The scissors of slump

Last week, US Treasury Secretary Janet Yellen told the US Congress that “We now are entering a period of transition from one of historic recovery to one that can be marked by stable and steady growth. Making this shift is a central piece of the President’s plan to get inflation under control without sacrificing the economic gains we’ve made.”

It’s true that the US economy since the depths of the pandemic slump, (which remember in terms of national output, incomes and investment was the worst since the 1930s – even worse that the Great Recession of 2008-9) has made a recovery.  But it could hardly be described as ‘historic’.  And as for the claim that the US economy, the best performing of the major economies in the last year, is heading towards ‘stable and steady growth’, that is not supported by reality. 

Yes, there is ‘full employment’ of sorts ie the official unemployment rate is near ‘historic’ lows, but many of these jobs are part-time, temporary or on contracts.  And many pay poorly.  The employment participation rate, which measures the number of people working out of those of working age, remains well below pre-pandemic levels, levels which were already in decline.

At the same time, productivity growth has been appalling.  More Americans have gone back to work since the pandemic but national output is not matching the increase in employment, so productivity per worker has collapsed – from growth rates that were already weak.  As a result, unit labour costs (wage costs per unit of output) have shot up, which is shrinking profit margins.

And despite Yellen’s assurances, the prospects for the US economy during the rest of this year and into the next are not promising, even dismal.  According to the Atlanta Fed’s GDP forecasting model, the US economy, after contracting in the first quarter of this year, is likely to grow at less than 1% in this current quarter.

Even more contrary to Yellen’s view are the latest reports from the World Bank and OECD economists on prospects for the world economy, including the US.  The World Bank’s Global Economic Prospects for June was entitled as Stagflation Risk Rises Amid Sharp Slowdown in Growth.

The World Bank economic forecasts were shocking.  “Global growth is expected to slump from 5.7 percent in 2021 to 2.9 percent in 2022— significantly lower than 4.1 percent that was anticipated in January.  It is expected to hover around that pace over 2023-24, as the war in Ukraine disrupts activity, investment, and trade in the near term, pent-up demand fades, and fiscal and monetary policy accommodation is withdrawn. As a result of the damage from the pandemic and the war, the level of per capita income in developing economies this year will be nearly 5 percent below its pre-pandemic trend.”

Growth in advanced economies is projected to sharply decelerate from 5.1 percent in 2021 to 2.6 percent in 2022—1.2 percentage point below projections in January. Growth is expected to further moderate to 2.2 percent in 2023, largely reflecting the further unwinding of the fiscal and monetary policy support provided during the pandemic. Among emerging market and developing economies, growth is also projected to fall from 6.6 percent in 2021 to 3.4 percent in 2022—well below the annual average of 4.8 percent over 2011-2019.

“The negative spillovers from the war will more than offset any near-term boost to some commodity exporters from higher energy prices. Forecasts for 2022 growth have been revised down in nearly 70 percent of EMDEs, including most commodity importing countries as well as four-fifths of low-income countries.”  So the World Bank forecasts stagnation in output with inflation still present.

As for the US, the World Bank forecasts just 2.5% growth in national output this year, 2.4% in 2023 and then just 2% in 2024 – a ‘stable and steady’ growth, you might say, but only at the low levels that the US economy has experienced in the long depression since 2009.  And the US performance is forecast to be the best among the advanced capitalist economies: the Eurozone area will manage only 1.9% by 2024 and Japan just 0.6%.

World Bank economists reckon that the combined impact of the pandemic and the war would leave global economic output in the five years from 2020 to 2024 more than 20 percent below the level implied by trend growth between 2010 and 2019.  The impact on poor countries will be much greater with developing economies a third less than expected and output in commodity-importing developing countries — especially badly hit by the sharp rise in food and fuel prices provoked by Russia’s invasion — more than 40 per cent less than expected!

The view of the OECD economists is, if anything, even more pessimistic.  In June’s Economic Outlook, called The Price of War. OECD economists emphasise the cost of the Russia-Ukraine war.  “The world is paying a heavy price for Russia’s war in Ukraine. It is a humanitarian disaster, killing thousands and forcing millions from their homes. The war has also triggered a cost-of-living crisis, affecting people worldwide. When coupled with China’s zero-COVID policy, the war has set the global economy on a course of slower growth and rising inflation – a situation not seen since the 1970s. Rising inflation, largely driven by steep increases in the price of energy and food, is causing hardship for low-income people and raising serious food security risks in the world’s poorest economies.”

Global GDP growth is now projected to slow sharply this year to around 3%. This is well below the pace of recovery projected last December. Growth is set to be markedly weaker than expected in almost all economies. Many of the hardest-hit countries are in Europe, which is highly exposed to the war through energy imports and refugee flows.  Global growth will slow further to 2.8% in 2023 – that’s near ‘stall speed’, with the UK having no growth at all, the worst result in the G20 (apart from Russia). Even the US will slow to just 1.2%. 

And inflation of the prices of goods and services in the major economies does not look like abating during the rest of this year.  Crude oil prices could go even higher than the current $120/b.  Jeremy Weir, chief executive of the commodity trade Trafigura, said that energy markets were in a “critical” state as sanctions on Russia’s oil exports following its invasion of Ukraine had exacerbated already tight supplies created by years of underinvestment.  “We have got a critical situation.  I really think we have a problem for the next six months . . . once it gets to these parabolic states, markets can move and they can spike quite a lot.” A parabolic move in markets is generally defined as when a price that has been rising suddenly surges to hitherto unseen levels, mimicking the right side of a parabolic curve. Weir added it was highly probable that oil prices could rise to $150 a barrel or higher in the coming months, with supply chains strained as Russia tries to redirect its oil exports away from Europe.

Energy prices are not rising because of ‘excessive demand’ or even because of ‘price-gouging’, but simply because supply is being restricted.  Supply dropped during the pandemic and now Russian exports are sanctioned and cannot be replaced by Saudi oil or US supply.

The global supply chain breakdown since the pandemic continues, particularly since the start of the Russia-Ukraine conflict but even before – see the NY Fed measure of supply squeeze below.

Of the major economies, the UK is set for highest inflation among G7 until 2024 and the lowest growth.  A combination of higher energy prices, a slumping pound, faltering economic growth, a deteriorating environment for small businesses, weak households, trade restrictions on Russia, a central bank that is tightening, and overall inflation at four-decade highs have all produced a toxic environment for the UK economy.   The so-called ‘misery index’ which measures the unemployment rate plus the inflation rate as an indicator of ‘misery’ for working-class households, is heading back towards levels not seen since the Thatcher era.

The nexus between rising prices and wages has led to sharp fall in real incomes as a result.  Price rises are outstripping wage growth nearly everywhere and households are seeing a loss of disposable income (ie after price rises and taxes) and so are forced to run down savings (some of which was built up during the pandemic lockdowns) to make ends meet.

As I have shown before in previous posts in some detail, that, contrary to claims by mainstream politicians, central bank governors and economists, there is no ‘wage-price’ spiral.  Wages are not driving prices up.  Indeed, it’s profits that have risen sharply as a share of value since the pandemic. However, rising unit labour costs (as shown above) because of low productivity growth, are beginning to eat into profit margins.

Falling profit margins will eventually lead to lower profitability and even a falling mass of profit.  That would be the signal for a new slump, especially if the costs of borrowing to invest rise as central banks hike interest rates in a vain attempt to ‘control’ inflation.  Falling profits is the formula for an eventual investment and production slump.  That’s one blade of the scissors of slump.

The other blade is debt.  As I have outlined on many occasions, I reckon this next major slump will be triggered by a corporate debt meltdown. In particular, remember the size of what are called ‘zombie companies’ that do not get enough profit to cover even their debt servicing commitments; and ‘fallen angels’, those companies which have borrowed too much to invest in risky assets that now face blowing up.  And corporations that are debt-loaded are heading for trouble as borrowing costs rise and banks tighten liquidity.  Already the Federal Reserve has raised its policy rate and moved from ‘quantitative easing’ to ‘quantitative tightening’, taking stock market prices down as a result.

The World Bank economists are worried.  “The faster-than-expected tightening of financial conditions worldwide could push countries into the kind of debt crisis we saw in the 1980s. That is a real threat and something we are worried about. Even quite small increases in borrowing costs will be a problem,” said Franziska Ohnsorge, a lead author of World Bank report.

World Bank data show that foreign debt in low-income countries rose by $15.5bn to about $166bn in 2020. Foreign debt in middle-income countries rose by $423bn to more than $8.5tn, leaving them especially exposed to interest-rate rises.  Central banks are raising rates rapidly in the most widespread tightening of monetary policy for more than two decades. Over the three months to the end of May, monetary authorities announced more than 60 rate rises. More are expected in the months ahead.

Any downturn in profits and rise in borrowing will expose the layers of businesses that are close to going bust.  In the UK, Financial Stability Board chairman Martin McTague, commented “there is still a massive problem with small businesses. They are facing something like twice the rate of inflation for their production prices and it’s a ticking timebomb. They have got literally weeks left before they run out of cash and that will mean hundreds of thousands of businesses, and lots of people losing their jobs.”  McTague referred to the Office for National Statistics (ONS) data, showing that 2 million (or about 40%) of the UK’s small businesses had less than three months of cash in reserves to support operations. He noted that 10% (or 200,000) were in grave danger, and 300,000 only had a few weeks of cash left. “It is a very real possibility because … they don’t have the cash reserves. They don’t have any way they can tackle this problem.”

In Europe, its largest financial asset manager has likened parts of the private equity industry to a “Ponzi scheme” that will face a reckoning soon.  “Some parts of private equity look like a pyramid scheme in a way,” Amundi Asset Management’s chief investment officer Vincent Mortier said. “You know you can sell [assets] to another private equity firm for 20 or 30 times earnings. That’s why you can talk about a Ponzi. It’s a circular thing.”  In other words, private equity companies are buying up companies with huge loans and then selling them onto each other using even bigger loans.  Eventually, somebody will lose out from this ‘pass the parcel’ form of finance. Leverage (borrowing) levels have increased proportionately, with debt levels reaching an all-time high.

The scissor blades between falling profitability and rising debt costs are closing and will eventually cut investment, jobs, prices and wages.

13 thoughts on “The scissors of slump

  1. Why do (mostly Western) economists focus on the performance of the US economy as a kind of benchmark for global economic performance? True, the United States is still the world’s largest economy, sets the agenda for other nations at the imperial center, and is itself a major producer and refiner of oil, IT software, and agricultural products. But since the inauguration of Roosevelt’s New Deal, the main product of the United States has been destructively productive war and the means of war, the latter of which are laundryable additions to US GNP. What doesn’t appear in GNP is war as a means of expropriation and theft of a targeted nation’s assets: e.g. The US of NATO’s theft and privatization of Ukraine’s rich public lands and Russian gold. How come this exceptionally violent and unaccountable nation can’t maintain its profitabilty?

  2. I like your use of the scissors but for me the real scissors effect is the cutting up of the world economy, the cutting of the global division of labour crafted since the mid 1990s. Capitalism creates bigger and bigger obstacles before it, which in turn it needs to crash through. This is not the 1920s. The global economy is more interdependent. The imperialists cut the global supply chains at their peril. Trump started it, Biden continues it and NATO’s bait and trap strategy in the Ukraine has intensified it. These few thousand self-entitled and psychopathic capitalist families based mainly in the USA and Britain who think they own this world will do anything and everything to protect and expand their property even if this has resulted in a scorching earth and mass starvation. They need to be stopped and only the international working class has the capacity to do this and end this calamity before it gets much much worse, which it will.

  3. Superb analysis based on a wealth of relevant data, great job as usual.
    If you’ll excuse my ignorance, for the table on NY Fed measure of supply squeeze, the title is “GSCPI” what does that stand for and what are the indices for measurement of supply squeeze; temporal? Quantities of commodities delivered? scales of inventory?….

    It’s a bit ironic to say the least, that all those media pundits and apologists of Capitalism who promote the idea of “International Order” created by Capitalism, can’t explain what type of an international order capitalism has created that it can’t even have an basic ordered and functional supply chain (most everyone predicting the supply chain crisis to continue for at least two more years.

    P.S. Thank you Mr. Jefferies for introducing your article, also very well informed and coherent. Is there a site or email for contacting you?

  4. “… oil … already tight supplies created by years of underinvestment.” -> Years of underinvestment? Why? May be because “Global conventional crude oil production peaked in 2008 at 69.5 mb/d and has since fallen by around 2.5 mb/d.” Page 45 of the World Energy Outlook 2018 by the International Energy Agency?

    1. Yeah. Also perhaps overproduction combined with dwindling demand over the years? Fracking that made the US energy independent is costly and needs high price oil to be justified, and so increased oil and gas supply through this technology becomes unlikely in the long run if the prices are too low.

      In their meeting in Vienna, March 2020, Russia didn’t agree with the Saudi to make supply cuts to stabilise prices which went down, and that was bad news for the US as drillers were shut down. From oilprice dot com:

      “Driven by low prices not seen much in modern history, formerly high-flying shale drillers like Chesapeake Energy have gone bankrupt. The service providers who do the actual work like Halliburton, (NYSE:HAL), Schlumberger, (NYSE:SLB) have written off tens of billions worth of fracking-related equipment, closed facilities and laid off thousands of workers.”

      From Investopedia (May 2021):

      “Frondel and Horvath did find that increased U.S. oil production due to fracking reduced oil prices. The authors conjectured that oil prices would have been around 40 to 50 dollars per barrel higher if the U. S. fracking boom had not occurred.

      “However, in the future, there will be limits to the extent fracking can be used to increase supply. Oil is scarce, and fracking is more expensive and complicated than traditional oil extraction. If the global supply of oil increases and oil prices drop far enough, then the high expense of fracking is no longer justified. In other words, the success of fracking eventually imposes a limit on itself, unless technological changes make the technique less costly.”

      The US can’t afford watching its fracking industry go bust. Is that the real reason stubborn Russia is currently “forced” to send its oil and gas elsewhere? Why Europe is pressured not to import it from Russia? So that prices go back up as they are doing?

  5. Set aside the drop in the profit rate, the European Union is preparing for embargoes in 83% of the world’s population, countries that did not join the embargo against Russia and these countries have about 90% of all commodities.
    They will stop selling Louis Vuitton bags, which is by passage are made outside the “western” world and perhaps stop buying useless things like ores, soy and food in general.
    We have to congratulate Ursula von der Leyen, because she is getting what the world left never has achieved, unify the third world.
    Long back I wrote about the back of the barter, I was mocking by one of the brilliant minds that dominates the comments on this blog. .
    Who made the mockery who introduces himself.

  6. “tight supplies created by years of underinvestment.” Sorry, that isn’t remotely accurate. Data compiled by the US Energy Information Agency clearly demonstrates that this “shortage” is the result of years of overinvestment and overproduction, manifesting in a declining rate of profit, and the decommissioning of wells. Investment tracks the prices of the commodity. In the recent uptick, the US producers, particularly in the shale fields, have hoarded cash, and not reactivated shut-in wells, or expanded exploration activities. Overproduction is the lead-in to the current crisis.

    Look at natural gas prices and supplies over the last 15 years. There’s no shortage of supplies. In fact one of the main drivers of the conflict in Ukraine is to drive Russian production out of the EU market.

    1. Agreed, also IMO to salvage US costly fracking industry that requires high oil price, and thus less supply; hence Russia has to go.

      Hell! This remainds me of 1914 – long before that really – when cheap, but high quality German manufacturing and commerce was forced to leave an overcrowded market…

  7. Michael,

    Longtime reader! I was wondering if you would say that the shutdowns achieved a substantial degree of the destruction of capital values. One thing that comes to mind is, while certainly more small businesses failed than would have otherwise, but on the other hand my impression is that it is not a vast number. But then also, as you note in this post, national output fell during the shutdowns. This seems to fit Marx’s criterion that “in so far as the reproduction process is checked and the labour-process is restricted or in some instances is completely stopped, real capital is destroyed.”

    Obviously the economy is still in a bad spot, so I have to imagine that it was not a great deal of capital values that were destroyed even if this did occur. Is there a quantitative way to measure exactly how much value was destroyed during this process?

    (also my apologies if this comment went through twice, was having some technical difficulties)

    1. Maybe adding up war expenditures help in finding a “quantitative way to measure…how much value [is being] destroyed” under present circumstances. The Western democracies have been increasingly involved in the US of Nato’s permanent state of war, and are now feverishly increasing their production of productively destructive means of war, which has a kind of keynesian mulitiplier effect, trigering the destruction of capital generally, and its concentration at the imperial centers.

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