Robert Brenner, "THE ECONOMY AFTER THE BOOM: A DIAGNOSIS"

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THE ECONOMY AFTER THE BOOM: A DIAGNOSIS
(PLEASE NOTE: THIS TEXT CONTAINS REFERENCES TO FIGURES WHICH HAVE BEEN
REPRODUCED IN THE PRINT VERSION OF THIS ARTICLE BUT OMITTED HERE)
Robert Brenner *

INTRODUCTION


THE LONG U.S. economic expansion has ended.  Whatever the outcome of 
the
current recession, the odds are against a return to the boom 
conditions of
the second half of 1990s.  It may indeed be difficult over the medium 
run
to avoid stagnation/slow growth, or even worse.

The reason, at the most general level, that the world economy, 
including
its leading, US component, appears to face fairly bleak prospects is 
that
it failed during the 1990s expansion to definitively transcend the 
long
economic downturn that had been plaguing it from the early 1970s 
through
the early 1990s.  Over-capacity and over-production leading to reduced
profitability in the international manufacturing sector - and the 
failure
of successive attempts of governments and corporations to successfully
respond to this - have been fundamentally responsible for continuing
stagnation on a system-wide scale, and there is as yet little clear
evidence that the problem has been overcome.  The sharp fall of the 
rate of
profit between 1965 and 1973, and its failure to recover, made for the
slowed growth of investment and output over the following two decades
throughout most of the world economy, issuing in much reduced 
productivity
and wage growth, as well as high levels of unemployment. 

A significant rise of the manufacturing profit rate between 1985 and 
1995
did, initially, provide a real basis for the U.S. boom of the 1990s. 
But
the rise in U.S. profitability and, eventually, U.S. economic growth, 
was
paralleled by - and to some extent caused - falling profitability and 
deep
recession in most of the rest of the advanced capitalist world, 
including
Japan and western Europe, during the first half of the 1990s.  
The sharp slowdown in much of the advanced capitalist world, and the
ensuing threat of disruptive crisis, obliged a fundamental reversal of 
the
US policy from a weak to a strong dollar in 1995.  This, in turn, 
limited
the U.S. surge, and, and over the second half of the 1990s the
manufacturing profit rate fell significantly and, with it, the 
fundamental
basis of the US economic revival. 

But even as corporate profitability began to fall between 1995 and 
2000 -
and in the face of this decline - the stock market took off on the 
greatest
run-up in its history, massively increasing the on-paper assets of
corporations and by the rising dollar.  The 'wealth effect' of rising 
share
prices thus replaced the revival of manufacturing profitability as the
economy's main engine.  Corporations found that their overvalued 
stocks
gave them access to almost unlimited financing. On this basis, they 
were
able to sustain a powerful investment boom, and the 1990s expansion 
was
enabled to continue.

Nevertheless, the growing gaps that opened up between rising stock 
prices
and accelerated economic growth on the one hand and falling 
profitability
on the other could not long persist.  From the middle of 2000, one 
after
another of the corporations that had led the boom, especially in
technology, media, and telecommunications (TMT) confronted disastrous
declines in profits, and the stock market crashed.  The wealth effect 
of
rising share prices now went into reverse: corporations found it much 
more
difficult to raise money and were forced to cut back on investment, 
setting
the economy on a downward course.

But the overriding problem was the mammoth overhang of excess capacity 
that
corporations had built up during the stock market run up, when they 
had
made use of their of their hugely increased paper wealth to make vast
additions to their plant and equipment that could in no way be 
justified by
their rate of return, since profit rates were already falling.   Too 
much
capacity made for too much production, and corporations were unable to 
sell
their output at prices that allowed them adequate (if any) profits.
Manufacturing profitability, already having fallen significantly 
between
1997 and 2000, plunged in 2000-2001, making for a profound crisis of 
the
manufacturing sector.  This set in motion the classical downward 
spiral in
which declining investment (declining orders for means of production) 
makes
for rising unemployment, which leads to declining consumption demand, 
which
leads to both increased bankruptcies and rising debt defaults, which 
put
further downward pressure on investment, and so forth.

As the U.S. recession deepened, the growth of U.S. demand fell 
sharply, and
the rest of the world economy, profoundly dependent upon U.S. imports,
followed the United States downward. As the international economy
contracted, U.S. export growth fell drastically, exacerbating the U.S.
downturn.  A mutually-reinforcing international downturn ensued, with 
the
drop-off in U.S. investment and economic growth from the year
mid-1999-mid-2000 to the year mid-2000-mid-2001 the greatest in U.S.
postwar history.

Over the course of 2001, the U.S. Federal Reserve brought down 
interest
rates at record-breaking speed and to an unprecedented extent.  As a
result, household debt exploded upward allowing consumers to continue 
to
increase their spending at a rapid rate.  Corporations were thus 
encouraged
to restore their inventories.  The frightening tailspin of the economy 
was
stemmed at least for the time being and GDP rose notably during the 
first
quarter of 2002.

Nevertheless, corporate profitability remained at its lowest level in
almost two decades, investment continued to plunge alarmingly, exports 
and
the trade/current account deficit continued in crisis, and--reflecting 
all
of this - the stock market was unable to launch a recovery.  The 
outcome
thus remained very much in doubt.  It is the task of this paper to 
provide
the basis for a firmer understanding of what might be expected next.


LEGENDS OF THE BOOM: THE OFFICIAL STORY 

The standard account of the US boom makes the "new economy" its point 
of
departure.  It focuses on the supposedly unique genius of the U.S. 
economy.
 If other countries would only follow the U.S. model, it implies, 
problems
of the world economy would vanish.   Nevertheless, this account can 
derive
its rosy picture by focusing only on the five boom years between 1995 
and
2000, with no historical context or comparisons; by ignoring the fatal
underlying weaknesses of the boom of those years; and by abstracting 
the US
economy from the world system as a whole, to which it was inextricably 
tied
and the problems of which ultimately brought it down. 

               The New Economy as Ideology of the Stock Market Run-up      


In the official version, enshrined in the Council of Economic 
Advisers'
Economic Report of the President 2001 (issued in early 2001!), as well 
as
the speeches of Alan Greenspan (available at the Federal Reserve 
website),
the U.S. economy relied on its open markets and its
entrepreneurial/financial institutions -particularly its highly 
developed
venture capital companies, its high tech startups, and above all its 
stock
market - to launch an epoch making revolution in information 
technology and
achieve a definitive break from the long downturn.  The long 
stagnation of
the 1970s and 1980s was thus supposedly the result of a sudden 
(unexplained
and unevidenced) exhaustion of innovation following the postwar boom, 
which
was ostensibly responsible for the long-term slowdown in productivity
growth.  But with the equally sudden availability of New Economy
technologies in the early 1990s, so the story goes, firms that could
mobilize the necessary 'intangible capital' - in the form of 
inventiveness,
skill, organization and so forth - were presented with unprecedented
potential profits.  Venture capital companies were thus ostensibly
motivated to fund high-risk, high-tech start-ups by their potential 
for
yielding generous rewards, when their stocks went on sale at initial 
public
offerings (IPOs) to enthusiastic investors willing to pay top dollar 
for
shares in what promised to be endlessly profitable info-tech 
enterprises. 
Banks were willing to provide these ventures with loans for the same
reason.

As Fed Chairman Greenspan never tired of explaining, the promise of 
New
Economy productivity gains thus raised the expected rate of profit, 
driving
up equity prices.  Corporations' rising share values allowed them -
especially those in the field of technology, media, and 
telecommunications
- easier access to finance, enabling them to boost investment (the 
"wealth
effect").  More rapid capital accumulation made possible further leaps
forward in technology, enabling productivity growth to rise even 
higher.
The latter raised potential profits, thus equity prices, thus 
investment
still more, issuing in what Chairman Greenspan termed a 'virtuous 
cycle' of
economic expansion, centered on the stock market and venture capital.
In this narrative, the stunning return on Netscape Corporation's 
Initial
Public Offering in August 1995 announced the vast potential of the New
Economy.  It thereby set off the mutually supportive stock market run 
up
and economic boom.  The synergy between stock market and real economy
produced what the Council of Economic Advisers insists on calling the
'extraordinary gains in performance' of 1995-2000. (Economic Report of 
the
President 2001, p.23)

                        The Bubble-Driven Boom 

In fact, U.S. economic performance during the height of the boom, from 
1995
through 2000, though better than during any other five-year period 
since
the start of the long stagnation in 1973, was anything but 
extraordinary.
In terms of the usual indices, U.S. economic performance in the five 
years
period between 1995 and 2000 did not quite match that in the twenty-
five
years between 1948 and 1973--and productivity growth, supposedly the 
source
of a U.S. economic breakthrough, was 15 per cent lower.

Figure 1 The U.S. Economy: 1948-1973 versus 1995-2000
[U.S.Economy4895002]
About Here
The US Economy: 1948-1973 versus 1995-2000

(average annual per cent increase, except for unemployment rate)

                                1948-1973               1995-2000

GDP                                              4.0                    
4.1             

Non-Farm Business Net Capital Stock      3.5                     3.8       
        

Non-Farm Business Labour Productivity    2.9                     2.5

Non-Farm Business Real Hourly Wages      2.8                     2.0       

Inflation/Consumer Price Index           2.4                     2.4       

Unemployment Rate (average)              4.2                     4.7       



Still, had the US boom of the 1990s possessed a firm basis and proved 
able
to sustain itself, it might very well have brought about the 
definitive
transcendence of the long downturn, both at home and internationally.  
But,
the salient fact about the US economic expansion, especially from 1995
through 2000, was that it was ever more dependent upon the stock 
market
frenzy, rather than vice versa, because it proceeded without support 
from
underlying profits.  The US's distinctive entrepreneurial-financial
institutions, with indispensable assistance from the US Federal 
Reserve,
produced not so much a boom as a bubble.  

Venture capital firms did provide a great deal of funding to high
technology start-up companies. But their contribution was minimal, 
until
the last years of the 1990s, when the equity price run-up was 
approaching
its peak.    At that point, venture capital firms did not have to 
depend
for their returns on these companies actual productive potential or
negligible ability to yield profits.   They could profit instead from 
the
insanely inflated returns that were being generated by the sale of
companies' shares at their Initial Public Offerings. (Economic Report 
of
the President 2001)

Equity investors more broadly did help finance some of these start-
ups, as
well as other more established information technology companies, by 
buying
their shares. But they did so not because these companies had 
delivered
high profits on the basis of their powerful technologies, but rather
because their stock prices were skyrocketing into the stratosphere, 
driven
by speculation.  Most E-businesses failed ever to make a profit; and 
even
the leading technology, media, and telecommunications companies (TMT)
companies at the heart of the 'New Economy' could not achieve profits 
that
remotely kept up with their equity prices.
Corporations did launch a huge investment boom and were thereby able 
to
raise productivity growth.  They could do so, however, only because 
their
inflated share prices made access to capital so easy, not because the 
New
Economy had raised profit-making possibilities.   A growing gap 
between
stock prices and profits at once drove the expansion, constituted its 
fatal
flaw, and brought it to a screeching halt in 2000-2001, and this is a 
point
to which it will be necessary to return.  .  

The US economy could not, in the last analysis, sustain its 
profitability
and momentum beyond mid-2000 because it remained inextricably bound up 
with
a global economy that remained plagued by stagnation, which resulted 
from
the perpetuation, and exacerbation, of over-capacity and over-
production.  
The underlying weakness of the total system and its US component was
manifested in that fact that, during the course of the business cycle 
of
the 1990s, the economic performance of the advanced capitalist 
economies
taken together was, by all of the standard measures - growth of GDP, 
per
capita income, labor productivity and real wages, as well as level of
unemployment - no better than that during the 1980s. The latter was 
itself
less good than that of the 1970s, which did not, of course approach 
that of
the 1960s and 1950s.  

Another way of saying this is that, even as neo-liberal, market 
enabling
measures have been ever more comprehensively implemented since around 
1980,
the economy of the capitalist core has been decreasingly able to 
deliver
the goods, especially to the broad ranks of its population.  For the
advanced capitalist world as a whole, wage growth during the last 
decade
fell to the lowest level of the post-war period, unemployment rates 
hovered
at or near their post-war peaks (outside of the US), and the welfare 
state
contracted, if at varying speeds.  All this was the case, moreover, 
despite
the enormous stimulus artificially imparted to the world economy by 
the
bubble-driven US boom. 

Figure 2 Declining Economic Dynamism
[DecliningEconomicDynamism999]
About Here


US REVIVAL, INTERNATIONAL STAGNATION, 1985-1995

Because the global economy during the past decade proved unable to
decisively transcend the long downturn, the long downturn must remain 
the
point of departure for understanding its recent and future trajectory.  
In
this respect, the actual story runs more or less in the opposite 
direction
to the official one. There is thus little evidence indicating a fall-
off of
the rate of technological advance, of the appearance of new 
inventions, in
the 1970s and 1980s.  There is, however, irrefutable evidence in these
years of continuing, deeply reduced profitability, especially in the 
U.S.
and international manufacturing sector.  The latter goes a long way 
toward
accounting for the long-term slowdown of capital accumulation, and it 
is
slowed investment that must bear a large part of the responsibility 
for the
long-term system-wide slowdown of innovation and productivity growth. 

                        The Long Downturn

Briefly, and schematically speaking, in the later 1960s and early 
1970s,
the intensification of international competition, driven especially by 
the
stepped-up entry of lower cost producers based especially in Japan but 
also
in western Europe, brought the long post-war boom to an end.  It did 
so by
making for system-wide over-capacity and over-production and 
precipitously
falling profit rates in manufacturing system-wide, which were largely
responsible for a major decline in profitability for the advanced
capitalist economies as a whole.  Sharp reductions in the 
manufacturing
profit rate hit the US first during the second half of the 1960s, 
bringing
down aggregate manufacturing profitability for the G-7 economies taken
together.  With the deep devaluation of the dollar of the early 1970s, 
and
corresponding appreciations of the yen and mark, Japan and Germany 
came to
shoulder a significant share of the overall profitability fall.

During the course of the 1970s, over-capacity and over-production 
actually
worsened.   Firms across the world economy tended to try to respond to
profitability and competitiveness problems by stepping up investment 
in
their own lines, rather than switching to new ones.  This was because 
they
possessed huge amounts of "proprietary capital" - ties to suppliers 
and
customers and above all technological capability - that they would not 
have
been able to make use of in other industries.   But the result was to
re-produce, and exacerbate, the initial problem.  At the same time, 
firms
based in the newly-developing economies of East Asia - and to some 
extent
Brazil, Mexico, and others as well - found they could enter certain 
lines
at a profit despite over-capacity, and this exacerbated the initial
situation.  Only the public subsidies to demand that resulted from
Keynesian deficit spending throughout the decade of the 1970s 
prevented the
onset of deep crisis. 

Figure 3 US Manufacturing and Non-Farm Non-Manufacturing Net Profit 
Rates,
1948-1999   
[USMFGNONMFGRNPRLGDONE]

Figure 4 Manufacturing Net Profit Rates: Germany, Japan, and the 
United
States, 1948-1999      
[USJAPGERMFGRNPRJULY6LGDONEEPADONE]
About Here
 
At the start of the 1980s, in the interest of fighting inflation and
restoring profit rates, the US, and other advanced capitalist states,
sought to combat the international over-capacity and over-production 
that
was the legacy of the Keynesian era by introducing high interest rates 
and
deep austerity.   These measures were designed, in the first instance, 
to
raise unemployment so as to reduce wage growth.  But they were aimed 
as
well to shake out the great ledge of high-cost, low profit means of
production that was holding down profitability.  Nevertheless, the
immediate result of their implementation was the outbreak of the
debt-crisis in the third world, accompanied by serious recession that
threatened depression in the US.  Keynesianism had to be re-introduced 
with
a vengeance, in the form of Reagan's massive military spending and tax 
cuts
for the rich.  

The combination of tight money and high government deficits that 
prevailed
in the US was indispensable in keeping the advanced capitalist 
economies
turning over. This was especially because most of these economies had
introduced harsh wage and social spending cutbacks that reduced 
domestic
demand, rendering them increasingly reliant upon exports and, in the 
last
analysis, the stimulus provided by US spending.   Nevertheless, the US
policy mix also slowed the shakeout of redundant and high cost plant 
and
equipment and labor that was still required to restore profitability 
and -
most important - it drove up real interest rates.  The advanced 
capitalist
states were clearly unwilling to sustain the sort of severe depression 
that
had, in the past, served to eliminate superfluous means of production 
and
labor and to provide the foundation for a new upturn.  But the price 
of
economic stability was record-high costs of borrowing, which, in
combination with still reduced profit rates, reined in capital 
accumulation
and economic growth, which remained heavily dependent upon government
deficits, through the end of the decade.

With the potential for good returns from investment in new plant and
equipment so sharply reduced, capital lurched during the course of the
1980s sharply in the direction of finance.  But with the real
economy producing such small surpluses, it was not easy to profit 
through
lending or speculation, except with the direct or indirect help of
governments - as, for example, via government borrowing at high rates 
of
interest or by exploiting the opportunities for corruption that came 
with
government de-regulation and privatization programs.   By the end of 
the
decade, a huge bubble in commercial real estate had gone bust.  The
leveraged mergers and acquisitions craze, no doubt the defining aspect 
of
the 1980s financial expansion, had also collapsed in ignominy.  Deeply
indebted corporations and profoundly exposed banks were thus left in
precarious condition, very much exacerbating and extending the 
recession
that hit in 1990. Economic stagnation thus perpetuated itself into the
first few years of the 1990s. 

US Manufacturing Recovery

Against the background of still much-reduced rates of return and 
slowed
growth internationally, between 1986 and 1995 the US manufacturing 
sector,
and thereby the private economy as a whole, achieved a striking 
recovery of
profitability and, ultimately, vitality.  It did so by taking a leaf 
from
the book of its leading international rivals in Germany and Japan,
achieving a powerful revival of international competitiveness and 
exports. 
But US manufacturers did not increase their competitiveness and
profitability by means of stepped up investment in aid of rising
productivity - at least not until very late in the game.  They did so
instead by means of the classical capitalist mechanisms of shakeout of 
high
cost, low profit means of production and re-distribution of income 
away
from both labor and their overseas rivals.   

In the extended cyclical downturns of the first half of the 1980s and 
the
first third of the 1990s, US corporations shed huge masses of high-
cost,
low profit means of production and, especially labor, and thereby 
began a
revival of manufacturing productivity growth without the assistance of
investment growth.  They benefited, too, by holding real wages 
virtually
constant during the decade after 1985 and taking advantage of Reagan
administration tax breaks that enabled them to sharply reduce the 
share of
taxes in profits.  Over the same period, they were also able to profit
mightily from the devaluation of the dollar by 40-60 per cent with 
respect
to the mark and yen.  This realignment of currencies was detonated in 
1985,
when the US obliged its main allies and rivals to agree to the Plaza
Accord, which called for bringing down the dollar from the heights it 
had
reached during the first half of the decade. Finally, from the time it
entered office in 1993, the Clinton administration sought to balance 
the
budget.  In this way, it reduced the growth of aggregate demand and 
thereby
helped somewhat to bring down both inflation and long term interest 
rates,
further improving competitiveness while also putting further downward
pressure on wages.  

Between 1985 and 1995, the US manufacturing sector increased its rate 
of
profit by about two-thirds.  It thereby succeeded in raising 
profitability
for the private economy as a whole above its level of 1973 for the 
first
time in more than 20 years.  The take-off of US manufacturing 
profitability
was deeply dependent upon an extraordinary recovery of US 
manufacturing
competitiveness, and exports rose more quickly over the decade than 
they
had during any previous ten year period in the postwar epoch.  The 
most
important outcome was the transcendence of the long period of 
manufacturing
investment stagnation.  From around 1994, capital accumulation sped up 
and
productivity growth leaped forward, amplifying the rise in 
profitability
and setting off the expansion of the 1990s. 

          Japanese and West European Manufacturing Impasse
In an ideal world of mutually complementary specialized productions, 
the
revitalization of the US economy might have ended up propelling the 
world
economy into a new era of growth.  But, before the mid-1990s, in the 
actual
world of manufacturing over-capacity and redundant production, the US
recovery not only imparted little increased dynamism to the world 
economy,
but came to a large extent at the expense of the economies of its 
leading
competitors and trading partners, especially Japan and Germany.  This 
was
because, right up until the end of 1993, it took place against a 
background
of continuing international over-capacity and over-production in
manufacturing.
US producers thus secured their gains in profitability primarily by 
means
of the falling dollar and essentially flat real wages, as well as 
reduced
corporate taxation, but without the benefit of much increase in 
investment.
 In what turned out to be pretty much a zero-sum game, they raised 
their
rates of return by reducing costs so as to successfully appropriate 
market
share from their rivals, while imposing upon them their lower prices.   
But
they generated in the process relatively little increase in demand, 
either
investment demand or consumer demand, for their rivals' products. When 
the
US government moved in 1993 to balance the budget, the growth of
US-generated demand in the world market received an additional 
negative
shock. 
As the opposite side of the same coin, from 1985 the manufacturing
economies of Japan, Germany, and elsewhere in western Europe faced an 
ever
intensifying squeeze. Their rising currencies, as well as their 
relatively
fast wage growth, made for declining competitiveness, thus increased
downward pressure on already reduced manufacturing profit rates and 
capital
accumulation. Meanwhile, the declining growth of investment, consumer, 
and
government demand throughout th
e global economy issued in stagnating purchasing power for their goods 
at
home and abroad, most especially in the US.  These economies could 
thus
avoid neither intensifying problems during the second half of the 
1980s,
nor severe crisis during the first half of the 1990s, and, from 1991, 
they
entered into their worst recessions of the post-war epoch. By mid-
decade,
as the yen rose to 79 per dollar, its highest level of the post-war 
epoch,
Japanese manufacturers could barely make a profit, and the Japanese 
economy
began to freeze up

THE STOCK MARKET BUBBLE AS ENGINE OF THE EXPANSION, 1995-2000

By spring 1995, the rising yen had begun to threaten international 
economic
stability.  The US government, recently traumatized by the Mexican 
Peso
Crisis with its associated Tequila Effect, felt it had no choice but 
to
bail-out the Japanese manufacturing economy.  It did so in much the 
same
way that the Japanese and German governments had bailed out a crisis-
bound
US manufacturing economy in 1985 - by engineering, in collaboration 
with
the other G-3 powers, a new rise of its currency.  The so-called 
reverse
Plaza Accord of summer 1995 marked a turning point for the world 
economy,
as the ensuing ascent of the dollar, as well as the East Asian 
currencies
tied to it, and parallel decline of the yen and the mark, initiated a
epochal shift away from the pattern of international economic 
development
that had prevailed for the previous decade.   

                Declining Profitability, Rising Equity Prices

As the dollar began to rise from the latter part of 1995 after a
decade-long descent, the weight of continuing international over-
capacity
and over-production in manufacturing shifted away from Japan and west
Europe and back toward the US. The revalued currency thus immediately 
cut
short that extended rise of US manufacturing competitiveness that had
underpinned the US profitability revival.  In 1996 and 1997, the US
manufacturing expansion did manage to sustain itself, as output shot 
up,
productivity growth accelerated, and costs of production fell 
impressively.
 Nonetheless, US manufacturing lost vitality, because squeezed between 
the
intense downward pressure on prices that was resulting from the 
surfeit of
international manufacturing supply and its own rise in relative costs 
that
was resulting from the rising currency.  Indeed, had US manufacturers 
not
succeeded in actually reducing real wages in these couple of years,
manufacturing profitability would have started to fall right then.  As 
it
was, a serious fall-off would not be long in coming.

Meanwhile, in 1995, under the terms of the Reverse Plaza Accord by 
which
the G-3 powers had agreed to the great turnaround of the 
dollar/yen/mark
exchange rates, the US, German, and especially the Japanese government 
let
loose a huge flood of funds onto US money markets to drive up the 
dollar,
mainly through the purchase of US Treasury instruments.  East Asian
governments, as well as hedge fund speculators from around the world,
followed suit.  As a result, US long term interest rates fell sharply, 
at
the same time as the Federal Reserve pushed down short term interest 
rates
(to help combat the Mexican Peso crisis).   

The enormous easing on financial markets that thus took place in 1995, 
as
well as the rise of the dollar itself, detonated the great stock 
market
run-up.  Hitherto - between 1980 and 1995 - US equity prices had risen
significantly, but no more than had corporate profits.  Up to 1995, in
other words, the rise of the stock market had been fully justified by 
the
underlying increase of corporate profits.  But, henceforth, equity 
prices
left corporate profits in the dust, especially as the manufacturing 
profit
rate ceased to rise and turned down, and the biggest stock market 
bubble in
US history blew up.

Figure 5 Index of Corporate Profits Versus New York Stock Exchange
Composite Index
[USSTOCKMARKVERSPROFINDEX95LGDONE: Chart2 1995]
About here

If the international financial shifts of 1995 set off the stock market 
run
up, Alan Greenspan and the corporations themselves perpetuated it.  By 
late
1996, Greenspan was publicly voicing worry about the "irrational
exuberance" of share prices.  But he was clearly even more concerned, 
in
private, about the possible stumbling of the US economy, especially as 
the
dollar rose and economic growth at first proved hesitant.  Greenspan 
thus
made no attempt to control the enormous increase of liquidity that 
resulted
from the influx of foreign money and his own reduction of interest 
rates. 
In fact, aside from a one-quarter point increase in early 1997, 
Greenspan
failed to raise interest rates between the beginning of 1995 and the 
middle
of 1999, with the result that during the second half of the decade the
money supply increased at quadruple the rate it had during the first 
half. 
Greenspan's loose money regime had the effect of pushing up the stock
market further and, not accidentally, stoking the "wealth effect"-i.e.
endowing corporations and households with the increased paper wealth 
that
allowed them to borrow more easily, as well as, in the case of the
corporations, to issue shares at inflated prices, and on that basis to 
step
up their investment and consumption, buttressing the economic 
expansion.   

US corporations were quick to exploit the easy money gifted by Alan
Greenspan.  Between 1995 and 2000, they increased their borrowing as a
fraction of corporate GDP to record levels, not mainly to fund 
expenditures
on new plant and equipment, but primarily to cover the cost of buying 
back
their own shares. In this way, they avoided the tedious process of 
creating
shareholder value through actually producing goods and services at a
profit, and directly drove up the price of their shares for the 
benefit of
their stockholders, as well as their corporate executives who were 
heavily
remunerated with stock options.  US corporations were the largest net
purchasers on the stock market between 1995 and 2000.

                The Wealth Effect of Rising Equity Prices

The runaway stock market allowed the US expansion to continue and
accelerate in the years between 1995 and 2000, even as the downward
pressure on the manufacturing profit rate came to deprive the 
expansion of
its initial solid foundation.  As the paper value of their assets 
inflated
far beyond any possible underlying economic value, corporations were
endowed with vast alternative sources of virtually costless funding, 
aside
from profits.  They could issue over-valued shares; they could also 
secure
endless supplies of credit by using the inflated value of their assets
essentially as collateral. They were thus able to maintain, even 
increase,
the rate of growth of their expenditures on new plant and equipment,
despite the diminishing relative contribution of profits.  Thanks to 
this
"wealth effect," the expansion achieved increasing vitality. 



LIMITS TO THE WEALTH EFFECT

Nevertheless, an economic expansion driven by skyrocketing share 
prices in
the face of stagnating or fall profits had a limited future.  The 
downward
tendency of profits was bound to register in the stock market, sooner 
or
later.    Once equity prices began to fall, moreover, the wealth 
effect
would go into reverse, and an economy faced with ever-greater over-
capacity
would plunge.  .  

The International Crisis of 1997-1998 

Nor were profitability problems and asset bubbles confined, at this
juncture, to the US.  Between 1985 and 1995, the East Asian 
manufacturing
economies had achieved extraordinary export-based growth, heavily on 
the
basis of the fall in the value of their currencies.  These devalued
currencies, which were pegged to the declining dollar, endowed these
economies with huge gains in competitiveness, and market share, with
respect to their Japanese rivals.  They also obliged Japanese 
manufacturers
to re-locate much of their low end production to East Asia and to
re-orient, in turn, a good part of their capital and intermediate 
goods
exports in that direction as well.  But, beginning in 1995, the tables 
were
turned.  The same rising dollar that that was both undercutting US
manufacturing profitability and helping to drive US equity prices 
upward
also pulled East Asian currencies skyward.  The economies of East Asia 
thus
began to experience the same dual trend toward declining manufacturing
competitiveness leading to downward pressure on manufacturing
profitability, on the one hand, and to an inflow of foreign funds 
leading
to upward pressure on asset prices, on the other, as did the US.   

The chain reaction did not stop there.   Between 1985 and 1995, in 
response
to the high yen, Japanese producers had reoriented production to East 
Asia,
increasing capital goods exports to the region, while re-locating 
lower end
manufacturing there.   When the yen fell from 1995 in the wake of the
reverse Plaza Accord, Japanese producers were able to regain domestic
market share from their East Asian rivals and force them out of third
markets.  But, the resulting crisis of East Asian manufacturing could 
not
but boomerang against the Japanese economy, for it deprived Japanese
corporations and banks of what had only recently become their best 
markets.
 By 1998, Japan had returned to recession.  

Nor did the US economy prove invulnerable.  In the wake of the 
bursting of
equity price, land, and construction bubbles and the consequent flight 
of
money from the region, the East Asian crisis broke out in earnest in
1997-1998 and was quickly exacerbated by Japan's return to negative 
growth.
  US producers lost market share in East Asia and Japan and were hurt 
by
low cost East Asian goods in their overseas and domestic markets.  In 
1998
and 1999, US exports, having risen at an unprecedented pace for the 
better
part of a decade, suddenly ceased to grow at all, while imports 
continued
to increase at their previous accelerated pace.  In the face of such
pressure, the US corporate manufacturing profit rate fell by 17 per 
cent
between 1997 and 2000 and was totally responsible for a corresponding
decline in the non-financial corporate profit rate of 9 per cent in 
this
period (the non-manufacturing non-financial corporate profit rate did 
not
fall at all).

Figure 6 US Corporate Manufacturing and US Non-Financial Non-
Manufacturing
Corporate Net Profit Rates, 1986-2000  
[AB ChartIndex]
About here

Meanwhile, starting from mid-1998, US corporate equities began to fall
sharply, in response to a decline of corporate profits under the dual
pressure of the crisis in East Asia and the inflated dollar. In the 
wake of
the ensuing Russian default and Brazilian crisis, the US descended, in
early Autumn 1998, into its most serious economic-financial crisis of 
the
post war epoch.  But, if the US went into recession, much of the rest 
of
the world economy, so dependent upon the US market, might be headed 
for
depression.

     The Fed Sustains the Bubble and the Bubble Sustains the Boom

In September-October 1998, with global financial markets freezing up, 
Alan
Greenspan and the Federal Reserve engineered their famous bail-out of 
the
LTMC hedge fund and lowered interest rates on three occasions.  They 
did
so, in the first instance, in order to stop the stock market's descent 
and
combat a crisis that threatened to bring down the international 
financial
system.  But Greenspan's goal was not merely short term, to head off 
equity
market and financial market collapse.  It was to assure equity 
investors
that he wanted share prices to rise so that the "wealth effect" of the
stock market's continuing ascent could keep the US, and world, economy
turning over.  

What Greenspan was attempting might usefully be called "stock market
Keynesianism".  In traditional Keynesian policy, demand was 
"subsidized" by
means of the federal government's incurring rising public deficits by
spending more than it took in taxes.  By contrast, in Greenspan's 
version,
demand would be increased by means of corporations' and rich 
households'
taking on rising private deficits, encouraged to spend beyond their 
means
by the increased paper wealth that was represented by the increased 
value
of their stocks.   By 1997-8, the US campaign to balance the budget 
had
reduced deficit spending to zero, and recourse to traditional 
Keynesian
methods was ruled out.  In order to stoke investment and consumer 
demand
and thereby counter-balance the worsening decline in manufacturing
competitiveness, exports, and profitability, the Fed thus had little 
choice
but to force up the stock market, further increasing the economy's
dependence upon the wealth effect.  

By virtue of his material reassurances to the equity markets, as well 
as
his paeans to the New Economy, Alan Greenspan pretty much achieved his
goals, with epoch making results.  Between the end of 1998 and the 
middle
of 2000, the stock market run-up and in turn the US economic boom 
entered
their most fevered phase.  With equity prices reaching their highest
levels, despite simultaneous fall-off of profitability, corporations 
all
across the economy - especially those in telecommunications, media, 
and
technology (TMT), which enjoyed a disproportionate share of the
stock-market increase - gained access to funds practically for free.   
On
this basis, they unleashed a further wave of growth, capital 
accumulation,
and productivity increase, accelerating the expansion still further.
  
Figure 7  Technology, Media, and Telecommunications: Equity Prices 
versus
Profits
[USTMTSHAREPRICESPROFITSLGDONE]
About here
 
Last but not least, the huge rise in US demand that resulted from the
speeding up of the expansion, plus the still rising dollar, rescued 
the
world economy from its crisis of 1997-1998, and incited a new 
international
economic upturn in 1999-2000.  The impact of the very rapid growth of 
US
imports was most evident in East Asia, where the unprecedented call 
for
high tech components practically single-handedly drove the NICs, as 
well to
some extent as Japan, from deep recession to rapid growth.   But it 
was
also indispensable, for western Europe, where US demand for cars, 
machine
tools, and other products made possible the rapid comebacks of both 
the
German and Italian economies, while the low currency eased Euro area
producers' access to third markets. 


FROM STOCK MARKET CRASH TO RECESSION  

The stock market was running over a cliff, but, like the proverbial 
cartoon
character, so long as equity investors refused to look down, to 
concern
themselves about corporate profitability, it could continue to move 
upward.
 In the last several years of the decade, the fall in profitability 
was,
for a time, partially mitigated by big productivity gains secured by
manufacturers by means of increased investment growth financed on the 
basis
of their inflated stock values.  It was also partially countered by
stepped-up consumption growth on the part of the wealthiest 20 per 
cent of
US households, who enjoyed a full 90 per cent of the increase in 
wealth
represented by stock market run-up and were, by themselves, 
responsible for
the historically unprecedented rundown of the US personal savings rate 
over
the course of the 1990s.   Nevertheless, the facts that, in these 
years,
even despite accelerated productivity and consumption growth, 
manufacturing
profitability fell significantly and capacity utilization failed to 
rise,
indicate that the build up of excess capacity had already assumed 
major
proportions even as the boom reached its zenith.

The stock market finally began to fall from spring 2000 and then, more
definitively, from late summer 2000, when a seemingly endless run of 
dismal
corporate profit reports dramatically deflated equity prices.   A huge
multitude of e-commerce firms that had never shown a profit collapsed
first, as they simply ran out of funds.  But, soon the crash consumed
almost all of the leading lights of the TMT sector (technology, media,
telecommunications), including such stock market darlings as equipment
makers Cisco, Lucent, and Nortel and components producers JDS Uniphase 
and
Sycamore.   Perhaps a third of total asset values extant in early 2000 
have
by now gone up in smoke.   

As a result of the fall in equity prices, the wealth effect has gone
sharply into reverse.   With their on-paper assets sharply reduced, 
firms
and households not only have found find it more difficult to borrow, 
but
less attractive to do so, especially since the growing threats of
bankruptcy and unemployment have led them to look to repair their
over-burdened balance sheets.  In turn, they have naturally cut back
expenditures on capital and consumer goods.   But with investment 
growth
falling, productivity growth has had to drop too, putting further 
downward
pressure on profitability.  

Above all, the economy has found itself in possession of great masses 
of
plant, equipment, and software, which can in no way be realized, 
especially
as the growth of consumption has plummeted.   The resulting over-
capacity
had succeeded in 2001 in reducing absolute profits (net of interest) 
in the
manufacturing sector by 60 per cent from their 1997 high point, while
bringing down the profit rate in the non-financial corporate sector as 
a
whole 25 per cent below its 1997 peak.  

Under the impact of the reverse wealth effect and in the face of 
mammoth
excess capacity, the growth of output and of investment fell faster 
than in
any other comparable period since World War II, GDP growth declining 
from
5.2 per cent in the year ending at mid-2000 to 0.8 per cent (on an
annualized basis) in the first half of 2001 and non-residential 
investment
growth from 11 per cent to minus 7.4 per cent over the same interval.   
It
is the collapse of investment in the face of manufacturing over-
capacity
and plummeting profitability that is at the heart of the recession.

Manufacturing employment and output began to fall immediately and
profoundly, in the wake of the stock market crash and profitability
decline, hours worked in manufacturing dropping by an astounding 12 
per
cent from their peak in 1997 to the first quarter of 2002.   But it 
was
only from around the middle of 2001 that the US economy as a whole 
began to
fully register the profound shrinkage of its markets that has followed 
upon
these fall-offs of growth and capital accumulation and to take the 
standard
measures of self-preservation.   Since that point, US non-
manufacturing
corporations have been lopping off great swathes of their productive
capacity, and, in particular, their labor forces, in an effort to 
restore
competitiveness and balance sheets, placing huge pressure on their 
rivals
to respond in kind.  The aggregate effect has been to set off a 
powerful
downward spiral in which falling investment and consumption has led to
rising layoffs, bankruptcies and loan defaults, making for further 
sharp
falls in demand, creating the pressure for deepening recession..

As the US entered recession, the rest of the world followed in virtual 
lock
step. The stock market's last upward thrust had performed the 
indispensable
function of rescuing not only the US, but also the world economy, from 
the
international economic crisis of 1997-1998 originating in East Asia.  
But
with US equity prices and investment collapsing, especially in high
technology, the film began to run in reverse.  Under the impact of
plummeting US imports, the economies of East Asia, Japan, and perhaps
western Europe, thus lost steam faster than that of the US.   As they 
did,
US export growth has fell even faster.   A mutually-reinforcing
international recessionary process was the result.   


CAN EXPANSIONARY POLICIES STEM THE TIDE?

To stem the economy's frightening plunge over the course of 2001, the
Federal Reserve lowered interest rates extremely sharply and extremely
rapidly. The idea of course was to encourage spending by making the 
real
cost of borrowing exceedingly cheap. 

Nevertheless, it should have been evident from the start that this 
policy
would have little direct effect on capital accumulation, the ultimate 
key
to any recovery.  Corporations already possessed far too much too much
plant and equipment, so had no desire to invest. They therefore 
wouldn't
borrow no matter how cheap it was to do so. In this sense, the Fed 
was, in
Keynes' famous phrase, 'pushing on a string.'

The historic reduction in interest rates has, however, been quite
successful, in its main short-term goal -i.e. to spur consumer 
spending.
Super-cheap credit thus has provoked an extraordinary increase of 
household
borrowing, especially by means of the re-financing of home mortgages, 
even
as unemployment has steadily increased. Rising personal consumption 
has
thus single-handedly saved the economy, at least for the moment.  In 
2001
and the first quarter of 2002 the growth of household borrowing 
increased
faster than at any time during the debt-driven 1990s.  This allowed
personal consumption expenditures to grow by 3.1 per cent in 2001, and 
by a
whopping 6 per cent in the fourth quarter of 2001.   In response to 
this
increase in spending on the part of consumers, corporations began
rebuilding the inventories that they allowed to run down as the 
downturn
deepened, and GDP has responded accordingly. It is the causal chain 
running
from the growth of household borrowing, to the growth of consumer
expenditures, to the growth of inventories that has been primarily
responsible for the major step-up of GDP growth in the fourth quarter 
2001
and first quarter of 2002.

Yet, precisely because the recovery has thus been almost solely 
dependent
upon the rapid growth of consumer spending, and behind that, consumer 
debt,
its foundations are very shaky.  Non-residential investment growth, 
the key
to economic health, has fallen like a stone - from an average annual 
rate
of 14 per cent in the first half of 2000, to 4 per cent in the second 
half
of 2000, to minus 3.2 per cent in 2001.  Export growth has also 
collapsed -
from 11 per cent in the first half of 2000, to 3.3 per cent in the 
second
half of 2000, to minus 4.5 per cent in 2001 (although it began to 
recover a
bit in the first quarter of 2002).   

The downward thrust of both investment and exports was responsible for 
the
downward spiral that gripped the economy until late in 2001. It is of
course the aim of policy makers to keep consumer spending driving the
economy until investment and exports can revive, with investment 
hopefully
recovering under the stimulus of continually rising consumer 
purchases. 
But the worry is that the overhang of excess plant and equipment that 
has
been responsible for declining profits will continue to forestall any 
new
burst in investment: indeed, in the first quarter of 2002, non-
residential
investment fell even faster, by a further 6.8 per cent (on an annual
basis).  As to exports, although they can be expected to rise to the 
extent
that the US upturn stimulates growth across the rest of the world 
economy,
it is virtually certain that they will lag far behind imports, given 
how
great is the US economy's propensity to consume.  This is sure to put 
ever
increasing pressure on the already record-high US current account 
deficit.
(see below).

How long reduced interest rates can drive consumer spending is itself 
a
critical question.  In 2001, the growth of household borrowing as a
percentage of GDP reached its highest point since 1980 (except for 
1985)
and household debt as a percentage of GDP hit its highest level ever,
almost 25 per cent above that in 1990.  It therefore seems quite 
possible
that, especially in the face of a still worsening employment 
situation,
households will soon have to cut back on their taking on of new debt 
and
thus reduce their spending.   That household consumption rose in the 
first
quarter of 2002 at only half the rate it did in the last quarter of 
2001
may perhaps indicate that such a slowdown is already in progress.  If 
it
is, the nascent upturn is likely to peter out.   

Against this background of profound uncertainty, the enormous 
'imbalances'
that are legacy of the bubble of the late 1990s loom like dark clouds.

i) The record ascent not only of household, but especially corporate,
borrowing was central to the boom. But as declining prospects and
bankruptcies have loomed ever larger, corporations have sharply cut 
back
their borrowing to reduce their vulnerability. Should this continue to
happen on a large scale, a big prop to investment will go by the 
wayside.
ii) In 2001, the US trade and current account deficits were again at 
an
all-time high, for the third year in a row.  Up until recently, 
overseas
investors have been more than willing to fund these deficits, making 
huge
direct investments in the U.S., as well as enormous purchases of U.S.
corporate equities and U.S. corporate bonds.  But as the U.S. economy 
in
recession has continued to disappoint expectations and the stock 
market has
continued to languish, the rest of the world appears finally to be 
finding
U.S. assets relatively less attractive.  In 2001, although foreign
purchases of bonds held up, foreign direct investment to buy or 
establish
US businesses fell by a huge 60.4 per cent, while purchases of US 
shares by
the rest of the world declined by more than 35 per cent and another 45 
per
cent (on an annual basis) in the first quarter of 2002.   

As a result of this disenchantment with US assets, pressure on the 
currency
has mounted and
, as this is being written (mid-June 2002), the dollar has fallen 
sharply,
especially against the euro.  Were these trends to continue, the Fed 
could
soon be faced with an excruciating choice: either let the dollar fall 
and
risk a wholesale liquidation of U.S. properties by foreign investors 
that
could not only wreak havoc in the asset markets, but also set off a 
real
run on the dollar; or raise interest rates and risk pushing the 
economy
back into recession.

iii) Equity prices have obviously fallen a great deal, in response to 
the
worsening business outlook. But paradoxically, their decline has 
failed to
bring stock values back into line with profits, because profits have, 
in
many cases, dropped as far.  At the end of 2001, S&P500 index had 
fallen by
more than one third, but the price-earning ratio of the corporations
represented there was no lower than it had been at its peak in mid-
2000.  
The same goes for the NASDAQ.  Stocks thus remain highly overpriced, 
and
the stock market would therefore appear to have a way further to fall.  

To make matters much worse, a stunning succession of accounting 
scandals
have wracked a growing number of the country's leading corporations.  
These
have been marked by top managers' systematic cover-up of company 
expenses
and corresponding inflation of company profits, as well as their 
personal
appropriation of company assets.   Many of the firms affected were 
only
recently among the top high-tech stars of the equity markets, 
including not
only Enron, but the telecommunications giants Global Crossing, Quest, 
and
World.com, not to mention Merck drugs and Adelphia cable.    These 
frauds
are in no way accidental, but are the unavoidable by-product of a 
bubble
economy that lacked a real base in profits.   

Because the stock market run-up was the main force keeping the economy
turning over in the face of falling profit rates during the last years 
of
the 1990s, federal officials had every interest in averting their eyes 
from
corporate accounting practices.  By the same token, since company
executives were driven to maximize "shareholder value" - especially as 
much
of their pay tended to come in the form of stock options - they were 
under
tremendous pressure to conceal the reality of dismal, and declining 
returns
as long as possible.   But, they could not of course do so forever, 
and the
inevitable disclosures have devastated investors' confidence and with 
good
reason.  

According to a recent report by SmartstockInvestor.com, the 
corporations
listed on the NASDAQ 100 announced profits for the first three 
quarters of
2001 of 19 billion dollars to shareholders and the media.  They did so 
on
the basis of the so-called "pro forma" standards that they are legally
allowed to use for this purpose.  However, these same 100 companies 
were
could not avoid communicating losses of 82.3 billion dollars for the 
same
period to the Securities and Exchange Commission. This is because, for
their profit reports to the SEC, they are legally required to use the
rigorous Generally Accepted Accounting Principles (GAAP).   Were the 
stock
market to continue to fall, with the economic recovery so fragile, the
effect on business confidence and the economy more generally would 
likely
be very depressing, opening up the possibility of a mutually 
reinforcing
downward spiral of both the dollar and asset prices. .




 Clouded Prospects

The bottom line is that the rate of profit, the ultimate key to any
recovery, remains very depressed, and the forces that drove it up 
during
the 1990s are gone. In 2001, manufacturing corporate profits fell to 
their
lowest level since 1986. At the same time, the non-financial corporate
profit rate fell to its lowest level since 1981.  Nevertheless, the 
dollar
remains relatively quite high, keeping down the international
competitiveness of US producers, and making any manufacturing profit 
rate
recovery exceedingly difficult.  And, of course, the wealth of effect 
of
the stock market boom no longer inflates demand or makes investment 
nearly
costless.

Figure 8
NB: PLEASE DO NOT FAIL TO USE REVISED VERSION OF THIS GRAPH
US Non-Financial Corporate Profit Rate, 1980-2001
[UNNONFINANCIALCORPNPRFedRes8001done [CHART2 1980]]
About here

Even as economic growth has accelerated to almost six per cent in the 
first
quarter of 2002, the Federal Reserve has so far failed to raise 
interest
rate, a sign that it is anything but confident that the economy is 
taking
off and the recovery is secure. By the same token, the stock market 
has
continued to stagger, falling back down near its depressed levels of 
autumn
2001 in the wake of 9/11.  Clearly, big business has serious doubts 
about
the consumer-led upturn. Alan Greenspan has declared the recession 
over.
But the economy is far from out of the woods.

* Robert Brenner is an editor of Against the Current. The above text 
is
partly based on his new book The Boom and The Bubble: The US in the 
World
Economy, published by Verso Press, April 2002.



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