International Socialist Review, April–May 2000

Notes of the Quarter

Economy

Ingredients for a Market-Led Downturn

From International Socialist Review, Issue 11, April–May 2000.
Downloaded with thanks from the ISR Archive.
Marked up by Einde O’Callaghan for the ETOL.

MEDIA PUNDITS and mainstream economists waxed euphoric last month as the current U.S. economic expansion became the longest in history. February marked the 107th month of expansion, surpassing the record set in the 1960s. A cover article in Business Week announced, Prosperity Is Reshaping the American Economy. GDP grew 6.9 percent in the last quarter of 1999, the federal budget has moved from deficit to surplus and unemployment is at a 30-year low.

According to Business Week, the expansion can continue indefinitely: “The U.S. economy is stable – and poised for more years of healthy growth.” Financial advisor Christopher Farrell agrees, arguing that “a recession ... isn’t on the horizon with entrepreneurship flourishing, employment growing, and incomes rising.” Above all, the boosters argue that the revolution in information technology and the rise of the Internet have transformed the economic landscape, creating a new economy of unprecedented growth and “unimagined prosperity.”

While recent innovations in computer, communications and information technologies have certainly been important, they are scarcely unprecedented. As Marx pointed out more than a century ago, capitalism is a competitive system that “cannot exist without constantly revolutionizing the instruments of production.” The whole history of capitalism has been characterized by technological revolutions. The 1920s, for example, saw innovations – from the spread of the automobile to the development of electronics – at least as profound as those of the 1990s, none of which prevented capitalism from entering its worst crisis to date in the 1930s.

In any case, the rosy economic predictions ignore the fact that by historical standards the current expansion is hardly impressive and is increasingly based on shaky foundations. Indeed, even some establishment voices have begun to recognize that all is not well. In a dissent to his own magazine’s cover story, Business Week’s economics editor Michael Mandel warned, “Sooner, rather than later, the New Economy boom is likely to be followed by a New Economy bust – a recession and stock market decline that could be much deeper than most people expect.”

Compared to the other postwar expansions, the present “boom” is by far the most lackluster. Growth averaged less than 3 percent in the first half of the 1990s, and while it has picked up since then, it is still well below the level of the 1950s and 1960s. Between 1961 and 1969, GDP grew by more than 52 percent, while in the current expansion it has grown less than 30 percent.

Moreover, the growth that has taken place has benefited only a few. Most working people have spent much of the past decade simply recovering income that they lost in the early 1990s. Median household income today is only slightly higher than its 1989 pre-recession level. For the poorest households, it is not even at that point. Meanwhile, incomes for the richest 5 percent are up 22 percent since 1989, and income inequality is at its highest level since the 1930s.

In the past few years, the median wage has increased slightly, but it is still lower in real terms than it was 30 years ago. In order to keep their heads above water, American workers are working longer and harder. According to one recent report, mothers in two-parent families “increased their average annual paid work by 223 hours – nearly six weeks – between 1983 and 1997. Fathers increased their work by 158 hours or four weeks in the same period.” It is this huge increase in the level of exploitation that underlies the recovery of the U.S. economy in the past ten years, allowing profit rates to return to the level of the early 1970s.

Increased corporate profits have in turn helped to fuel the huge increase in stock values since 1995. Last year, the Dow Jones average gained more than 25 percent, while the Nasdaq composite index – representing the country’s most prominent high-tech and Internet companies – rose by an astonishing 86 percent. But it is becoming increasingly clear that stocks are grossly overvalued and the current market boom is nothing more than a huge speculative bubble.

For most of the twentieth century, the average price/earnings (P/E) ratio for stocks was 14. Today, the P/E ratio for the S&P 500 is more than twice this number, while the P/E for the Nasdaq is a phenomenal 200. For some Internet companies, the figures are unbelievable. Yahoo!, for instance, has a P/E of more than 2,000. As Doug Henwood, editor of Left Business Observer, notes, “Most Internet firms have no earnings, so their P/Es are infinite.” Amazon.com, a familiar example, has lost more than $600 million, but its share prices continue to go up.

The plain fact is that the profits needed to justify these extravagant numbers are unlikely to materialize. According to a study by Federal Reserve economists, stock prices have been inflated by as much as 50 percent as a result of U.S. companies buying back their own shares. In 1998, for example, the companies in the S&P 500 spent $148 billion buying back shares, often with borrowed money. Corporate executives with generous stock-option deals have profited enormously from this process. But the borrowing cannot go on indefinitely. Eventually the mania will turn to panic and the bubble will burst.

Yet even this possibility doesn’t worry Business Week “The U.S. economy is so vibrant,” it writes, “that even a big tumble in the stock market might not be enough to knock it off-kilter.” But this sanguine assessment must be taken with a very large grain of salt. First, a sharp market decline is likely to have a major impact on consumer spending, which has been driving the expansion in recent years. According to Federal Reserve Chair Alan Greenspan, one-quarter of economic growth since 1996 has been due to wealthy consumers spending more because the value of their investment portfolios has increased.

Meanwhile, the rest of us have been accumulating debt at a record level. American households are spending more than they earn, the ratio of household debt to income is higher than it’s ever been and the personal savings rate is at an all-time low. Total outstanding consumer debt reached $1.38 trillion last November, up 79 percent from 10 years earlier. Non-business bankruptcies increased 60 percent between 1991 and 1998. “When the American consumer reaches the point where they can’t borrow any more,” warns Bill Fruth, president of the research firm Policom Corp., “consumption will come to a grinding halt, then jobs will be eliminated and people’s ability to pay off the debt will be diminished.” If this coincides with a stock market decline that leads to large numbers of layoffs, the effect could be devastating.

The second reason that a market crash is likely to impact the wider economy has to do with the growing U.S. trade deficit – the amount by which imports exceed exports. One reason that high levels of consumer spending have not pushed up inflation is that much of the rest of the world is in recession, which has allowed the U.S. to rely on a steady flow of cheap imports over the past few years. As a consequence, however, the trade deficit has ballooned. Last year it reached a record $271.3 billion, 65 percent higher than in 1998. This year, it may reach $400 billion, almost 4 percent of GDP.

In order to finance this massive shortfall, the U.S. has to attract an equally large quantity of foreign capital, making the economy highly dependent on outside investors. Up to now, foreign investors have been more than happy to oblige. But if the stock market crashes and they lose confidence in the U.S. economy, they will attempt to unload their unwanted dollars. Interest rates would shoot up to protect the dollar’s value, and the economy could once again be thrown into recession.

No one can say for sure when or how the boom will end, but the weaknesses of the U.S. economy – an unsustainable stock market bubble, massive levels of private debt and the huge trade deficit – mean that it cannot go on forever. “There are strong parallels [with the 1920s], all of which make me worry,” says University of California economist Barry Eichengreen, an expert on the Great Depression. “If you believe history repeats itself, all the ingredients are there for a stock market-led downturn.”