"At particular times, a great deal of stupid people have a great deal of stupid money...the money of these people - the blind capital - is particularly large and craving. It seeks someone to devour it and there is a plethora; it finds someone and there is speculation; it is devoured and there's panic." Walter Bagehot.

The world is heading for a major slump in the next 12-18 months. All the signs are there.

On the surface, all seems reasonably rosy. The world's stock markets have recovered from their autumn crash, when they fell by 20% or so on average after Russia defaulted on its state debts and a large speculative investment ('hedge') fund had to be bailed out by the US Federal Reserve prompting a looming global credit crunch. The US stock market Dow index finished 1998 at over 9000, up nearly 15% on the year and most European markets did even better. Only the relatively less important so-called 'emerging markets' did badly.

And the 'real economy' of developed capitalism also performed reasonably well. The US grew by over 3.5%, Europe was up 2.5% plus and the UK managed something similar. Only Japan continued to dive by nearly 3%. But so-called emerging Asia suffered the worst slump in a lifetime, while Russia entered yet another horrific downturn as the rouble collapsed. Latin America is now sliding into recession. Overall, the capitalist world grew about 1.5%, hardly enough to compensate for population growth. And 1998 was a relatively good year. The neon signs of a deep slump ahead are flashing.

Marxists have argued that the key to understanding the movement of economic forces under capitalism lies with profits (the fuel of capitalism), interest rates (the oil and lubricant of capitalism) and world trade and demand (the size of the track or road ahead). The direction of all these factors suggests: slump ahead!

World profitability is falling. In Japan, profits are falling absolutely, down 25% a year at present. And, contrary to popular belief, profits have started to fall absolutely in the US and the UK as well. Only in Europe, did they rise in 1998, but there are already signs of a slowdown in growth in Germany.

In the emerging world, profitability has taken a huge hit. It's not difficult to see why. Prices of basic commodities that the post-colonial economies sell, like metals, oil, minerals, grain, coffee, meat etc, are now at a 20-year low. Prices have fallen 20% in the last year and crude oil prices have plummeted over 30%, a fall only matched by the last great oil crisis of 1986.

Commodities

This very fall in world commodity prices suggests a secular downturn in world demand and general malaise in the strength of world capitalism. The Asian crisis has led to a huge drop in world demand for basic goods. It has led to deflation world-wide. While the world's central bankers, as always, continue to publish 'inflation reports', the world heads into a deflationary spiral. Indeed, there is outright deflation already in Japan (zero price rises), China (prices down 3% this year), Singapore (down 1%) and Brazil (down 1%).

Why have profits started to fall? As Marx explained, capitalists cannot go on increasing profits because of an inherent contradiction in the capitalist mode of production. Profits come from the surplus value extracted from the labour power of those employed. The surplus comes about because the prices of goods and services sold by the capitalists exceed the wages paid to the workforce for creating these products.

But that can only continue as long as the value of labour power per unit of production time (or the unit costs of labour to use the capitalist term) and the cost of machinery and raw materials are kept below the price of each unit. But each capitalist is competing against the others. If others can sell at lower prices they will take the market. The pressure is on to keep costs down while boosting production.

The modern capitalist way to do this is to increase productivity of the workforce for a given wage bill. That can be done by increasing the intensity of work (longer hours, faster etc), but mostly, by introducing technology to the production process. A better machine (and in the 1990s, we mean a machine with a better computer) will raise productivity the most.

Increased productivity lowers prices. If it lowers the prices of machines and raw materials, that will boost the profits of the manufacturer. But if it also lowers the prices of the goods the capitalist is selling, then more units of production must be sold to sustain profitability. More production requires more investment in labour and machines and also better productivity. Investment in machines rockets - the process is unending.

But the growth in productivity of labour starts to fall off. That's because more machines may not be better ones and the labour force, the key to production, cannot be increased any more or made to work harder. Wages start to rise, while the pressure of competition makes it impossible for capitalist producers to raise prices to keep profits up.

US Boom

The 1990s have followed the Marxist scenario. Take the US boom of the 1990s. Since 1994, one-third of growth in overall national output is due to a rise in spending on machines. This has led to a sharp increase in productivity in the last three years, up 1.9% a year. That's much faster than the post-1973 average of just 1.1% a year (but still lower than the 'golden era' of capitalism 1950-73, when productivity grew at 2.8% a year). This productivity boom has been due mainly to the computer revolution. Investment in computers is rising at over 25% a year! Between 1991-98, US business invested 113% more in machines. That's an even larger increase than in the 1920s boom.

But here's the crunch. Production capacity is now outstripping demand globally and in the US. The huge expansion in machines and the computer revolution is no longer delivering the profits. And once profits start to fall, as night follows day under capitalism, investment in machines and labour will be cut back. Manufacturing investment is already starting to fall; only computer investment stays up for the moment. And, with unemployment at a capitalist low of just 4.3%, US businesses are now starting to lay off workers.

Moreover, US firms are now borrowing at a rate over their cash receipts unprecedented for 30 years. They are stretched to the limit financially. And US consumers are also spending so much that their savings ratio (the amount left from household income after spending) is actually negative for the first time since records began! That means the average American family is spending every day more than the income coming in. US households are in better shape after this boom, so they can afford to run down their savings for a while. But their net wealth is not in as good shape as it was before the recession of 1979-81.

And here's the frightening thing for capitalism. American households with two solid incomes have been spending more and not just on the usual consumer goods. They have been betting on the stock market. With the aim of getting a good income when they retire (given the lack of a decent state pension), they've been giving their money to investment fund managers to invest in stocks and shares for their old age.

The huge increase in these funds has led to a massive stock market boom. Share prices have rocketed in the last three years. Investors have been buying anything that moves. Take the so-called technology stocks like the internet companies, Yahoo and Amazon. They have made no profits since they were started and yet their share prices have risen thousands of percent! America Online is now worth more on the stock market than General Motors.

It's a classic stock market bubble like the South Sea bubble of 1720 or the boom of the 1920s. The US stock market ended 1998 priced at 30 times annual average profits. That means if you buy a US share, it will take 30 years of profit to get your money back in the dividend! So the only way you can make money on the stock is for the price to rise. Everything depends on the stock market keeping on rising. So far, the euphoria continues. A recent survey of 'experts' in the US showed the highest score yet for those expecting the stock market to keep on going up in 1999.

Fictitious Capital

America's new wealth is mainly invested in fictitious capital, as Marx called it. The net wealth of US households has risen 40% in three years, but if you take out 'financial' assets, like shares and bonds, 'tangible' wealth, like property, cars etc has risen only about 5%. Borrowing by American households is now 140% of net wealth and borrowing to invest in the stock and bond market has risen from 15% of the total borrowing to 25%!

Yet in the real economy business profits are falling and investment is beginning to drop. Manufacturing employment in the US is down 150,000 in the last six months. It's true that the computer and internet revolution may provide some continued support to investment in 1999, particularly given the work needed to overcome the danger of 'millennium bug', the predicted computer crash engendered by the Year 2000.

But investment growth cannot go on outstripping profits for much longer. It will have to slow sharply. And once investors in the stock market realise that profits are falling and investment in the real economy is slowing, they will pull back from buying shares. A stock market crash, the precursor of which we saw last September, will appear with a vengeance.

Now it's true that the stock market is no clear indicator of a slump in the real economy. As the famous capitalist economist, Paul Samuelson, remarked, the stock market crash has predicted four of the last nine economic recessions! So, will the crash of 1999 be like 1929 or like 1987, which led quickly to a renewed capitalist boom as central banks sharply cut interest rates and governments started to spend and run up budget deficits?

The answer again lies in the real movement of the capitalist economy. Unlike 1987, but like 1929, profits are now falling. There was a similar 'technology investment' boom in the 1920s. It did not save capitalism from slump. Indeed, the heavy dependence on the technology sector made the subsequent slump in investment even greater when that sector dived. That will be repeated for the computer sector from 2000 onwards. Indeed, the millennium bug effect could knock up to 0.5% off the world's GDP growth rate in 2000 through the disruption to production.

Manoeuvre

And this time there is much less room for manoeuvre in cutting interest rates. Reducing interest rates on borrowing has always been one way of getting out of a capitalist crisis. If bankers take less of a cut from the profits made by manufacturers and businesses, then profits in the real economy can be bolstered. But it's real interest rates (that is after taking into account inflation) that is key. If real interest rates stay high, then real manufacturing profits will stay low.

Central bankers have already been cutting interest rates. The US Federal Reserve Bank has made several reductions. So has the Bank of England in recent weeks. Even the cautious bankers of Europe have finally made a small cut. The Bank of Japan already has rates near zero. What these cuts have done in boost the world's stock markets and renew the financial mania that has swept the world.

Profits

But it will not stop a collapse in real profits, investment and production. That's because real interest rates are still well above historic levels. As fast as bankers cut rates, inflation drops faster. As world inflation head towards zero because of collapsing demand in the 'emerging world' and increased price competition in the 'rich world', real interest rates stay high. In the US, interest rates are about 5% with inflation at 2% (real rate 3%). In Europe interest rates are 3% with inflation below 1% (real rate 2.5%). In Japan (already in a deep slump), interest rates are 1% but there is deflation of 1% (real rate 2%). To boost profits, real rates need to be negative and that's not going to happen.

At the same time, government spending is not being increased, except in slumping Japan. The US and UK governments are actually running budget surpluses. In Europe, deficits have been driven down to under 2% of GDP, unprecedented in 30 years. So the capitalist real economy will get no help from the bankers or from governments.

And this time, the launch of a new currency for the bulk of Europe will make things worse. Desperate to ensure a strong Euro, the new European Central Bank will be very reluctant to cut interest rates and so weaken the new currency, while the Euro governments have agreed to keep budget deficits close to zero and no higher than 3% of GDP forever!

In the 1920s, most of the world's currencies were tied to the value of gold. In effect, they could not be devalued to help exports and so recover from a recession by exporting it abroad. To keep the currency tied to gold, central bankers had to keep interest rates up while prices fell. So they contributed to the eventual 1930s depression.

In the 1990s, Asian governments tied their currencies to the dollar. As the dollar strengthened from 1995, Asian currencies rose, making their exports uncompetitive. The result has been a huge slump. Now Europe's currencies are tied to the Euro. It means each economy's fortunes are tied to the largest economies, Germany and France. If they slow down, so will the rest of Europe, for no country can devalue its currency. It's another gold standard.

The world will dive because profits are falling, investment will be cut back and unemployment will start to rise again in the 'rich world'. Profits have started falling as investment has outstripped sales because of the inherent drive of capitalists to compete and because there are limits to the surplus value that can be extracted from the world's workforce. Interest rate cuts can alleviate that process, but not stop it.

Similarly, increased world trade can relieve the burden of selling excess production. In 1997, world trade rose 10.8% in volume, way above the increase in world GDP of just 3%. Indeed it has been a feature of the 1990s that the ratio of world trade growth to world output growth has shot up compared to the 1960s and 1970s. That reflects the intensified pace of 'globalisation' in trade and investment. Capitalism is more a world economy than ever before.

Downturn

But it also reflects the downturn in world growth seen since 1973. The end of a unique golden era of rising profitability, fast growth and full employment of 1948-73 meant that low profitability in the OECD could only be compensated for by increased markets in the 'emerging world'. This expansion of capitalist imperialism repeats the first great upsurge of capital exports in the latter half of the 19th century, and also during the inter-war period before the Great Depression of the 1930s.

But in 1998, world trade growth fell back sharply to rise just 3.7% in volume. With world commodity prices falling, with Asia in deep crisis and with Japan in depression, world demand took a tumble. It won't be any better this year. Latin America, led by Brazil, is heading for recession. Eastern Europe, headed by Russia, will slow sharply. Japan remains at the bottom of a pit. There will be no escape for other economies by exporting to these.

That means the danger of protectionism will grow. The US will complain that its rising deficit on trade is due to other economies failing in their duty to boost demand and reduce trade restrictions. The Americans will threaten counter-measures. They have already caused a ruckus over bananas, and more significantly over telecommunications and insurance trade restrictions. The US Congress will be kicking up about having to save the world without getting anything in return. In response, Japan and Europe will be reluctant to make any concessions to the US, with unemployment rising in their economies.

A huge credit bubble is fuelling the world's stock markets as in the 1920s, while production slows and profits start to fall. Real interest rates remain too high to help manufacturers and will not be lowered by the bankers sufficiently, partly because of inherent caution and partly because you cannot have interest rate below zero! World prices continue to fall away just like the 1920s and 1930s. And governments are tied into the capitalist ethic of balanced budgets and won't allow the state to intervene to boost capitalism until it is too late. Remember President Roosevelt was elected in 1932 on a programme of a balanced budget and did not resort to deficit financing until 1937, and that was for the war build-up.

World Growth

Recently, the OECD did an important study. This international research institute, representing the rich world, forecasts world growth of 1.7% for 1999. However, the OECD argued that if three things happened this year together, then the world would go into recession. The first was another crisis developing in Russia, or Brazil or China that forced these countries into slump. The second was a banking collapse in Japan and the rest of Asia, which kept that region from recovering. The third was a collapse in world stock markets along with some investment bank bankruptcies.

All of these things are probable, not just possible, in 1999. Brazil and Russia are already there. China could follow unless it devalues. If it does that, it will drive the rest of Asia into a deflationary spiral. Asia's banks are on a knife-edge and could easily crumble.

The US market is headed for crash bringing the rest down. The US consumer will suffer and pull in the horns. Last year, the misnamed Long-Term Credit Management investment fund borrowed over $3trn (30% of US GDP!) to bet on financial markets for its clients. They and the US government had to save LTCM with taxpayers money rather than have an almighty collapse of credit markets.

Scandals

This is very likely to happen again. At present, the world's bankers have lent over $1trn to the countries of Asia, Latin America and ex-Stalinist Eastern Europe. That's more than all their shareholder capital and reserves put together. They will have probably lost about 40% of their loans already. Eventually they will have to admit this on their books. Expect some more scandals.

The world recession of 1999-2000 will develop into the depression of the 2000s, as in the 1930s and as earlier in the global slumps of 1830-44 and 1885-96. Capitalist profitability peaked in the mid-1960s, just as it did from 1896 to 1910. It fell sharply until the end of the recession of 1979-81, just as it did from 1910. It recovered somewhat from the mid-1980s to now, after two world recessions destroyed old industries and boosted labour productivity first by mass unemployment and latterly by investment in machines (mainly computers) - just as it did in the 1920s.

But the booms of the 1980s and 1990s have not restored the profitability of capitalism's post-war golden era. And now the gains from a world globalisation are petering out, as they will from the computer revolution. The long capitalist winter is coming.