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The following article appeared in Left Business Observer #85, September 1998. It retains its copyright and may not be reprinted or redistributed in any form - print, electronic, facsimile, anything - without the permission of LBO.
Since Asia broke in the summer of 1997, LBO's official stance has been confusion. Was this was another of the regional financial crises we've gotten used to seeing - like the banking crises in the U.S. and Scandinavia in the late 1980s/early 1990s, the European monetary crisis of 1992, Mexico's 1994/5 disaster - or was it the opening movement of a broad and possibly monstrous global deflation, the one policymakers have been staving off for years? If it was the second, it was likely that things would get worse where they were already bad, and spread savagely beyond their point of origin. So far, things have been breaking badly. There is no sign of recovery in Southeast Asia; the crisis has spread to Russia, and Latin America looks wobbly. The authorities have pulled off many an improbable bailout over the years, and they may once again, but they sure do have their hands full.
Japan's latest GDP figures were far worse than expected, showing an annualized decline of 3.3% in the second quarter - the third consecutive decline, the worst losing streak since the stats began in 1955. It's not an economy in "freefall," as it's sometimes described, but it's still pretty sick. A consolation is that there's been no collapse in employment so far.
That's not true elsewhere in Asia, where the International Labour Organisation estimates that 15-20 million will lose their jobs by yearend. Indonesia's unemployment rate will be 12% and real wages will be down 15%. Thai unemployment is likely to be 6% (and jobless rates in the so-called Third World notoriously miss marginally employed people working in the "informal sector," selling pencils on the street or combing through trash), compared with 2% two years ago. Korean unemployment is already 7%, more than double last year's rate. Even if China avoids implosion, 3.5 million are likely to become jobless this year. Malaysia plans to boot half its 1.8 million migrant workers, 200,000 of them by yearend, under a program called Ops Nyah or "Operation Get Out"; 800,000 will be booted by Thailand, Korea, and Hong Kong. Many displaced workers will be returning to the Philippines and Indonesia, which are in no shape to welcome them.
The Asian collapse is extraordinary, but Russia's is in a class by itself - a collapse not just of the economy, but of the whole society. Life expectancy is back at late 19th century levels, and the population seems to be shrinking, something not seen in modern times in a country not at war. Virtually no noncriminal institution is functioning healthily. Orthodox sorts are still blaming the Soviet regime for the disaster - a real stretch, since the bulk of the collapse happened after the USSR ceased to exist, when it was receiving the brilliant advice of the International Monetary Fund (IMF) and Jeffrey Sachs's Harvard Institute for International Development (HIID).
Sachs, known as the intellectual father of "shock therapy" for the former socialist world, is getting a lot of press for his criticisms of the IMF. Of course he's right that the Fund's strategy has been a disaster, and that no recovery in Russia will be possible without massive debt relief. But Sachs, director of the HIID, is himself deeply implicated in the disaster. With his former Harvard colleague Larry Summers at Clinton's Treasury Department, the U.S. government deputized HIID to run its "aid" program in Moscow, a program that amounted to greasing the theft of state enterprises by the present gang of oligarchs who run Russia. (The full story is told by Anne Williamson in an unpublished book chapter.)
In textbook economics, the unrich tolerate capitalists' wealth because they supposedly invest it and employ the nonrich to produce goods and services. In Russia, though, the capitalists steal money and sock it away abroad. Investment and employment have collapsed, and food and consumer goods have to be imported. Because of import dependence, the ruble's crash has already driven up the prices of basic goods by 40%. Will Russians starve and freeze in vast numbers this winter?
Is this crisis just a storm out of nowhere, or does it have a history? One effort to answer this question (though it's been in preparation for years and so wasn't intended as such) is a book-length essay by historian Robert Brenner that takes up the whole of New Left Review's May/June issue. For Brenner, today's crises are the latest phase in a "long downturn" that began with the first oil shock in 1973. (As the neary chart shows, recent growth rates are in line with those of the 19th and early 20th centuries, so "downturn" may be the wrong way to think of it, but let's not quibble.) The underlying cause of this downturn, argues Brenner, is a decline in corporate profitability, which is empirically true and theoretically solid. But what caused the decline in profitability? One school of thought has persuasively blamed it on the strength of the working class worldwide in the 1960s and 1970s, which forced higher wages, a more generous welfare state, and tighter regulations on a reluctant capitalist class; this raised the costs of doing business, and contributed to an attitude problem among the toilers. Rejecting this, Brenner blames it on the increase in international competition, which keeps a lid on prices and badly squeezes profits.
Focusing almost exclusively on the U.S., Japan, and Germany, Brenner convincingly explains rapid growth in the ex-Axis powers by their rapid gains in world export shares, which made it profitable to sustain high levels of investment and technological upscaling. But as their market share growth slowed, profitability sagged and with it investment and growth. The long-term rise of the yen and D-mark against the dollar meant that Japanese and German manufacturers had to cut costs sharply just to offset currency-induced price rises. They relocated production to low-wage enclaves - Germany to Eastern Europe, Japan to Southeast Asia, and both to the U.S. - leaving home market investment low, and depressing growth. Still, these moves weren't enough to offset the cost advantage gained by the U.S. with the dollar's long slide and relatively low and declining wages.
Though profit rates sagged, Brenner emphasizes, big multinationals (though he curiously makes nations, not capitals, the main subject of his narrative) didn't scrap old plants; they kept working them, exerting further downward pressure on prices, even though the system would be better served by weaker ones going under. In the old days, a deep depression might have cleared away all this excess capacity, but throughout the 1970s and early 1980s, big government deficits propped up demand, preventing the liquidation. In other words, for Brenner, the system suffered from a lack of exit.
In the second half of his essay, Brenner begins conceding enough to undermine the first half. He concedes that the U.S. could be in a profitability upswing (a position held by Anwar Shaikh, as this newsletter reported in issue #80). And one reason for this, Brenner also concedes, is the ability of U.S. employers to cut wages, close plants, fire thousands, and work their remaining workers harder. This is something Japanese and German employers have found it much more difficult to do. He also could have mentioned the wave of takeovers and restructurings of the last 15-20 years, which, aside from being carnivals of greed, were also about liquidation and exit, as combined firms eliminated redundant functions, shut plants, and cut costs in every way imaginable. So, U.S. profitability recovered because exit rose, labor was crushed, and an already minimal welfare state was pared back - and neither Japan nor Germany has seen more than a hint of either. Yes, intensified competition has placed relentless downward pressure on prices and profits, but Japanese and German employers were politically incapable of taking the cost-cutting measures their American counterparts have been very visibly taking for the last 20 years.
Brenner has surprisingly little to say about Asia outside Japan, but, as the nearby chart shows, the "developing" countries in Asia - mainly China, Korea, Malaysia, Singapore, Taiwan, and Thailand - made great leaps forward in market share from the early 1970s until their export growth slowed sharply in 1996. (By contrast, the "developing" nations of the Western Hemisphere have gone nowhere, despite lots of hype about Latin American dynamism.) While these countries were expanding, they were clocking some of the fastest growth rates ever seen, a fact that contradicts Brenner's generally stagnant picture of the world.
How does Southeast Asia fit into the big picture? Certainly the region's rise helped intensify the competitive pressures on the Big Three - though the growth miracle, especially in its later phases, was heavily powered by Japanese investment in the late 1980s and early 1990s, as that country's firms sought to cut costs, under the pressure of the yen's rising value. That investment also helped fill the order books of Japanese capital equipment makers, as new plants in Thailand, Malaysia, and Indonesia were outfitted. But as the yen started weakening in 1995, Japanese multinationals grew less interested in offshore production, resulting in smaller capital inflows into Southeast Asia and more export competition from mainland Japanese producers. At the same time mainland Japanese producers were offering increased competition at the high end (frustrating the upscaling designs of Korean firms), China was providing increasing competition on the lower end. Export growth across Southeast Asia slowed markedly, and the boom rather quickly turned into a bust.
But facing that bust, Southeast Asian firms are hardly retreating; they're doing everything they can to cut prices and pump up exports. China is already complaining about cheap steel imports from Korea, as are American producers. Here Brenner's argument - one also made, it should be noted, in several books by the unjustly neglected economist Michael Perelman - about the hangover of long-lived capital equipment is very relevant. Firms outside Asia would probably be happiest if half of Asia were shut down completely now, or if they could buy up the better bits themselves, but life is more complicated than that.
So we have a world where the capacity to produce far outstrips the capacity to consume. Yes, profitability has been partly restored in the U.S., but the only way we've been able to sustain a mass consumption economy on stagnant wages is through heavy domestic and international borrowing: consumer debt is at record levels and the U.S. is now around $2 trillion in debt to the outside world. The old strategy for coping with overcapacity problems, deficit spending worldwide and the U.S. pumping up consumption in its role as the world's buyer of last resort, is just not on offer this time around. Instead, budget deficits are being cut all over, and, as Deputy Treasury Secretary Larry Summers put it recently, U.S. national economic strategy is based "on promoting exports, a...high level of investment and capacity creation...[and] fiscal discipline." The first is bad news for strapped exporters everywhere, the second compounds the overcapacity problem, and the third means constricted demand.
Nor is policy anywhere else tuned to expanding demand. Japan has exhausted all monetary stimulus; interest rates are now the lowest in recorded history, breaking a record previously set by Genoa in 1619, and it still hasn't helped. And fiscally, despite talk of stimulus, Japanese policy has lately been anything but stimulative. After adjusting for the state of the business cycle - the so-called structural balance, which is a better measure of budgetary policy than the raw figures that are swollen or constricted by the temporary state of business - Japan tightened fiscal policy in 1997 and again in 1998. The 1997 tightening was driven by an increase in the value-added tax, which has to be one of the dumbest moves in the history of fiscal policy; it helped end a little burst of growth in 1995 and 1996.
But it's not just policy that's got Japan down. For decades, the Japanese system was set up to maximize growth above all, which means maximizing investment at the expense of consumption. Consumption's share of Japanese GDP fell from around 66% in the late 1950s to 58% in the late 1980s and early 1990s - the reverse of the U.S., where it rose from 63% to 68%. Firms were insulated from stock market pressures, and enjoyed indulgent banks, who financed ambitious investment programs through good times and bad. With regulation, guidance, and guarantees, the state stood behind this structure. As Brenner shows, these high levels of investment were also sustained by a steady increase in the Japanese share of world exports. From the 1950s through the 1970s, Japanese exports grew by 10-15% a year; in the 1980s and 1990s, though, the rate fell to 5% and under. Japan still runs a large trade surplus, only because the weak economy has kept the growth in imports even lower than exports. Those surpluses pile up in the form of financial assets, heavily invested abroad (and no doubt more so as the financial market is further deregulated), but do nothing to boost real investment levels and get the economy going again. But why invest in plants that could produce only meager profits selling into saturated export markets?
This crisis, like the deflationary crises of the 19th century and the 1930s [disclosure alert: if you order Kindleberger's book via that link, LBO gets a small commission], has been transmitted internationally through finance, trade, and commodity prices. With each round of debt defaults and stock market routs, people with money - both lenders and spenders - get more nervous, more likely to hoard their money than part with it. Without new credit and new spending, the real economy weakens. Increased competition from cut-price Southeast Asian imports is hurting producers in China and Ohio, and U.S. and European exporters are feeling the loss of Asian demand. Since Asia has gone from being the most rapidly growing market to the most rapidly shrinking, demand for oil, metals, and other basic commodities is falling, and so are their prices. This hurts oil exporters like Mexico and Nigeria, and copper exporters like Chile. This weakness leads to the threat of more financial losses as commodity-exporters' debt becomes more questionable. And so on.
U.S. grain producers, who'd been looking to Asia to compensate for the end of federal farm price supports (under the cynically named Freedom to Farm Act), are now facing grain prices well below the cost of projections. And, notes Mark Ritchie of the Institute for Agriculture and Trade Policy, farmers in the Red River Valley are finding that their highly bred monoculture crops (old-style hybrid strains, not genetically engineered ones) lack the genetic diversity to stand up to pests.
Themes of ecological crisis haunt the financial one. Each of the first eight months of the year broke previous temperature records. When Asia was breaking apart last summer, massive fires were burning in Indonesia, smogging the whole region. Now floods, aided by rampant clear-cutting of forests, are swallowing up huge hunks of China. As of early September, Brazil - a country on the verge of financial crisis - was host to 27,000 drought-fed wildfires. Always quick to turn distress into loans, the World Bank was quick to offer help to Brazil under its new Disaster Management Facility, established in July "with the aim of creating a more comprehensive and rapid response to natural disaster emergencies," including "a program on market incentives for investments in activities to prepare for natural disasters." In its press release, the Bank didn't comment on the contribution of Bank-financed dams, highways, industrial projects, or farming practices to so-called natural disasters.
As if 27,000 fires weren't enough, Brazil is at grave economic risk. Total foreign debt is now around $200 billion, and the government's domestic debt is around $300 billion. Much of it is very short term, and has to be rolled over regularly. The country needs money coming in to finance its big trade deficit and to keep servicing the old debts. But instead money has been leaving, putting pressure on the currency, the real, whose firmness the government has made its most cherished economic goal. To reverse the outflow, interest rates were jacked up to 40%, which makes the government's interest burden tons heavier. Keeping everything together is now the main concern of the U.S. Treasury, the IMF, and Brazil's creditors.
One reason Brazil has a trade deficit is that tight money and a firm currency have deindustrialized the country. President Cardoso, the former Marxist theorist of neocolonial dependency turned orthodox neoliberal (you could say his analysis hasn't changed, he's just changed sides), has won great praise abroad for his strategy, but the country has barely grown, and hours worked in manufacturing are about 20% below where they were in 1992. If Cardoso wins the October 4 election, the markets will be happy, but Brazil will face a strict austerity plan that would deepen the recession that's probably already underway. If Lula and the Workers Party do well, then the markets will despair and who knows what will happen? It's hard to see how putting Brazil into deep recession will make its debts any easier to service, but the higher financial wisdom will try to find a way.
Brazil is attracting the most attention, but Colombia and Ecuador have already devalued their currencies, and Venezuela is under pressure to do so; all three are oil exporters who've been hurt by the decline in crude prices. Another oil exporter, Mexico, is facing capital flight and a wavering peso. If it, or Brazil, were to collapse, then the U.S. economy would feel it hard, as banks and exporters faced big losses.
Also running along with the financial crisis is a political one, with the high bourgeoisie apparently shaken, and their various national governments often weak. Most critically, Japan's ruling class seems weak and dithering. As LBO goes to press, the parliament seems to have crafted some sort of bank bailout, but it should have done that long ago, for the ruling class's own sake, and the details are still unclear. It's said that one reason the government has been unable to mount a proper bailout is fear of popular reaction; though the unemployment rate has climbed a few tenths of a point, most people have felt little of the financial crisis, and lots are happy to see financiers cringe and moan. What a contrast with the U.S., where the now-forgotten $200 billion S&L bailout was mounted with almost no public debate - a political strength for U.S. capital that Brenner can't capture in his numbers.
But it's not just Japan that's politically weak. The IMF is low on cash and lower on credibility. (One reason it's under such broad attack, even in elite circles, may be that unlike the Latin debt crisis of the 1980s, when most of the debt was public, the debt of the 1990s is mainly private, and putting economies through the wringer makes private debt less likely to be repaid; governments can always tax people as much as they need to pay their debts.) Germany is facing a close election, and no government that emerges is likely to be strong. Europe as a whole is on the verge of its monetary and economic union, so it's not clear who's in control. Clinton is preoccupied with morals charges; even though the public says it's behind him, the political class seems to have pronounced him dead. Trying to act presidential, he called for some sort of coordinated G-7 lifeboat operation, but Hans Tietmeyer, the head of the German central bank, said the Bundesbank wasn't about to lower interest rates, which left it up to the U.S. to lead the way. That leaves the world dependent for its rescue on Alan Greenspan, assisted by Bob Rubin.
This issue went to press before the Fed's September 29 policy meeting; vigorous interest rate cuts are expected. But it's impressive how slow they've been to come, and with so much open dissent. In Congressional testimony on September 16, Alan Greenspan hinted he might move - the markets saw his remarks that deflationary forces "continue to emerge" and are "moving in our direction" as a hint of possible ease rather than something to worry about. But in public speeches and leaks to journalists, other Fed officials - Greenspan's colleagues on the Board of Governors and presidents of the regional Fed branches - have declared themselves in no generous mood. To them, the U.S. domestic economy is strong, probably too strong. A sustained unemployment rate under 5% has helped push up real wages, but deflationary pressures have kept down prices, resulting in a profits squeeze, especially in manufacturing, where global competition is sharpest. Normally, a Fed facing this situation would tighten, probably severely, but even the hawks concede that the international scene makes this impossible.
In September 23 testimony, Greenspan spoke ominously of crisis tendencies not yet subsided or about to, and used words like "virulence" and "erosion." Markets took this as an easing sign, but gains were mostly undone on the 24th, when the bailout of Long-Term Capital Management was announced. LTCM was a hedge fund - a pool of speculative capital, free of almost all regulation - formed by John Meriwether, one of Salomon Bros. Big Swinging Dicks who starred in Michael Lewis' Liar's Poker. Partners include two Nobel laureates in economics, Robert Merton and Myron Scholes, as partners, as well as former Fed vice chair David Mullins. [Click here for Merton's amusing research interests; this used to be on his Harvard web page, but it was mysteriously removed.] Merton and Scholes are grand wizards of finance theory; their math made the world of derivatives possible, and earned them their 1997 Nobel. LTCM borrowed hugely - $2-5 billion in capital was turned into $200 billion in positions, far more than most hedge funds leverage themselves - and bet that the neat world of their models would never break down in practice. It did, and they lost monstrously. Their peers, heavily coached by the New York Fed, put together a $3.5 billion "bailout" of the fund, which could represent anything from an orderly liquidation to another speculation that the fund could recover. The Fed had reportedly determined that LTCM's failure would pose systemic risk, and that a disorderly liquidation would hugely disrupt the markets. For the first time, a hedge fund has been deemed too big to fail, a status formerly reserved for countries and large banks; from its partners list, it was certainly too important to fail.
Several questions emerge from the LTCM affair. Will the bailout only encourage more recklessness in the future? (It's nice how welfare for the poor is said to be so morally corrupting, while protection of the rich is a systemic necessity.) How is the LTCM bailout not an instance of the cronyism so roundly denounced in Asia? What were the banks who lent so hugely to the fund thinking, and had they been thinking like that in many other, yet-undiscovered ways? And if only a relatively minor and brief bit of turmoil in the U.S. financial markets could deliver such an exquisite corpse as LTCM, what would a two-year, 50%-off bear market do? Just what horrors lurk in the financial structure after 16 years of nearly ceaseless giddiness on Wall Street?
But we shouldn't get carried away by anxiety; there's also rich potential in this turmoil. It should never be forgotten that the present crisis is the fruit of overproduction tendencies deep within capitalism as a system, exacerbated by the various policies of the last two decades collectively known as neoliberalism (emphasis on exacerbated, since the policies themselves emerge from capitalism as naturally as overproduction: their whole point was to reverse the sagging profitability of the 1970s). The free movement of capital which was supposed to guarantee maximum efficiency has instead given us instability and collapse, and the opening of economies to trade has intensified those tendencies towards overproduction, as everyone scrambles to out-export everyone else. And the various ecological disasters accompanying the panic should remind us that you can't externalize the natural costs of production forever; at some point - like now - they're going to bite back. It's a lot harder to bail out an ecosystem than a hedge fund.
Not only is the confidence of the high and mighty shaken, financial
orthodoxy is discredited around the world, if not yet in its homeland,
the U.S. Russia has defaulted on some debt, and looks like it
might tell the IMF to stuff it. Malaysia - led by a repressive
bigot, Mahathir Mohamed, it shouldn't be forgotten by those tempted
to admire him - has instituted controls on capital movements,
a move counter to the political trends of the last 20 years. But
while orthodoxy is being rejected, no one really knows what to
substitute for it. If there were a left to speak of anywhere in
the world, it could probably make some hay with all this.
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