World economy: stock market crash brings world recession nearer
Workers Power Global, London: 22 July 2002

Last week the stock markets finally crashed after months of scandal over profit figures for the USAâs big corporations. World Com was the last straw. More than $3bn of expenses were wrongly found not to have been deducted against profits weeks ago and the financial marketsâ confidence has been shot to pieces.

By 19 Julyâs close Nasdaq was down 75 per cent on March 200 high and is now under 1400. S&P has lost 42 per cent of its value from its December 1999 peak. In Europe the FTSE index closed down 48 per cent on its September 2000 peak.

Market capitalisation in the United States is down nearly $6 trillion from its peak (37 per cent) and world market capitalisation has fallen by $11.3 trillion from peak (35 per cent).

There is a suspicion that there are dozens of big US multinationals out there lining up to reveal similar tales of wrongdoing, leading a to a huge scaling down of reported profits for the late 1990s. Naturally, it is also fuelling the view that profit projections for the next years are also too rosy.

Nothing justified the valuations of late 1990s, especially after 1997 when profits started to fall. Past profits were systematically overstated because the stock market bubble of 1997-2000 gave company valuations that implied earnings rising a high double-digit rates into the indefinite future.

To keep reported profits in touch with stock market valuations accountants and company directors eventually went from ãcreative accountingä to fraud in one leap.

Most commentators consider the stock markets remain overvalued even after last weekâs crash. The S&P earnings/price index is still three times its post-war long-run average of 15, which The Economist believes "implies a drop in share prices of three-fifths to return to historic norm."

The markets are still more generously valued than anytime in last 100 years apart from 1929 and recent 1999/2000 peaks. Peter Eavis of the TheStreet.com believes that the S&P and Nasdaq have to be halved from present levels ãbefore stocks hit a floor."

This huge devaluation of fictitious capital, nevertheless represents a mountain of paper wealth that has been critical in the last seven years to keeping consumer demand rolling along ö the engine of the US economy. If recession now grips the US this year then the world economy cannot escape the consequences.

During 1995-2000 the USA generated 40 per cent of the global increase in real demand. After markets peaked and started to unwind in the spring of 2000 there was an immediate contraction in corporate sector; business investment fell away to virtually nothing as profits were flat.

Meanwhile aggressive interest rate cuts (7 times to a historic low of 1.75%) spurred a borrowing and housing price boom among households. The tens of millions of US citizens that own shares saw their ãwealthä rise and borrowed heavily on the basis of their rising assets. All this made household debt reach 4 per cent of GDP by early this year, compared to long run average of 2 per cent.

Peter Eavis says: ãBut this lending binge won't offer much lasting help, because all it has done is inflate prices in the housing and services sector, shore up demand for autos and make it much easier for the government to suddenly run up a huge deficit. All those uses are consumptive and divert resources from productivity-enhancing investment. What's more, firms are too debt-laden to go back to '90s-level investment spending."

A recession is likely. Why? First, it is unlikely that consumer demand can continue at its recent past rate. It would only be possible if external investors were prepared to finance US consumersâ borrowing and thereby finance the growing current account deficit and foreign claims on US assets. On present rates of growth this would grow if unchecked from the current 20 per cent to 50 per cent in five years time. But the US dollar is falling as foreigners withdraw holdings.

Even before the latest market collapse Mayâs retail figures showed a 0.9% fall in sales. More is to come.

Can the EU or Japan reflate their economies to become the engines of growth? In 1993-2001 EU GDP growth averaged 2 per cent and Japan 1.5 per cent. Japan has little left in locker to stimulate spending after a decade or more of failed measures. The EU would need aggressive ECB action.

A continued recovery in the USA is, according, to the neo-liberal realist Martin Wolf of the Financial Times "no more than a fairy story to comfort frightened children". Wolf sees three possible scenarios:

(i) Continued growth in US demand, implying rising deficits, debts and asset prices. This would keep the world economy going and postpone the crash for few years and then it will be worse when it comes. (ii) There is a slow adjustment in US, leading to the need for the EU and Japan to adjust their economies to take up slowly falling demand in the United States.

(iii) A strong crash in asset prices and markets in the USA, further capital flight, an investment and consumption contraction ö all with a dire effect on the rest of the world.

As Wolf says: "The true choice may be between going over a high cliff in some years from now or going over a rather lower cliff quite soon."

In the last weekâs everyone from serious neo-liberals to George Bush himself have admitted that the present crash and scandals have deflated the reputation of capitalism, or at least the Anglo-American free market, stock market driven version of it.

Five years ago its virtues were unlimited we were told, as it was spawning a ãnew paradigmä, ö a new epoch of high-tech, high productivity capitalism that justified the new stock market valuations and promised stability and prosperity for all.

Now this particular American Dream is in tatters. The crisis is deepening. Socialists and revolutionaries are being proven correct at every turn. Now it is time to turn this moral authority into a mass movement of working class resistance that destroys the capitalist system before its destroys us.

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