denying prophecy; as soon as investors start to think the worst is over, the yen pops up and undermines expansion'.


If the value of the dollar continues to drop, and there is little indication that the trend will be reversed, the Federal Reserve would probably raise interest rates to support the dollar. The slide of the dollar has been accompanied by a drop in the value of US shares, and suddenly some speculators are starting to predict 'a slide of dire proportions, implying that US share prices are heading for a fall of between one-third and one-half'. (Evening Standard, 14 September 1999)

It is too early to conclude that the world economy has reached a new turning point, although many factors point in that direction: the fall in the value of the dollar; signs of a sharp downward adjustment in US share prices; the Federal Reserve's reversal of earlier interest rates cuts; the strengthening of protectionist sentiments in the US; the beginnings of capital outflows from the US; a growing reluctance by foreign speculators to finance the soaring US deficits; and the rise in the oil price. Moreover, the threatened devaluation of the Chinese yuan, further stagnation in Latin America, or countries being forced to default on their loans, could all trigger a new slump.

Even the IMF has issued warnings about the prospect of a hard landing in the US, commenting that the combination of strong growth and low inflation in 1996-98 was the result of 'fortuitous but temporary events'. The same report also says that there is no evidence of a 'new economy or new paradigm'.

Share prices will drop sharply as the US economy moves towards a recession or slump. When 'the US markets reach their peak - and many believe that this will happen soon - recovery in Asia will be its first casualty'. (International Herald Tribune, 18 May 1999) Not only Asia will be affected but Europe as well.


Per Olsson

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