>Date: Mon, 17 Apr 2000 13:58:49 -0400
>From: Andy Lehrer <[EMAIL PROTECTED]>
>Reply-To: [EMAIL PROTECTED]
> With the stock market "correction" this past week, now seems like a
>timely moment to send out the following article "When Will the Bubble
>Burst" from the April 1999 issue of Socialism Today. ST is the monthly
>magazine of the Socialist Party (England and Wales), a section of the
>Committee for a Workers' International (CWI). For more info on the CWI
>and its Canadian section, Socialist Alternative (and sections around the
>world), please go to http://www.socialistalternative.net
>
>To subscribe to the SocialistAlternative-List, an announcement list
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>
> When will the bubble burst?
>
>
> Propelled by the stock-market bubble
> Rebound from the '98 'correction'
> A new-era economy?
> The coming crash
>
> The US appears to be an 'oasis of prosperity', still
>swimming strongly while much of the world sinks. Despite last year's
>turmoil, Wall Street's Dow Jones index is nudging the 10,000 mark. The
>latest US figures show rapid growth, reduced unemployment and near-zero
>inflation. The US's demand for imports continues to cushion the
>floundering economies of Asia, Latin America and even Europe. Has the
>new era capitalist economy really arrived? On the contrary, argues LYNN
>WALSH, the recent growth spurt has been propelled by a highly unstable
>cycle of consumer spending and business investment-fuelled by a crazy
>stock exchange bubble. Sharpening trends within the US economy and the
>still spreading world slump mean that the days of the US boom are
>numbered.
>
> "JOY TO THE WORLD", proclaimed the Wall Street Journal
>(22 December) just before Christmas: "Despite everything, America still
>embraces a culture of optimism; Impeachment? Iraq Tensions? Humbug!
>Markets soar, polls rise, masses spend". The US economy, according to
>the New York Times (18 December) was a "Hotbed of rest in a sea of
>crisis and confusion".
>
> "At the first blush", commented the Boston Globe (3
>January 1999) in its Business Outlook '99, "the lesson of 1998 seems to
>be that the US economy can take a licking and keep on ticking - perhaps
>indefinitely". This is the mood of most wealthy financial investors and
>business pundits. The present
>growth cycle, over seven years long, is the longest peacetime recovery
>in US history. On 14 March, the Dow Jones (the New York Stock Exchange's
>leading index) broke, for the first time, through the mystical 10,000
>barrier - and many speculators, intoxicated by their unbelievable run of
>profit-making luck, are even looking forward to the 15,000 mark.
>
> Because they weathered the Asian crisis, the collapse
>of Russia, and the near-meltdown of Long Term Capital Management and
>Wall Street has bounced back, most investors, big and small, feel that
>the US is immune from the economic laws that govern the rest of the
>world. Despite warnings from the Federal Reserve and the US Treasury,
>they believe in the 'new economic paradigm' (unlimited capitalist
>growth, without inflation and periodic downturns) - and they believe it
>is here to stay. They fail to see that the recent surge of US financial
>markets has been produced by temporary, extremely contradictory,
>conjunctural factors which will not last much longer.
>
> Growth (which reached 5.6% annual rate in the last
>quarter of 1998) has been fuelled by the continued rise of share prices
>- which in turn has been fuelled by the flood of relatively cheap
>capital into US financial markets. While the Asian crisis hit US
>exports, at the same time it directed a flood of foreign capital into
>the US, helping to drive interest rates down and push consumer spending
>to even higher levels. There was $218bn of foreign direct investment
>into the US during 1998, much of it from overseas corporations which
>were using dollars from the US trade deficit to expand their operations
>in the US.
>
> The surge of capital into shares - interrupted by the
>gyrations of major stock markets in August last year - was stimulated
>further by the action taken by the US Federal Reserve to avert a
>meltdown of world financial markets after the Russian collapse and LTCM
>crisis. This gave a new lease of life to the stock market-led consumer
>boom, reinforcing the economic feel-good factor despite the spread of
>crisis to Latin America early this year.
>
> An increasing number of commentators, however, are not
>only predicting lower growth for the US this year (2% or less) but are
>warning of looming dangers. "There is a lot of potential for getting
>whipsawed", commented one investment economist. Another said: "If you
>look at the economy's top-line numbers, they look spectacular; it's only
>when you look below the surface that you begin to see the cracks".
>(Boston Globe - Outlook '99, 3 January 1999)
>
> In reality, there are a lot of very deep cracks,
>spreading all the time. The profits-growth of the corporations is
>slowing down, and their investment is increasingly financed by borrowing
>(much of it in the form of foreign-held debt). There is already a marked
>downturn among US manufacturers (272,000 jobs lost, March-December
>1998), who have lost sales in Asia and elsewhere and are at the same
>time being undermined by cheaper imports in their home market. Consumer
>spending (up 4.8% in 1998) has remained strong, but has increasingly
>outstripped income, relying on growing consumer debt. The US trade
>deficit continues to grow (up from $110bn in 1997 to an estimated
>$164bn in 1998). Meanwhile, despite some claims that the Asian crisis
>has stabilised and the world crisis is 'bottoming out', the slump is
>spreading. It is only a matter of time before these cracks bring about
>the deflation of the US's bubble economy.
>
> Propelled by the stock-market bubble
>
> IN THE FIRST place, it was the high level of corporate
>profits (up from 5.5% of GDP in the early 1980s to 10% now) - restored
>to the peak levels of the post-war upswing period - which attracted a
>growing number of investors to the stock exchange. The super-profits
>(together with lower levels of corporate and personal taxation for the
>wealthy) was rooted in the enormously increased exploitation of the
>working class since, under Reagan, US capitalism turned to neo-liberal
>policies. Wages and benefits were driven down, working hours enormously
>increased, and workplace rights undermined. The sharpened polarisation
>between rich and poor produced a layer of wealthy strata with plenty of
>spare income to invest on the stock exchange. Alongside foreign
>investors and the corporations themselves, the bourgeois and
>upper-middle-class investors helped provide the liquidity - the 'barrels
>of cash' - which rolled into the stock exchange. Mutual funds, which
>provided a vehicle for many investors, grew ten times between 1990 and
>1998, with total funds of $5.4 trillion. Over the same period, the
>proportion of their funds invested in company shares rose from 25% to
>56% (with the proportion invested in company bonds and especially in the
>money market falling proportionately). (New York Times, 4 January 1998)
>
> The ever increasing demand for shares pushed up their
>prices even further. In turn, the capital gains which accrued to
>shareholders through trading (not counted by the government or taxed as
>income) attracted even more investors.
>
> Stock exchange capitalisation (the total value of
>shares issued) rose to 150% of US GDP, up from 65% at the end of 1989.
>This represented a stimulus to the economy of about $11trn - $5trn of
>which was injected in 1996-97. This largely offset the sharp fall in
>federal government expenditure, which occurred as a result of cuts under
>Bush and especially under Clinton, and also counteracted the stagnation
>in the incomes experienced by the majority of workers until the last
>couple of years. One commentator, Dean Baker, has ironically referred to
>this as "Bull Market Keynesianism", a stimulation of demand through
>stock exchange speculation for the benefit of the rich (The American
>Prospect - January/February 1999).
>
> The prolonged rise of the stock exchange, of the
>so-called 'Bull Market', also has an ideological dimension which is
>linked to the capitalist triumphalism of the post-1989 period.
>Expressing the resurgence of corporate profits and fabulous speculative
>gains, the bull market has reflected - and at the same time reinforced -
>the renaissance of US capitalism's economic power and self-confidence.
>Although not in the long run an independent factor, in the 1990s the
>very existence of the galloping bull market contributed to the strength
>of the economy, fostering an optimistic, speculative mentality amongst
>wealthy Americans and attracting a flood of investment from abroad. The
>concentrated infusion of profits from financial markets, moreover, has
>had an intoxicating effect on many big business leaders, speculators and
>market pundits - blinding them to underlying social and economic
>realities.
>
> While the influence of the stock market has increased,
>imposing short-term profit targets on corporations, it plays a more and
>more parasitic role. During the post-war upswing, stocks financed about
>5% of real investment. But between 1980 and 1996, far more stock was
>retired (bought back by the companies issuing it) than new stock issued
>to investors, making the stock market a negative source of funds,
>equivalent to about minus eleven percent of total capital expenditure.
>(See Doug Henwood, Wall Street, p72). In 1997 US corporations brought
>$41.2bn more in shares than they issued (corporations buy back their own
>shares in order to keep up the price of the remaining stock or in the
>process of taking over other companies).
>
> During the early phase of the expansion, corporate
>profits were such that businesses had enough cash both to increase
>capital investment and also cover dividend payments to shareholders -
>and in many cases they also had cash left over for their own speculative
>activities.
>
> The stock exchange, then, acts not as a source of
>investment funds, but as a mechanism for handing out profits to a
>wealthy layer of shareholders, so-called 'investors'. Part of business
>profits, in other words, are capitalised in stock values - and the
>personal wealth of shareholders is thereby raised. A key factor
>promoting growth during the US growth-spurt since 1996 is that a large
>proportion of shareholders have increased their personal consumption in
>proportion to the increase in their personal wealth. The rise in house
>prices has also had a similar 'wealth effect', with increased property
>values being transferred into increased consumption.
>
> This boom rests primarily on the shoulders of rich
>consumers. Share ownership, it is true, has become much more widespread
>(through mutual funds, etc), and over half the population now owns
>shares. But ownership of shares is highly concentrated: 10% of the
>wealthiest households own 89% of shares. The spending spree of the rich
>and the super-rich was a major factor in pushing up personal
>consumption, which accounted for around 65% of growth in 1997 (while
>private investment accounted for around 38% and federal state and local
>government expenditure only 6%). The growth of consumption, of course,
>stimulated higher business investment, which in turn created more jobs
>and, in the last two or three years, just about lifted average household
>incomes above the previous peak level of the 1980s.
>
> The dynamics of this growth phase produced an enormous
>overvaluation of share prices. The stock of all US corporations is worth
>roughly 26 times their collective profits - the highest level since 1945
>and twice the historical average, which means their stocks are now
>extremely expensive by historical standards. (Henwood, Left Business
>Observer, No.87, December 1998) If share valuations (in relation to
>company profits) were equal to those at the peak of the 1980s boom, just
>before the 1987 crash, the Dow Jones index would be somewhere between
>5,000 and 7,000 - not hovering around 10,000. (International Herald
>Tribune, 16 March 1999)
>
> Overvaluation on this scale cannot be sustained
>indefinitely. There was, in fact, a 'correction' last August-October -
>but it was cancelled out by the subsequent rebound on Wall Street and
>world stock exchanges - giving rise to the illusion among many
>capitalists that the bull market can run for ever.
>
>
> Rebound from the '98 'correction'
>
> EVEN IN 1996 Greenspan, chairman of the Federal Reserve
>Bank, was warning of the dangers of 'overheating' (inflation) and
>'irrational exuburence' on the stock exchange. According to orthodox
>economic doctrine, rapid growth combined with low unemployment would
>inevitably lead to inflation. US unemployment was below 6% for four
>years, and during 1997-1998 dropped to around 4.5%. Greenspan's fears in
>this direction, however, have not been borne out - so far. The weakness
>of the US unions and increased job insecurity kept wages low, while
>after the outbreak of the Asian crisis in July 1997 falling import and
>commodity prices also helped reduce inflation to almost negligible
>levels in the US.
>
> The Fed, however, had been tightening monetary policy
>since the beginning of 1994, with a rise in interest rates from 3% to 6%
>between February 1994 and February 1995. As inflation was falling, real
>interest rates (the nominal rate minus current inflation) were pushed up
>to around 4%, an historically high level. This appeared to have no
>effect on the US boom, however. In fact, growth accelerated in
>1997-1998, as the Asian crisis brought a renewed flood of capital into
>the US economy.
>
> The situation changed dramatically with the collapse of
>the Russian economy in August 1998. Although Russia is only about the
>size of the Netherlands in terms of GDP, its default on its foreign
>debts had a major impact on US and European banks. At that moment, a
>number of big banks and finance houses were clearly threatened with
>collapse, which could have triggered a world financial catastrophe. This
>was shown by the bankruptcy of the hedge fund, Long Term Capital
>Management, whose total collapse was only narrowly averted through a
>rescue organised by the Federal Reserve Bank. There were convulsions on
>US (and other) stock exchanges between August and October 1998, with a
>fall of between 20% and 25% in US share values.
>
> The global financial system was a heartbeat away from
>systemic collapse, a terrifying experience for the leaders of the
>Federal Reserve and the US Treasury. In response, they hurriedly
>implemented an expansionary policy, with three interest rate cuts (down
>to 4.75%) in seven weeks. The US also put enormous pressure on the
>European Central Bank to reduce European (EMU) interest rates.
>
> From a domestic point of view, the Federal Reserve was
>inclined to tighten monetary policy to counteract 'irrational
>exuberence' in the US. But they were forced to cut rates in order to
>counteract the effects of the global financial crisis. According to the
>minutes of their 17 November meeting, the Federal Reserve policy-makers
>recognised that their third rate cut "might trigger a strong further
>advance in stock-market prices that would not be justified on the basis
>of likely future earnings and could therefore lead to a relatively sharp
>and disruptive market adjustment later". (International Herald Tribune,
>11 January 1999)
>
> The Fed's rates cuts, however, gave a further boost to
>stock prices, which were already at least 30% overvalued. Affluent US
>investors, who were hardly affected by the August-October turmoil,
>continued to pour their money into shares. Given low interest rates,
>shares offered a much higher return (even if they were purchased on the
>basis of loans). Overseas investors, fleeing from the 'submerging
>markets' of Asia, Eastern Europe, and Latin America also poured more
>money in. An additional boost to share prices came from the major buyers
>of equities, the big corporations themselves, which were buying up their
>own stock (to keep up their share prices) or who were involved in
>massive takeover operations (amounting to over $2.5bn in 1998).
>
>
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