Many
years ago, the economist Charles Kindleberger had identified the pattern
of a financial crisis in his classic work,
Manias,
Panics and Crashes. The crisis
is the last phase of a cycle which begins with an initial boom. The
upswing usually starts with some change, such as new markets, new
technologies or political transformations. It proceeds via credit
expansion, rising prices - especially of financial assets - and
euphoria. Speculative mania emerge, "as a larger and larger group
of people seeks to become rich without a real understanding of the
processes involved". Eventually, of course, the markets cease
rising and, as a consequence, those who have taken on excessive
borrowing find themselves in distress. This generates other failures,
and the downslide begins. The final phase can become a self-feeding
panic, involving a downward free fall.
But
then financial markets are notoriously prone to cycles; asset markets
have always tended to go boom and bust. This in itself does not
necessarily make for major real economic depression unless there are
other deflationary forces operating, or unless the effects of the
financial failures on the real economy are not counterbalanced by
increased spending in some other way. Major economic depressions do not
result from credit cycles in themselves, but from a complex interplay of
real and financial factors that reinforce each other.
The
central message of Keynes, many decades ago, was that such a downward
spiral can be broken by public action. But as Kindleberger pointed out,
in a global economy, such public action depends upon institutions, power
configurations and division of national responsibilities which cannot be
taken for granted to exist.
Thus,
deflation can be transmitted across countries, through trade flows
through the movements of private capital. In the interwar period which
gave rise to the Great Depression, the fears of capital flight and
inflation prevented governments from engaging in expansionary fiscal and
monetary strategies which could have warded off the crisis. This could
happen because in that period there was no clear leader in the
capitalist world, ready to take on both the power and responsibilities
associated with leadership.
Such
a leader has to operate at both financial and real levels to prevent
economic collapse. It has to avoid widespread financial collapse by
continuing to provide funds when others are unwilling, and it must also
operate on the real economy, to ensure a continued expansion of demand
and economic activity. This means running large trade deficits, and
ensuring continued and expanding markets for the exports of countries
facing economic difficulties. These duties are in fact necessary for
stable international capitalism.
But
the world economy today has no such leader, despite the clear hegemony
of the United States in both political and economic terms. This makes
the current deflationary pressures - in terms of both financial and real
economic variables - stronger today than they have been at any time
since the Great Depression. A snapshot view of the world economy today
reveals a picture of stagnation and decline that would have been simply
unbelievable even two years ago.
The
talk of possible recession has been in the air internationally for some
time now. And of course, after the September 11 attacks on New York and
Washington, the US Government, the IMF and others were quick to seize on
this as the excuse for predicting a future downturn, which could then be
claimed as the adverse fallout of international terrorism. The truth is
of course, that the weakness in the international economy was already
well advanced for some time before September 2001. In fact, much of the
world economy had actually been experiencing a slowdown or recession for
several years before the last quarter of 2001.
In
fact, the most striking feature of international economic trends during
the 1990s was that the US experienced strong growth while most of the
other economies in the world system languished. This was essentially
because confidence in the US dollar had made American capital markets a
haven for the financial investors. This fed a consumption-led boom
within the US, and also caused growing current balance of payments
deficits for the US economy. The current account deficit of the US
reached the record level of $ 450 billion by the end of 2001.
These
trends made the latter half of the 1990s unique in the history of
post-war capitalism or another reason. In the past the country holding
the international reserve currency did not face any national budget
constraint because it could print money and spend it across the world,
since everyone was willing to accept and hold such money. As a result,
the government of that country routinely resorted to deficit spending to
keep the world economy moving. That is, the US economy played the role
of locomotive of world growth by sustaining deficit-financed spending.
According
to one estimate (published by Morgan Stanley) the growth in US gross
domestic product was responsible for about 40 percent of the cumulative
increase in world GDP in the five years ending in mid-2000, which is
twice America's share of the global economy. In this period, demand
growth in the US was 4.9 per cent per annum compared to 1.8 per cent in
the rest of the world. In other words, US economic expansion pulled the
rest of the world behind it, at least to some extent.
That
process ended some time in late 2000. And with the US engine of growth
slowing down, it meant that other countries - which had been relying on
the huge demand for their exports from the US to keep their own growth
rates positive - were adversely affected. This has been immediately
evident in terms of world trade. WTO figures suggest that the growth of
world trade in volume terms, which was more than 12 per cent in 2000,
was only around 2 per cent in 2001. And when this is combined with
continued deflation in terms of trading prices in world markets for
primary commodities and many manufactured goods, world trade in value
terms was stagnant.
Patterns
of output growth and prices in the major economies
The growth patterns in the major developed industrial
countries are crucial indicators of the overall pattern
of the international economy.
Chart 1 provides the IMF's latest estimates
and projections of growth of real GDP. It should be
noted that these estimates, published in December
2001, are already significantly lower than those published
by the IMF just three months earlier. While the IMF
has attributed the decline to the September terrorist
attacks, it could be argued that the earlier estimates
were anyway to optimistic, as many had suggested at
the time.
Chart
1 >> Click
to Enlarge
Thus
the United States economy, which had led in terms of growth rates of
more than 4 per cent per annum until 2000, fell to only 1 per cent
growth of real GDP in 2001. In fact, other sources suggest even lower
growth figures for the US for the past year.
Industrial output in particular has been falling for more than a
year.
Further,
this period of slowing growth has been accompanied
by decelerating and now even declining price levels,
raising a real threat of deflation for the first time
since the Great Depression. Chart 2 gives the IMF
estimates of changes in consumer prices, which suggest
that inflation slowed down sharply and there was deflation
in Japan. But other sources point to stronger tendencies
towards deflation even in the US economy.
Figures
from the US Labour Department indicate that while
wholesale prices rose by 0.1 per cent in January 2002,
they had fallen a cumulative 2.6 per cent in the year
to January, which was in fact the biggest 12-month
drop in half a century. Similarly, the data on industrial
capacity, (only 75 per cent in January 2002) have
been argued to reflect strong productivity growth,
but they also raise concerns about the risk of deflation
- a vicious cycle of falling prices, profits, production
and employment. Business investment in the US fell
by nearly 13 per cent in the last quarter of 2001
compared to the previous year, making it the fourth
consecutive quarter of falling investment.
Chart
2 >> Click
to Enlarge
