And the financiers then, as today, firmly had the upper hand. As is well known, the Great Depression that erupted in 1929 was the culmination of a long period of deregulation and economic freedom for Wall Street and a great bull market built on an orgy of debt, along with mind-bending rises in economic inequality. In the late throes of the boom the richest twenty-four thousand Americans, for example, received 630 times as much income on average as the poorest 6 million families7; and the top 1 percent of people received nearly a quarter of all the income—a proportion slightly greater than the inequalities suffered at the onset of the global crisis in 2007. “We have involved ourselves in a colossal muddle,” Keynes wrote in the 1930s, “having blundered in the control of a delicate machine, the working of which we do not understand.” The similarities with our current situation can hardly be missed.
Though there was no interconnected offshore system in his day—just the few assorted havens I described in the last chapter—Keynes still offered penetrating insights that help us understand the offshore system and are eerily prescient in light of the recent global financial and economic crisis.
When a company or government sells bonds or shares, investors hand over money in exchange for pieces of paper that give the holder title to a future stream of income. When the bonds or shares are first issued, savings are mobilized, funds are raised, and they flow into productive investment. This is generally healthy. But the next step is when things change. A secondary market appears in these pieces of paper, where the shares and bonds are traded. These trades no longer contribute to creating new productive investment in the real world: They merely shuffle ownership. Well over 95 percent of purchases in global markets today consist of this kind of secondary activity, rather than real investment. Keynes explained what happens when you start to separate real business operations in the real world from their owners. The holders of paper, the investors, become detached from the real businesses that they are investing in, and incentives change dramatically. When this happens across borders, the problem gets worse still: “When the same principle is applied internationally it is, in times of stress, intolerable,” Keynes continued. “I am irresponsible towards what I own, and those who operate what I own are irresponsible towards me.”
Shuffling ownership of bits of paper may seem to promote efficiency by helping capital flow to those projects that offer the highest risk-weighted returns, Keynes noted. A little speculative trading in these markets may well improve information and regulate prices. But in the real world, when the volume of this dealing is a hundred times bigger than the underlying volume of real trade, the results can be catastrophic. “Experience is accumulating,” he said, “that remoteness between ownership and operation is an evil in the relations among men, likely or certain in the long run to set up strains and enmities which will bring to nought the financial calculation.”
His words seem more apt than ever in a world where credit derivatives, asset-backed securities, and other products of financial engineering have placed ingenious but impenetrable barriers between investors and the assets they own, becoming great financial tinsel that is repackaged and resold down chains of investors across the planet, at each step being distanced further from the people and businesses who populate the real world.
Now consider the offshore system in light of this. The secrecy jurisdictions, by applying a sort of super-lubricant to the flow of capital around the world, dramatically widen these chasms inside capitalism. They are the supreme generators of remoteness and artificiality: creating secrecy barriers and generating unfathomable complexity as corporations garland their financial affairs around the world’s tax havens to fox the world’s tax authorities and regulators, and to shield particular investors against other nations’ laws and regulations. As we have discovered since 2007, the system was wildly inefficient: consider the wealth destroyed and the costs heaped onto the shoulders of taxpayers.
Capital no longer flows simply to where it gets the best return but to where it can secure the best tax subsidies, the deepest secrecy, and to where it can most effectively evade the laws, rules, and regulations it does not like. None of this has anything to do with allocating capital more efficiently. Keynes would have viewed the explosion in offshore finance since the 1970s—and the massive capital flight it fostered—with horror.
With all this in mind, we can now turn to one of Keynes’s great feats: the construction of a new world order after the Second World War that was the antithesis of the offshore system that would follow.
As Britain entered into the Second World War, Keynes went to Washington to negotiate the terms on which the nation was to receive U.S. assistance and to discuss what might come after the war. Many Americans, he soon realized, were rather more hostile to Britain than he had supposed. Roosevelt, for example, despised the British empire, mistrusted England’s aristocracy, and, Skidelsky notes, “suspected the Foreign Office of pro-fascist tendencies.”8
Americans had fairly effectively chained and muzzled Wall Street after the Great Depression, and policymakers in Washington saw the far more lightly regulated City of London—the financial heart of the hated British empire—with deep suspicion. Britain was discriminating against American goods in international trade, and Roosevelt’s Republican opponents were horrified at the prospect of entanglement in another foreign war. Why help Britain again, many asked, after Britain had snared America into entering the First World War, then refused to pay its war debts and hung on to its empire. After the British army was forced into a humiliating retreat from Dunkirk in 1940, some in Washington were also reluctant to back what looked like a lost cause.
Global economic might had already shifted decisively across the Atlantic from London to New York, but Britain still held India by force, along with much of Africa and the Middle East. Keynes’s combative and too-clever-by-half style fitted Americans’ stereotypes of the British as super-wily imperial puppeteers, ready to bamboozle them. When Keynes first met U.S. Treasury Secretary Henry Morgenthau, who was no lover of technicalities, Keynes spoke for an hour, in great detail—and Morgenthau “did not understand one word,” a Washington insider later wrote to a friend.9 Harry Hopkins, one of Roosevelt’s advisers, called Keynes “one of those fellows that just knows all the answers.”
But Keynes’s problem was more fundamental. America wanted Britain to fight fascism, and it was prepared to give huge military aid under its Lend-Lease Act of March 1941, but it also saw the war as the chance to dethrone Britain and its empire once and for all. As Keynes wrote later, the U.S. administration took every possible precaution to see that the British were as near as possible to bankrupt before giving any help. “Why do you persecute us like this?”10 he once asked his American counterparts. In response to the challenge, Britain’s chief aim was, as Keynes put it, “the retention by us of enough assets to leave us capable of independent action.”11
It was a grueling war for Keynes, in a decidedly unequal contest. He was seriously ill, diagnosed with septic tonsils and a “large heart and aorta,” and he was representing an empire on its knees. When Keynes disagreed with his American counterpart Harry Dexter White, the American economist Brad DeLong wrote, “he usually lost the point because of the greater power of the United States. And in almost every case it seems to me that Keynes was probably right.”12
As the war went on, Keynes turned his attention in Washington to negotiating the construction of a new cooperative international monetary order to govern future economic relations among the nations of the world, grounded upon efforts to restrain the international financial freedoms that had preceded and helped cause the Great Depression. The rampant capitalism of that era, founded upon an old alliance between Wall Street and the City of London, had involved freely floating currencies, strictly balanced government budgets, and free flows of capital around the world—a little like the modern global financial system. “The decadent international but individualistic capitalism,” Keynes wrote, “is not a success. It is not intell
igent, it is not beautiful, it is not just, it is not virtuous—and it doesn’t deliver the goods. In short, we dislike it, and we are beginning to despise it.” On this broad point his American colleagues were with him: Morgenthau said that the aim must be “to drive the usurious money-lenders from the temple of international finance.”13
Keynes’s negotiations culminated in the Bretton Woods Conference in 1944, the outcome of which would shape the international financial architecture for decades. The conference involved many nations but was an American production: The U.S. Treasury stage-managed the drafting committees and the conference to produce the desired results. U.S. Commission chairmen would prevent a vote on anything they didn’t want voted on and would arrange the discussion to stop inconvenient topics from being aired.14 It was hard to see what the international “monkey house” of delegations from other countries would do, Keynes archly commented: “Acute alcohol poisoning would set in before the end.”
Keynes had hoped that the IMF would become a depoliticized institution, overseeing automatic mechanisms to resolve global financing imbalances automatically and remove politics—and raw American power—from the equation as far as possible. He did not get his wishes, and when these matters were decided at a subsequent meeting in 1946, Keynes said acidly that he hoped “there is no malicious fairy, no Carabosse”—a reference to the wicked fairy-tale godmother figure of Sleeping Beauty, popularized in Tchaikovsky’s and later Diaghilev’s ballet—“whom he has overlooked and forgotten to ask to the party.” Fred Vinson, a top U.S. negotiator, who felt he was the target of the remark, was heard to say in response, “I don’t mind being called malicious—but I do mind being called a fairy.”15
Many people today see the IMF and World Bank—the children of the Bretton Woods Conference—as the handmaidens of globalization, of unfettered trade and capital flows, and the instruments of Wall Street bankers. This was not the original idea. Keynes did want open trade, but finance was to remain tightly regulated: otherwise, surges of flighty capital would generate recurrent crises that would hamper growth, disrupt and discredit trade, and possibly drive fragile European economies into the arms of the communists.
Keynes understood the basic tension between democracy and free capital movements. In a world of free capital flows, if you try to lower interest rates, say, to boost struggling local industries, capital is likely to drain out overseas in search of higher returns, thwarting your original intent.16 Investors hold a kind of veto power over national governments, and the real lives of millions of people will be determined not by their elected representatives but by what the Indian economist Prabhat Patnaik called “a bunch of speculators.” Freedom for financial capital means less freedom for countries to set their own economic policies: from financial freedoms a form of bondage emerges.
Keynes’s answer was simple and powerful: control and constrain the flows of capital across borders and limit the trade in currencies through exchange controls. He believed that financing was usually best when it happens inside, rather than between, countries. Capital controls would give governments more room to pursue objectives like maintaining full employment: Instead of limiting the scope of democracy in the interests of speculators and financiers, the plan was to limit the international mobility of capital: Finance would be society’s servant, not its master. “Let goods be homespun whenever it is reasonably and conveniently possible,” he wrote. “Above all, let finance be primarily national.” The Bretton Woods plan, for all its faults, was designed to tame the forces of international finance.17
Capital controls can be hard to imagine for those who have not experienced them. To get foreign exchange for overseas trips, for example, you needed official permission. Frequent international travelers, for instance, would have a section in their passports, “Foreign Exchange Facilities—Private Travel,” that would be filled with official stamps and signatures authorizing access to sums of foreign exchange. Companies had to get permission to shift money across borders.
This short history helps us to see how very far indeed we have now traveled from the system created by Keynes and his American counterpart Harry Dexter White. Dismantling capital controls is one thing. But we have taken a full step again beyond that, to a world where capital is not only free to flow across borders but is actively and artificially encouraged to flow, lured by the offshore attractions of secrecy, evasion of prudential banking regulations, tax evasion and avoidance, and more. Once again, Keynes would have been horrified.
There is something else about this episode that is rather less well known.
Many mainstream economists embrace a simple idea that goes something like this. Poor countries lack capital. Foreign investment can fill the gap. So it makes sense to free up flows of capital to let capital flow into these capital-starved countries, where it can get higher returns. This may seem like a sensible idea, but what mainstream theory has failed seriously to address is that if you free up capital flows, money might not necessarily flow in. It might, instead, flow out. And the ways in which it may flow out might be unusually harmful.
Keynes understood the problem. “Advisable domestic policies might often be easier to compass, if the phenomenon known as ‘the flight of capital’ could be ruled out,” he said. His words were prescient, for capital flight in his day was nothing when compared to the world-bending amounts that flood out of poor countries into the secrecy jurisdictions today.
He also knew there was a problem: Even in a world of tight capital controls, there would be leakage. Multinational companies needed permission to move investment capital overseas but had much more freedom in moving money for current purposes—that is, for financing trade and other day-to-day business. Of course, they could easily disguise a capital payment as a current one. To this, however, Keynes and Harry Dexter White had an answer. “What is often forgotten,” the Canadian scholar Eric Helleiner notes, “is that Keynes and White addressed this with a further proposal. They argued that controls on capital would be more effective if the countries receiving that flight assisted in their enforcement.”18 In the earliest drafts of the Bretton Woods agreements, both Keynes and White had required that the governments of countries receiving the flight capital would share information with the victims of that flight. In short, they wanted transparency in international finance. Without the lure of secrecy, capital would have far fewer incentives to flee.
Enter Wall Street bankers and their lobbyists. U.S. banks had profited hugely from handling European flight capital in the 1930s, and, fearing that transparency would hurt New York’s allure, they gutted the proposals. While early drafts of the IMF’s Articles of Association had “required” cooperation on capital flight, the final version that emerged from the Bretton Woods conference saw that word replaced with “permitted.” And through that one-word gateway drove a great, silent procession of coaches and horses across the Atlantic, laden with treasure from a shattered Europe. And the capital flight that ensued was as bad as Keynes and White had feared: A U.S. government analysis in June 1947, admitting that it only saw a part of the picture, found that Europeans held $4.3 billion in private assets, an enormous amount in those days, and far bigger than America’s jumbo postwar loan to Britain that year.
American bankers were thrilled. And a new economic crisis exploded in Europe. America filled the hole with aid: the giant Marshall Plan of 1948. It is widely believed that the plan worked by offsetting European countries’ yawning deficits. But its real importance, Helleiner argues, was simply to compensate for the U.S. failure to institute controls on inflows of hot money from Europe. Even in 1953, the authoritative New York Times correspondent Michael Hoffman noted, American postwar aid was smaller than the money flowing in the other direction.19
Henry Cabot Lodge, a Republican senator, was one of those who raised his voice to object to the stink. “There is a small, bloated, selfish class of people whose assets have been spread all over the place,” he said. “People of moderate means in this country are being taxed
to support a foreign aid program which the well-to-do people abroad are not helping to support.”20 The comparison with Hillary Clinton’s words about Pakistan can hardly be missed. These words would be painfully familiar today to citizens of Argentina, Mexico, Indonesia, Pakistan, Russia, Nigeria, and so many other nations that have watched powerlessly while local elites mount raids on their countries’ wealth and collude with Western financiers and businessmen to hide it offshore, avoid paying tax on their income, and then expect Western aid donors to fill the gaps. The Marshall Plan had set the precedent: American taxpayers would foot the bill for policies that delighted Wall Street and its clients. What was presented as enlightened self-interest was substantially a racket, in the precise sense of a fraud, facilitated by public ignorance. As we shall soon see, the rackets have multiplied ever since.
Keynes died in April 1946, less than a year after the Nazis surrendered in Europe. The accolades poured in. “He has given his life for his country, as surely as if he had fallen on the field of battle,” said Lionel Robbins, one of his most potent ideological adversaries. Friedrich Hayek, Robbins’s former pupil who was just then fathering a new free-market ideology to dethrone Keynesianism, called him “the one really great man I ever knew.”
Though Keynes had failed in many ways, many things he advocated were put in place, not least widespread capital controls. And events seem to have proved him right—or at least not wrong. The first two years after the war marked a brief period when U.S. financial interests dominated policymaking, and the restrictive international order was in abeyance. But the disaster that ensued, and the new economic crisis in 1947, discredited the bankers, and from the following year things became more restrictive.
Treasure Islands: Dirty Money, Tax Havens and the Men Who Stole Your Cash Page 8