Global capitalism is in danger. Leading lights of global finance capital are sending out warning signals with growing urgency and desperation.
Alan Greenspan is puzzled, referring to the decline of long-term interest rates at a time of rising short-term interest rates as a “conundrum.” To solve the conundrum, Martin Wolf of the Financial Times argues, we must revisit the “1930s” (“The Paradox of Thrift: Excess Savings Are Storing Up Trouble for the World Economy,” Financial Times, 13 June 2005).
According to Wolf, the world’s “private sector” wants to save far more than it is willing to invest. As the “excess savings” cannot be profitably absorbed by capitalist investment, they have driven down the real rates of return on capital to below “normal” levels. Profit-starved investors are therefore forced to “reach for the yield,” moving into increasingly riskier assets — hence a general narrowing of the interest spreads between riskier longer-term assets and safer shorter-term ones.
To absorb the excess private savings, Japanese and Eurozone governments have been running large fiscal deficits, which have so far failed to “kick-start” their economies. With fiscal and monetary policies being ineffective, the excess savings have to be somehow exported. As a result, many economies have been running current account surpluses (that is, they have to lend their “excess capital” to the rest of the world).
This in turn leads to global imbalances. While many economies want to lend out their “excess capital,” only a few are willing to borrow, namely, the Anglo-Saxon economies — the U.S., the U.K., and Australia. The U.S. current account deficit alone absorbs about 75 percent of the combined excess savings of the world.
“What are the dangers of this way of managing the desired excess savings?” Wolf Asks. “The Answer is: large.”
Wolf points out that the current “solution” obliges “an explosive increase” in both the U.S. current account deficit and net foreign debt. Even if the current account deficit stabilized at its current ratio to GDP (possible only in the unlikely event of a huge improvement in U.S. exports performance), the debt-GDP ratio would rise towards 100 percent. More realistically, if the current import-export trends continue for another ten years, the U.S. current account deficit would be well over 10 percent of GDP and the net foreign debt would exceed 120 percent of it.
“To believe that this will be sustainable is to hope that investors are prepared to make an open-ended commitment to holding assets that are unhedged against the foreign exchange (and other) risks created by just one jurisdiction,” says Wolf. To translate it into less technical language, to sustain the U.S. deficit and debt trends, global investors would have to allow the dollar-denominated assets — which are now essentially low-return and high-risk junk bonds — to make up an ever rising proportion of their asset portfolios.
What led to this “global savings glut”? According to Wolf, the financial crises of the late 1990s “made everyone more cautious.” Many governments have been practicing “tight monetary and fiscal policies,” obsessed with accumulating foreign currency reserves. Liberalization of capital flows, the keystone of neoliberalism that brought huge fortunes to financial capitalists, produced one financial crisis after another. Financial crises, however, became a boon to the ruling class, as they disciplined the governments of the “emerging market economies,” making sure they behaved “responsibly.” Fiscal and monetary “responsibility” — i.e. responsibility to global investors — has depressed mass consumption and productive investment throughout the world — hence the “global savings glut.”
In this context, global effective demand can only be sustained by asset bubbles and debt-financed consumption in the U.S. — the ailing hegemon of global capitalism.
Historically, the U.S. private sector financial balance fluctuated around a surplus of 3 percent of GDP (that is, the U.S. households and businesses as a whole had an income greater than their expenditure by about 3 percent of GDP). During the late 1990s, this balance sank to an all-time low of a deficit of 5 percent of GDP. After the burst of the stock market bubble, it briefly moved back to zero but then again entered the negative territory, now staying at about a deficit of 2 percent of GDP.
The U.S net national saving rate now hovers at a record low of 1.5 percent of GDP. The household debt-income ratio is at an all-time high. The expansion of consumption and household debt has been largely driven by the housing market boom. How long can the real estate bubble last?
In 1998, after the Asian, Russian, and Brazilian crises, in an atmosphere of “flight to safety,” there were massive capital flows to the U.S. that prolonged the life of the stock market bubble, only to collapse two years later. Stephen Roach, the chief global economist of Morgan Stanley, now sees a similar development (“Global: Re-Sequencing,” The Morgan Stanley Global Economic Forum, 13 June 2005).
Over the last two years, a massive investment bubble has taken shape in the Chinese economy, where the investment-GDP ratio is approaching a ridiculously high 50 percent, possibly a world historical record. As China’s investment bubble is about to burst, the Chinese economy could slow down significantly next year, dragging down other Asian economies with it.
As the Chinese and other Asian economies slow down, global commodity prices are likely to fall, with “bullish” implications for global interest rates. If such an outcome makes “a pro-growth, pro-market Fed . . . reluctant to tighten much more,” according to Roach, “it would undoubtedly provide the interest-rate-, asset-dependent American consumer with yet another life. . . . It could lead to a final blow-out in already frothy US property markets, along with a last-gasp surge of refi activity to tap such new found wealth” (“Global: Re-Sequencing,” 13 June 2005).
However, Roach warns: Not only would such a surge “push household indebtedness to ever-higher highs, but it would undoubtedly depress income-based saving even more. The result would be a further widening of an already record US current account deficit — setting the stage for a far more treacherous endgame” (“Global: Re-Sequencing,” 13 June 2005).
In 2001, despite the sharp correction of the private sector financial balance, the U.S. economy managed to avoid a depression only because the government sector made a corresponding expansionary swing from a surplus of 1 percent of GDP to a deficit of 5 percent of GDP. As Wynne Godley of the Levy Economics Institute points out, after the burst of the current property bubble, highly indebted U.S. households could see their consumption fall sharply. Another fiscal expansion to compensate for that fall would skyrocket the deficit (“Imbalances Looking for a Policy,” Policy Note, April 2005).
Assume the U.S. current account deficit rises to 8 percent of GDP and the private sector balance swings back to a surplus of 2 percent of GDP when the property bubble eventually collapses. By accounting rule, the U.S. government deficit would have to rise to 10 percent of GDP! Deficit of such a magnitude can hardly be justified politically nor sustained financially, unless the U.S. and the global economy sink into a Japanese-style stagnationary depression, with the constant threat of a dollar collapse looming larger over time.
Is there any chance that such a “treacherous endgame” can be prevented within the existing global capitalist framework? Significantly, Paul Volcker — who presided over the interest rate hike that, together with the infamous Reaganomics, broke the back of American labor and marked the arrival of the neoliberal era — is not optimistic:
It’s not that it is so difficult intellectually to set out a scenario for a “soft landing” and sustained growth. . . . China and other continental Asian economies should permit and encourage a substantial exchange rate appreciation against the dollar. Japan and Europe should work promptly and aggressively toward domestic stimulus and deal more effectively and speedily with structural obstacles to growth. And the United States, by some combination of measures, should forcibly increase its rate of internal saving, thereby reducing its import demand.
But can we, with any degree of confidence today, look forward to any one of these policies being put in place any time soon, much less a combination of all?
Maybe, we are once again living in a “Keynesian world,” pregnant with the possibilities of depressions, wars, popular movements, “new deals,” and revolutions — a world of great horrors and great hopes.
1 Volcker, of course, glosses over the contradiction between the removal of “structural obstacles” — which never fails to involve further attacks on working people’s living standards and their economic and social rights — and the goal of stimulating domestic demand.
Minqi Li was a political prisoner in China during 1990–1992. He teaches political economy at the Department of Political Science of York University, Toronto, Canada.