Saturday, August 29, 2015

Stock Market Decline Signals End of World

Newsflash: Stock markets sometimes go down. Recessions occasionally happen.

The Militant's Brian Williams ruins an otherwise perfectly good article with breathless predictions of catastrophe. At the end, his soothsaying is completely detached from reality, as even he admits. The article's final words:
Whether the stock market will continue to tumble this week, or take a breather, the capitalists have no answer to the crisis of their system. The crisis will deepen.
Facts be damned--we're doomed no matter what.

For all that, The Militant is the only paper on my regular beat that takes economics seriously. Mr. Williams does a creditable job as their lead reporter on the issue, and this article is no exception. He's got the facts mostly right.

This is both true and important:
World trade in the first half of 2015 has tumbled to the lowest level since 2009. Steel, oil, iron ore, copper, aluminum and nickel are contracting. The Bloomberg Commodity Index, which follows a basket of 22 raw materials, is at its lowest point in 16 years.
In China, where production is mostly geared for export, exports dropped 8 percent in July from a year earlier, and auto sales dropped 7 percent. Manufacturing in August shrank at the fastest pace since 2009.
And finally there's this, though I'd put a different spin on it.
“The trigger was most likely the sudden deterioration of leading economic measures, energy prices, and industrial commodities, both in the U.S. and globally,” investment analyst John Hussman wrote in his weekly column Aug. 24.
I think these facts get to the nub of the issue and the news is not good. I, too, think that the economy is in for a rough patch. I predict a recession, and mostly for the reasons Mr. Williams cites.

So no question that global trade is declining, and when trade declines we're all getting poorer. If international trade is shrinking, then it's hard to imagine that trade within national borders (domestic trade) is growing. So Mr. Williams is right to suggest that the Chinese economy may very well be in recession, government statistics notwithstanding.

Mr. Williams adduces that this conclusion also follows from the fall in commodity prices. But here he is in error, as summarized by Scott Sumner's catchy phrase Never reason from a price change. For prices can change for two reasons: either slack demand means there is a contraction in the amount consumed, or cheaper production has increased supply leading to lower prices that way. The former is an adverse demand shock to the economy, while the latter is a beneficial supply shock.

The decline in oil prices is due to American fracking--that is a supply shock. By making oil cheaper it benefits all users of oil, i.e., all consumers. It makes us richer. That cannot be the cause of recession.

On the other hand, nobody has been fracking for iron ore. While the world's supply has greatly expanded over the years, the current price decline looks to be due to shrinking demand, notably from China. This is an adverse demand-side shock, and will result in a shrinking of the economy, possibly leading to recession.

Mr. Williams conflates these two effects--he's reasoning from a price change. The fall in commodity prices is, in fact, a complicated phenomenon whose effects probably cancel out.

Nevertheless, the hard truth is that China cannot continue to grow at a rate substantially faster than the global economy, which looks to be in the 3-4% range. China has maxed out because it has fully deployed its excess agricultural labor force into the cities, and it is a country in long-term demographic decline. It's growth rate going forward will not be significantly faster than that in the US or Europe.

Also, China can no longer export its way out of recession. It is simply too big--the world is not big enough to consume all of China's output. So China will have to grow domestic consumption to maintain growth. There's a lot of room for that--Chinese are still poor people--but they're going to have to make substantial changes to their political and economic institutions for that to happen.

So the world has to readjust to diminished, long-term growth prospects in China. Another word for that is recession, which is what I think will happen. But contra Mr. Williams it does not auger the end of the world. Why? Because while Mr. Williams correctly cites the overproduction of commodities as a drag, that is only a small bit of the economy. Services make up almost 80% of the American economy, and over 40% of the Chinese economy. Commodities have little effect on the service sector, and hence are a relatively small contributor to growth.

The headline article in the same issue of The Militant is also relevant. It concerns the looming expiration of union contracts with the steel industry: ArcelorMittal, USSteel, and ATI, among others. At the latter, workers have been locked out at a plant near Pittsburgh. The piece--actually a series of articles by multiple authors--reports on labor actions happening around the country.

The issues focus around pensions, healthcare, overtime, and working conditions. Plants near Birmingham and Philadelphia are closing. "The price of steel has dropped sharply in the past year," consistent with Mr. Williams' analysis.

So it is very clear that there will be fewer steel workers in the future than there are today.
  • There is too much global manufacturing capacity. Some plants have to close.
  • Workers will become more productive--jobs will be lost through automation.
  • Competitors from overseas and non-union mini-mills will reduce the competitiveness of closed-shop companies.
Thus the union's battle is already lost. It is only a question of how long they can hold out.

Here is a poignant demand.
Workers now pay no premium and have a total annual deductible of $600 for family coverage, Arabia told the Militant. ATI is demanding a $214 monthly premium with a $6,000 to $8,000 deductible. “It’s a plan designed to keep people from using it,” Arabia said. “Plus new hires will get only a health savings account of $500 per year, and no pension, just a 401(k) plan.”
Organizers clearly hope that capitalists will pay for continued pension and health benefits. But capital never pays operating costs (unless the firm is going bankrupt). Capital is for investment. Operating costs will always be borne by either the customer (higher prices) or by the employee (lower wages). As the size of the workforce shrinks, the existing employees will shoulder an ever growing burden paying pensions for retirees.

Just ask the United Mine Workers how that has worked out.

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