World Public Forum

Published on 25 August 2010

Written by Larry Elliott

Larry Elliott An article by Larry Elliott Guardian's economics editor published on guardian.co.uk on Monday 23 August 2010.

The structural problems of the US economy are too deepseated and intractable to be solved by regular doses of cheap money.

"This sucker's going down." That was George Bush's pithy description of the US economy when the financial crisis in the autumn of 2008 threatened to bring down every bank on Wall Street.

Concerted international co-operation of a sort never seen before averted disaster that winter and by the middle of last year the world's biggest economy seemed to be on the mend. American factories started to hum again, shares rallied sharply and growth resumed. The US was showing its traditional resilience when faced with adversity and all was right with the world.

That judgment now appears premature. The latest economic data from the US has been poor. Traditionally, America's flexible labour market has meant job creation in the aftermath of recessions has been robust; this time it was weak even when output was growing strongly in late 2009 and 2010. Recently it has gone into reverse.

The official unemployment rate in the US is 9.5% but the real level of joblessness is far higher after part-time workers who would prefer to have full-time jobs are taken into account. In a country with a less generous welfare system than that in Europe, unemployment acts as a brake on demand, making consumers save rather than spend.

That sense of caution has been reinforced by the state of the US property market, which is also going backwards after the expiry in the spring of tax breaks to buy homes. Those states that enjoyed the biggest boom in house prices during the bubble years are now caught in a vicious downward spiral where a crashing property market leads to higher unemployment, rising foreclosures and further downward pressure on house prices.

Pressure on individual states to balance their budgets has made matters worse. Public sector workers are being laid off, leading to still higher unemployment and even lower house prices.

The risk of the US suffering a double-dip recession should come as no surprise given the profound nature of the shock provided by the seizure in financial markets two years ago. What happened then was that the flow of credit dried up as banks hoarded liquidity and became ultra-reluctant to lend.

Central banks and finance ministries everywhere rightly concluded that there would be a repeat of the deflationary slump of the 1930s unless they flooded the global economy with money. So they slashed interest rates, cranked up the electronic printing presses and announced massive fiscal stimulus packages.

Money supply
This process has worked, but only up to a point. Excluding China, the annual growth rate in the global money supply has fallen from 10% at the height of the financial crisis to zero. Without the action taken by the Federal Reserve, the Bank of England, the European Central Bank and other central banks there would have been a collapse of credit every bit as disastrous as that seen in the Great Depression.

China's stringent capital controls meant most of the benefit from its monetary and fiscal stimulus was felt domestically. Output rebounded quickly and strongly from the collapse in late 2008, and this in turn convinced investors that Asia could provide the engine for global growth while North America and Europe gradually recuperated. That explains why equity and commodity prices rebounded with alacrity from the spring of 2009 onwards, and why Germany – the world's main supplier of the machinery to power industrial development in the emerging world – enjoyed an export-led boom in recent months. But welcome as it was, China's emergency action was not cost-free. The economy lacked the capacity to cope with the sheer scale of the stimulus and showed signs of overheating. Policy has been tightened and China is now showing signs of slowing.

Stalling China
Provided China has a pause for breath rather than a sharp retrenchment there is still a chance that the global economy will muddle through. Factories in Germany and Japan will churn out manufactured goods for Asia, stock markets will take heart that a second leg to the global downturn has been avoided, and cheap money will start to stimulate demand growth in the US once consumers have built up their savings to a level they consider prudent.

But in the US, the Fed is starting to contemplate a much bleaker scenario in which the US and Chinese economies stall simultaneously, with knock-on effects on those countries (a vast number) seeking to export their way out of trouble. The fear, already reflected in global bonds markets, is of softer output, fresh trouble for the banks, and deflation. James Bullard, the president of the St Louis Federal Reserve Bank, noted last week that the US was closer to the deflation seen in Japan in the 1990s than it has been at any other time in its history.

This is a clear sign that the Fed is considering another dose of quantitative easing this autumn. It probably wouldn't take much more poor economic news to trigger it. The mid-term elections for Congress are looming and plenty of the Democrats elected on Obama's coattails two years ago are fretting about losing their seats in November. Ben Bernanke's speech at the annual symposium of central bankers in Jackson Hole on Friday will be scrutinised for hints that the Federal Reserve chairman might be preparing to live up to his nickname of "helicopter Ben" and spray the US economy with more money.

It would be a controversial move. Some would argue that the excesses of the bubble years have to be purged from the system and that any attempts to avoid the necessary adjustment merely prolongs the Great Reckoning and threatens a burst of inflation. Others believe that the problems of the US economy are too deep seated and intractable to be solved by regular doses of cheap money.

Giovanni Arrighi in his book The Long Twentieth Century argues that there have been four major phases of capitalist development since the Middle Ages, starting in Genoa and moving on to Holland and Britain before the start of American dominance during the Great Depression of 1873-96.

It was during this period, Arrighi argues, that commerce started to play second fiddle in Britain to finance, just as it had in Genoa and Holland when their phases of pre-eminence were drawing to a close. The financialisation of the American economy in turn can be traced back to the mid-1970s, so by this interpretation of history, the dotcom collapse of 2000-01 and the financial crisis of 2007-08 (with the military entanglements in Iraq and Afghanistan sandwiched in between) are part of a much longer term development. According to this thesis, the concentration of economic power on Wall Street, the stagnation of incomes for all but the rich, the structural trade deficit, the military overreach, the switch from being the world's biggest creditor nation to its biggest debtor add up to a simple conclusion: we are in the twilight years of the long American century.

Such a conclusion is contested in Washington but may help explain why, as Albert Edwards of Soci?t? G?n?rale puts it: "Unprecedentedly strong monetary and fiscal stimulus has led to unprecedentedly weak recovery." This will worry Bernanke, who made his name explaining how policy makers could avoid repeating the mistakes made during Japan's lost decade and can anticipate the dire consequences of a period of deflation for a nation wallowing in debt.

Despite rising commodity prices, core inflation in the US is low. The Fed still has levers to pull and if there is the remotest possibility of this sucker going down again, it will pull them.

An article from guardian.co.uk © Guardian News and Media Limited 2010

Giovanni Arrighi was a member of the WPF “Dialogue of Civilizations” Possible Futures Research Group. His article “The End of the Long Twentieth Century” will be published in the first volume of the “Possible Futures” book series this year.

About the Possible Futures Research Group
Many hoped the end of the Cold War would usher in an era of open exploration of the best collaborative solutions to global problems and of respect for the different conditions and civilizational histories of different regions. However, the post-Cold War era was dominated by neo-liberalism and market fundamentalism, and by a securitization of international relations led by a single superpower. Although liberal economic policies enjoyed major successes, they have also entered a period of crisis. Neo-liberalism has not offered an adequate intellectual basis for tackling the world's many major challenges. Accordingly, it is necessary to renew open exploration of key issues facing humanity on a multilateral basis.

Global dialogue among policy-makers, social movements, and indeed civilizations depends on grounding in the best available scientific and humanistic knowledge. In order to bring such knowledge to global dialogue the World Public Forum “Dialogue of Civilizations”, Social Science Research Council (USA) and Carleton University (Canada) support the work of the international research group “Possible Futures”. As a result this group produces reports on key issues of global concern, which will be presented at Rhodes Forum and in the “Possible Futures” book series beginning to be published this year.