How America went for broke
By Simon Nixon
There are those who say that the terrorist attacks on the United States were deserved, that America had it coming, that the attacks will change the world for ever. To blame the United States for an act of terrorism in which thousands of innocent civilians lost their lives is morally abhorrent. But the irony is that if these commentators had confined their comments to the state of the US economy, they would have been spot-on. If ever there was anything that was America’s own fault, and that will change the world for ever, it is the coming US recession.
Anyone reading the newspapers during the past week could be forgiven for concluding that the events of 11 September have changed the course of the US economy. Within days of the attacks, without even waiting to see the evidence of a full week’s trading, many of the biggest names in US industry, including General Electric, Boeing and the big investment banks, were blaming the terrorists for a dramatic collapse in profits and the need for swingeing job cuts. UK firms such as British Airways and Virgin were soon to follow. Meanwhile, many Wall Street economists, consistently wrong with their forecasts all year, gratefully seized this face-saving opportunity to pronounce that they now believe that a recession is inevitable.
This attempt to blame the terrorist attacks does not bear scrutiny. America has been heading for a nasty recession all year. The cynical timing of these latest company announcements adds greatly to the short-term dangers, fuelling investor panic, but they make little difference to America’s long-term prospects. The state of the US economy is dire, and it is dire today for exactly the same reasons as were true three weeks ago.
America is reaping what it has sowed over the last two decades. So convinced did successive US administrations become that the stock market was the only efficient way to allocate capital in the economy that they blew away virtually every safeguard within the financial system. Financial systems, just like political systems, require checks and balances to ensure that no part of the system becomes too powerful. But US policy-makers, driven by an ideological belief in the virtues of unfettered free markets, sat idly by as capital markets, and the investment banks that dominate them, systematically eroded every attempt to control them — culminating in the 1998 repeal of the Glass-Steagal Act, a totemic piece of New Deal legislation passed in response to the devastation caused by the Great Crash of 1929.
The result has been the biggest bubble of all time, a grotesque misallocation of capital leading to massive overcapacity in certain sectors of the economy and near-collapse in others. Share prices became the sole measure of economic success in the US economy, and investment banks became adept at channelling funds to where share prices were rising fastest, sucking in money from around the world to drive them higher. The US economy was transformed into a giant pyramid scheme, the like of which had not been seen since the South Sea Bubble in the 1720s.
The comical excesses of the dotcoms may have grabbed the headlines, but by far the biggest misallocation of capital took place in the telecoms sector. It spent an estimated $4,000 billion building new networks to meet the expected explosion in Internet traffic. So great is the excess capacity, it is said that if the entire population of the world — all six billion of us — were to talk solidly on the telephone for a year, it could be transmitted over existing networks within a few hours. According to industry estimates, less than 2 per cent of the fibre-optic cable buried under Europe and North America has even been turned on, or ‘lit’, and of that which has been lit, only about 10 per cent is in use.
The excesses of the telecoms sector are reflected elsewhere in the economy; not just in the technology sector, but also in the services industries — banks, airlines, advertising and public-relations agencies — that catered to the ‘new economy’. Meanwhile, other areas of US industry, such as the utilities, have been starved of investment. A bungled privatisation of the Californian power industry, for example, has left the state unable to meet the demand for electricity.
For 20 years America has been borrowing unprecedented quantities of money to play its stock-market casino. Even after the latest falls, the US stock market is worth 120 per cent of GDP, compared with 40 per cent for much of the 1980s, and far above its previous peak of 72 per cent in 1972. Meanwhile, the US trade deficit stands at a record 4 per cent of GDP; no country has ever been able to sustain a deficit on this scale for long. The US currently absorbs 64 per cent of all global capital flows to finance its deficit. Capital has been sucked out of the rest of the world, including many developing countries, to enable America to indulge itself. It is no coincidence that Citicorp, the giant US bank, has its largest branch outside New York in Buenos Aires.
For years Americans deluded themselves that they were actually making this money rather than borrowing it. With the ever-rising stock market fuelling the illusion of wealth, they embarked on an orgy of personal spending, building up an average credit-card debt of $7,000 per household and allowing the proportion of their incomes saved to fall below zero for the first time since the 1920s. But now the casino has closed for business, and America finds that it has run out of chips.
The likelihood is that it will take years to pull out of this recession. Warren Buffet, the legendary US investor, is said to have told friends that America faces eight years of slump. The Japanese market bubble burst more than 10 years ago, and its economy has never recovered. Today, the Japanese financial system teeters on the edge of collapse, adding to the uncertainty in the global economy. The last time the US faced a collapse of this nature — in 1929 — it took a decade of slump and the second world war to pull it out again. It is fanciful to hope that President Bush’s war on terrorism, coming at the end of the greatest boom in history, will have a similar effect on the US economy as the second world war did, coming on the heels of the great depression.
A 1930s-style slump remains extremely unlikely. But, when America does eventually pull out of this recession, it is likely to find that it will have changed everything. Its pre-eminence in the global economy will no longer be taken for granted. At the height of the mania, America financed its Internet speculations by flogging off its much-derided ‘old economy’ to anybody who would take it. Already many of its utilities have been bought by the French and Germans, its supermarkets by the Dutch and Belgians, its bankrupt steel industry by the Brazilians.
And then there is China. This year its economy will grow by 8 per cent, and with the vast majority of its GDP dependent upon domestic trade, it remains well insulated from the downturn in the global economy. Moreover, earlier this month China joined the World Trade Organisation, a momentous event utterly eclipsed by events in America. With the United States spiralling into recession and distracted by its war on terrorism, much of Asia will now look to China to lead it out of its slump. A new economic superpower may be about to emerge.
America has only itself to blame for the predicament it finds itself in. It is paying the penalty for two decades of uncritical faith in the stock market. For the second time in 100 years, it has sacrificed economic stability to the greed of the financial community. Surveying the carnage wreaked upon the US economy in the aftermath of the 1929 stock market crash, Franklin Delano Roosevelt observed, ‘We have always known that heedless self-interest was bad morals; we know now that it is bad economics.’ But there are some lessons, it seems, that we are destined never to learn.
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Carl
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