Marvin Zonis is Professor Emeritus, the Graduate School of Business, The University of Chicago. He is an expert on global economics, politics and leadership.
Probably the most important thing to say is that this has happened before and will happen again. Most of us will survive. The question is what our survival will look like.
The pain of the fall in the stock market and the fall in house prices means that U.S. consumers will cut back. Household debt is at record levels and the consumers appear tapped out. Since household consumption drives the economy – some 70% of the GDP of the US is private consumption – economic growth is bound to slow dramatically. (“The debt of the household sector has increased from 60% of GDP during the early 1990’s to almost 100% recently. Household borrowing is still positive but the growth rate has plunged from nearly $1.2 trillion per annum three years ago to only $500 billion recently.” David Hale Global Economics, September 24, 2008)
Unemployment in the US will increase adding to consumer reluctance. Some one million jobs will have been lost in the US by the end of 2008.
The debacle on Wall Street necessitates greater regulation of financial institutions, which will be forthcoming especially if Democrats control the House and Senate and the Presidency as now appears likely. The principle task of the next administration will be to formulate and implement wise regulations in the face of crisis.
The dollar will remain the global currency but weakness in the dollar is likely. The lower the level of global confidence, the higher the demand for dollars. But as confidence returns, that demand will diminish. Where will the funds go other than in USD? The beneficiaries will be the CHF and commodities.
The depth of the US economic slowdown, which appears to have entered a recession, and its length are open questions now but expect at best sluggish growth, if not negative growth, until 2010. The only area of growth in the US economy has been exports. But beginning in the second quarter of 2008, the economies of the G-7 countries began contracting. The market for US exports is shutting down.
FDI in the US is not likely to diminish because of the global abundance of dollars seeking a home, depressed US asset prices, as well as weakness to be expected in the Euro.
The fiscal position of the US Government will weaken even more significantly than it is at present. Lower taxes and higher benefits and payouts will hasten the day of the fiscal train wreck without significant government action. (“The sum of the liabilities assumed by the government during the past six months from its transactions-Fannie and Freddie, AIG, Bear Stearns, and eleven failed banks-exceed 50% of GDP. The rescue plan, which Mr. Paulson outlined last week, could push the fiscal deficit in 2009 up to $1.5 trillion.” David Hale Global Economics, September 24, 2008)
The free wheeling capitalism of the US is no more. That style of ‘wild west’ capitalism will not serve as a model for the world, if it ever did. European-style regulation, and Chinese ‘intervention and control’ are much more likely to be the model other countries adopt. This will be facilitated by the European sense that the US has completely lost its moorings.
This sense is facilitated by the fact that very few believed that the total of credit default swaps (at their peak – some $62 trillion) could ever be gracefully wound down. As early as his ‘annual letter to shareholders,’ in March of 2003, Warren Buffett referred to derivatives as “financial weapons of mass destruction” and suggested they were a “time bomb.” Why, it is reasonable to ask, did so many ignore the warning when it was pretty clear to all that $62 trillion was a staggeringly large number? Was it grandiosity that led the Wall Street crowd to assume the lives of prudent action did not apply to them? Was it the mass operation of ‘the greater fool’ theory? Or was it, as seems to have been the case with Lehmann CEO Dick Fuld, a case of massive and collective psychological denial?
U.S. global leadership will be more difficult than ever. The US lost its moral authority with the invasion of Iraq. It has now lost its claim to authority in economic development and fiscal management.
The weakening global authority of the US will contribute to further weakening of the UN and increasing demands for making the Security Council more representative of the global distribution of political and economic power. India, Japan, Brazil, among other states, seek permanent seats with veto power.
Russia’s war in Georgia and the West’s beating up on Russia in return – especially Secretary of State Condoleezza Rice’s diatribe – has led to a freeze in relations and Russia’s willful refusal to participate in further US foreign policy initiatives. So the Russians refuse additional sanctions against Iran. That is only the beginning of what will be a period of intense hostility and foreign adventures for the Russians – such as sending nuclear weapons capable bombers to Venezuela and establishing a military pact with that country – contributing to additional international strains.
International condemnation and the US financial crisis have contributed to a marked weakening of the Russian economy and the withdrawal of massive liquidity from the Russian stock exchange. Russian banks are weak and many Russian companies will suffer from their country’s relative global isolation.
The European economy is already in recession and the likelihood of an ECB rate reduction by the end of 2008 is in the cards. The key is Germany’s ability to continue to drive the European economy through its booming exports. Those exports, however, have already begun to fall and global economic weakness will see additional declines. The euro will weaken against the dollar.
Japan’s economy has already witnessed a significant slowdown as exports in August fell 22 percent (yoy). As U.S. consumption slows and imports decline so will the countries dependent on exports to the US for their prosperity.
Goldman Sachs predicts that booming consumer spending in the BRICs – Brazil, Russia, India, and China – will compensate for the inevitable slowdown in consumer spending in the US. The result, Goldman predicts, will be to maintain global economic growth at 3.5% per year. In my view, this is a wildly optimistic assessment. US consumer spending in the third quarter of 2008 actually declined. Consumer spending in China and India combined, according to New York University economist Nouriel Roubini, is about 1/6th of that of consumer spending in the US. It is difficult to imagine consumer spending in the BRICs picking up the slack in the US. Remember also that both Brazil and Russia are “unreformed” economies that continue to depend on commodity exports whose prices continue to decline.
China’s banks, for one thing, are loaded with off balance sheet obligations and continue lending beyond government instructions. They are unknown entities whose value cannot now be assessed. They can be saved with another massive Chinese government bail-out, well within the capabilities of the PRC given its huge foreign exchange holdings. But the bail-out will spook foreign investors and Chinese entrepreneurs as well. Chinese exports to the US are slowing and the Chinese Central Bank recently cut interest rates. A substantial drop in Chinese economic growth is in the cards. A ‘hard landing’ in China – economic growth dropping to, say, 5 or 6 percent -- would spell political instability.
The most likelihood for China is for a substantial growth slowdown. One result will be a further drop in international commodity prices with countries such as Brazil, Argentina, Australia, Canada being especially vulnerable. A significant drop in the dollar is likely to supply a countervailing force as investors move into commodities.
Given John McCain’s association with and commitment to the Bush administration, he appears the clear loser on November 4. But if Barack Obama loses the Presidential election, we will understand more about the depth of racism in the United States.