China currency devaluation and signs of slowdown spark global financial panic

Global stock markets plunged on Aug. 24, now designated “Black Monday” by financial commentators. The Dow dropped more than a thousand points seconds after the opening bell, closing the session down 588 points, or more than 3.5 percent.

After an initial rebound the following day, the market again closed lower—by 205 points, or 1.3 percent.

After strong rise, Shanghai stocks plunge.

China’s Shanghai index fell even more sharply, dropping more than 15 percent over the two days, with trading in many stocks halted after falling their 10 percent daily limit. Millions of small investors in China have seen their life savings wiped out.

Stock markets in Europe and elsewhere also crashed as both individual and institutional investors rushed for the exits. Trillions of dollars in asset values were wiped out as a result.

The panic was sparked by the surprise devaluation of the Chinese yuan Aug. 11-12 by about 3.5 percent against the U.S. dollar, aimed at boosting falling Chinese exports and countering a slowdown in the formerly fast-growing economy. New data confirming the slowdown added to the gloom.

A new economic crisis imminent?

The steep declines in share prices pose the question, is the economic recovery from the 2007-2009 “Great Recession,” weak as it has been, now about to end? Are we at the beginning of another major crisis of overproduction that will see millions of people again losing their jobs, as well as widespread loss of homes and individual and business bankruptcies?

This is certainly not out of the question, but it should be kept in mind that stock market crashes do not always signal an imminent economic crisis. The October 1987 crash in the U.S. market is a prime example. That plunge of more than 20 percent in one day was triggered by an apparently modest monetary tightening by the Federal Reserve, the U.S. central bank, in response to a speculative rise in share prices, stimulated by newly developed computerized “program-trading” strategies that then got much of the blame for the crash.

According to Wikipedia: “Following the stock market crash, a group of 33 eminent economists from various nations met in Washington, D.C. in December 1987, and collectively predicted that ‘the next few years could be the most troubled since the 1930s’. However, the economy was barely affected and growth actually increased throughout 1987 and 1988, with the DJIA regaining its pre-crash closing high of 2,722 points in early 1989.”

In fact, this major crash occurred right in the middle of the extended period of relatively steady economic expansion, from around 1985 to 2001, that was celebrated in a 2004 speech by Ben Bernanke, then a member of the Fed’s Board of Governors, as “the Great Moderation.”

Fed tightening and the strong dollar

The Federal Reserve has again embarked on modest monetary tightening as a result of ending the huge expansion of its “monetary base” through several rounds of “quantitative easing,” which involved buying up Treasury and mortgage debt with the electronic equivalent of newly created paper dollars. This was part of an unprecedented effort by the Fed and U.S. government to bail out the banks, which were de facto bankrupt, and facilitate an economic recovery following the Great Recession.

A key result was low interest rates as the Fed and investors bid up the price of Treasury bonds and mortgage debt. The low rates were supposed to stimulate an economic recovery, but this was only partially successful. Capitalist governments at the same time imposed major austerity programs as part of the decades-old neo-liberal agenda aimed at rolling back gains in social programs such as education, pensions and health care that the working class in the advanced capitalist countries had won in the relatively prosperous decades following World War II.

Right-wing economists argued that tax cuts along with the budget cutbacks would increase corporate profitability, in turn strengthening the economy overall—creating millions of new jobs and benefiting workers as well as the middle class.

Austerity policies, especially in Europe, were also imposed by the respective capitalist ruling classes to restore solvency to governments whose finances had been severely strained by the bailouts of its banks and major corporations.

The net result of Fed monetary tightening and capitalist austerity has been a strong dollar and an extremely sluggish recovery, and in some countries of Europe renewed recession. In the case of Greece, the economic contraction has been on the scale of the 1930s Great Depression.

The strong dollar and overproduction in relation to sluggish demand has resulted in falling prices for oil, copper and other primary commodities—putting great strains on emerging economies such as Russia, Brazil and Venezuela that depend on exports of raw materials to finance imports of consumer goods and industrial machinery.

If these falling prices were to spread to commodities in general, the resulting deflation would produce a new deep-going crisis of overproduction as businesses are forced to cut back production and lay off workers on a massive scale.

The Federal Reserve, however, has been hinting recently that the recovery of the U.S. economy has reached the point where it soon will be possible to tighten monetary policy another notch by raising the target the Fed sets for a key short-term interest rate that it controls known as the federal funds rate. The prospect of such a rate hike has further strengthened the dollar against most other currencies as well as the money commodity gold.

The paper dollar has also been strong thanks to it being the main reserve currency in the world and the basis of the monetary system propping up the U.S. empire.

(For more on the ill effects of the paper dollar system, see “Strong dollar destabilizes world economy.” For readers with a background in Marxist economic theory, various posts to the Critique of Crisis Theory blog explain the key role of the money commodity gold, in conjunction with the law of labor value, in regulating the capitalist economy.)

The Fed about to make a ‘dangerous mistake’?

In a Aug. 23 Financial Times article, entitled “The Fed looks set to make a dangerous mistake,” former Treasury Secretary Larry Summers warns that “raising rates in the near future would be a serious error that would threaten all three of the Fed’s major objectives—price stability, full employment and financial stability.”

Summers explains: “Like most major central banks, the Fed has put its price stability objective into practice by adopting a 2 per cent inflation target. The biggest risk is that inflation will be lower than this—a risk that would be exacerbated by tightening policy. More than half the components of the consumer price index have declined in the past six months—the first time this has happened in more than a decade. CPI inflation, which excludes volatile energy and food prices and difficult-to-measure housing, is less than 1 per cent.”

He concludes: “… for reasons rooted in technological and demographic change and reinforced by greater regulation of the financial sector [apparently, for Summers, austerity policies have nothing to do with it—JB], the global economy has difficulty generating demand for all that can be produced. This is the ‘secular stagnation’ diagnosis. … Satisfactory growth, if it can be achieved, requires very low interest rates that historically we have only seen during economic crises.”

If Summers has his way, the Fed will hold off for an indefinite period implementing further monetary tightening. In any event, such tightening is probably off the table for the Fed’s next Open Market Committee meeting in September and possibly also for its following meeting in December.

It also is not excluded that the Federal Reserve will go back to another round of quantitative easing if the U.S. economy shows serious signs of slowdown, although Fed officials really don’t want to do this if they can avoid it. They realize full well that a renewed growth in the size of the Fed’s monetary base, on top of the enormous growth that has already occurred, threatens a collapse of the paper dollar system down the road, and with it the collapse of the U.S. empire.

Slowing growth in China

In the face of “secular stagnation” in the global economy, the rapid growth that has characterized the Chinese economy in recent years cannot continue. That growth has been fueled to a large extent by massive exports, mostly to the U.S. and Europe. To produce those exports has required massive imports of raw materials and component parts from other countries.

Both exports and imports have dropped sharply recently, putting in serious jeopardy China’s projected growth of 7 percent for this year. According to Panos Mourdoukoutas, writing in the Aug. 9 issue of Forbes, “China’s exports plunged 8.3% in July, far worse than expected. …”

Mourdoukoutas adds: “Exports to the European Union dropped by 12.3% in July while those to the United States dropped 1.3%. Exports to Japan dropped by a whopping 13%.”

The Chinese government has attempted to keep up the relatively high rate of growth by encouraging infrastructure development and housing construction on a massive scale, but this cannot go on indefinitely in the face of sluggish or non-existent economic growth globally.

Hence, the Chinese government’s decision to devalue the yuan, which will make goods produced in China cheaper on the world market—unless other countries also devalue, which is already happening. Increased imports of Chinese goods into the United States will inevitably worsen the U.S. trade balance, already deep in the red, ultimately weakening the U.S. dollar as well.

A new crisis of overproduction

A new crisis of overproduction, which could be even more severe than the Great Recession, is on the way. It is even possible that a new super-crisis eclipsing that of 1929-1933 in the United States could be approaching. Some parallels are apparent.

China with its dynamic economic growth has been playing a role in the global economy similar to the role of the fast-growing U.S. of the 1920s, while the declining but still dominant U.S. empire today parallels the decline of the British empire in the earlier period. The U.S. with its “Asian pivot” is attempting to “contain” China, just as Britain oriented its foreign policy in the early 20th century toward containing a dynamic Germany.

Further, China’s extraordinary economic growth drove prices of primary commodities such as oil and copper to unsustainable heights prior to the Great Recession, far above underlying labor values. The economic demands created by World War I had a similar effect, which ultimately led to the crash in prices and the global economy that ensued in 1929-1933.

The capitalist industrial cycle has not been suspended or abolished, despite the best efforts of pro-capitalist economists and policymakers to achieve that impossible aim. It is only a question of how soon a full-blown crisis of overproduction will hit the strongest economies—not only the financial markets but also the “real economies.” It has already begun in some countries and will inevitably spread.

The workers’ movement needs to prepare for this outcome and the radicalization and political polarization it will produce.

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