On Oct. 10, a day investors may soon refer to as “Black Wednesday,” the U.S. stock market, as measured by the Dow Jones Industrial Average, plunged more than 800 points, or 3.14 percent. Share prices across the world fell sharply as well. The next day, the Dow lost nearly 550 points.
A continuing steep decline in the bond market preceded the drop in share prices, meaning that long-term interest rates, which vary inversely with bond prices, are rising sharply. That means mortgage and other interest rates are also rising, putting in jeopardy once again home construction and auto and other retail sales. It also means that working people are paying more to service their growing credit card, home equity, and student loan debts.
There are also signs of weakness in the underlying economy, which has been relatively strong lately, as has been “trumpeted” by Donald Trump and his newly appointed Federal Reserve Chair Jerome Powell.
On Oct. 4, the U.S. government issued its monthly jobs report. The report for September showed 134,000 jobs added in the month, below the 168,000 that had been expected and the lowest monthly number for the year, though some analysts blamed recent storms for putting a dent in job creation. The report also showed the unemployment rate dropping to 3.7 percent. In addition, average hourly wages paid to American workers rose 0.3 percent, while the 12-month rate of hourly wage gains came in at 2.8 percent – well under 1 percent taking inflation into account, unimpressive for the boom phase of the industrial cycle.
The growing perception that the economy is strong caused big investors to dump bonds in favor of stocks, until a few days ago when they began dumping stocks as well. Trump’s huge tax cut for corporations and the wealthy – Congress recently made the one-year cut in income taxes permanent – has resulted in a huge and growing federal deficit that must be financed by government borrowing, putting more downward pressure on the bond market. The U.S. 10-year Treasury yield has, as of this writing, jumped to as high as 3.26 percent. A month ago, it was around 2.88 percent.
Has ‘critical phase’ begun?
The financial markets may be telling us that the “critical phase” of the current economic “boom” – the last stage of an industrial cycle before the inevitable “bust” – has begun. Karl Marx described the periodic capitalist industrial cycle – typically lasting around 10 years – as going through four main stages: overproduction crisis, depression, average prosperity, and boom. It is now more than 10 years since the start of the last overproduction crisis – known as the “Great Recession” – which began in 2007 and ended in mid 2009.
This month marks the 10th anniversary of the failure of Lehman Brothers, the giant investment bank, which precipitated the overproduction crisis proper. The anniversary has been the occasion of much comment in the financial press focused on whether another even “greater” recession may be in the offing. What follows is my assessment of where we are in the industrial cycle and the possible political consequences for the 2018 mid-term elections and beyond.
The boom stage of the cycle – usually called the “business cycle” in the corporate media – generally enters into a critical phase lasting weeks or months that immediately precedes the next overproduction crisis. This phase – in the post-international gold standard, “dollar standard” era – is typically marked by a convergence of three interrelated bond and money market trends: (1) an accelerating depreciation or appreciation of the U.S. dollar against the money commodity gold; (2) a decline in primary commodity prices in terms of gold; and (3) a flattening (or actual inversion) of the “yield curve” – the difference between long- and short-term interest rates.
What makes this phase of the industrial cycle “critical”? Earlier in the cycle, beginning with the stage of “average prosperity,” the government and monetary authority (central bank, in the U.S. the Federal Reserve System) have some latitude in regulating the pace of economic expansion by means of fiscal policy (taxation and spending) and monetary policy (tightening and loosening credit). Once the critical phase is reached, however, this latitude all but disappears. The Federal Reserve can still determine the form of the rest of the cycle and ensuing crisis (whether inflationary or deflationary) but not its substance.
The yield curve is normally positive and rising during the early part of an economic expansion, because long-term lending, whether to the government or private businesses and consumers, carries more risk than short-term lending. However, near the end of an industrial cycle, when businesses experience a buildup of unsold inventories and need increasing amounts of cash to pay debts, short-term rates begin moving up relative to long-term rates, causing the yield curve to flatten or roll over.
In the last cycle, short-term rates actually rose above long-term rates as early as late 2005, causing what is called an “inverted yield curve.” In the previous cycle, the yield curve inverted at the start of 2000, preceding the (relatively mild) overproduction crisis that began in 2001. Currently, the yield curve is in a sharp decline but hasn’t inverted.
At its last meeting, Sept. 25-26, the Federal Reserve Open Market Committee for the third time this year raised its target for the Federal Funds rate, the interest rate commercial banks charge one another for overnight loans. The Fed manipulates this rate by, among other things, buying and selling three-month Treasury bills on the money market. Raising this target, together with the continued rise in economic activity, has further boosted short-term rates.
At the same time, the Federal Reserve has been selling off its huge holdings of government and mortgage bonds acquired in the course of bailing out the banks and other corporate entities during the last recession. This, along with the current economic expansion, has added to the downward pressure on the bond market. The resulting rise in interest rates, in turn, has caused the U.S. dollar to appreciate against gold and also against most foreign currencies. For developing countries with large dollar-denominated debts, the result has been serious economic and political problems as governments are forced to hike interest rates and impose austerity to save their currencies.
The rising interest rates in the U.S. also threaten to prick the price/rent “bubble” that has developed in the housing market in many areas of the U.S.
The Federal Reserve could stop selling its gargantuan bond holdings for the time being, temporarily halting or reversing the rise in bond yields and putting off the bursting of these bubbles, but that would threaten the stability of the dollar. The result would likely be a rapid depreciation of the U.S. dollar against gold – which may already have begun Oct. 11 with a jump of nearly $35 an ounce in the dollar price of gold – and a possible runaway inflation, which would force the Federal Reserve to tighten credit further.
Even short of multiple bubbles bursting, rising interest rates eventually kill an economic expansion by eliminating what Karl Marx called the “profit of enterprise” – the difference between total profit produced by workers’ labor and interest paid out to money capitalists (banks and other lenders). Once the profit of enterprise drops to zero, industrial capitalists have no incentive to keep producing and begin closing down production and laying off workers, initiating another overproduction crisis.
The ‘dollar standard’ versus the gold standard
Under the “dollar standard,” the U.S. dollar and other “fiat currencies” represent in circulation the money commodity gold, just as paper currencies did under the international gold standard. Unlike under the gold standard, however, when the gold value of a dollar was legally fixed (for many years at 1/35th of an ounce of gold bullion), now it is allowed to “float,” varying from day to day and minute to minute. Owing to its massive depreciation since 1971, when Richard Nixon took the dollar off the gold standard, the paper dollar’s gold value has recently been fluctuating around 1/1,200th of an ounce of gold.
Under the dollar standard as under the gold standard, when a boom begins to wane as overproduction in relation to the market intensifies, prices in gold terms (real prices) begin to fall. However, top policymakers – in particular former Federal Reserve chief Ben Bernanke – drew the lesson from the experience of the deflations associated with the super-crisis of 1929-34 and steep “Roosevelt recession” of 1937-38 to never again allow (nominal) prices to fall, thereby preventing, they hope, another super-crisis and Great Depression.
The Fed cannot prevent real prices from falling when the economy turns down, but it can to a certain extent keep nominal prices (in paper dollar terms) from falling – simply by printing enough paper dollars or their electronic equivalent, thereby devaluing the currency. When real prices begin to fall, the Fed will likely once again opt to step up its money printing to keep nominal prices rising at the central bank’s current target rate of 2 percent a year.
As was widely expected, as a result of the massive printing of money that went along with the bank bailout during the last recession, the dollar price of gold rose sharply between 2008 and 2011, from around $680 per ounce at its low point in 2008 to roughly $1,925 an ounce in 2011. The Federal Reserve was forced to allow this rise – and dollar depreciation – to counter the sharp fall in nominal prices that occurred during the recession (which it couldn’t entirely prevent despite all the money printing) and then ensure the resumption of the steady modest rise in nominal prices that the Fed normally strives to achieve.
As the economic recovery gained momentum beginning in 2011, the Fed was able to reverse the dollar depreciation and rising gold price trend through late 2015, bringing the gold dollar price back down to about $1,050 per ounce. After that, the dollar again depreciated briefly but then held relatively stable until April of this year. After April, the dollar price of gold fell sharply, representing an accelerated appreciation of the dollar, one of the three key trends indicating that the current “boom” has reached the critical stage.
As already mentioned, the relationship between short- and long-term interest rates, called the yield curve, has turned down sharply. And although producer prices in terms of gold are still in a rising trend, the prices of several key commodities have begun to fall. These include copper, a major industrial metal, as well as coal, still a major source of energy – down about 12 and 5 percent, respectively, in recent months. The real price of oil has continued in a rising trend, most likely because of U.S. sanctions on major oil-exporters Iran, Russia and Venezuela.
Adding to the probability that the current “boom” has reached the critical point are the market reactions to the latest jobs report. The downward trend of the bond market has continued, and stock market investors, as already indicated, have begun to panic as well.
Policymakers assured us that the Federal Reserve through its money-printing “quantitative easing” frenzy a decade ago prevented another Great Depression. But it certainly didn’t prevent a deep recession causing millions to lose their jobs and homes. And the working class and unemployed did not even enjoy the full benefit of falling prices for food and other necessities, thanks to the depreciation of the dollar that occurred in the aftermath of the crisis. Most workers are still suffering from the aftereffects, including stagnant wages and social safety net cutbacks.
The industrial cycle can have a profound effect on political outcomes. For example, Hitler came to power in January 1933, near the bottom of the super-crisis of 1929-1934, putting the main blame on Jews and a conspiracy of “international Jewish bankers” for that unprecedented overproduction crisis as well as for Germany’s defeat in the First World War. As the German economy recovered, Hitler was able to take credit, provide some relief to the unemployed, and rebuild the military, just as Franklin Roosevelt was able to do in the United States after he came into office in March 1933. This then, combined with intensified international capitalist competition – reflected in the tariff wars and competitive currency devaluations of that period – set the stage for World War II.
A big difference between the two political leaders was that Hitler crushed the Socialists and Communists, along with the labor movement of Germany, and then launched a war against the Soviet Union and carried out his “final solution” (of the Jewish question), whereas Roosevelt agreed to an alliance with the Soviet Union and presented a “friendly face” to the Socialists, Communists and labor movement of this country – touted as the “popular front against fascism” – before going to war against Germany and Japan and ensuring the rise of the U.S. world empire.
As a general rule, capitalist politicians always get the blame for economic crises that occur on their watch, and always take credit when they come to power as the economy rebounds. In the U.S., Herbert Hoover and the Republican Party got the blame for the super-crisis of 1929-33. In the German case, it was the Social-Democrats and other leading politicians of the Weimar Republic, painted by Hitler and his paramilitary Brownshirts as dupes or agents of the “international Jewish conspiracy.”
In view of the approaching overproduction crisis, it is likely that Trump (or Pence) along with the Republican Party will get the blame. Whoever takes office in 2021 will get credit for the upswing that follows. That could be a Democrat with an FDR-like “progressive” image, along with a “blue wave” takeover of Congress. In view of federal deficits that will loom as far as the eye can see due to Trump’s massive tax cuts for the rich, and the steepening decline of the U.S. empire (in contrast to its earlier rise), the new administration is unlikely to enact social programs at all comparable to those of FDR’s New Deal. In fact, economic circumstances will likely dictate, as was the case with the Clinton administration of the 1990s, further cutbacks of social programs. As was the case with FDR and every administration since, however, the new administration can be counted on to carry out new wars.
Meanwhile, fascist movements on the rise already, could in the worst case come to power in Germany (though still a long ways from that) and/or other parts of Europe.
A ‘blue wave’ in November?
A possible outcome for the upcoming mid-term U.S. election in November is a “blue-wave” Democratic Party takeover of Congress (or at least the House of Representatives), although that can’t be predicted with assurance. In that case, the stage would be set for gridlock between the legislative and executive branches of government – a paralysis of capitalist rule on top of the current chaos surrounding the Kavanaugh nomination to the Supreme Court and the massive movement of women against it.
Then, both major capitalist parties could be blamed for the coming overproduction crisis and the suffering it will produce. Trump (or Pence) would likely pin the blame on the Democrats in Congress – along with the Federal Reserve (for raising interest rates) – while the Democrats would likely blame Trump and his economic nationalism, “treasonous” connections with Russia, and all-around corruption. Generally, the administration in power gets the most blame when the economy tanks on its watch.
Depending on the severity of the next crisis – and that is impossible to predict with precision – all this finger-pointing – including between warring factions within both parties – could open the way for the capitalist two-party system in the U.S. to suffer further damage. The result could be a sharpening polarization of U.S. politics, with a deepening mass radicalization on the left along with a further rise of fascist forces on the right.
It is crucial that the ensuing class struggle be decided in favor of the working class and most oppressed.