by Adam Tooze
The events of 2003, 2008 and 2017 are all no doubt defining moments of recent international history. But what is the relationship among them? What is the relationship of the economic crisis of 2008 to the geopolitical disaster of 2003 and to America’s political crisis following the election of November 2016? What arc of historical transition do those three points stake out? What does that arc mean for Europe, for Asia? How does it relate to the minor but no less shattering trajectory traced by the United Kingdom from Iraq to the crisis of the City of London in 2008 and Brexit in 2016?
The contention of this book is that the speakers at the UN in September 2008 were right. The financial crisis and the economic, political and geopolitical responses to that crisis are essential to understanding the changing face of the world today. But to understand their significance we have to do two things. We have to place the banking crisis in its wider political and geopolitical context. And, at the same time, we have to get inside its inner workings. We have to do what the UN General Assembly in September 2008 could not do. We have to grapple with the economics of the financial system. This is a necessarily technical and at times perhaps somewhat coldhearted business. There is a chilly remoteness to much of the material that this book will be dealing with. This is a choice. Tracing the inner workings of the Davos mind-set is not the only way to understand how power and money operated in the course of the crisis. One can try to reconstruct their logic from the boot prints they left on those they impacted or through the conformist and contradictory market-oriented culture that they molded.13 But the necessary complement to those more tactile renderings is the kind of account offered here, which attempts to show how the circulation of power and money was understood to function—and not to function—from within. And this particular black box is worth prizing open, because, as this book will show, the simple idea, the idea that was so prevalent in 2008, the idea that this was basically an American crisis, or even an Anglo-Saxon crisis, and as such a key moment in the demise of American unipolar power, is in fact deeply misleading.
Eagerly taken up by all sides—by Americans as well as commentators around the world—the idea of an “all-American crisis” obscures the reality of profound interconnection.14 In so doing, it also misdirects criticism and righteous anger. In fact, the crisis was not merely American but global and, above all, North Atlantic in its genesis. And in a contentious and problematic way it had the effect of recentering the world financial economy on the United States as the only state capable of meeting the challenge it posed.15 That capacity is an effect of structure—the United States is the only state that can generate dollars. But it is also a matter of action, of policy choices—positive in the American case, disastrously negative in the case of Europe. Clarifying the scale of this interdependence and the ultimate dependence of the global financial system on the dollar is important not just for the sake of getting the history right. It matters also because it throws new light on the perilous situation created by the Trump administration’s declaration of independence from an interconnected and multipolar world.
I
To view the crisis of 2008 as basically an American event was tempting because that is where it had begun. It also pleased people around the world to imagine that the hyperpower was getting its comeuppance. The fact that the City of London was imploding too added to the deliciousness of the moment. It was convenient for the Europeans to shift responsibility across the channel and then across the Atlantic. In fact, it was a script prepared ahead of time. As we will see in the first section of this book, economists inside and outside America critical of the Bush presidency, including many of the leading macroeconomists of our time, had prepared a disaster script. It revolved around America’s twin deficits—its budget deficit and its trade deficit—and their implications for America’s dependence on foreign borrowing. The debts run up by the Bush administration were the bomb that was expected to go off. And the idea of 2008 as a distinctively Anglo-American crisis received a backhanded confirmation eighteen months later when Europe experienced its own crisis, which appeared to follow a rather different script, centered on the politics and the constitution of the eurozone. Thus the historical narrative seemed to neatly arrange itself with a European crisis following an American crisis, each with its own distinct economic and political logic.
The contention of this book is that to view the 2008 crisis and its aftermath chiefly through its impact on America is to fundamentally misunderstand and underestimate its economic and historical significance. Ground zero was America’s housing market, for sure. Millions of American households were among those hit earliest and hardest. But that disaster was not the crisis that had been widely anticipated before 2008, namely, a crisis of the American state and its public finances. The risk of the Chinese-American meltdown, which so many feared, was contained. Instead, it was a financial crisis triggered by the humdrum market for American real estate that threatened the world economy. The crisis spilled far beyond America. It shook the financial systems of some of the most advanced economies in the world—the City of London, East Asia, Eastern Europe and Russia. And it went on doing so. Contrary to the narrative popular on both sides of the Atlantic, the eurozone crisis is not a separate and distinct event, but follows directly from the shock of 2008. The redescription of the crisis as one internal to the eurozone and centered on the politics of public debt was itself an act of politics. In the years after 2010, it would become the object of something akin to a transatlantic culture war in economic policy, a minefield that any history of the epoch must carefully navigate.
If mapping this misunderstanding, charting the global financial crisis outward from its hub in the North Atlantic and presenting the continuity between 2008 and 2012, is the first challenge of this book, the second is to account for the way in which states did and did not react to the turmoil. The impact of the crisis was uneven but global in its reach, and by the vigor of their reactions, emerging market governments spectacularly confirmed the reality of multipolarity. The emerging market crises of the 1990s—Mexico (1995); Korea, Thailand, Indonesia (1997); Russia (1998); and Argentina (2001)—had taught how easily state sovereignty could be lost. That lesson had been learned. After a decade of determined “self-strengthening” in 2008, none of the victims of the 1990s were forced to resort to the International Monetary Fund. China’s response to the financial crisis it imported from the West was of world historic proportions, dramatically accelerating the shift in the global balance of economic activity toward East Asia.
One might be tempted to conclude that the crisis of globalization had brought a reaffirmation of the essential role of the nation-state and the emergence of a new kind of state capitalism. And that is an argument that would gain ever greater force in the years that followed, as the political backlash set in.16 But if we look closely not at the periphery but at the core of the 2008 crisis, it is clear that this diagnosis is partial at best. Among the emerging markets, the two that struggled most with the crisis of 2008 were Russia and South Korea. What they had in common apart from booming exports was deep financial integration with Europe and the United States. That would prove to be the key. What they experienced was not just a collapse in exports but a “sudden stop” in the funding of their banking sectors.17 As a result, countries with trade surpluses and huge currency reserves—supposedly the essentials of national economic self-reliance—suffered acute currency crises. Writ spectacularly larger, this was also the story in the North Atlantic between Europe and the United States. Hidden below the radar and barely discussed in public, what threatened the stability of the North Atlantic economy in the fall of 2008 was a huge shortfall in dollar funding for Europe’s oversized banks. And a shortfall in their case meant not tens of billions, or even hundreds of billions, but trillions of dollars. It was the opposite of the crisis that had been forecast. Not a dollar glut but an acute dollar-funding shortage. The dollar did not plunge, it rose.
If we are to grasp the dynamics
of this unforecasted storm, we have to move beyond the familiar cognitive frame of macroeconomics that we inherited from the early twentieth century. Forged in the wake of World War I and World War II, the macroeconomic perspective on international economics is organized around nation-states, national productive systems and the trade imbalances they generate.18 It is a view of the economy that will forever be identified with John Maynard Keynes. Predictably, the onset of the crisis in 2008 evoked memories of the 1930s and triggered calls for a return to “the master.”19 And Keynesian economics is, indeed, indispensable for grasping the dynamics of collapsing consumption and investment, the surge in unemployment and the options for monetary and fiscal policy after 2009.20 But when it comes to analyzing the onset of financial crises in an age of deep globalization, the standard macroeconomic approach has its limits. In discussions of international trade it is now commonly accepted that it is no longer national economies that matter. What drives global trade are not the relationships between national economies but multinational corporations coordinating far-flung “value chains.”21 The same is true for the global business of money. To understand the tensions within the global financial system that exploded in 2008 we have to move beyond Keynesian macroeconomics and its familiar apparatus of national economic statistics. As Hyun Song Shin, chief economist at the Bank for International Settlements and one of the foremost thinkers of the new breed of “macrofinance,” has put it, we need to analyze the global economy not in terms of an “island model” of international economic interaction—national economy to national economy—but through the “interlocking matrix” of corporate balance sheets—bank to bank.22 As both the global financial crisis of 2007–2009 and the crisis in the eurozone after 2010 would demonstrate, government deficits and current account imbalances are poor predictors of the force and speed with which modern financial crises can strike.23 This can be grasped only if we focus on the shocking adjustments that can take place within this interlocking matrix of financial accounts. For all the pressure that classic “macroeconomic imbalances”—in budgets and trade—can exert, a modern global bank run moves far more money far more abruptly.24
What the Europeans, the Americans, the Russians and the South Koreans were experiencing in 2008 and the Europeans would experience again after 2010 was an implosion in interbank credit. As long as your financial sector was modestly proportioned, big national currency reserves could see you through. That is what saved Russia. But South Korea struggled, and in Europe, not only were there no reserves but the scale of the banks and their dollar-denominated business made any attempt at autarkic self-stabilization unthinkable. None of the leading central banks had gauged the risk ahead of time. They did not foresee how globalized finance might be interconnected with the American mortgage boom. The Fed and the Treasury misjudged the scale of the fallout from the bankruptcy of Lehman on September 15. Never before, not even in the 1930s, had such a large and interconnected system come so close to total implosion. But once the scale of the risk became evident, the US authorities scrambled. As we shall see in Part II, not only did the Europeans and Americans bail out their ailing banks at a national level. The US Federal Reserve engaged in a truly spectacular innovation. It established itself as liquidity provider of last resort to the global banking system. It provided dollars to all comers in New York, whether banks were American or not. Through so-called liquidity swap lines, the Fed licensed a hand-picked group of core central banks to issue dollar credits on demand. In a huge burst of transatlantic activity, with the European Central Bank (ECB) in the lead, they pumped trillions of dollars into the European banking system.
This response was surprising not only because of its scale but also because it contradicted the conventional narrative of economic history since the 1970s. The decades prior to the crisis had been dominated by the idea of a “market revolution” and the rollback of state interventionism.25 Government and regulation continued, of course, but they were delegated to “independent” agencies, emblematically the “independent central banks,” whose job was to ensure discipline, regularity and predictability. Politics and discretionary action were the enemies of good governance. The balance of power was hardwired into the normality of the new regime of deflationary globalization, what Ben Bernanke euphemistically referred to as the “great moderation.”26 The question that hung over the dispensation of “neoliberalism” was whether the same rules applied to everyone or whether the truth was that there were rules for some and discretion for others.27 The events of 2008 massively confirmed the suspicion raised by America’s selective interventions in the emerging market crises of the 1990s and following the dot-com crisis of the early 2000s. In fact, neoliberalism’s regime of restraint and discipline operated under a proviso. In the event of a major financial crisis that threatened “systemic” interests, it turned out that we lived in an age not of limited but of big government, of massive executive action, of interventionism that had more in common with military operations or emergency medicine than with law-bound governance. And this revealed an essential but disconcerting truth, the repression of which had shaped the entire development of economic policy since the 1970s. The foundations of the modern monetary system are irreducibly political.
No doubt all commodities have politics. But money and credit and the structure of finance piled on them are constituted by political power, social convention and law in a way that sneakers, smartphones and barrels of oil are not. At the apex of the modern monetary pyramid is fiat money.28 Called into existence and sanctioned by states, it has no “backing” other than its status as legal tender. That uncanny fact became literally true for the first time in 1971–1973 with the collapse of the Bretton Woods system. Under the Bretton Woods agreement of 1944, the dollar, as the anchor of the global monetary system, was tied to gold. This was itself, of course, no more than a convention. When it became too hard for the United States to live with—upholding it would have required deflation—on August 15, 1971, President Nixon abandoned it. This was a historic caesura. For the first time since the advent of money, no currency in the world any longer operated on a metallic standard. Potentially, this freed monetary policy, regulating the creation of money and credit as never before. But how much freedom would policy makers actually have after throwing off the “golden fetters”? The social and economic forces that had made the gold peg unsustainable even for the United States were powerful—at home the struggle for income shares in an increasingly affluent society, abroad the liberalization of offshore dollar trading in London in the 1960s. When those forces were unleashed in the 1970s without a monetary anchor, the result was to send inflation soaring toward 20 percent in the advanced economies, something unprecedented in peacetime. But rather than retreating from liberalization, by the early 1980s any restriction on global capital flows was lifted. It was precisely to tame the forces of indiscipline unleashed by the end of metallic money that the market revolution and the new neoliberal “logic of discipline” were inaugurated.29 By the mid-1980s Fed chair Paul Volcker’s dramatic campaign to raise interest rates had curbed inflation. The only prices going up in the age of the great moderation were those for shares and real estate. When that bubble burst in 2008, when the world faced not inflation but deflation, the key central banks threw off their self-imposed shackles. They would do whatever it took to prevent a collapse of credit. They would do whatever it took to keep the financial system afloat. And because the modern banking system is both global and based on dollars, that meant unprecedented transnational action by the American state.
The Fed’s liquidity provision was spectacular. It was of historic and lasting significance. Among technical experts it is commonly agreed that the swap lines with which the Fed pumped dollars into the world economy were perhaps the decisive innovation of the crisis.30 But in public discourse these actions have remained far below the radar. They have been displaced from discussion by controversies surrounding the bailouts of individual banks and subsequent waves of ce
ntral bank intervention that went by the name of quantitative easing. Even in the memoirs of Ben Bernanke, for instance, the transatlantic liquidity measures of 2008 receive little more than a passing mention by comparison with the fraught politics of the AIG takeover or mortgage credit relief.31
The technical and administrative complexities of the Fed’s actions no doubt contribute to their obscurity. But the politics go beyond that. The bank bailouts of 2008 provoked long-running and bitter recrimination and for good reason. Hundreds of billions of taxpayer funds were put in play to rescue greedy banks. Some interventions yielded a return. Others did not. Many of the choices made in the course of the bailouts were highly contentious. In the United States they would exacerbate deep rifts within the Republican Party, with dramatic consequences eight years later. But the problem goes beyond individual decisions and party political programs to the way in which we think and talk about the structure of the modern economy. Indeed, it goes directly back to the analytical agenda of reimagining international economics, forced on us by the crisis and articulated by the proponents of the macrofinancial approach. In the familiar twentieth-century island model of international economic interaction, the basic units were national economies that traded with one another, ran trade surpluses and deficits and accumulated national claims and liabilities. Those entities were made familiar by economists, who gave them an empirical, everyday reality in statistics for unemployment, inflation and GDP. And around them an entire conception of national politics developed.32 Good economic policy was what was good for GDP growth. Questions of distribution—the politics of “who whom?”—could be weighed up against the general interest in “growing the size of the cake.” By contrast, the new macrofinancial economics, with its relentless focus on the “interlocking matrix” of corporate balance sheets, strips away all the comforting euphemisms. National economic aggregates are replaced by a focus on corporate balance sheets, where the real action in the financial system is. This is hugely illuminating. It gives economic policy a far greater grip. But it exposes something that is deeply indigestible in political terms. The financial system does not, in fact, consist of “national monetary flows.” Nor is it made up of a mass of tiny, anonymous, microscopic firms—the ideal of “perfect competition” and the economic analogue to the individual citizen. The overwhelming majority of private credit creation is done by a tight-knit corporate oligarchy—the key cells in Shin’s interlocking matrix. At a global level twenty to thirty banks matter. Allowing for nationally significant banks, the number worldwide is perhaps a hundred big financial firms. Techniques for identifying and monitoring the so-called systemically important financial institutions (SIFI)—known as macroprudential supervision—are among the major governmental innovations of the crisis and its aftermath. Those banks and the people who run them are also among the key actors in the drama of this book.