The limits of finance-led capitalism in the US

Trevor EvansBerlin School of Economics and Law

Key features of US economy since 1980

• Strengthened position of financial sector

• Major corporations plan globally; outsourcing

• Redistribution of income to top

• Dependence on credit expansion (and asset bubbles) sustained by expansionary monetary (& fiscal) policy

• Net inflows of financial capital

The rhythm of growth

-4

-2

0

2

4

6

8

10

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

US economic growth (change in real GDP over 4 quarters, %)

Corporate profitability & investment

0

2

4

6

8

10

12

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Total

Nonfinancial

Financial

US corporate profitability (pre-tax profits as % GDP)

Source: US Bureau of Economic Affairs, National Income and Product Accounts, Table 1.14

2

4

6

8

10

12

14

16

18

20

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Total

Nonresidential

Residential

US private fixed investment (% GDP)

Source: Bureau of Economic Affairs, National Income and Product Accounts, Table 1.1.5

0

200

400

600

800

1,000

1,200

2002 2003 2004 2005 2006 2007

Fixed investment Net purchase of corporate equities Net dividend payments

US non-financial corporations spending on fixed capital, share buy-backs and dividends ($ billions)

Source: Federal Reserve Board, Flow of Funds Accounts, Table F102

Employment & income

-3

-2

-1

0

1

2

3

4

5

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Change in US employment over 12 months (millions)

Source: Bureau of Labour Statistics, Current Employment Statistics Survey, seasonally adjusted

85

90

95

100

105

110

115

120

125

130

1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

90th percentile

80th percentile

50th percentlie

10th percentile

$7.79

$15.11

$26.27

$35.23

Changes in US real hourly wages at percentile points, all workers (1979=100)

Source: The State of Working America, 2006/2007, Table 3.4 and 2008/2009, Table 3.5. Figures in dollars show income in 2007.

Average annual increase

Fraction of total growth captured by top 1%

Average income

Top 1%

Bottom 99%

Clinton expansion 1993-2000 4.0% 10.3% 2.7% 45%

Bush expansion2002-2006 2.9% 10.9% 1.0% 73%

Source: Thomas Pickerty & Emmanual Saez, ‘Income inequality in the US’, Updated data, July 2008

Real annual income growth by groups

7

9

11

13

15

17

19

21

23

25

1915 1925 1935 1945 1955 1965 1975 1985 1995 2005

Excluding capital gains Including capital gains

Share of top 1% in US national income, 1915-2006 (%)

Source: Thomas Pickerty & Emmanuel Saez, ‘Income inequality in the US’ Updated data, July 2008

US indebtedness by sector (% GDP)

Source: Federal Reserve Board, Flow of Funds Accounts

20

40

60

80

100

120

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Financial business

Households

Non-financial business

Government

The Crisis

Background to crisis• Fed responded to stock market crash by cutting lead interest rate

from 6.5% (2001) to 1.0% (2003)

• Growth of lending– Leveraged loans (Private equity funds)– Mortgage lending

• Securitisation

• ‘Shadow banking system’– Investment banks– Hedge funds– Structured investment vehicles

• House-price bubble

-25

-20

-15

-10

-5

0

5

10

15

20

25

1990 200092 94 96 98 02 04 06 08

US house price inflation (%)

Source: S&P / Case-Shiller House Price Index

The crisis• Fed raises interest rates 2004-2006; peak of housing-price boom

• House-price bubble ends 2006; prices fall 2007 – Mortgage backed securities loose value– Banks announce first losses from investments

• 9 August 2007: Breakdown in trust between banks; money market dries up

• 15 September 2008: Failure of Lehman Brothers sets of chain of financial failures and credit crunch

• Oct 2008: Leading capitalist states agree to inject capital in banking systems; partial nationalisation of banks; chain of failures stemmed

• US Recession– Official start December 2007– Major deepening 2008 Q4 and 2009 Q1 – ‘Green Shoots’

0

1

2

3

4

5

6

7

1 month inter-bank rate

Overnight inter-bank rate

Fed funds target rate

Jan 07 Apr Jul Oct Jan 08 Apr Jul Oct

US inter-bank interest rates (%)

Policy response• Monetary expansion

– Massive provision of reserves– Lending to non-financial companies– Purchasing government bonds– … but banks not lending– How to deal with toxic / troubled / legacy assets?

• Fiscal expansion– Bush: $168 billion (2008)– Obama: $787 billion (2009-10)

• Regulatory reform– Systemic risk to be monitored– Limited coordination of regulatory agencies

• Sources of future growth?

International transmission

Source: IMF, World Economic Outlook, Update, July 2009

Economic Growth (%)

Source: IMF, World Economic Outlook, Update, July 2009

Transmission to W. Europe

• Banking system– European banks investments in US mortgage backed

securities– Huge bank losses (IMF estimate €737 bn)– Major contraction of credit

• Trade– EU dependence on exports made it highly vulnerable

to US recession– Germany most vulnerable of large economies

Euro area inter-bank interest rates (%)

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

1 month inter-bank rate

Overnight inter-bank rate

ECB main rate

Apr 07 Jul Oct AprJan 08 Jul Oct

Transmission to E. Europe

• Financing current account deficits– Hungary– Baltic states (Estonia, Latvia, Lithuania)

• Contraction of credit by W. European owned banks

• Exports to W. Europe– Czech Republic– Slovakia– Slovenia

Transmission to rest of world

• Demand for manufactured goods in US and Europe (Japan, China, India …)

• Primary commodity prices – Oil (Russia, Middle East, Venezuela)– Mineral & agricultural products (Latin America, Africa)

• Remittances (Mexico, Central America, Indonesia, India)

Economic Growth (%)

2007 2008 2009 2010

Projections

Source: IMF, World Economic Outlook, Update, July 2009