WORLD ECONOMY: Stagnation fuels fears of deflation, trade war



"The industrial economies are awash with excess capacity, most are experiencing disinflation and some are threatened by outright deflation. With unfortunate echoes of the 1930s, policy-makers are being tempted to use exchange rates to maximise their share of manifestly inadequate global demand."

This was how economists John Llewellyn and Russell Jones described the current state of the world economy in the May 13 Global Letter issued by the Wall Street-based Lehman Brothers investment bank.

Less than a week later, during the May 17-18 meeting of finance ministers from the G8 countries — the major imperialist economies plus Russia — US treasury secretary John Snow departed from the traditional Washington "strong dollar" policy, saying that its devaluation over the last year had been "helpful to US exporters" and that so far there had only been "a modest realignment" in the exchange rates of the dollar and the euro — a signal that Washington policy-makers have opted for a 1930s-style "beggar-my-neighbour" currency war.

Since the beginning of the year, the US dollar has lost 9% of its value against the euro, and is now 28% below its level of a year ago — making European exports to the US 28% more expensive and US exports to Europe 28% cheaper than a year ago.

While the finance ministers were meeting, figures were released showing that the economies of Germany, Italy and the Netherlands had all contracted during the first quarter of this year — by -0.2%, -0.1% and -0.3% respectively. Germany and the Netherlands are now officially in recession, having experienced two consecutive quarters of negative growth.

On May 15, Reuters reported: "Germany's economy is barely growing, unemployment is rising and inflation is so low that some see a risk of Japan-style deflation. The country, once Europe's economic powerhouse and anchor of its currency system, is now viewed as the continent's biggest problem, the red light at the back of the euro train... Germany is sinking under the fiscal burden it took on with unification in 1990, hamstrung by the constraints of European monetary union and buffeted by a stormy global economy. Its economy slipped into a technical recession at the end of 2001 and has stagnated since."

Germany's economy has grown at an average rate of just 1.3% per year since 1992, and last year grew by only 0.2%. Unemployment, now around 4.5 million, is forecast to hit a post-war high of 5 million next northern winter.

Reuters added: "The European Union (EU) economy stagnated in the first three months of 2003, as the region's gross domestic product showed no growth for the first time in almost two years, according to estimates from the EU's statistics agency."


On May 16, a Japanese cabinet office report revealed that Japan's economy remained at a virtual standstill during the January-March quarter as gross domestic product (GDP) rose a mere 0.006% compared with the previous quarter. This translates to an annual rise in GDP of 0.025%. It was the fifth quarter in a row that an increase was reported, but the rate of growth was so low that, in reality, Japan's economy has had zero growth.

Together, the EU and Japan account for 40% of world economic output. "The world doesn't have much of a growth cushion", Stephen Roach, chief economist at Morgan Stanley investment bank, told the May 15 New York Times. "Though the US has been a reliable motor for the rest of the world, Mr Roach said that with a growth rate of less than 2%, it could no longer be counted on to drag along Europe and Asia... Indeed, the US is indirectly aggravating Europe's misery, through the dollar, which has tumbled 26 per cent against the euro in the last year. That could hobble growth in Europe by making German cars, Italian shoes and French wine more expensive in the American market."

The US economy, which accounts for 31% of the world's economic output, expanded at a real annual rate of 1.6% in the first quarter of this year, after growing by an average of 0.2% in 2001 and by 2.9% in 2002.

In testimony before the US Congress on May 21, Alan Greenspan, head of the Federal Reserve Board, the US central bank, described recent data on the US economy as "disappointing". In particular, he singled out the official unemployment rate, which rose to 6% (adding in part-time workers who want full-time jobs, the US unemployment rate is in fact around 11%) and industrial production, which fell 0.5%, in April.

Manufacturing capacity in use declined to 74.4% in April, the lowest level since June 1983. Indeed, manufacturing capacity utilisation has not recovered since it slumped from its 1997 peak of 84% to 75% during the 2001 recession.

"Business investment and employment in the US is likely to continue shrinking this year, according to a six-monthly survey of US purchasing executives", the May 21 London Financial Times reported.

Because of massive levels of unused capacity throughout the economy, the US Institute for Supply Management said manufacturers expect business investment to fall another 3.1% in 2003 — a reversal from the December forecast of a 4.6% increase. They also expect a further 0.5% decline in employment.

In his testimony to Congress, Greenspan expressed concern that a "substantial fall in [the rate of] inflation", or disinflation, would be "unwelcome". While dismissing the likelihood that the US economy is threatened with a sustained period of across-the-board declines in prices, or deflation, Greenspan added: "The threat, even though minor, is sufficiently large that it does require very close scrutiny and maybe action on the part of the central bank."


With deflation, prices for goods, services, stocks and real estate fall across the board. Consumers — seeing a steady stream of discounting — delay making purchases to wait for even better deals later. Businesses respond by throttling back production and cutting investment, wages and jobs, sending the economy into a deflationary spiral. The last time this happened in the US was during the 1930s Great Depression.

Fears of deflation have been fuelled in the US by figures released on May 16 showing that wholesale prices dropped by 1.9% in April.

The May 16 London Financial Times reported: "Fears of deflation in the US rose on Friday as stock prices fell and government bond yields dipped to 45-year lows after a key measure of inflation dropped to its lowest level in 37 years. The concerns were heightened by reports that Japan's deflation gathered pace in the first quarter with prices down 3.5 per cent from a year ago, their fastest 12-month drop on record.

"The fall may fuel concerns that the Japanese economy could be in a deflationary spiral. Japanese prices have been falling since 1995 at an average annual rate of 1 to 2 per cent. The latest figures showed deflation accelerating in the 2002 financial year to 2.2 per cent, a record for a full year."

The same day, the CNN/Money web site reported that, since the last northern summer, US Federal Reserve policy-makers "have been openly discussing the lessons of Japan — whose economic situation in the 1980s and 1990s bears an eerie resemblance to the US economic situation in the 1990s and 2000s."

These similarities were highlighting by well-known economist Paul Krugman in an article that appeared in the May 27 New York Times: "The American situation is strikingly similar in some ways to that of Japan a decade ago. Like Japan circa 1993 or 1994, the United States is now facing the aftermath of a huge stock market bubble. Also like Japan, America faces a problem not of sharp downturn but of persistent underperformance — an economy that grows, but too slowly to prevent rising unemployment and falling capacity utilisation."

Prices for consumer durables (goods that last longer than three years) have been declining in the US for several years now. According to the US Bureau of Labor Statistics, in April the prices of consumer durable goods fell at their fastest pace since 1938. Prices for appliances such as refrigerators and washing machines were down 2.6% in the 12-month period that ended in March, according to the bureau, and have fallen 9% over the past five years. Prices for bedroom furniture were down 1.5% in the year ended in March and 5% over five years. TV prices were down 12% in the past 12 months and nearly 40% over five years.

Potential crisis

While a declining US dollar would reduce deflationary pressures in the US by raising the prices of imported goods, it carries with it the potential for a financial crisis. If the decline in the US dollar becomes too rapid, there is a risk that foreign investors, who have financed the growing US foreign debt, could stop doing so.

The US rulers' policy of allowing a substantial devaluation of the dollar against the euro and the yen reduces European and Japanese exports to the US, further exacerbating productive overcapacity in the economies of the EU and Japan and intensifying the pressure toward a deflationary spiral in those economies.

Globally stagnating markets are also leading to growing trade disputes between the EU and the US. According to the May 21 Business Week magazine: "The Europeans are threatening to levy $4 billion in penalty tariffs against the US as early as January if Congress doesn't repeal the 30-year-old tax break for exporters. The US meanwhile, is threatening its own action against a European moratorium on imports of genetically modified corn, soybeans, and other crops from the US.

"The growing enmity between the two trading blocs has held up global negotiations for freer trade at the Geneva-based World Trade Organisation. The WTO talks 'are losing momentum', complains Boeing corporation CEO Philip Condit."

From Green Left Weekly, June 4, 2003.
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