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Mainstream, Vol XLIX No 17, April 16, 2011

World Economy Splutters: Dark Clouds on the Horizon

Thursday 21 April 2011, by Kobad Ghandy

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(This article was written much earlier last year by Kobad Ghandy, the Maoist leader, from Tihar Jail No. 3 (where he is lodged) for Mainstream but it reached us late. However, we are publishing it in view of the importance of its contents. He has promised to write a sequel to it. —Editor)

On June 5, US economist Nouriel Roubini said in an interview: “The eurozone is facing a period of zero growth if not recession, and the United States is heading for financial trouble.”

If corporate insolvency heralded the global meltdown and recession in 2008, in 2010, it is sovereign insolvency that is threatening to snowball into a deeper crisis. No longer is this restricted to fringe countries like Dubai, Iceland and the Baltics, but has now hit a eurozone country—Greece. And the contagion is threatening to spread to Spain, Ireland, and Portugal. So panicky were the EU leaders to prevent a domino effect that they put together a war-chest of $ 1 trillion at an emergency meeting called in mid-May. The IMF helped out by providing 25 per cent of the sum. Of this Greece alone would get $ 150 billion to prevent it from collapse.

From the Baltics to the Mediterranean, the bills for an unprecedented borrowing binge are starting to fall through. In Russia and the former Soviet bloc, where high oil prices help feed rapid growth, a mountain of debt must be refinanced as short-term IOUs come due. Even rich countries like the US, EU and Japan are increasing government spending to shore up slack economies, raising concerns about these governments’ ability to shoulder their debts.

The world’s major economies are caught in a vicious circle. To prevent a collapse of the giant institutions, governments spent huge amounts on stimulus packages to bolster demand and prevent their economies from collapsing. This has been coupled by falling tax revenues due to the deep recessionary conditions.
These spiralling expenditures, together with falling revenues, have resulted in gigantic debts and unsustainable budgetary deficits. Now, it is these debts that are facing default, with many a government unable to service them.

As The Economist said (February 2010): “Last year it was the banks, this year it is countries. Europe’s leaders are struggling to avert the biggest financial disaster in Euro’s 11-year history. There are few signs of recovery in the rich world. The US’ latest GDP figures are misleading. Output grew at 5.7 per cent in the fourth quarter of 2009 (October-December) mainly because firms are rebuilding stocks. With the economy still shedding jobs, share prices falling, the household market still wobbly and household debt shrinking, consumer spending is likely to remain subdued. In Europe and Japan the situation is far grimmer. Though exports are recovering Japan has slipped back into deflation. In the eurozone, recovery was faltering long before the Greek crisis hit. Domestic demand has stalled even in countries such as Germany.”

But the public debt is not the only problem. Corporate debt may set off a crisis that, in some ways, is already unfolding. According to Kleiman (of Kleiman International), $ 200 billion of corporate debt is coming due in 2009-10, half of which are from companies in Russia and the UAE.

No wonder The Economist stated: “At this year’s Davos Summit (in end January) there was a deep sense of worry about the ability of national governments and international financial systems to continue the required impetus, and in the desired direction, that might be required by the global economy. There were multiple divisions of opinion on these counts, as well as considerable confusion.”

In fact many leading economists warn that the world economic system could be heading for a double-dip recession. This is very serious as the only other time it occurred was during the 1930s. But what does a double-dip recession entail?

This occurs when an economy begins with a recession, in which unemployment rises to high level and then begins to fall at a disappointingly low rate. Then, before employment returns to normal, there is a second recession. As long as economic recovery is not complete, that is a double-dip recession even if there are years between the declines. Under that definition, there has been one serious double-dip recession in the last century—it started with the 1929-33 recession, which was followed by a recession in 1937-38. Between those declines, the unemploy-ment rate never moved below 12.2 per cent. These two recessions, lumped together as one event, is called the Great Depression.

Though the gravity of the situation is serious, governments do not seem to have learnt any lessons from the 2008-09 crash. Their speculative economic policies continue unabated—not only in their own developed economies, but also aggressively pushing to open up the financial markets in the developing countries. India, for example, has, even after the crisis, continued opening up its financial markets. Such policies are increasing the fragility of the world economic system that can result in nothing else but disaster.

A quick glance at the state of affairs as it stands today in the major economies of the world, will indicate the depth of the rot within.

European Sovereign Debt Crisis

TODAY, the focal point of the crisis has shifted from the US to Europe. The threat of default of a eurozone country has sent shivers down the spine of not only Europe but the entire international community. Yet, Greece is only a symptom of a debt-ridden disease affecting the European economies.

A few months back, the centre of panic was the Baltic countries of Estonia, Lithuania and Latvia. All these nations have witnessed the bursting of outsized property and credit bubbles in the second half of 2009. All these countries contracted last year by as much as about 20 per cent. As a counter-measure they have resorted to high fiscal deficits. There was a surge of concern in European establishments about the financial contagion spreading. The Swedish banking and financial system was particularly over-exposed in the Baltics and that country was desperately lobbying for a massive bail-out package by the European community.

And then the crisis in Greece broke out, which has been in the making since the end of last year. As the powerful eurozone members, led by Germany, dithered over a rescue package, the crisis worsened. It was only when Greece’s debt crisis (public debt is 115 per cent of the GDP) headed for default, threatening a run on its banks, that the EU/IMF package was hastily put forward.

But it was becoming clear that the crisis was not confined to Greece with signals emanating from financial markets of the European sovereign debt crisis snowballing into a major catastrophe, $ 1 trillion was raised as a bail-out fund. But even this is not likely to be sufficient to face the magnitude of the potential crash.

$ 2.6 trillion (22 per cent of Europe’s GDP) is the amount foreign banks and other financial companies have lent to public and private institutions in Greece, Spain (€1.5 trillion) and Portugal—three economies so mired in economic trouble that analysts assume that a significant portion of that mountain of debt may never be repaid. The European Central Bank said that eurozone banks had written off bad debts of € 238 billion in 2009 and would have to make provisions of further losses of € 90 billion this year and € billion in 2011. Moody Credit Ratings warned that banks in the UK, Ireland, Portugal, Spain and Italy all face challenges, with those countries likely to go the same way as Greece.

The situation in Europe is tragic—highly indebted countries are bailing out bankrupt countries. Debt, as a percentage of GDP is Italy 116 per cent, Belgium 97, Hungary 78, France 78, Portugal 77, Germany 73, Britain 68 and Spain 53 per cent.

These huge debts are piling up due to the deep recession Europe faced in 2009. And with the economies continuing to stagnate they can only increase. The EU 27 countries witnessed a negative growth in GDP of 4.5 per cent. For most countries the decline was the worst since World War II. The GDP growth rate was for Germany five per cent, France two per cent, Spain four per cent, and Britain five per cent. For Britain it was the largest slump since 1931. And now with the crash of British Petroleum in the stock market, this icon of British capitalism faces a possible $ 40 billion payout due to the oil spill in the Gulf of Mexico.

In East Europe (many of whom have joined the EU) the situation was even worse: Ukraine 15 per cent, Romania seven per cent, Hungary six per cent and Czech Republic four per cent. Particularly, the two pillars of eurozone were in dire straits. Last year German trade suffered its largest slump since 1950. In France businesses are closing, unemploy-ment is 10 per cent and farm incomes are diminishing. As many as one million French citizens are expected to slide into poverty this year. In Spain unemployment is 18 per cent with 40 per cent of its under-25 unemployed. The growth rates for France, Germany and Britain for 2010 are predicted at 1.9, 2.5 and 2.8 per cent. As we go to the press reports are coming in that another EU member, Hungary, is heading the Greece way.

US: Heading for Prolonged Deflation

THE May employment growth recorded a mere four lakhs—that too all of which were part-time jobs in the government. These depressing figures further affected world markets.

The US economy is hit by three severe problems. First, as with Europe, a spiralling public debt. Second, a commercial property bubble, replacing the housing bubble of 2008. And third, severe deflationary pressures on the economy.

The huge fiscal deficits have become a major danger. These envisage a fiscal deficit of $ 1 trillion this year and $1.3 trillion in 2011. This will take the US public debt at the end of this year to 62 per cent of the GDP. To fund these huge borrowings the US will have to rely on mega-purchase of its treasury bonds by China and other countries. It is ironic that it is primarily China’s huge foreign exchange reserves, invested in US bonds, that are helping keep the US economy afloat. A sudden withdrawal could precipitate a severe crisis for the US.

Now, if we turn to the looming default on commercial property loans, it threatens to become a problem more severe than the housing bubble. Some $ 500 billion worth of commercial property loans made by US banks are due to mature this year at a time when commercial property is already in free fall. According to an estimate by the US Department of Treasury, nearly 1000 regional banks operating across the country are facing the severe threat of large-scale defaults.

And as far as the spectre of deflation goes, in May 2010, consumer price inflation fell below one per cent—a 44-year low. The renowned economist, Paul Krugman, says (The Indian Express, May 22, 2010): “Low inflation, or worse deflation, tends to perpetuate an economic slump, because it encourages people to hoard cash rather than spend, which keeps the economy depressed, which leads to more deflation. This vicious cycle is not hypothetical: just ask the Japs who entered the deflationary trap in the 1990s, and, despite occasional episodes of growth, still can’t get out. It could happen to the US.”

Together with high levels of unemployment the scenario becomes even more frightening. Krugman adds: “And what about the near-record unemployment, with long-term unem-ployment worse than anything since the 1930s? What about the fact that the US employment gains of the past few months have so far brought back a five lakh jobs of the more than 80 lakhs (8 million) lost in the wake of the financial crisis? Recent data suggests that we may be heading for a Japan-like lost decade, trapped in an era of high unemployment and slow growth.”

Crisis brings New World Equations

JAPAN, the world’s second largest economy, is in a situation even worse than the two other major centres of international capital—the US and Europe. In December 2009 Japan unveiled a $ 81 billion new stimulus package to keep it from lurching back into recession. Today Japan has the largest debt to GDP ratio in the world, at 190 per cent. With the economy still in the doldrums, poor growth will not generate enough tax revenue to reduce the debt. In fact, in the 2010 budget (April 1st) borrowings at ¥ 44 trillion ($ 468 billion) are for the first time forecast to exceed tax revenues at ¥ 37 trillion. So, Japan’s troubles can only worsen.

But, the history of capitalism has shown that the impact of the crisis is never even. Some get affected more than the others. This results in changing world alignments. The crisis of the 1930s and 1940s saw a major shift in world alignments with the centre of economic power shifting from Europe to the US. Today we see that China is hit much less by the crisis and is threatening to destabilise the US-dictated order.

In China, growth is back at 8.5 per cent and exports have rebounded to earlier levels. Today it has overtaken Germany to become the world’s largest exporter. This is a significant factor given that the crises and two world wars of the last century were fought over capture of markets.

The changing equations can be seen from the following chart (The Economist, January 9, 2010):

Share of World Exports

Country 1970 2000 2009
China 0.8% 3% 9.5%
Japan (1988-10?) 6% 8% 5%
Germany 11% 10% 9%
US 14% 12% 8%

The US is worried by China’s growing domination of world trade. Paul Krugman reflects that fear when he says: “China has become a major financial and trade power. But, it does not act like the other big economies. Instead, it follows a mercantilist policy, keeping trade surplus artificially high. And in today’s depressed world, that policy is, to put it bluntly, predatory. China’s currency is pegged by official policy at about 6.8 Yuan to the dollar. At this exchange rate, China’s manufacturing has a large cost advantage over its rivals, leading to inflow of dollars from those surpluses should have raised the value of the Yuan… Chinese mercantilism may end up in reducing employment in other countries by around 1.4 million jobs.”

But world trade is not the only sphere of China’s growing clout. Today, it has the largest dollar stock in the world—an all-time record of $ 2.3 trillion foreign exchange resources. Much of this it is investing—particularly in energy resources—throughout the world. The investments are not only in its Asian backyard, but in most countries with rich oil and gas resources. Huge investments have been made in Africa, Central Asia, Iran, and some countries of Latin America. Not only that, while the US is fighting the war in Afghanistan, China has quickly struck the largest single commercial contract ever in the history of that country—$ 3 billion for developing the Aynak copper mines.

China’s economic power is now getting reflected in its growing political clout. Even die-hard pro-US countries like Japan and Australia have begun veering towards China. For example, the landslide victory last August of the Democratic Party of Japan, ending 50 years of unbroken rule by the conservative Liberal Democrats, has brought growing fissures with the US to the fore. Simultaneously, relations with China have warmed.

If this trend continues, which most probably it will, China is likely to become a major player in the world arena in the near future. The deepening crisis will only weaken the other major powers, giving China an opportunity for increasing assertion.

Crisis Impoverishes the Masses, Reduces Demand

IN this period of growing crisis, governments, in order to save themselves from bankruptcy, are introducing massive cuts on people’s welfare. But these austerity measures are only for the masses, big business continues to get largesses in the name of encouraging growth. But, with the purchasing power of the masses dropping, demand will drop and recessionary conditions continue.

In 2009, austerity measures hit the masses badly while the number of billionaires multi-plied. While the number of unemployed increased by 27 million (50 per cent of which in the US, West Europe and Japan) 200 more were added to the billionaires’ list. At 1011, their aggregate capital expanded by over 50 per cent to $ 3.6 trillion during the crisis year. In India too, while lakhs were pushed into poverty the number of billionaires doubled to 52.

Just one example of the disastrous impact on the masses is to be witnessed in Greece. The austerity packages that were adopted by the Greek Government before the recent bail-out were so painful that it led to six general strikes and street violence. The government raised the retirement age in the public sector from 61 to 65; average public sector wages have been cut by 20 per cent and pensions by 10 per cent; VAT (tax) has been raised from 19 to 23 per cent and there has been an excise tax increase of about 30 per cent on gas/patrol, alcohol and tobacco.

These austerity measures were insisted on by the donors—IMF and ECB (European Central Bank)—before granting them loan. Ironically, Germany itself has announced (on June 7, 2010) severe austerity measures on its people.

With fiscal deficit and the governments’ debt burden soaring, governments around the world, are being pushed to implement Greek-like policies—attacking the living standard of the masses, reducing employment—thereby reducing the overall purchasing power of the masses. This will only depress demand, perpetuate the low growth rates and deepen the recessionary conditions.

It is a Catch-22 situation for global capitalism. These austerity measures and high unemploy-ment rates will mean lower government expen-diture and depress domestic demand, further restricting growth. This also means lesser resources in the hands of governments to continue with stimulus packages. This would mean more borrowings and yet greater debt. It is a trap governments are unable to come out of.

In spite of this deep crisis, triggered by policies promoting speculative financialisation of the economies, the ruling elite of the world’s major economies have not learnt any lessons. The same wild speculative financialisation continues unabated, not only in their home countries but are being aggressively pushed throughout the world—insisting on complete liberalisation of financial markets in third world countries.

The speculative economy continues to grow to such an extent that we find the daily turnover of currency derivative trading in April 2010 was an unbelievable $ 4 trillion (in 1988 it was $ 500 billion). What is more, today, globally, currency constitutes 60 per cent of trading volumes, followed by commodities markets and entities. Though it was precisely such speculative policies that brought down the financial pillars of the US economy in September 2008, the same policies continue unabated.

And many a servile government of the Third World bows to the dictates of these Western powers. Yet, we see, those that have fully complied, have been the worst hit. For example, Kenya, Botswana and Bolivia—that introduced full-fledged capital account convertibility—have seen many of their private banks collapse.

Unfortunately, India is treading a similar path of liberalisation of financial markets continuously. India opened out its financial market to currency derivative trading in August 2008—a month before the great collapse. But even after the collapse currency derivative trading has grown with such speed in just the last one year-and-a-half that it is already set to overtake the equity market. The daily turnover is now a mammoth Rs 30,000 crores. By the end of the year the figure is expected to double. Not only this, to further encourage speculative activity the NSE and MCX-SX (Stock Exchanges) waived transaction fees on currency derivatives.

Such wild speculative growth can and will have a disastrous impact on the Indian economy in the long run—though, in the immediate, it may help boost the much-trumpeted high growth rates. But this is not all. The open-door policy to foreign capital has resulted in a massive $ 17 billion inflow in 2009. Notwithstanding the government’s claims of strong fundamentals and sound banks, the government has pumped in a huge Rs 15,000 crores into public sector banks—of which Rs 9000 crores was gifted in just this May. The Indian economy and banks are not as sound as the government and media would like to portray.

Even in other spheres of the economy, India is being fully opened out. There is talk of opening out retail, defence and numerous other sectors to foreign capital. With economies in stagnation in the developed countries, they are making a bee-line toward countries like India to utilise its cheap labour, cheap intellectual wealth and cheap raw materials. To take just one example—in the sphere of Research and Development (R&D) of the Fortune 500 companies, 63 are involved in R & D in India. General Electric has spent more than $ 50 million on its R & D centre in Bangalore and Cisco is spending $ 1 billion on a second global headquarter in the same city.

No doubt with all this, the GDP rates go up—but the edifice that is being created is terribly fragile. As long as the people’s standard of living does not rise (in fact it has been going down) and domestic demand is not generated, no growth can be a sustaining one.

September 2010 Worse than September 2008?

THE sovereign debt crisis in Europe is creating a scare similar to that of 2008. After Greece it was Hungary. Who is next? Though the crisis is so deep, there is total confusion on how to face it. This was reflected at the recent G-20 meet, held in South Korea in the first week of June.

The consensus reached at the April G-20 meet totally broke down at this meeting. In April it was reiterated that governments should keep up support for their economies (that is, stimulus packages) until the recovery was “firmly entrenched”. In June, faced with a huge debt crisis, no consensus could be reached as in April. The meeting was inconclusive.

Profligate government spending to boost demand and revive the economy, or austerity measures to reduce fiscal deficits—are the diame-trically opposed policies facing governments—both are leading to disaster—the former due to the fear of bankruptcy, the latter due to fear of deeper recession.

Come September the Lehmann Brothers Syndrome of 2008 can be re-invented—but this time it could involve not just financial giants, but nation-states themselves. Meanwhile it has just been reported (June 11) that “worldwide, toxic assets are in the range of $ 10 trillion, which will be able to destroy the world financial system in the world”. Bad days lie ahead.

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