Well founded pessimism

17 April by Michael Roberts

Only last February, I posted that there had been a burst of optimism about the state of the world economy in 2023. The consensus view then was that the G7 economies (with the sorry exception of the UK) would avoid a slump this year. Sure, there will be a slowdown compared to 2022, but the major economies were going to achieve a ‘soft landing’ or even no landing at all, but just motor on, if at a low rate of growth. The international agencies like the World Bank, the OECD and the IMF upgraded their forecasts for global growth.

However, all that optimism has proven “unfounded” as I suggested then. Even in the best performing G7 economy, the US, a recession (ie ‘technically’ two consecutive quarters of contraction in real GDP GDP
Gross Domestic Product
Gross Domestic Product is an aggregate measure of total production within a given territory equal to the sum of the gross values added. The measure is notoriously incomplete; for example it does not take into account any activity that does not enter into a commercial exchange. The GDP takes into account both the production of goods and the production of services. Economic growth is defined as the variation of the GDP from one period to another.
) now seems probable. Even the US Federal Reserve FED
Federal Reserve
Officially, Federal Reserve System, is the United States’ central bank created in 1913 by the ’Federal Reserve Act’, also called the ’Owen-Glass Act’, after a series of banking crises, particularly the ’Bank Panic’ of 1907.

FED – decentralized central bank : http://www.federalreserve.gov/
accepts that a recession is unavoidable. At its last meeting, its economists agreed that there would be a ‘mild recession’ in US economic activity this year.

And according to economists at the Bank of America, there are plenty of signals that suggest a recession in the US has not been avoided and they provide several charts to back that up. First, there was the significant decline in manufacturing activity. “March ISM was 46.3, lowest since May 2020. In past 70 years whenever manufacturing ISM dropped below 45, recession occurred on 11 out of 12 occasions (exception was 1967),” BofA said. Indeed, globally there appears to be a manufacturing recession.

Second, the current ‘buoyant’ jobs market won’t last because it often follows manufacturing activity downwards – it’s a lagging indicator.

“Weak ISM manufacturing PMI suggests US labor market will weaken next few months,” BofA said, adding that it viewed the February and March jobs report as “the last strong payroll reports of 2023”.

Then there is the inverted bond yield curve that always presages a recession.

Also, global house prices are falling, creating a slump in construction and real estate development.

Another reliable indicator is the Leading Economic Index (LEI) published by the Conference Board. The LEI for the US fell for the 11th straight month in February, which is the longest slump since the collapse of Lehman Brothers in 2008. “While the rate of month-over-month declines in the LEI have moderated in recent months, the leading economic index still points to risk of recession in the US economy,” said Justyna Zabinska-La Monica, senior manager at the Conference Board.

These are some indicators of a forthcoming recession, but they are not the causes. I have argued that there are two principal drivers of a slump: falling profits and profitability; and rising interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. costs. These are the two closing scissors that cut off the accumulation of capital and force companies to stop investing, reduce employment and, among the weaker brethren, go bust.

The BoA economists also recognise these factors. They note that a decline in manufacturing often coincides with lower earnings.

And their global earnings model also suggests imminent decline in corporate earnings.

Much has been made on the left about the huge rise in corporate profit Profit The positive gain yielded from a company’s activity. Net profit is profit after tax. Distributable profit is the part of the net profit which can be distributed to the shareholders. margins after the end of the pandemic. And this is undoubtedly the main contributor to the inflationary spiral experienced in all the major economies in the last 18 months – not any wage-cost push as the Keynesians argue; or too much money supply as the monetarists argue. A January study from the Federal Reserve Bank of Kansas City found that “markup growth”—the increase in the ratio between the price a firm charges and its cost of production—was a far more important factor in driving inflation Inflation The cumulated rise of prices as a whole (e.g. a rise in the price of petroleum, eventually leading to a rise in salaries, then to the rise of other prices, etc.). Inflation implies a fall in the value of money since, as time goes by, larger sums are required to purchase particular items. This is the reason why corporate-driven policies seek to keep inflation down. in 2021 than it had been throughout economic history.

University of Massachusetts Amherst economists Isabella Weber and Evan Wasner published a paper that has been widely taken up entitled, “Sellers’ Inflation, Profits and Conflict: Why Can Large Firms Hike Prices in an Emergency?”. It found that corporations engaged in “price gouging” during the pandemic. The authors went on to argue that price controls may be the only way to prevent the “inflationary spirals” that could come as a result of this gouging.

Albert Edwards, a global strategist at the 159-year-old bank Société Générale, has now followed up on this thesis that has come to be called ‘Greedflation’. Corporations, particularly in developed economies like the US and UK, have used rising raw material costs amid the pandemic and the war in Ukraine as an “excuse” to raise prices and expand profit margins to new heights, Edwards said.

There is no doubt that corporate margins have been at record highs. Both in the US and in Europe. But I have thrown some doubt on the explanation that current high inflation has been caused mainly by ‘price-gouging’ from monopolistic corporations.

And the Kansas Fed paper cited above agrees. The authors reckon that “although our estimate suggests that markup growth was a major contributor to annual inflation in 2021, it does not tell us why markups grew so rapidly. We present evidence that the timing and cross-industry patterns of markup growth are more consistent with firms raising prices in anticipation of future cost increases, rather than an increase in monopoly power or higher demand. First, the timing of markup growth in 2021, as well as earlier in the pandemic, does not line up neatly with the spike in inflation during the second half of 2021. Instead, the largest growth in markups occurred in 2020 and the first quarter of 2021; in the second half of 2021, markups actually declined. Therefore, inflation cannot be explained by a persistent increase in market power after the pandemic. Second, if monopolists raising prices in the face of higher demand were driving markup growth, we would expect firms with larger increases in current demand to have accordingly larger markups. Instead, markup growth was similar across industries that experienced very different levels of demand (and inflation) in 2021.“

The authors cast doubt on the simple explanation of “greedflation,” understood as either an increase in monopoly power or firms using existing power to take advantage of high demand. So the post-Keynesian mark-up theory of inflation and the policy conclusion of price controls looks faulty.

I wrote a post last September that, anyway, profit margins were beginning to fall. The average profit margin for the top 500 US companies 2022 is estimated at 12.0%, down from 12.6% in 2021, if still well above the ten-year average margin of 10.3%. And as overall economic growth in the US slows – corporate sales revenue growth is slowing too.

Indeed, I found that the final data on US pre-tax corporate profits in Q4 2022, show a 5-6% fall in each of the last two quarters of 2022, or a 12% fall from the peak in mid-2022. Profits fell year-on-year for the first time since the pandemic slump. The post-pandemic corporate profits boom is over.

The slowdown in US corporate profits is replicated in all the major economies. Here is my latest estimate of global corporate profits based on five key economies. The pandemic slump recorded a 20% fall in global corporate profits in 2020, followed by a 50% recovery in 2021, but now profits growth has slowed to just 0.5% in Q4 2022. And note, as I have done before, that profits had stopped rising through 2019 even before the pandemic, suggesting that the major economies were heading for a slump before COVID emerged.

Then there is the credit squeeze from rising interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
and monetary tightening (ie a fall in money supply growth). This is happening because the major central banks are still determined to try and ‘control inflation’ with high interest rates (even though this has been shown to misunderstand the causes of current inflation).

In its minutes, the Fed put it this way: “With inflation remaining unacceptably high, participants expected that a period of below-trend growth in real GDP would be needed to bring aggregate demand into better balance Balance End of year statement of a company’s assets (what the company possesses) and liabilities (what it owes). In other words, the assets provide information about how the funds collected by the company have been used; and the liabilities, about the origins of those funds. with aggregate supply and thereby reduce inflationary pressures.” So even a recession will be needed to bring inflation down. In that, the Fed is right – indeed inflation rates will stay well above pre-pandemic elevls unless there is a slump.

After the pandemic, central banks tried to return to the easy money policy adopted during the long depression of the 2010s in order to boost economic recovery. A tremendous credit boom took place in 2022, which led to a surge in US bank lending of $1.5trn.

Alongside bank loans there was an explosion in what is called low-quality lending that brought debt loads in corporate America to record highs. The total US stock of “subprime” corporate debt (junk bonds Junk Bonds The nickname in the USA for high-risk bonds, also called High Yield Bonds, issued by a company whose solvency is considered doubtful. This type of bond is considered highly speculative by the rating agencies. , leveraged loans, direct lending) has reached $5tn. Total non-financial corporate debt (bonds and loans) stands at $12.7tn, making low-quality debt as much 40% of the total.

This debt financed very speculative or highly indebted companies either in the form of a loan (“leveraged loans”) or non-investment grade bonds (“junk bonds”) and includes corporate loans sold into securitizations called Collateralized Loan Obligations (CLOs) as well as loans extended privately by non-banks that are completely unregulated. Years of growth, evolution, and financial engineering have spawned a complex, highly fragmented, and under-regulated bond market Bond market A market where medium-term and long-term capital is lent/borrowed in the form of bonds. Bonds are creditor stakes issued by companies or States. .

And this was replicated globally. The annual report from the Global Financial Stability Board FSB
Financial Stability Board
The Financial Stability Board is an informal economic group that was created during the G20 meeting in London in April 2009. It succeeded the FSF (Financial Stability Forum) that had functioned since the G7 in 1999. The Board is made up of 26 national financial authorities (central banks and finance ministries), several international organizations and groups that devise financial stability standards. Its raison d’être is to enable cooperation in the fields of supervision and the observation of financial institutions.

Financial Stability Board : http://www.fsb.org/
on the so-called Non-Bank Financial Institutions (NBFI) found that the “NBFI sector grew by 8.9% in 2021, higher than its five-year average growth of 6.6%, reaching $239.3 trillion. […] The total NBFI sector increased its relative share Share A unit of ownership interest in a corporation or financial asset, representing one part of the total capital stock. Its owner (a shareholder) is entitled to receive an equal distribution of any profits distributed (a dividend) and to attend shareholder meetings. of total global financial assets from 48.6% to 49.2% in 2021.”

Central banks have no idea of what is causing inflation and how to control it, but they go on hiking rates even if it causes bank failures, corporate bankruptcies and a slump. Fed governor Kocherlakota noted that “central bankers have expressed concerns that above-target inflation could lead “inflation to become unmoored” (Bernanke 2011) or “inflation to become entrenched” (Powell 2022).” That could give rise to the follow-up need to bring down “inflation expectations” through a severe recession. As Bernanke (2011) saids, “the cost of that in terms of employment loss in the future, as we had to respond to that, would be quite significant… To the best of my knowledge, there are no macroeconomic models in the academic world that integrate possibilities of this kind. “ So not a clue.

The recent US banking crisis was a result of the growing credit squeeze on banks, mainly smaller ones, and on companies. And it is not over – either in the US or Europe. As interest rates rise, depositors are switching their money from weak banks into better yielding accounts such as money market funds MMF
Money Market Funds
Mutual investment funds that invest in securities, including money funds.
, fleeing those banks that put their customer deposits into loss-making assets like government bonds. This has led to a sharp decline in bank lending to companies across the US.

and in Europe.

So there are less funds for investment and survival and at higher interest rates. Up to now, because corporate profits had risen so much, even though corporate debt to GDP had risen to all-time highs, most US firms have been able to cover the debt servicing costs comfortably. But that is over. The infamous zombie companies (up to 20% of all firms in the US and Europe) are facing bankruptcy.

Bankruptcy filings have spiked across major industries. In March, 42,368 new bankruptcies were filed, up 17% from a year back. It was also the third straight month of bankruptcy increases. Meanwhile, venture capital funding for start-ups declined by 55% in the first quarter of 2023 compared to the same period a year ago. This is the lowest level in over five years.

And here is how John Plender of the FT put it: “the most draconian tightening in four decades in the advanced economies with the notable exception of Japan, will wipe out much of the zombie population, thereby restricting supply and adding to inflationary impetus. Note that the total number of company insolvencies registered in the UK in 2022 was the highest since 2009 and 57 per cent higher than 2021.”

In its latest economic report, the IMF IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.

says the world economy is experiencing “a rocky recovery”. It forecasts that global growth (which remember, includes China, India and other large ‘developing’ economies) will slow this year to 2.8%. And that’s the base forecast. If credit tightens further and interest rates stay high, global growth could drop to just 1%. The G7 economies will grow little more than 1% this year and, after accounting for population growth, hardly at all. The UK and Germany will contract.

UNCTAD follows the IMF with an even more pessimistic forecast for global growth this year – just 2.1%. It concludes that “This could set the world onto a recessionary track…. With the era of cheap credit coming to an end at a time of “polycrisis” and growing geopolitical tensions, the risk of systemic calamities cannot be ruled out. The damage to developing countries from unforeseen shocks, particularly where indebtedness is already a source of distress, will be heavy and lasting.”

United Nations Conference on Trade and Development
This was established in 1964, after pressure from the developing countries, to offset the GATT effects.

points out that debt servicing costs have consistently increased relative to public expenditure on essential services. The number of countries spending more on external public debt service Debt service The sum of the interests and the amortization of the capital borrowed. than healthcare increased from 34 to 62 during this period.

Vítor Gaspar, head of fiscal policy at the IMF, said that by 2028, the world’s public debt burden was on course to match the value of goods and services produced in the world. “By the end of our projection horizon — 2028, public debt in the world is expected to reach almost 100 per cent of GDP back to the record levels set in the year of the pandemic”.

His answer was a new bout of ‘austerity’ (ie cutting public spending and raising taxes). “Fiscal tightening can help by moderating the growth of aggregate demand and therefore contributing to more moderate increases in policy rates,” he said, adding that this in turn would “ease the pressures on the financial system” triggered by the surge in borrowing costs over the course of 2022.

According to Fitch Rating, national debt defaultsare at a record high. There have been 14 separate default events since 2020, across nine different sovereigns, a marked increase compared with 19 defaults across 13 different countries between 2000 and 2019.

The long depression of the 2010s is continuing into the 2020s. The World Bank World Bank
The World Bank was founded as part of the new international monetary system set up at Bretton Woods in 1944. Its capital is provided by member states’ contributions and loans on the international money markets. It financed public and private projects in Third World and East European countries.

It consists of several closely associated institutions, among which :

1. The International Bank for Reconstruction and Development (IBRD, 189 members in 2017), which provides loans in productive sectors such as farming or energy ;

2. The International Development Association (IDA, 159 members in 1997), which provides less advanced countries with long-term loans (35-40 years) at very low interest (1%) ;

3. The International Finance Corporation (IFC), which provides both loan and equity finance for business ventures in developing countries.

As Third World Debt gets worse, the World Bank (along with the IMF) tends to adopt a macro-economic perspective. For instance, it enforces adjustment policies that are intended to balance heavily indebted countries’ payments. The World Bank advises those countries that have to undergo the IMF’s therapy on such matters as how to reduce budget deficits, round up savings, enduce foreign investors to settle within their borders, or free prices and exchange rates.

’s latest economic report makes dismal reading for the world economy. “The global economy’s “speed limit”—the maximum long-term rate at which it can grow without sparking inflation—is set to slump to a three-decade low by 2030.” Between 2022 and 2030 average global potential GDP growth is expected to decline by roughly a third from the rate that prevailed in the first decade of this century—to 2.2% a year. For developing economies, the decline will be equally steep: from 6% a year between 2000 and 2010 to 4% a year over the remainder of this decade. These declines would be much steeper in the event of a global financial crisis or a recession.

A lost decade could be in the making for the global economy,” said Indermit Gill, the World Bank’s Chief Economist. Unless, of course, Generalised Artificial Intelligence with ChatGPT saves the day for capitalism.

Michael Roberts

worked in the City of London as an economist for over 40 years. He has closely observed the machinations of global capitalism from within the dragon’s den. At the same time, he was a political activist in the labour movement for decades. Since retiring, he has written several books. The Great Recession – a Marxist view (2009); The Long Depression (2016); Marx 200: a review of Marx’s economics (2018): and jointly with Guglielmo Carchedi as editors of World in Crisis (2018). He has published numerous papers in various academic economic journals and articles in leftist publications.
He blogs at thenextrecession.wordpress.com

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