8.8 million officially unemployed. Downsizing. Bankruptcies. Budget cuts. Growing debt. Any worker can tell the economy is in trouble these days.

But it took Alan Greenspan, chairman of the Federal Reserve Bank, to publicly acknowledge fears of a serious economic crisis, including the prospect of deflation, for red flags to go up throughout the political and financial establishment.

So what is going on? What is plaguing the economy? What is deflation and how will it affect the average worker?

Deflation is a general fall in prices over a sustained period. While that may sound great at first to workers, a deflationary spiral can have a profoundly negative impact on the economy. Falling prices means falling sales and profits for corporations, which forces firms to try to minimize costs, squeeze wages and layoff workers. This in turn leads to workers buying fewer goods, triggering a further lowering of prices as companies attempt to attract buyers, thus deepening the downward spiral.

Deflation also in effect makes debt larger since wages and prices are falling, but debts remain the same. The result is a massive increase in debt defaults and bankruptcies – leading banks with too much bad debt to go bust.

“We’re living in amazing times,” said Ian Morris, HSBC chief domestic economist. Deflation “has never been an issue since the 1930’s” (NY Times, 5/7/03).

According to Greenspan and most “experts,” a deflationary crisis remains unlikely. But for Greenspan to even utter the word – speaking about such a threat for the first time since the Great Depression – is a sign of how nervous the capitalist class is about the economy.

Signs of deflation are increasing. The “annualized rate of core consumer-price inflation over the past 6 months [was] below 1%, the lowest rate in almost four decades” (The Economist, 6/14/03). With a sluggish economy, weak demand, and massive over-capacity, prices could begin to fall on a widespread scale.

The IMF recently released a report warning that Germany, the world’s third largest economy, which is already in a recession, now faces a serious threat of deflation. Japan, the world’s second largest economy, has been caught in a deep deflationary trap for the past decade.

Journalist William Greider recently asked a financial economist at a major US hedge fund where the United States appears to be at this point. “We are in the second or third year of what Japan has gone through,” the economist surmised. When asked how much longer this might go on, he responded: “Another ten years, if you think about Japan, another ten years” (The Nation, 6/30/03).

The main factor pushing prices down is a classical crisis of over-capacity in the US and world economy, or what Karl Marx called a “crisis of over-production.” The “world is awash with excess capacity in industries from telecoms and airlines to banking and cars, putting downward pressure on prices” (The Economist, 5/17/03).

Manufacturing is operating at only 72.5% of its productive capacity – lower than the 1990-91 recession and approaching the severity of the 1982 recession.

According to the up-side down logic of capitalism, in a world of poverty and hunger, we have “too many” things, “too much” wealth. How is this possible?

When economists talk of “over-capacity,” they do not mean there are too many goods compared to what people actually need, but that there are more goods than can be sold on the market at a high enough rate of profit. There is plenty of need for more housing to be built to end the housing crisis sweeping through many cities, and also to house the homeless. Yet there is not enough money to be made for it to be worthwhile for a capitalist to invest his capital.

On the basis of capitalism, the solution is to destroy productive capacity, purging the system of its “excesses” in order to restore the conditions for profitable investment again. The cost for this is primarily paid for by the working class in the form of mass layoffs, cuts in wages and benefits, speed-ups, poverty, and cuts in social services.

Bubble Trouble
The US economy began to slow down in 2000 with the bursting of the stock market bubble, which is still enormously over-valued. But the recession from 2001was cushioned by continued consumer spending. With real wages falling and unemployment rising, this was only possible on the basis of massive amounts of consumer debt, facilitated by the Federal Reserve’s policy of low interest rates and easy credit.

This continued the long-term trend of growing consumer debt, which has been used to artificially maintain workers’ living conditions (and spending) despite the bosses’ assault on workers’ wages and benefits over the past 25 years.

Personal debt is now at an extraordinary 130% of disposable income, up by nearly a third since the mid-1990’s (The Nation, 6/30/03). With the inevitable contraction of consumer spending as debts are re-paid off, the main dynamo of the US economy over the past period will be removed. This will add to the deflationary pressures on the economy, forcing companies to lower prices as demand falls.

Alongside the mountain of consumer debt are the gigantic debts the US owes to the world. The current account deficit (the trade deficit plus the balance of profits on investments, dividends, currency transfers, etc.) stands at approximately $500 billion.

The 1990’s boom was largely financed by foreign capital, which propped up the stock market, the strong dollar, and the account deficits. It was also this influx of foreign capital that helped finance consumer debt.

This is clearly unsustainable in the long run and will bring about a sharp and painful economic correction at a certain stage.

Another potential danger to the economy is a sharp fall in the dollar. The dollar has dropped 8% against the currencies of America’s trading partners this year, and 27% against the euro from its peak in 2001. This reflects a sharp falling off of foreign investment into the US economy.

If the dollar continues to slide, or plunge at certain stage, it would wreak havoc in the world’s currency system, which is based on the dollar. A falling dollar and capital flight from the US will severely undermine the sustainability of the massive US debt. It would also mean a further plunge in Wall Street stocks and bonds, causing another shock to the system and hurting workers’ pension funds.

The Federal Reserve’s continual cutting of interest rates to stimulate the economy (now the world’s lowest interest rates after Japan’s) has helped push the dollar down and made the US less attractive to foreign capital since capitalists can receive higher interest rates in other countries.

But if the US were to raise interest rates to attract more foreign capital in order to prop up the dollar and the account deficit, it would put a break on the US economy, thus increasing the danger of deflation and making the US debt mountain more expensive.

A Way Out?
Many capitalist commentators believe a slow, steady decline in the dollar can offer a way out for the US economy. A lower dollar, they argue, will mean fewer imports (as their price in US dollars would go up) and more exports (as US goods would be cheaper in other countries). They also hope it will counteract deflationary pressures by helping to raise prices in the US since imported goods would theoretically become more expensive.

In reality, due to the anarchy of the market, it is unlikely the dollar can fall in a slow and manageable fashion. But even if their scenario worked out, it would only export the crisis to other countries by reducing the world’s exports to the US. Over the past period, the world economy has depended upon the US market as the buyer of last resort. A fall in world exports to the US would throw the world economy into crisis, which would unavoidably work its way back into the US. Further, a devalued dollar would represent an attack on US workers in the form of falling real wages due to prices increasing.

Meanwhile, Greenspan, Bush, and the pundits continue to maintain that “a rebound is just around the corner” and that “the fundamentals are sound.” Leaving aside the fact that their predictions have been repeatedly wrong, their actions contradict their own claims.

The Federal Reserve continues to cut interest rates, a move that is designed to stimulate the economy and to counteract deflationary pressures. Interest rates have been cut 13 times since January 2001, with short-term rates now at 1%, the lowest level since 1958.

For the capitalist economy to begin growing, business needs to start investing. But with massive over-capacity and low demand, what incentive is there to build new plants? Greenspan’s 13 interest rate cuts have failed to change this.

Likewise, the Bush administration’s tax cuts for the rich are unlikely to have much of a stimulative effect, as the rich are likely to pocket most of the tax cuts and spend very little. Moreover, it will massively increase the federal budget deficit, creating enormous pressure to cut federal, state and local budgets, particularly services needed by the poor and workers.

Whatever the exact course that the US economy takes, we can be sure that big business will try to make the working class pay for the crisis of their system. As working class people move into struggle to defend themselves against the assault on their living standards, they will increasingly seek out an alternative to the capitalist system.

With socialist measures, capitalism’s crisis of over-capacity and its parasitical financial speculation could be overcome through the establishment of a rationally planned global economy. Working people would finally harness the enormous productive capacity they have created under capitalism to meet the needs of humanity in an environmentally sustainable fashion.

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