Is the recession over?

The media is highlighting the greenshoots breaking through the ashes after the wildfire of financial contagion has now largely passed - yet, is it true that things are looking up or are journalists simply looking for a good news story to break the duck?

It is always difficult to correctly anticipate the future behaviour of market economies to any great degree of certitude and, in particular, with any confidence of timing. However, it didn't take a macro-economist to have realised that the boom in the Irish housing industry would eventually collapse under its own contradictions. That most mainstream media pundits were exposed as simply cheerleaders of the expansion was due to a variety of factors, not least the experience of unexpectedly prolonged growth at that stage but most importantly self-interest. Economic advisers to financial services companies never talk down a bubble; it is in their self-interest to urge the public to continue buying so that they get their bonus as the bubble continues. To some extent this perpetuates the bubble beyond its natural limits.

But the difficult question is when and how it was going to deflate; with a hard or a soft landing. Just where the overextended market would break was unknown. That it would happen in the USA was not a given but reflected the uncontrolled nature of that economy and the heightened contradictions in a society of extreme polarisation which wanted to sell property to some of its poorest citizens. But it could have been that the inability to repay credit would have broken down first in Estonia, or Ireland for that matter, and subsequently spread like a financial contagion to the core economies.

The complexity of the market and its inherent opacity - the polar opposite of the efficient and rational market hypothesis - is the cause of these difficulties in analysis. Few knew exactly how much bad credit there was out there and the exact tipping point at which some unfortunate multinational corporation would be exposed without adequate cover.

So we can anticipate downturns but not with any great exactitude.

In a similar manner, it is difficult to anticipate the recovery. It would appear from German, French and Japanese statistics that all three of these economies have exited the recession and are now in the depression of the economic cycle (in the classical economic sense of the term denoting that period until GDP returns to its pre-collapse peak - terminology which has been changed by modern economists for obvious political reasons). The reality is that while meagre growth has returned to these countries they have experienced a fall in GDP that they have yet to make up. Consequently, unemployment remains higher that it was in all developed economies and in most continues to rise.

Yet, there are signs that markets, businesses and consumers are more positive in the consumption-driven economies of the US and the UK. Is this a sign that they are pulling out?

Firstly, as we analysed in the previous post there are inherent limitations to economic analysis which seeks to rationalise events and trends primarily through mass-psychological explanations. There is an innate fickleness to public opinion and it can be shifted considerably by media stories. Furthermore, the market does not follow confidence but the expectation of mass confidence - a not inconsequential insight. At the same time, increased confidence might result in higher consumption and investment and might considerably shorten the depressionary period. So what's happening?

Hard economic data is difficult to come by and even this needs to be interrogated robustly. Few people are suggesting that the UK and USA are experiencing growth right now but that data would certainly suggest that the rate of the fall in GDP has certainly slowed dramatically.

The Property Market Rebound

The headline figures in the press which are being read as indicating a rebound are property price indices which are indicating growth in both economies. This data would be of significant importance given the interrelationship between the financial world and the construction sector. Much of the bad debt is held against property and if the market was to increase dramatically this would result in a significant erosion in exposure to bad debt.

The problem with the property price increases is that they are occuring at a time where the amount of property going to market is considerably lower than it was. Very few homeowners are selling right now as prices are just too low - why sell now rather than wait for prices to rebound fully? It is a buyers market but the reality is that with the massive extension in credit arising from central banks, there's currently a lot more credit out there - not for lending but for investing in undervalued property - and it is chasing very few properties. In this context property prices can only go up. The likelihood is that as more property begins to come to market the upswing will gradually slow down and may even reverse.

However in the meantime, the property price rises may well be instrumental in improving wider consumer and business confidence and will lower perceived losses associated with the public sector bailout of the banking sector.

The Inventory Cycle

Key to understanding medium-term market dynamics is the inventory cycle. While the expansion in the credit market has distorted its former simplicity of operation, it is still of huge consequence to analysing the turning points of the industrial cycle. The peak of the cycle occurs at maximal extension in inventory terms. So, when the economy takes a nose dive orders to suppliers collapse rapidly and this is how the contraction in the high street works its way throughout production. One of the defining characteristics of all busts is that it ends up hitting manufacturers of productive machinery most as other manufacturers decide to cut back on capital purchases in a poorer economic climate. This is why the German, French and Japanese economies which were not exposed to the financial crisis to the same extent felt the pain of the current contraction.

What happens in practice is that all sectors of the economy start to run down their inventories to cut expenditure at a time of short operating capital. At some point usually a few months into the recession, this inventory runs out and placing orders cannot be avoided. It would appear that this is precisely the point at which we are currently. Orders to manufacturers rise first on the back of inventory replenishing (evidenced by the expansion in the 'productive' economies of Germany, France and Japan and the reduction in the collapse in exports from China).

It is entirely likely that this might be a short-term bounce associated with the inventory cycle which may give way once again to contraction. This is particularly a risk as consumption in these 'net producer' economies is not a driver in global growth and in the 'net consumer' economies consumption remains low despite massive state pump-priming.

Back to Economic Fundamentals

The stimulus packages both the US and UK governments have pushed through their financial sectors have had limited impact. The banks simply absorbed the extra money to recapitalise and would appear to be using the money to make some immediate profits to try and rebalance their state of near (or actual) insolvency. This is evidenced by the high rates of profit-making that the more solvent banks are enjoying at present.

Even if GDP recovers half a percent, it has to be remembered that figures occurs in the context of the most substantial monetary injection ever and against a massive public sector investment stimulus. These will not continue indefinitely but if public consumption and investment are abstracted the private economy has clearly continued to contract.

Furthermore, if rising high street consumption patterns are abstracted from UK consumption statistics, remaining consumption has suffered another significant contraction.

The issuance of large monetary stimuli by Governments will inevitably increase public borrowing rates and will cause long-term inflation. Both US and UK governments now admit that their current expansionary economic policies will have to be curtailed in the next few years and agree that budget deficits will be cut substantially. Due to the negative economic impact of tax increases on growth, the reality is that this will mean a significant contraction in public sector consumption following the end of, and even alongside, the stimulus package.

Global Implications

Despite these negative medium-term observations, we will, undoubtedly, see some form of recovery at some stage. Afterall, the financial crisis appears to have been avoided by the nationalisation of the debt of corporate finance and the bailout of the superwealthy. Consequently, the contraction that has occured in the US economy may halt as the stimulus passes through their real economy. However, due to inevitable and continuing deleveraging within the financial services sector growth it is likely that growth will be sluggish even before taking account of a future contraction in public consumption. And that's assuming no other sector of the credit market causes fundamental collapse in the financial services sector and no government defaults on sovereign debt (far from certain at this point).

On the basis of this analysis, there is a significant likelihood of a W-shaped recession in the US.

While the US remains mired in an extensive economic depression (as defined above) with GDP only slowly recovering, China and India will continue their onwards expansion based on internal investment and consumption. This, in turn, will benefit their key trading partners and the suppliers of raw materials across the world but be inadequate to raise the US economy. The rising demand in developing countries will further increase input prices and result in commodity-cost inflationary pressures across the global economy, these will subsequently further aggravate the sluggish growth in developed economies. It is hard to avoid concluding that we will see a return of 'stagflation' in future years.

Impact on Britain's Economy

The British situation would appear far worse than the US. Financial Services are Britain's primary economic sector and with the gradual diminution of North Sea Oil as a resource, Britain's economy looks highly exposed to the worsening global business climate. In comparison, the USA's large internal market, variety of high technology sectors of competitive advantage and its immense natural resource base will always provide a basis for the return of growth in the long-term.

In effect, the British economy is built around the super-exploitation of the third world; surplus value expropriated is distributed via London (the world's centre for financial services). This was the major achievement of the Thatcherite revolution in the 1980s, the price of which was wider deindustrialisation through long-term higher interest rates. The social cost of this process was considered necessary as the returns from financial services are much greater than that from production alone and furthermore the British government had realised that they couldn't hope to compete in the latter for very long.

The problem is that in producing all this wealth, the Financial Services sector processes huge trade volumes and runs massive risks. Given the commitment of all the mainstream parties to propping up the financial markets, the exposure to the underlying British economy, as in the case of Iceland, is many multiples total British GDP. These banks, while too big to fall, are also too big to bailout. This is the reason we are having a debate around curtailing the financial services sector that is ongoing with the Lord Turner, chief of the city's regulator (the Financial Services Authority), raising the prospect of the Tobin Tax.

The Tobin Tax - A Reformist Bogeyman

The Tobin Tax was named after James Tobin, a pro-free trade, neo-Keynesian, US economist. As might be anticipated from its origins, the tax is not meant to be revolutionary but has the potential to have massive implications for financial capitalism.

The suggestion is that a mere 0.1% tax is imposed on all financial services transactions. Whereas once this suggestion was only supported by the liberal-left and radical reformists, a cause of some regret to Mr Tobin, it is now becoming an issue which might get raised by some governments at the coming G20 meeting.

The tax, although apparently innocuous, would hover like a sword of Damacles over the global financial services sector. Within the market, a large proportion of trades are based on repeatedly making very small gains on a short-term basis. The repetition of such trades at large volumes results in significant yields. Applying a 0.1% tax on all transactions would simply wipe out whole sectors of market trading and make uneconomic all but the longer-term transactions.

The reason the market is squeeling in anticipation of this tax is that for the first time it is viewed as a real possibility. With the centralisation of trading in large-scale computerised systems which have resulted in significant efficiency gains (and profits) to traders, applying the tax would be technically easy. Moreover, avoiding it would be very difficult as it would mean the foregoing of those trading efficiency-related profits (again small but financially of huge significance).

The British Government is raising this through the proxy of the FSA as they are concerned that they would not be able to cover another similar financial collapse in the future and, it would appear, they realise that the super-profits accruing through the sector will not be returning very quickly in any case. In the context of longer-term deleveraging, lower rates of financial profit-making and increased regulatory burdens all contributing to reduced medium-term profitability, the cost of this measure might not be unbearable and the risks of not taking this action would appear huge in comparison.

So, there is now little to lose. If Britain were to move, only the US would need to agree to ensure the adoption of the tax globally which usefully could address some of the budgetary deficits arising from the recent collapse. It is unlikely in the extreme that the proceeds from the tax would be committed to third world development as its radical proponents have demanded in the past; instead, expect it to be absorbed by an increasingly desperate British Treasury.

Promoting Tobin Tax as a Transitional Demand

The Tobin Tax is not a revolutionary tax. It would leave unscathed the fundamental contradiction between social production and private ownership of the means of production. It would not fundamentally challenge the market only restrict its operation. As such it is a reformist demand but one with significant implications.

The restriction of the free play of financial capitalism would appear to be key demand in the transformation of Britain's economy away from a parasitic, financial basis to a productive, industrial basis.

Revolutionaries must be able to deploy reformist demands in order to advance towards revolutionary goals. As such, the demand for the implementation of the Tobin Tax represents a concrete expression of a politics grounded in today's realities. The tax would not resolve the contradictions of the capitalist system but would make a substantial improvement to the medium-term prospects of working people. Insofar as it would restrict the ability of financiers to gamble at public expense it would appear a useful demand in raising awareness of the negative impact of capitalism.

Socialism or Barbarism calls for the immediate implementation of the Tobin tax with profits ring-fenced to development in the third world! Nothing short of the overthrow of the private ownership of the means of production will provide the basis for fundamental change to the current inequality but it will help revolutionaries raise awareness of the negative implications of the market and provide the basis for a future full-scale expropriation of all capitalists!