The New York Times reported Nov. 1: “As dozens of countries slip deeper into financial distress, a new threat may be gathering force within the American economy—the prospect that goods will pile up waiting for buyers and prices will fall, suffocating fresh investment and worsening joblessness for months or even years.
“The word for this is deflation, or declining prices, a term that gives economists chills.”
Citing the U.S. Labor Department’s latest dismal report on employment, the Associated Press reported Nov. 7: “The nation’s unemployment rate has bolted to a 14-year high as another 240,000 jobs were cut last month. …” According to the Associated Press, a staggering total of 1.2 million jobs have disappeared so far this year.
Meanwhile, the Washington Post reported Nov. 4: “Activity in the nation’s manufacturing sector, beleaguered by tightfisted consumers and the global credit crisis, declined last month to the lowest level in more than two decades, offering economists more evidence that the country is entering a deep recession.
“The Institute for Supply Management’s index of conditions in the manufacturing sector is at its lowest level since the nation was in a recession in September 1982. Export orders have collapsed, and businesses appear to be struggling to sell inventories of items ranging from appliances to tobacco products,” the report said.
Adding to the evidence of an economy in dire straits, the Commerce Department reported Nov. 4 that factory orders dropped by 2.5 percent in September from August, much worse than the 0.7 percent drop analysts expected. That is on top of a revised 4.3 percent decline in August. (Yahoo News, Nov. 4)
The crisis is global. World stock markets lost an estimated $5.79 trillion during October, the biggest monthly loss ever. The October loss eclipsed the previous record, which was set just one month earlier, when 52 global stock markets lost a combined $4 trillion. Through the first 10 months of the year, world markets have lost about $16.22 trillion. (Standard & Poor’s Index Services, Nov. 3)
The root cause of this crisis is the inevitable overproduction phase of the capitalist business cycle. During each such phase, more goods—be they houses, cars, clothing, or television sets—are produced than can be sold at a profit, leading to an inevitable crash.
Capitalist governments are incapable of “solving” crises of overproduction short of a curtailment of production and employment. Their only hope is to prevent the crisis from reaching extreme levels such as in the early 1930s—levels that would expose the complete bankruptcy of capitalism.
Corporate moguls, capitalist politicians and media pundits go to great lengths to hide this fundamental truth with elaborate lies and fabrications. To admit that capitalism itself is to blame for these recurring crises would be an indictment of the very system that brings them enormous profits at the expense of working people. It would be a call for its destruction.
Economy tanks, dollar gains
As the slump has deepened, the U.S. dollar has gained against other major currencies, especially the Canadian and Australian dollars, the British pound and the euro. It has also appreciated about 8 percent in the past year against gold, the universal measure of value.
If this trend were to continue, it is almost certain under current circumstances to result in a general deflation—not just in the price of oil, which has already crashed, but in the price of virtually every commodity, including the price of labor power: workers’ wages.
We could see a replay of the early 1930s, with plummeting industrial production, soaring unemployment, massive personal and corporate bankruptcies, many more foreclosures and evictions, even deeper cuts in federal, state and local government services, and more.
The evidence cited above, along with recent dismal numbers on retail sales, foreclosures, and personal bankruptcies, suggests what could be in store.
Why has the dollar been strong while the economy has tanked? As Karl Marx put it in the third volume of “Capital”: “In a system of production, where the entire continuity of the reproduction process rests upon credit, a crisis must obviously occur—a tremendous rush for means of payment—when credit suddenly ceases and only cash payments have validity.” In other words, the dollar in its role as the means of payment becomes the object of “a tremendous rush” when “credit suddenly ceases” or is sharply reduced during a crisis.
But what about the bailouts of the banks in the trillions of dollars? Should that not be inflationary? Not necessarily—or at least not in the short term.
From August 2007 to mid September 2008, the Federal Reserve injected liquidity into financial institutions in trouble—that is, it extended credit to them. This was an effort to counteract the credit market meltdown that had occurred stemming from the subprime mortgage crisis.
Up to recently, however, the Federal Reserve drained reserves from the banking system as a whole, roughly the equivalent of what it had selectively injected. As a result, though the reserves of the troubled banks were boosted, overall reserves across the board remained nearly unchanged. This “sterilization” policy reflected the Fed’s fear of runaway inflation.
Recall that oil and other industrial commodities had, up to June-July 2008, shot up in price as a result of an economic boom centered in Asia, wild speculation by hedge funds and other wealthy investors, and a depreciating dollar. As the economy began turning down in earnest, however, the bull market in oil, gasoline and other commodities abruptly went into reverse, credit contracted and the dollar gained in value as capitalists around the world scrambled for cash.
Move to save banking system
It quickly became apparent to the Federal Reserve that the immediate threat was not inflation, but deflation. Not a slowly deflating real estate bubble, but a vicious economic downturn. Not a few isolated financial institutions failing, but the collapse of the banking system as a whole.
Hence the additional $700 billion bipartisan bailout of the banks hurriedly cobbled together by Congress and the Bush administration in October 2008. Estimates of the total amounts involved in the all-time-record welfare program for the banks, counting loan guarantees, range up to $2.5 trillion!
Candidates Barack Obama and John McCain, along with Democratic and Republican leaders in Congress, backed and defended the bailout plans in the face of widespread popular anger. Obama, along with McCain, opposed inclusion of a provision in the bailout bill that could have made it possible for millions of people facing foreclosure to remain in their homes. Why? Because the big banks were against it.
Since the passage of the bailout, the U.S. Treasury has “injected equity” amounting to tens of billions of dollars via the purchase of newly issued, non-voting preferred stock, partially nationalizing the biggest banks. The Federal Reserve has made huge additional loans to save Fannie Mae and Freddie Mac, AIG and other giant financial institutions. A result of the bailouts has been an unprecedented expansion of bank reserves. (See the chart of the monetary base.)
‘High-powered money’ explodes
The monetary base, also referred to as “high-powered money,” consists of banks’ vault cash plus reserves in the Federal Reserve. The monetary base, as its name implies, is the basis for the “money supply”—that is, the money in circulation that provides the means to carry out all the myriad purchases, loan payments and other transactions that go on in the capitalist economy every day.
As you can see from the chart, the monetary base has skyrocketed in recent weeks. In essence, banks have more cash at hand, which they could potentially put into circulation by extending loans and other forms of credit to their customers.
Despite this, the broader U.S. money supply is still expanding relatively slowly. Based on the “M2” definition of money supply, which counts cash in circulation, checking and savings account deposits, and non-institutional money market funds, the money supply has grown year over year by only about 7 percent, compared to the nearly 50 percent year-over-year growth of the monetary base. See chart of M2 Money Stock.
While growth of the broader M2 money supply does not always correlate with that of the monetary base, a divergence of this magnitude is unusual. Why is it happening?
It is happening because the banks are mostly sitting on their bulging reserves rather than making new loans. The plummeting economy is causing them to focus on preserving their capital rather than expanding it—they would rather hold on to what they have than risk losing it in these uncertain times. As the economy dives, the risk increases that outstanding loans will not be paid off and their capital, already seriously depleted by losses on investments in mortgage-backed securities gone bad, will be wiped out.
The hundreds of billions of dollars in bailout funds pumped into the banks through loans and stock purchases, plus hundreds of billions more in loan guarantees as well as forced mergers, may have staved off a collapse of the banking system. These measures clearly have not, however, provided significant stimulus to the economy. They have done nothing to stem the massive wave of foreclosures and evictions that have swept the country, nor have they prevented hundreds of thousands of workers from losing their jobs.
Will Obama and the new Congress save the day?
There is widespread hope that a new Obama administration and the Congress with an expanded Democratic majority will take strong action to stem the crisis along the lines of Franklin D. Roosevelt’s “New Deal” measures started in 1933.
The problem is, however, that the United States economy is in a qualitatively less favorable situation now as compared to 1933.
First, inventory liquidation and plant shutdowns had been going on some three and a half years by the time Roosevelt was inaugurated in March 1933. The current downturn has been going on for a year or less. By March 1933, the economy had bottomed out, overproduction had been largely wiped out, and a cyclical upturn was on the agenda. We are nowhere near that point now and most likely will not be by the time Obama is inaugurated and the new Congress convenes in January 2009.
Second, the United States was a strong creditor country with a favorable trade surplus in 1933. It is now by far the biggest debtor country in the world, with a huge trade deficit financed by massive loans from the exporting countries of Asia and oil-rich Middle East U.S. allies.
Third, the United States is currently bogged down in two expensive wars, while in 1933 the country was at peace. Obama has promised to “end” the Iraq war—while leaving a sizable “residual force” there indefinitely—but also to expand the U.S. forces deployed in Afghanistan and the U.S. military overall. The effect on the U.S. budget and foreign debt will not be favorable.
Fourth, the privileged role of the U.S. dollar as the world’s reserve currency is now in question. Any serious effort to “reflate” the economy as Roosevelt did starting in 1933 would surely jeopardize that role—possibly leading to a situation in which the United States could no longer import far more than it exports forcing a further sharp drop in U.S. living standards.
Dollar collapse
Should a “New Deal”-style reform package be attempted under current circumstances, the crisis is not likely to be overcome, but rather simply to change form.
The money supply would likely explode causing the dollar to fall and prices to rise ever more sharply, possibly ending in a hyperinflation. The dollar’s role as world reserve currency would likely be finished. Interest rates would go through the roof, as happened in the 1970s, causing much of what remains of U.S. industry to be destroyed.
Such an outcome would make it difficult, if not impossible, for the U.S. government to continue to finance the huge global network of military bases, its far-ranging naval fleets and the wars in Afghanistan and Iraq.
It is not surprising that in his Nov. 4 acceptance speech, Obama attempted to dampen the high expectations of his euphoric supporters: “The road ahead will be long,” warned the new president-elect. “Our climb will be steep. We may not get there in one year or even one term.” (Chicago Tribune, Nov. 4)
The world capitalist system has clearly entered into a historic crisis, stemming from contradictions that have been building for decades. The Party for Socialism and Liberation, the ANSWER Coalition (Act Now to Stop War and End Racism) and other organizations have staged rallies, pickets and marches protesting the bailout of the banks while millions of working-class families were left to fend for themselves.
The PSL and ANSWER have led mass mobilizations demanding an immediate end to the wars in Iraq and Afghanistan and bringing U.S. troops home from around the world. We have called for using the vast sums saved for a massive public works program, which could provide jobs, repair hurricane damage, expand non-carbon-based energy sources, and meet other social needs. We have demonstrated for an indefinite moratorium on foreclosures and evictions, and raised other demands for dealing with the economic crisis in ways that benefit working people.
Independent mass struggles around such demands are crucial at this time. Measures wrested from the capitalist government through militant struggle can alleviate suffering now. At the same time they can lead to the only long-term solution: organization of the working class to replace the capitalist government and state with workers’ power, take control of the economy, and carry out production for human needs rather than profit.
