World Economy

Where the Global Economy Is Going and Why

By the Editors

The editors of The New York Times, one of the most influential voices of the American ruling class, dramatically began an editorial entitled “Spillover” in its July 30 edition with words deliberately intended to spark the country’s economic and financial decision makers into action. They wrote:

“By the end of last week (July 27), any lingering hope that the housing downturn would be contained has vanished. As this week begins, signs of contagion seem to be everywhere.

“Unnerved by mounting losses in mortgage-related investments, investors have started to shun tens of billions of dollars in corporate debt offers as well—and seem likely to go on doing so for months to come. That would stanch the flow of easy money that has fueled the leveraged buyout boom, which would, in turn, expose the extent to which stocks have also come to depend on cheap credit. Stocks took a dive last week because debt-driven buyouts had long boosted the share prices of targeted companies.”

The editors go on to describe the chain reaction triggered by the housing bubble’s destabilization of the economic and financial infrastructure of the U.S. capitalist economy:

“The fallout of housing-related turmoil is also likely to extend beyond financial markets.... The double whammy of weakness in housing and in autos has already hit the chemical maker Dupont. Last Tuesday, the company was the DOW’s biggest loser, in part because of lackluster demand for a pigment used in house paint and lower paint sales to automakers.”

Finally, reflecting their increasingly pessimistic economic outlook, the editors dismissed assurances by Treasury Secretary Henry Paulson Jr. that “the economy was very strong.” Rather, they argue that such an evaluation “ring[s] hollow in the absence of an international reporting framework to monitor the positions taken by globally active hedge funds.”

This, by the way, is a reference to the special role played by hedge funds in the creation of the current financial crisis. While the increasing number of corporate buyouts by well-heeled buyout firms like Cerberus Capital Management, which recently took over Chrysler, use mostly borrowed money—as much as 95 percent. Curiously enough, in a marked departure from the past, the present crisis appears to have hit the superrich harder than most other investors. That’s one of the peculiar consequences of the collapse of the hedge funds.

According to Wikipedia, the online encyclopedia, a hedge fund is a private investment fund charging a performance fee and is typically open to a very limited range of qualified investors. This means that one must be rich enough to be eligible. But it also guarantees that the biggest losers will be multimillionaires, billionaires, and multibillionaires—though only for the time being.

The Times and most other mouthpieces of big business have concluded that the current credit crisis is destabilizing all aspects of the American and global economic order. They claim that this crisis has been inspired and fueled by artificially low interest rates—without which the economy would have collapsed long ago.

Although the market slide of July 27 (less than 400 points) amounted to less than a 3 percent drop in the Dow Jones Industrial Average, more than a few financial commentators referred to it as “Black Friday”—signifying the possible beginning of a major financial and economic crisis.

Compared to the crash of October 19, 1987, a date that is known as Black Monday, when the Dow plummeted 508 points—a loss of 22.6 percent of its value in one daythe July 27 slide was much smaller. Yet, despite the far greater size and significance of the 1987 devaluation, the stock market regained its balance in a surprisingly short period of time, thus confirming once again the highly unpredictable and anarchic character of the capitalist economic system.

Even though that 22.6 percent stock-market dive had no long-term impact on the economy, the great stock market crash of 1929 began, paradoxically, with a more modest 9 percent drop in the stock market on what became known as the Black Thursday of October 24, 1929. That day was indelibly marked as the event that opened the door to the Great Depression of the 1930s.

One thing leads to another, and another— ad infinitum

Floyd Norris, one of the most competent of The Times’s economic analysts, was featured on the front page of its August 17 edition in an article entitled “With Markets Moving Wildly, Insight Suffers.” He evidently aimed to shed some light on what appears to be a mystery to many, if not most, investors, big and small. To many of us, the more arcane interactions of the modern capitalist economy are like any complex system containing billions of independent atoms and molecules, each with a trajectory of its own. The market has a near-infinity of variables, many of which are hidden from view. The determinism of classical science, and the workaday world we know from direct experience, tend to break down and be superceded by the more ambiguous laws of probability. An understanding of that highly contradictory reality evidently guides this particular Times columnist so effectively.

Norris starts off by posing a question.

“Twenty-first-century financial markets react with lightning speed to events halfway around the world. Investors in China can immediately see what happened in New York and make trades based on the news. So why is the credit panic of 2007 being played out in slow motion? One reason is that those involved have never seen anything like this before. Information may arrive instantly, but insight takes longer....

“But last week, things got dicey. Thornburg Mortgage owned a lot of AAA-rated mortgage securities, and had borrowed up to 95 percent of their value. Now the lenders, suspecting the securities were worth less, wanted more cash. To get it, Thornburg had to sell securities, and few wanted to buy. Suddenly the commercial paper market, so willing to lend to Thornburg at small margins just weeks before, was not interested in lending even at much higher rates.

“As for the share price, it went into freefall on Tuesday, amid rumors that the company could not meet its obligation. Trading was halted with the stock under $8. On Tuesday night, it conceded it was having trouble raising money to finance mortgages. It said the dividend it had promised to pay on Wednesday would be delayed by a month..

“But it insisted that it was not bankrupt. Even marking down the value of its assets to current market value, it said, it was still worth $14.28 a share. Consequently its price climbed back up above $12.”

Since then we have continued following the trajectory of events that began on July 27 until the present time as recorded in the New York Times.We focus primarily on reports in this New York daily because it is one of the few major news publications that has been less concerned with cheerleading the investor class with assurances that this crisis is not as worrisome as it may appear. Rather, the Times has tended to stress the underlying weakness of the U.S. economy that makes it far more vulnerable to the boom-bust crises of capitalism.

When Ben Bernanke, Chairman of the Federal Reserve, took the unusual step on Friday, August 17, of announcing a one-half-point drop in the so-called discount rate, it was a tacit acknowledgement by the Fed that it had made a mistake the previous week in playing down concerns over the spreading distress in the credit markets.

But in the Times of Sunday, August 19, in an editorial entitled “Watershed,” the editors took care to commend the Fed for its efforts to “manage the turmoil in the financial markets.” But, what was nevertheless implied was that those in charge of managing the U.S. economy exercised poor judgment at a crucial moment that would have added significantly to the already panicked investor class—something that a responsible representative of the ruling class does not do.

Nevertheless, it was an indication that the editors saw the Fed’s reversal as a belated recognition that the market’s credit crunch represented a major threat to the broader economy and that it was not as healthy as the Fed had declared a few weeks earlier. But The Times is convinced that the Fed needs to do much more than “calming the markets.” Rather, the editors insist that the reversal “should be seen as only a necessary first step toward addressing much bigger issues—issues that President Bush and his aides continue to deny. The real work—that of leaders, not managers—is to understand how the economy became so vulnerable to current global market instability, and to articulate an agenda for reducing those underlying weaknesses. There is no return to “normal” that would not be the same as sticking one’s head back in the sand.”

The editors, pressing their argument that the roiling stock market is in danger of slipping out of control, zero in on the underlying source of the current crisis—one that is of world historic significance.

“The bare facts are that the nation—heavily indebted—needs to attract some $800 billion a year from abroad, either by borrowing the money or by selling American assets. No serious analyst believes that an imbalance of that magnitude is sustainable [our emphasis]. In fact, the erosive effects are already evident. Debt must be repaid by sending money abroad, leaving less to invest domestically. Selling off American assets means reduced investment returns to Americans.

“And that’s if things go smoothly. Ever present is the risk that the vital foreign inflows will wane, with severe repercussions on interest rates and the dollar.”

This takes us to the deeper cause of today’s unfolding economic crisis. And that’s a problem of such proportions as to make the “new economy” bubble that burst at the end of the 1990s, and today’s housing bubble, which is in the early throes of bursting, look almost insignificant in comparison!

Keynesian economics

We must once again refer to the grandmother of all economic bubbles: the one that was created at Bretton Woods, New Hampshire, in 1944 at a meeting of the soon-to-be victors of World War II. That’s when the decision was made by the major allied powers to adopt a seemingly impossible reform of the global capitalist monetary system. The scheme, as developed by its chief architect, British economist John Maynard Keynes, was designed to gradually separate the world’s currencies from their gold base—a process that by now is as close to completion as it ever can be.

Thus, beginning soon after Bretton Woods and continuing until the end of the 1970s, gold took a back seat while the dollar was elevated to serve as the closest thing to the role played by gold, silver, and other precious metals for the last 5,000 years.

The winners of the second World War knew that this war had ended the crisis of overproduction of the 1930s by using up all the surplus goods clogging store shelves and warehouses, thus triggering the Great Depression. Thus, they feared that the end of the war would set in motion another boom like the one in the U.S. following World War I in the 1920s, which had ended in the biggest of all busts in October 1929.

The “invisible hand” that regulates the capitalist economy, after all, does its job in its own way and in its own fashion—that is, by the automatic, self-regulating mechanism known as the boom-bust cycles of capitalist production. And therein lies one of the fatal internal contradictions of the profit system. Those meeting at Bretton Woods in 1944 decided to prevent another Great Depression by transforming the U.S. dollar into something much bigger than a single nation’s currency. They intended it to serve also as the world’s second-most reliable universal means of exchange and eventually to totally replace gold.

The dollar could, almost instantly, play such a unique role because most of the world’s gold reserves at the end of the second World War were locked away in U.S. Treasury vaults in Ft. Knox, Kentucky. For all practical purposes, the gold-based dollar had for years been considered as good as gold. However, the purely paper dollar could not immediately play the role formerly played by gold and silver. First, a sort of bridge had to be built, to ease the transition from the dollar’s serving solely as a national currency to serving also as an international means of payment between trading nations.

The huge gold reserves lodged in Ft. Knox could serve as such a bridge, providing there was agreement by all participating nations to carefully and cooperatively organize the transition from a gold-based global monetary system to one based on faith in the dollar or possibly, as events might determine, by adding a few more strong currencies to serve as an international medium of exchange along with the dollar.

In other words, because the U.S. alone had enough gold in its Treasury to back up the dollar whenever American exports were less than its imports, or when its taxes and other Federal revenues were less than its expenditures. This was an indispensable precondition because the main purpose of the Keynesian scheme was to make possible an exponential expansion of credit that was impossible in the preexisting monetary system based exclusively on gold and silver.

Why the dollar instead of gold

Gold, historically, exercised a virtual dictatorship over the traditional monetary system based on precious metals. Thus when the first kings and other rulers were unable to pay their governments’ bills to creditors, they began issuing extra “gold” coins by cutting the size of the coins or by maintaining their former size and weight by adding base metals to their new coinage.

Starting thousands of years ago, then, all moneychangers as well as ordinary merchants learned to tell the difference between the fakes and the Real McCoy simply by flipping a coin in the air. The tone of its ring allowed them to tell the difference. Some became expert enough to deduce a close approximation of its gold content from the precise tone of its ring. Thus, there really is such a thing as “the ring of truth,” and it wasn’t long before everyone knew the difference between the king’s counterfeits and the real thing.

After many years, and after paper money redeemable in gold had been increasingly circulated, both government-backed paper, and gold and silver coins served side by side as real money. Consequently, a different sort of “ring of truth” became necessary for telling the difference between real gold-backed paper and counterfeits. There were a host of clues by which the most perceptive merchants, banks, and moneychangers became expert in telling the difference. Thus, they tended to replace the counterfeits with gold coins at every opportunity.

It wasn’t long before almost everyone refused to accept paper, good or bad, and insisted on payment in gold. Now, all paper money tends to decline in value in accord with the amount of paper euros, pounds, yen, and dollars printed by governments. Thus, rising prices are now the ring of truth that tells us that there are far too many paper dollars in circulation—which also serves as a measure of the ever-growing size of public debt!

But in order to get the world to smoothly accept dollars as the international medium of exchange, U.S. and world capitalism were compelled to act as though the world system was still based on the gold standard. That is, trading nations continued to honor the historic practice of redeeming each other’s currencies in gold upon demand.

Given that the main purpose of Keynesian economics was to open up a near-limitless quantity of available credit in purely paper currency, the U.S. would eventually run out of gold. But Keynes and his supporters were confident that by that time it would be possible to break with the practice of backing the dollar with gold—at least for an extended period of time. However, the declining value of the dollar brought about its dethroning from its former position of being “as good as gold.” It has since reached a point where the euro, the yen, and the pound must share the paper crown with the dollar by being “almost, but not quite, as good as gold!”

That is, by the end of the 1970s the slow bleeding of gold from U.S. reserves had evolved into a veritable hemorrhage, draining the life force from the dollar. That’s when then-President Richard Nixon was forced to declare an end to the normal practice of settling balance-of-trade and other deficits between nations with gold, thus completing the transition from a dollar based on gold to one based exclusively on faith in the enormous productive capacity of the U.S. economy.

It’s one thing to be able to produce in abundance, but it’s something else again to be able to maintain a reasonable balance between imports and exports. Hence the Times’s warning that “to attract some $800 billion a year from abroad, either by borrowing the money or by selling American assets” is not “sustainable.” And this takes us to the heart of the problem: the $9 trillion—and rising—national debt.

‘By that time, we’ll all be dead’

Market critics long ago posed the question: Won’t such a steadily rising public debt eventually grow to a point where it can never be repaid—and worse, won’t a time come when the U.S. can no longer manage to service the veritable mountain of debt that must inevitably accrue? Keynes has very often been quoted as having responded: Yes! But by that time, we’ll all be dead. And now, some 60 years later, Keynes and his peers are indeed dead.

One measure of today’s gargantuan debt is nearly 9-trillion dollar U.S. public debt ($8,977,709,393,923.33). But that’s only part of the problem. There are indications that the old saying, “statistics don’t lie, but liars can figure,” could mean that the debt is likely to be deliberately underestimated but really is much higher.

But, there also is the matter of the private debt, and estimates for this tend to range far higher because there appears to be no reliable way of measuring the debt incurred by individuals.

The various forms of private debt range from financed purchases of autos and trucks, to credit card and mortgage debt, to the voluminous private debt incurred by corporations and other private institutions. This includes hedge funds, at a time when “leveraging”1 of the purchases of billion-dollar corporations has become a major national pastime for corporate America and the capitalist world.

As noted above, the Times had quoted Treasury Secretary Henry Paulson Jr. as saying that “the economy was very strong...” and went on to say that such an evaluation “ring[s] hollow in the absence of an international reporting framework to monitor the positions taken by globally active hedge funds.” In other words, hedge funds keep the extent of their borrowings secret!

It is likely that no one knows all the facts about the size of both public and private indebtedness. Neither is anyone in a position to make even so much as a ball-park estimate of the total private debt. For instance, Standard and Poor’s has issued a report entitled “U.S. Credit Quality in a 25-Year Retreat Toward Junk.” According to this report, “the International Swaps and Derivatives Association’s Midyear 2006 Market Survey notes that the notional value of credit derivatives outstanding had increased by 52 percent during the first six months of 2006, reaching $26 trillion!”

This selection from Standard and Poor’s suggests, at a minimum, that total private debt is a multiple of the public debt incurred by the United States. When we include the private debt of the advanced industrial nations of the world, the inverted pyramid of global debt can be seen to be resting upon a much too narrow apex and base of real existing capital. While no one can predict when the entire inverted pyramid will collapse—as its architect had long ago conceded it would—all indications are that it will come sooner than anyone might think.

It has become increasingly evident that the U.S. capitalist economy is sinking ever more deeply into one of history’s most destructive of all economic crises. It is a scenario that combines the paralysis of the productive forces, runaway inflation, and disintegration of the nation’s social, economic, and political infrastructures. And when the U.S. goes, so too will the entire capitalist world go down the drain.


1Leveraging; that is, what Wall Street calls buyouts of billion-dollar corporations and other such investments in which extremely small investments are accompanied by as much a 90 percent borrowed capital. Leveraging, consequently, explains how hedge funds got into the trouble now bankrupting and threatening to bankrupt many more.