A Steep Downhill

We have effectively entered the second Great Depression of the capitalist world. This article attempts to offer an idea of the extent and the velocity of the decline in economic activity and, above all, of the destruction of wealth around the world. It remains to be seen whether concerted action by our governments can brake the fall. Likewise, the geopolitical consequences of this extraordinary collapse have yet to be fully experienced or analyzed. I live 10 blocks from Wall Street. This has allowed me to bear witness to an economic collapse that has no precedents, though lessons can be gleaned from the 1907 U.S. banking crisis, the great financial/economic crisis of 1929-1932 and, more recently, the collapse of the world’s second economy – Japan – in the 1990s.(i)

But this crisis is worse than all of those. In contrast to the Japanese crisis, this is a synchronized, global crisis. And the magnitude of the present crisis is much greater than that of the Great Depression of 1929-1932. We are dealing with the collapse of the most recent phase of globalization, and this reminds us that the globalized economy is effectively centered not merely in the United States, but, to be more precise, on Wall Street. And this financial center turns out to be just like the center of a doughnut or, in New York, the center of a bagel – in other words, a hole.

It is a crisis that, by virtue of its size and the specific dynamic of the capitalist system, has swept across the world like a supernatural catastrophe, beyond any human control. In the face of this phenomenon, the planet’s governments are preparing for battle with all the fiscal and monetary tools at their disposition. But if this is a battle, it is not a fair fight but a pitched conflict: something out of science fiction, like the book War of the Worlds (H.G. Wells, 1898) or the subsequent radio broadcast (Orson Wells, 1939). On one side stands the sharpest economic contraction since 1980, the strongest deflationary wave since the Great Depression, the worst real estate collapse in history and the highest tally of bankruptcies on economic record. To confront these monsters, our leaders stand ready with the boldest combination of money issuance, government rescue packages and stimulus plans ever tried.

The majority of politicians and economists are hoping that this defensive strategy succeeds in slowing and disarming the ghouls threatening us. They are hoping that our governments and their leaders rescue nearly all of the great institutions now floundering; that they print money indiscriminately in order to finance the many poor decisions made by big banks, insurance companies and large manufacturers; that they rebound from the current financial and credit paralysis without stopping to consider its causes; that they maintain a high level of public debt (both foreign and domestic) for an indeterminate time; and that they counter deflation with inflation.

In the heat of the moment, however, they have not stopped to consider that, once unleashed, inflation is very difficult to slow; that it may very well destroy the value of a currency; and that, in the long run, inflation can condemn capitalism to a miserable fate.

Others – whose ranks are thinnest but who are among the most orthodox of thinkers – believe that this strategy (which was initiated in the final days of the Bush administration and will be continued with greater fervor by the new Obama administration) is optimistic in the short- and mid-range, but fatal in the long run. In other words, the success of this strategy, if it does succeed, will be short-lived. They believe that, in spite of all their weapons, the intervening forces will fail to achieve their proposed objectives, namely:

_ – They will not succeed in reversing the long overdue liquidation of bad debts;
_ – They will not succeed in slowing the necessary decline in the cost and quality of life;
_ – They will not succeed in creating an inflationary exit strategy and lowering the value of the dollar;
_ – They will not succeed in delaying the days of hard work and sacrifice;
_ – They will not succeed in protecting inefficiency and discouraging innovation; and
_ – They will not succeed in institutionalizing mediocrity in the name of security.

The lower house of the American Congress has just approved a more than $800 billion stimulus package. Meanwhile, the Treasury Department has already acknowledged the failure of its previous effort, the $700 billion TARP program, which was intended to inject money into the economy through the beleaguered financial sector. In the first skirmishes of this great battle, the great enemy –Deflation– has neutralized the best intervention plans.

Deflation is not merely a decline in prices, though right now this decline is plain to see. Almost all of the businesses I pass by have slashed their prices and fees from 30 to 70 percent. Deflation, however, is something more than this: it represents an extreme case of wealth destruction. Of course, the further we explore the subject, the more doubts arise, such as those noted by our co-editor, an astute economist. Is the “artificially” generated product of reckless indebtedness rightfully called wealth? Many people, perhaps, would answer yes, since more bricks or other intangibles were generated. But accountants, who tend to be more conservative in their assessments, would likely answer no, since the liabilities that have sustained this wild generation of assets exceed the assets themselves and, from the accounting perspective, net worth is negative. Could it be that wealth is simply a measure of assets, with the nature and size of liabilities wholly irrelevant (a formulation that lurks behind many of today’s sectoral “bubbles”)? Or, on the other hand, is wealth better conceived of as a measure of net worth?

Whatever the case may be, what is certain is that right now wealth is being destroyed at an accelerating pace and we are all feeling the impact in our daily lives. Compared to this destructive rhythm, governmental measures – for all their haste – are painfully slow. The most daring rescue packages are far smaller than the wealth being “burned” on a daily basis. And, more worrying still, our leaders have been unable to ensure that these funds reach those who truly need them.

First, the wealth already destroyed is several times larger than the most generous of the rescue packages. Each quarter, the U.S. Federal Reserve publishes a detailed account of national wealth divided into five categories: real estate, corporate equities, mutual fund shares, pension and insurance reserves and assets of non-profit non-governmental organizations, including universities, churches and foundations. The latest results, based on the Federal Reserve’s Flow of Funds report, are as follows:

[Chart 1 – Massive wealth destruction in the U.S.
2007-2008.
->http://www.opinionsur.org.ar/charts.doc]

Source: Federal Reserve, Flow of Funds (in billions of dollars)

This chart clearly shows how, in the first quarter of 2007, homes began to lose value in the real estate sector. This marked the beginning of the so-called sub prime mortgage crisis, with losses totaling $53 billion. In the second quarter, the losses ballooned to $190 billion. They increased in the third quarter ($496 billion) and rose again in the final quarter to $708 billion. It was in this quarter that wealth destruction spread to other sectors: stock market values, life insurance, pension funds. By the close of 2007, losses already totaled $1.5 trillion dollars (a trillion is a million millions, or 10 to the power of 12). This trend accelerated in 2008. Families have lost about $3 trillion in real estate value in the first quarter and continued to lose in the second quarter, in spite of an economic stimulus package. In the third quarter, losses rose again to $3 trillion. By the end of the year, losses added up to nearly $8 trillion! This sum is eight times greater than the stimulus package proposed by Obama and 11 times greater than the Treasury’s first rescue package (Secretary Paulsen’s TARP program). Over the last several months, the government has lavished new and sizeable sums on guarantee programs in order to prevent large institutions from going bankrupt. But money guaranteed is not the same as money spent. While I sit writing these words, there is great concern over how to avoid the failure of no less important an institution than Citibank. I believe there is no solution other than the outright nationalization of Citibank, and perhaps of other giants of private banking who have bitten off more than they can chew.

In the second place, liquidation of private debt – the strongest of all deflationary forces – has already begun. For several decades, the U.S. economy has borne mounting debt, and now the levels are no longer sustainable: mountains of loans, promissory notes, bonds, mortgages, credit cards and bank paper accumulated year after year. But everything changed in the third quarter of 2007. It started with the liquidation of short-term debt in the interbank markets and in the corporate short-term debt market (commercial paper). Later, the liquidation extended to the mortgage sector and to bonds. In the third quarter of 2008, mass liquidation was already well underway. Charts 2 and 3 help give an idea of the process:

[Chart 2 –
Collapse of mortgage debt in the U.S.->http://www.opinionsur.org.ar/charts.doc] [Chart 3 –
Acceleration of wealth destruction in the U.S. 2007-2008.
Losses in billions of dollars.->http://www.opinionsur.org.ar/charts.doc]

This all adds up to something much more serious than the strangulation of credit, which represents a decline in the creation of new debt. We are dealing with the destruction of unpaid debts, which are then written off as losses. The process is plain to see in U.S. towns and cities: housing prices have fallen; there has been mass mortgage foreclosure; and creditor banks, forced to move their numbers from assets to liabilities, are now themselves facing the prospect of bankruptcy. It is a classic, nearly textbook, cycle of deflation and debt collapse – strikingly similar to what happened between 1929 and 1932, though many would rather not admit it.

As if this were not enough, prices have begun to fall. In recent months, the prices of commodities have declined just as they did during the Great Depression. The price of oil has fallen 73%, copper 66%, nickel 73%, platinum 66% and wheat 64%, to give just a few examples.

The Producer Price Index, which is more reliable and sensitive than the Consumer Price Index, is dropping at a rate of 2% per month. Naturally, all of this is reflected in the Dow Jones Industrial Average, which has suffered the worst fall in its 75-year history.

Finally, up until this point, government-spending programs have been inadequate. As the cowboys like to say, you can lead a horse to water, but you can’t make it drink. The massive sums of money lent to the banks have not left their vaults. Whom are the banks going to lend to? Meanwhile, manufacturers have announced massive layoffs and shelved plans for new investment and construction. They simply have too much idle capacity. It is fitting to remember what Marx said: The roots of capitalist crises lie not in too few goods but too many. There are too many unsold houses, too much clothing waiting to be bought, too many unused offices and too many empty shopping malls.

It is likely that the new Obama administration will initiate a series of massive public works projects, similar to Franklin Roosevelt’s WPA in 1933. But this is easier said than done. The risk is that, executed too hastily, this effort will merely multiply useless programs. But, without quick action, the economy will simply continue its precipitous decline. This is the dilemma that Obama has inherited. A historical warning: In the ‘90s, Japan executed a stimulus package consisting of an outlay of 10.7 trillion yen in August 1992, 13.2 trillion yen in April 1993, 6.2 trillion yen in September 1993, 15.3 trillion yen in February 1994, 14.2 trillion yen in September 1995, 16.7 trillion yen in April 1998, 23.9 trillion yen in November 1998 and 18 trillion yen in November 1999. The total: 118.2 trillion yen, equivalent to $1.3 trillion in today’s dollars (adjusted for inflation and GDP relative to the U.S. economy). All this amounted to nothing: Japan lost a decade mired in mediocre or no growth and falling stock prices. Did Roosevelt’s stimulus and public works package fare any better in the 1930s? Studies on the subject – among them one by Mr. Bernanke, chairman of the U.S. Federal Reserve – are far from conclusive. And the debate continues over why, with all of Roosevelt’s stimulus packages, it was not until 1943 – in the middle of the Second World War – that the U.S. economy finally recovered.

Will we have better luck, or will we have to endure ten years of social and economic recomposition? This is the big question that looms over the young presidency of the serious and respectful Mr. Obama. What a present Bush has left his successor!

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Note: i) I do not mention the Argentine meltdown of 2001-2 because that country is such an exceptional case, and has been for most of the last century.

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