As deflation and depression loom, the United States could be at a historical turning point.
‘This sucker’s going down” was George W Bush’s pithy description of the United States’ economy when the financial crisis of late 2008 threatened to bring down every bank on Wall Street.
Disaster was averted by concerted international cooperation of a sort never seen before and, by the middle of last year, the world’s biggest economy seemed to be on the mend. Factories started to hum again, shares rallied sharply and growth resumed.
The US seemed to be showing its traditional resilience. That judgment now appears premature. The latest US economic data has been poor. Traditionally, the US’s flexible labour market has meant job creation after recession has been robust. This time it was weak even when output was growing strongly in late 2009 and 2010. Recently, it went into reverse.
The official unemployment rate in the US is 9.5% but real joblessness is far higher when part-time workers who want full-time jobs are taken into account. In a country with a less generous welfare system than Europe, unemployment acts as a brake on demand, making consumers save rather than spend. Their caution has been reinforced by the US property market, which is also going backwards after the expiry of tax breaks to buy homes.
States that enjoyed the biggest boom in house prices during the bubble years are now caught in a vicious downward spiral, in which a crashing property market leads to higher unemployment, rising foreclosures and further downward pressure on house prices. Pressure on individual states to balance their budgets has made matters worse. Public-sector workers are being laid off, leading to still higher unemployment and even lower house prices.
The risk of the US suffering a double-dip recession should come as no surprise, given the profound shock provided by the seizure in financial markets two years ago. What happened then was that the flow of credit dried up as banks hoarded liquidity and became ultra-reluctant to lend. Central banks and finance ministries everywhere rightly concluded that there would be a repeat of the deflationary slump of the 1930s unless they flooded the global economy with money.
So they slashed interest rates, cranked up the printing presses and announced massive fiscal stimulus packages. This process has worked, but only up to a point. Excluding China, the annual growth rate in the global money supply has fallen from 10% at the height of the financial crisis to zero. Without the actions of central banks there would have been a collapse of credit every bit as disastrous as that of the Great Depression.
China’s stringent capital controls meant most of the benefit from its monetary and fiscal stimulus was felt domestically. Output rebounded quickly and strongly from the collapse in late 2008 and this convinced investors that Asia could provide the engine for global growth while North America and Europe gradually recuperated.
That explains why equity and commodity prices rebounded with alacrity from the spring of 2009 onwards and why Germany, the world’s main supplier of the machinery to power industrial development in the emerging world, has enjoyed an export-led boom in recent months. But welcome as it was, China’s emergency action was not cost-free.
The economy could not cope with the sheer scale of the stimulus and showed signs of overheating. Policy has been tightened and China is now showing signs of slowing. Provided China pauses for breath rather than sharply retrenches, there is still a chance that the global economy will muddle through.
German and Japanese factories will churn out manufactured goods for Asia, stock markets will take heart that a second global downturn has been averted and cheap money will start to stimulate demand growth in the US once consumers have built up savings to a level they consider prudent. But in the US, the Fed is starting to contemplate a much bleaker scenario in which the US and Chinese economies stall simultaneously, with knock-on effects on the many countries seeking to export their way out of trouble.
The fear, already reflected in global bond markets, is of softer output, fresh trouble for the banks, and deflation. James Bullard, the president of the St Louis Federal Reserve Bank, noted last week that the US was closer to Japan’s deflation in the 1990s than at any other time in its history. This is a clear sign that the Fed is considering another dose of “quantitative easing” this autumn.
It probably wouldn’t take much more poor economic news to trigger it. Mid-term elections for Congress are looming and many Democrats elected on President Barack Obama’s coat-tails two years ago are fretting about losing their seats. Ben Bernanke’s speech at the annual symposium of central bankers in Jackson Hole last week will be scrutinised for hints that the Federal Reserve chairman is preparing to live up to his nickname of “Helicopter Ben” and spray the US economy with more money. It would be a controversial move.
Some argue that the excesses of the bubble years must be purged from the system and that any attempt to avoid adjustment merely prolongs the Great Reckoning and threatens a burst of inflation. Others believe the problems of the US economy are too deep-seated to be solved by regular doses of cheap money.
Giovanni Arrighi, in his book, The Long Twentieth Century, argues that there have been four major phases of capitalist development since the Middle Ages, starting in Genoa and
moving on to Holland and Britain before the start of American dominance during the Great Depression of 1873-1896. It was then, Arrighi argues, that commerce started to play second fiddle in Britain to finance, as it had in Genoa and Holland when their preeminence was drawing to a close.
The financialisation of the American economy can be traced to the mid-1970s, so by this interpretation of history, the dotcom collapse of 2000-2001 and the financial crisis of 2007-2008 (sandwiched by the military entanglements in Iraq and Afghanistan) are part of a much longer-term development.
According to this thesis, the concentration of economic power in Wall Street, the stagnation of income for all but the rich, the structural trade deficit, the military overreach, and the switch from being the world’s biggest creditor nation to its biggest debtor add up to a simple conclusion—we are in the twilight of the long American century. Washington contests such a conclusion but it may help explain why, as Albert Edwards of Société Générale puts it: “Unprecedentedly strong monetary and fiscal stimulus has led to unprecedentedly weak recovery.”
This will worry Bernanke, who made his name explaining how policy-makers could avoid repeating the mistakes of Japan’s lost decade and can anticipate the dire consequences of a deflationary period for a nation wallowing in debt. In spite of rising commodity prices, core inflation in the US is low. The Fed still has levers to pull and, if there is the remotest possibility of this sucker going down again, it will pull them.—