The Economy

Recession, Depression or Stagflation
of Another Kind

By the Editors

Before the Great Depression of the 1930s, the words recession and depression were virtually synonymous. Both terms referred to the beginning of a cycle of economic contraction. However the recessions that have occurred since the end of World War II were not actual contractions. On the contrary, these post-WWII recessions were characterized by a slowing of the rate of economic expansion rather than a contraction of the overall economy.

These days, if we read between the lines of the reports appearing in the mass media, it can be seen that Washington and Wall Street’s economic experts believe that an old-fashioned recession of the worst kind is heading our way.

Thus, one of the New York Times’s most perceptive economic commentators, Floyd Norris, was among the first to recognize and comment on the critical state of the U.S. economy in his December 28, 2007 column titled, “Credit Crisis? Just Wait For a Replay.” He begins by posing the key question:

“What if it’s not just subprime?

“As 2007 ends, it seems that the financial world shakes every time a company reveals some new exposure to the disastrous world of sub-prime mortgage lending.

“But just how different was sub-prime lending from other lending in the days of easy money that prevailed until this summer? The smug confidence that nothing could go wrong, and that credit quality did not matter, could be seen in the many other markets as well.

“‘The severity of the sub-prime debacle may be only a prologue to the main act, a tragedy on the grand stage in the corporate credit markets,’ Ted Seldes, the director of investments at Protégé Partners, a hedge fund of funds, wrote in Economics and Portfolio Strategy.

“‘Over the past decade, the exponential growth of credit derivatives has created unprecedented amounts of financial leverage on corporate credit,’ he added. ‘Similar to the growth of sub-prime mortgages, the rapid rise of credit products required ideal economic conditions and disconnected the assessors of risk from those bearing it....’

“But if the credit insurers turn out to have had inadequate reserves, what are we to make of the credit default swap market? Mr. Seldes calls it ‘an insurance market with no loss reserves,’ and points out that $45 trillion in such swaps are now outstanding. That is, he notes, almost five times the United States national debt. [Emphasis added.]”

He goes on to explain that one of the most remarkable results of the sub-prime crisis is “that total losses to the financial system may be about equal to the amount of sub-prime loans that were issued.” Norris reports the hedge fund director, Seldes, as also having said in an interview “the financial leverage placed on the underlying assets was so high that the losses multiplied, as the profits did when times were good.”

Norris ends by saying that it was the “greatest credit party in history, made possible by a new financial architecture that moved much of the activities out of regulated institutions and into financial instruments that emphasized leverage over safety. The next year may be the one when we learn whether the sub-prime crisis was a relatively isolated problem in that system, or just the first indication of a systemic crisis.”

Posing the threat of a “systemic crisis” is as close as a responsible bourgeois economist like Norris can go toward suggesting that the threatening recession may turn out to be much longer and deeper than any of the post-World War II recessions. After all, one of the differences between a recession and a depression is that a depression is far deeper and much longer lasting.

Then in the January 25 edition of the British financial journal, The Economist, the editors, reflecting the fact that the American crisis is global, in a piece titled, “It’s Rough Out There,” said this:

“The financial storm that blew up in America’s subprime mortgage market last year has become a hurricane. The ill wind from reckless property lending blasted first the market in asset-backed securities, then banks’ balance sheets and, most recently, stock markets. Across the globe, more than $5 trillion has disappeared from the value of public companies in the first three weeks of January....”

A couple of days later, in an op-ed piece, “Paying the Price for the Fed’s Success,” James Grant, the influential editor of the Wall Street publication, Grant’s Interest Rate Observer, rakes the “experts” over the coals for allowing the “supposedly ‘contained’ sub-prime mortgage problem [to] metastasize into a global financial panic—some days to the down side, other days to the up side.” ( New York Times, January 27)

Grant’s criticisms essentially reflect the generalized concerns over the deeply troubled U.S. economy that has the most serious economic experts in Washington and Wall Street in a tizzy of befuddlement, fear and panic. Grant sums it all up in two sentences:

“Striving so mightily to make one and one add up to three or four or five, Wall Street, Main Street and Washington collectively brought us to the impasse of 2008, in which a debt crisis is superimposed on a downturn in the economy, which is overlaid on a bear market in real estate, which is conjoined with a persistent and worrying weakness in the overseas value of the dollar. As for the crackup in complex mortgage-backed securities, now at the center of the debt predicament, the global bank, UBS, has justly called it the biggest failure of ratings and risk management ever.”

Barely a month later, the Times published a report by another of its seasoned economic commentators, David Leonhardt, titled, “Worries that the Good Times Were Mostly a Mirage.” The headline was followed by the more pointed subhead, “So how bad could it get?” Leonhardt writes:

“Until a few months ago, it was accepted wisdom that the American economy functioned far more smoothly than in the past. Economic expansions lasted longer, and recessions were both shorter and milder. Inflation had been tamed. The spreading of financial risk, across institutions and around the world, had reduced the odds of a crisis. Back in 2004, Ben Bernanke, then a Federal Reserve governor, borrowed a phrase from an academic research paper to give these happy developments a name: ‘the great moderation.’

“These days, though, the great moderation isn’t looking quite so great—or so moderate.

“The recent financial turmoil has many causes, but they are tied to a basic fear that some of the economic successes of the last generation may yet turn out to be a mirage. That helps explain why problems in the American sub-prime mortgage market could have spread so quickly through the world’s financial system. On Tuesday, Mr. Bernanke, who is now the Fed chairman, presided over the steepest one-day interest rate cut in the central bank’s history.

“The great moderation now seems to have depended—in part—on a huge speculative bubble, first in stocks and then real estate, that hid the economy’s rough edges. Everyone from first-time home buyers to Wall Street chief executives made bets they did not fully understand, and then spent money as if those bets couldn’t go bad. For the past 16 years, American consumers have increased their overall spending every single quarter, which is almost twice as long as any previous streak.

“Now, some worry, comes the payback. Martin Feldstein, the éminence grise of Republican economists, says he is concerned that the economy “could slip into a recession and that the recession could be a long, deep, severe one.” [January 23, 2008.]

Thus, it has become increasingly evident to these economic analysts that the U.S. capitalist economy is sinking ever more deeply toward one of history’s most destructive of all economic crises, combining what now appears to be a long and deep crisis of overproduction together with a jump in the rate of inflation. In a word, the demon of inflation joins the devil of recession causing more than a few economic commentators to hark back to the late 1970s when stagflation, the worst of both worlds, roiled the U.S. economy.

This is a most significant departure from the initial impact of a classic economic contraction, which had historically been accompanied by falling, not rising, prices. However, ever since the dollar replaced gold as the international, measure of value, standard of price, and medium of exchange, the value incorporated in commodities by human labor power tends to fall as science and technology produces ever-more sophisticated labor-saving machines.

That is, under normal conditions, when the cost of production falls, prices also fall. But after the global monetary system was separated from its golden base we no longer live under normal conditions. In effect, the falling value incorporated in commodities by labor-saving machines is not only hidden from view by the steadily increasing quantity of valueless paper dollars in circulation; it also explains why prices can rise while the value of commodities fall.

Stagflation, the worst of both worlds

We say the worst of both worlds advisedly. Bad as was the stagflation of the 1970s, it was not as bad as it could get. For example, one of history’s most destructive combinations of economic contraction and inflation—stagflation—sent Germany into a prolonged crisis following its defeat in World War I.

Forced to sign the Versailles Treaty along with the draconic reparations demanded of Germany by the victors of the first Great War, as WWI was known at the time, Germany, which had been one of the richest and most dynamic industrialized imperialist powers in Europe before the war, was transformed into the poorest and hungriest after its defeat.

Thus, in the few short years after it was forced to sign the “peace treaty,” a period of stagnation began that combined mass unemployment and an inflationary crisis best illustrated by the change in the value of Germany’s 1-mark note, which as late as July 1921, could buy a half-dozen eggs and a loaf of bread. The mark fell in value to such a point that by November 1923, the 1-mark note had 9 zeroes added to it, but it could still only buy what the 1-mark note could buy in 1921.

Meanwhile, unemployment had soared to levels nearly as high as during the early years of the Great Depression. The rest is history: Germany entered a period of rising revolutionary struggle that could well have ended in socialist revolution. However, because of the failure of leadership, it ended with the victory of Adolph Hitler’s fascist Brown Shirts, the smashing of the revolutionary German working class, the holocaust and World War II. 1

Though it would be premature to predict that a German-style hyperinflation, joined together with mass unemployment is in the making, it cannot be excluded. After all, the main weapon to combat the kind of economic contraction we saw in the 1930s, now in the hands of the Federal Reserve, remains what boils down to the continued pumping of valueless paper dollars into circulation—reducing the value of all dollars—to combat the threat of a recession of the pre-WWII kind.

This takes us to the source of the current crisis and why something like a German-style combination of inflation and economic contraction has already begun, creating episodes of panic among masses of investors as well as among the economic experts in Washington and Wall Street.

Once again on the debt bomb

The monetary system launched in 1944 at Bretton Woods, New Hampshire, by representatives of 44 governments including most of the capitalist world’s imperialist powers was set into motion in order to prevent another Great Depression such as the one that led to World War II. That is, all the measures that attempted to bring the Depression to a halt did not work.

Today, no one knows the true size of America’s public and private debt. However, before the adoption of the Keynesian scheme separating the global monetary system from its golden base one could estimate the extent of any capitalist nation’s indebtedness by measuring the quantities of gold—the most reliable objective measure of value—backing up its outstanding currency. That not only served as a measure of a nation’s solvency but also the creditworthiness of the private sector.

Now that the world monetary system is no longer based on gold, the only measure of the value of currencies is its value relative to the purchasing power of all other currencies; thus no one knows for sure how much each of the world’s paper currencies are really worth. That means that the bottom can drop out of the monetary system suddenly and with little or no warning.

Behind Bernanke’s appointment

According to a report in the Sunday, January 20, New York Times magazine titled, “The Education of Ben Bernanke,” by Roger Lowenstein, “the current Chairman of the Federal Reserve devoted much of his career to studying the causes of the Great Depression.” Lowenstein starts off by pointing out why Bernanke was selected to replace Alan Greenspan. He writes:

“By the time President Bush nominated him to run the Federal Reserve, at the end of 2005, Bernanke knew more about central banking than any economist alive. On virtually every topic of significance—how to prevent deflationary panics, for instance, or to gauge the effect of Fed moves on stock-market prices—Bernanke wrote one of the seminal papers.... And having devoted much of his career to studying the causes of the Great Depression, Bernanke was the academic expert on how to prevent financial crises from spinning out of control and threatening the general economy.”

Thus, if we knew nothing else about the current economic crisis, we now know this much: The appointment of Ben Bernanke to head the Federal Reserve by the real U.S. decision-makers, means that they had anticipated the possibility, if not the likelihood, of an approaching breakdown of U.S. economic equilibrium. It also suggests that they had reason to believe that the next recession would be nothing like the ten previous post-WWII recessions which were all milder, of shorter duration and accompanied by longer periods of expansion than their pre-war predecessors.

In other words, those in charge of keeping the economy on an even keel knew that it was in trouble when Bernanke was chosen to head the Federal Reserve in October 2005. But they also knew that there’s nothing that the Fed can do in the upper reaches of the political, financial and monetary superstructure of the U.S. economy that can fix the source of the unfolding capitalist economic crisis—which lies deep inside the economy at the point of production. The most they can do in the superstructure of the extraordinarily complex American capitalist economic order is keep the underlying contradictions from worsening.

The real problem is, of course, the tendency of the rate of profit to fall. And while it cannot be fixed once and for all time, it can be boosted temporarily by reducing wages and benefits at the point of production and by shifting the tax burden from the rich and superrich to the backs of those on the lowest rungs of the economic ladder.

That’s where the auto industry’s attack on the autoworkers and their union comes into the picture.

GM’s attack on the UAW was an attack on all workers

It doesn’t take a Nobel prize-winning economist to know that the relation between wages and profits is like the two ends of a seesaw; when wages go up profits go down and when wages go down profits go up.

Readers of this magazine know that for the last two years we have focused on the campaign initiated and led by General Motors to lower the wages, benefits and living standards of all members of the United Auto Workers union by more than 50 percent. As we now know, Detroit’s Big Three—GM, Chrysler and Ford—will have already gone a long way toward accomplishing their objective well before the new UAW contract expires in 2011.

We also made clear in our coverage that the attack on the UAW was only the first stage of an attack by capitalist America on the wages, benefits and living standards of all American workers.

The significance of this two-sided attack by Washington and Wall Street on both the fundamental contradictions at the point of production and in the upper reaches of the capitalist economy is a measure of capitalist America’s growing fear of another Great Depression made far more life-threatening by the growing mountain of public and private debt.

History repeats itself—but always with a difference

The “Roaring Twenties,” as it was then known for a variety of reasons, roared in more ways than one. America in the 1920s, was a decade of phenomenal economic growth while the rest of the world’s advanced industrial countries were in a slump. It gave rise to something once known as American exceptionalism, which had been born and reborn more than a few times in American history. It was also a part of the widely touted myth at the time that because the United States was prospering while the world was stagnating it was no longer subject to the laws of capitalist economics.

To be sure, America’s economic health in a stagnating world was indeed an exception to the rule, but it had nothing whatever to do with its exemption from the laws of capitalist economy as laid down by all of history’s most respected economic theoreticians ranging from Adam Smith to Karl Marx. As a matter of fact, the main difference between America in the 1920s and today, is the fact that America was then the world’s biggest creditor nation, while the rest of the world was mired in debt in the aftermath of the Great War, as World War I was known in those days.

That is, from the 1920s until the early 1960s the United States was the world’s largest creditor nation with virtually the entire world paying interest on loans made by Washington and Wall Street to both sides of World War I.

The 1930s and today

If, as the evidence suggests, the U.S. economy is heading toward a major economic crisis on the order of the 1930s, there are several important differences between then and now that must be taken into account starting with the existence of an exactly opposite financial relationship between America and the world in the 1920s and 1930s, and America and the world today.

While the U.S. was the world’s creditor nation back then, America today is the world’s major debtor nation by far. Moreover, in addition to borrowing on a grand scale in order to offset its balance of payments and budgets deficits, it must now also borrow to help pay the interest on its growing mountain of debt.

That is—like the millions of American “homeowners” with sub-prime mortgages, many of whom are already unable to so much as pay the interest on their mortgages, the government of the United States faces a similar problem but on a grander scale.

In other words, like homeowners, corporations and banks defaulting on their debts because they can no longer pay the interest, much less the principal. Capitalist America now is in the exact same position as the millions of workers who owe more than they can ever repay.

In fact, taking all its obligations into account—economic, political and military—capitalist America is locked in an inescapable debt trap of its own making. Worse yet, unlike the homeowner with a mortgage worth more than the house they live in, capitalist America cannot walk away from its mortgage and rent another house!


1 Search the Internet for Leon Trotsky’s, Germany: The Only Road, (September 1932). It provides the best analysis of Hitler’s rise to power and why the two mass workers’ parties, Social Democrat and Communist, failed to form a united front that could have easily crushed the fascist threat and overthrown German capitalism and conquered state power and carried through a socialist revolution.