Crashed

by Adam Tooze

  III

  In 2011 the Tea Party caucus had come close to forcing the United States into fiscal crisis. That had been avoided at the last minute by a compromise under which a bipartisan “super committee” would make recommendations on deficit reduction. When that failed to reach agreement in January 2012, it meant that automatic sequester cuts would be triggered in January 2013, affecting the entire government machine, including defense.45 This nondiscretionary mechanism was popular with the Rubinite fiscal reform crowd.46 Among the loudest and most influential voices for budget cuts was the coalition of business interests and Washington insiders gathered by Peter G. Peterson in the Fix the Debt campaign.47 They had a strong preference for entitlement cuts and, given their suspicion of the kind of “political crap” that frustrated businessmen and policy experts alike, automatic sequester was far from being the worst of all possible worlds. As Obama’s ex–budget director Peter Orszag put the argument in October 2011 in the wake of the first budget showdown with the Tea Party: “To solve the serious problems facing our country, we need to minimize the harm from legislative inertia by relying more on automatic policies and depoliticized commissions for certain policy decisions. In other words, radical as it sounds, we need to counter the gridlock of our political institutions by making them a bit less democratic. . . . We need to jettison the Civics 101 fairy tale about pure representative democracy and instead begin to build a new set of rules and institutions that would make legislative inertia less detrimental to our nation’s long-term health.”48

  Unless something was done, the automatic cuts coming down the road in 2013 were huge—$563 billion in a single year, a contractionary antistimulus that might well trigger a new recession. To avoid this disaster, tense negotiations began in the hope of reaching a deal. The so-called grand bargain worked out between Obama and Boehner in 2011 was a lopsided demonstration of Washington’s rigged politics in action. It traded deep cuts in entitlements for some carefully chosen increases in taxes that would hit higher-income households but cushion “job-creating” and “growth-generating” businesses. To the Left it was outrageous.49 The mainstream deficit-reduction campaign was riddled with conflicts of interest. Many of the most active exponents of entitlement cuts were lobbyists for targeted tax exemptions. As one cynical observer put it, “It’s easier to get face time in Washington as a deficit hawk than as a corporate hack.”50 Meanwhile, the effort by Peterson lobbyists to present the austerity movement as a grassroots and youth-driven movement was exposed as a risible joke. The campaign included a bus tour of college campuses called “The Can Kicks Back,” a bizarre YouTube clip in which the venerable Senator Alan Simpson was persuaded to dance Gangnam style, and a cack-handed effort to deluge Congress with scripted letters from indignant teens protesting the debt burden their grandparents were threatening to pass down to them. It wasn’t so much grassroots as “Astroturf.”51

  Countering the posttruth of the mainstream austerity campaign made for good journalistic exposés. It also made sense for the Left to focus its fire on the likes of Peterson, Orszag, Simpson and Bowles, who were assumed to be the real power brokers in Washington. What no one reckoned with was the astonishing aggression and energy of the Far Right, which was not interested in reducing government so much as stopping it altogether. The Tea Party caucus inside the Republican Party was a small, determined and well-funded group. As far as deficit reduction was concerned, they would accept only spending cuts. And the spending they wanted to stop, in particular, was Obamacare, which they regarded as a lethal “socialist” threat to America’s future. The Republican leadership might worry about losing centrist votes. They knew that the budget crisis of 2011 had not played well with the electorate. But the most hard-core Tea Party advocates did not listen. To the Taliban of the Right, it was clear that Romney had lost because he was a moderate, compromising on immigration and health care. The only way to win back the electorate, at least the electorate in their gerrymandered Republican congressional districts, was to take the hardest line possible.

  By January 2013 no cross-party agreement had been reached. The automatic sequester was put off for two months by stopgap legislation. Meanwhile, the debt limit was raised sufficiently to cover spending until May. With a substantial section of the Republicans agreeing to modest tax increases on the highest earners and on large inheritances, it seemed as though a crisis might be avoided. But the timeline was now pressing. On March 1 the sequester cuts came into full effect, hitting the budgets of the military, FEMA, the FBI, the FDA and the SEC. America’s apparatus of government began to go into hibernation.52 In 2013 the sluggish economic recovery in the United States would be further slowed down by a fiscal tightening equivalent to almost 1 percent of global GDP. The United States moved from being significantly more expansive than the EU in 2008–2009 to being far more contractionary.

  Global Fiscal Tightening or Loosening as % of Global GDP

  Source: Credit Suisse.

  Meanwhile, to keep basic government functions going, ad hoc spending authorizations were approved to cover the federal government through September. Crafting a proper budget for 2014 was more than Congress could manage. On March 21, March 23 and April 10, first the House, then the Senate, and finally the White House released separate budget proposals. The Senate and the White House were close together in terms of both the deficit reduction ($1.8–1.9 trillion over ten years) and the balance of spending cuts and tax increases they proposed.53 The Republicans in the House were in a different world. They called for much bigger cuts ($4.6 trillion over ten years) to be achieved entirely by slashing spending. The House would not consider the Senate budget, and neither the Senate nor the House would vote on the White House proposal. The incoherence of US fiscal policy was reaching a new pitch. On May 19 the debt ceiling was reinstated at a level that covered borrowing since suspension in February but without provision for any new debt. The Treasury was, therefore, forced back on the expedients it had resorted to in 2011, raiding government cash tills and running down reserve funds. By mid-October the Treasury would run out of money and be forced to prioritize bill payments. It would be tantamount to a selective default. To prepare for this contingency, mainstream Republicans in May 2013 proposed a bill to ensure that at least the government’s bondholders were paid.54 To John Boehner, the conventionally minded Republican leader in the House, this seemed like a sensible first step to order the federal government’s affairs in case of bankruptcy. But the Democrats had no interest in making the unthinkable more manageable, and the proposal that Chinese creditors should be paid ahead of serving military and social security recipients made easy political meat. The Full Faith and Credit Act was soon dubbed the “Pay China First Act” and voted down by the Democrats. Obama announced that he would veto the bill if it passed.

  With the summer having gone by without any movement toward a deal, on September 25 the Treasury announced that it would run out of cash on October 17, 2013. Nancy Pelosi appealed to Boehner to remember the sacrifice that the Democrats had made to pass the TARP program for President Bush.55 But that cut no ice with a Republican majority that did not remember the Bush years fondly and was terrified of being outflanked on their right wing by the Tea Party caucus, for whom TARP and the bailouts were anathema. With the Republicans demanding swinging cuts and privatization of Medicare, no deal could be reached, and on October 1, 2013, at 12:01 a.m. Eastern Time, the government went into partial shutdown, with up to 850,000 federal employees put on temporary unpaid leave.56 The White House was forced to suspend the president’s foreign travel. At a meeting of APEC in Indonesia, the American president would not make his rendezvous with his Chinese counterpart. It was not until October 16, hours before the Treasury’s final deadline, that the Senate passed a continuing resolution to fund the government through February 2014, a temporary expedient with which the Republican leadership fell into line once they realized the political damage they were suffering from the standoff. />
  IV

  Though a disaster was avoided, it is important not to normalize what had happened. The radical right wing of the Republican Party, xenophobic nationalists, many of them evangelical zealots, motivated by a worldview fashioned by the alt-right, or Pat Buchanan’s extreme America-first nationalism, a group whose hard core accounted for 10 percent of the House of Representatives, had threatened to paralyze the most important nation-state in the global system. As Steve Bannon, the editor of the Breitbart news site, a cheerleader of the Tea Party and a rising star of the alt-right, gushed to a Daily Beast journalist in November 2013: “I’m a Leninist. Lenin wanted to destroy the state, and that’s my goal too. I want to bring everything crashing down, and destroy all of today’s establishment.”57 For the likes of Bannon, the crisis of 2008 and the bailout had marked a fundamental caesura in American history. The morning of September 18, 2008, when Bernanke and Paulson’s alarmism had scared President Bush into approving the TARP plan, was a fundamental turning point. It was a moment, according to Bannon, at which the threat of systemic collapse revealed the true power structure: “We are upside down; the industrial democracies today have a problem we have never had before; we are over-leveraged . . . and we have built a welfare state which is completely and totally unsupportable.”58 Only a no-holds-barred struggle against the liberal elite and the state they had constructed in their image could save America. If this discomforted the failed Republican establishment as well, all the better.

  To challenge the power structure, Robert Reich had called for a new progressive age, a new civil rights movement, a movement unafraid to question the status quo at all levels. That challenge had arrived, but it came from the Right, not the Left. The world was aghast. In Japan, Newsweek appeared on newsstands declaring “Ruined America—a Superpower Destroys Itself.” The Wall Street Journal reported on “Shutdownfreude” spreading across Europe, as for once it was America, not the eurozone, that was in the dock of global public opinion.59 Der Spiegel commented bleakly: “The United States had embarrassed itself on the global stage. . . . Is this how a superpower behaves?”60 One might respond that only a superpower could possibly afford to behave like this. But how long would the United States be able to uphold that position if it was internally so at odds that it was unable to decide whether to honor its debts or pay its soldiers? Predictably, Xinhua, China’s official news agency, took a dim view. Editorialist Liu Chang wrote: “As US politicians of both political parties are still shuffling back and forth between the White House and the Capitol Hill without striking a viable deal to bring normality to the body politic they brag about, it is perhaps a good time for the befuddled world to start considering building a de-Americanized world.”61 On a lighter note, a Canadian comic living in China commented: “Chinese must be wondering: When will America embrace real reform? How long can this system survive? Where is America’s Gorbachev?”62

  Nor was it only foreigners who were worried. If the Tea Party would turn the Republican Party into a vehicle for an attack on the creditworthiness of US government, what was safe? So far the Tea Party had made Obamacare its main target. What would be next? By 2014 the Republican Right would block immigration reform and refuse to fund the Export-Import Bank, both priorities of American business. At the G20 the Americans were embarrassed to report that funding for the IMF was being held hostage by Republican opponents of abortion who wanted contraception excluded from Obamacare.63 What if the Republican zealots targeted Fed independence or trade policy next?

  Of course, there were business interests aligned with the Tea Party on tax and welfare issues. The coal lobby wanted environmental regulation stripped away. A clique of right-wing oligarchs saw the movement as the vehicle for a cultural and socioeconomic counterrevolution.64 But with the 2013 budget fight, the mainstream of the American business leadership could no longer ignore the problem. Over the winter of 2013–2014, the Chamber of Commerce mobilized not to fight organized labor but to resist the Republican insurgency. “No fools on our ticket” was the Chamber’s slogan for the 2014 midterms, a euphemism for excluding the Tea Party.65 A spokesman for the Chamber put it this way: “The crowd that wants to come to Washington and blow the place up and shut the place down, that’s a threshold issue for us. . . . We care about governing.”66

  By 2014 the signs of realignment were undeniable. While the Tea Party inveigled against “special interests” that had “come to dominate our political culture,” “self-serving politicians” and “the interfering strong hand of a powerful elite,” it was Democratic candidates who advertised themselves as “business friendly.”67 As Senator Chuck Schumer of New York put it, “Democrats and business are on the same side on a range of issues. . . . The Tea Party has dragged the Republican Party so far to the right that business is now closer to mainstream Democrats than Republicans.”68 The alignment that had first become clear during the bank bailout of 2008 was becoming something more entrenched. In the name of nationalism and the American Dream, the right wing claimed the cause of systemic change, while the Democratic Party establishment filled the middle ground the Republicans vacated. The question of the comprehensive progressive campaign to fight for greater equality was left begging.

  Chapter 20

  TAPER TANTRUM

  That the astonishing events in Congress in 2013 did not lead to an immediate crisis in the bond market pointed to the resilience of the US Treasurys as the global safe asset of choice. Though the Chinese and Germans might complain and the market blipped, demand for US Treasurys quickly recovered. Ultimately, the market for IOUs drawn on the American taxpayer was underwritten by the Fed. Unlike the ECB, America’s central bank left no doubt that it backed its government’s debt. QE3 bond purchases provided immediate support, keeping prices up and rates down. This provided at least one point of stability for global investors. But after the events of 2013 questions could no longer be avoided. Was one of the unintended side effects of the stability generated by the Fed to free politics from market constraints and thus enable Republican extremism? Did America’s ability to ride out short-term budget crises like those of 2011 and 2013 lead contemporaries to underestimate the future dangers that the degeneration of American democracy might bring with it? And how long would the Fed’s technocratic interventions compensate for America’s lackluster economic recovery and the shambles in the legislative branch? How long could the Fed continue with QE3? When would the Fed begin tapering? Compared with the chaos in fiscal policy, these were, on the face of it, “normal” monetary policy questions, except that since 2008 there was no longer any such thing as normal monetary policy. The enormous expansion of the Fed balance sheet underpinned not just the US banking system but the entire global dollar system. Furthermore, the Fed had not just expanded its balance sheet, it had changed its composition. Buying up long-term securities in exchange for cash reserves, the Fed had absorbed onto its books the maturity mismatch that had undone the shadow banking system. After successive phases of QE, it was the Fed that held long-term securities that were matched against short-term liabilities such as cash and deposits by American and European banks.

  Despite some nail biting by inflation hawks, this posed no immediate stability risk. The banks were happy to hold their cash reserves with the Fed. If interest rates went up, the Fed, as one of the largest holders of bonds, would suffer a capital loss. But this was more than made up for by the $350 billion in profits that the Fed paid to the Treasury between 2008 and 2013.1 The real question was the likely fallout in the financial markets and money markets when the Fed changed its stance. Any move to moderate the Fed’s bond purchases, let alone to unwind its position, implied a comprehensive adjustment in the willingness of the markets to absorb not only a greater volume of bonds but also some of the maturity mismatch that the Fed was carrying. And that would have to happen at the same time as short-term interest rates were nudging up. If, on the other hand, the Fed continued QE3, its balance sheet would further inflate, bond pric
es would remain elevated, interest rates would remain stuck near zero and imbalances would further accumulate. In 2008 the Fed had embarked on a vertiginous tightrope walk from which there was no way back to the certainties of the great moderation.

  I

  Both at home and abroad, the Fed’s low interest rate policy created a superheated investment climate. By its bond-purchasing program, which pushed up bond prices and depressed yields, the Fed incentivized investors to shift out of bonds and to place their funds in higher-risk, higher-return assets. How far this impulse actually went to explain the stock market boom is debatable. The econometric evidence is strongest for the impact of QE1 in launching the first phase of the stock market recovery in 2009.2 But for the average Wall Street booster, the visual association between the Fed’s balance sheet and the surging value of the S&P 500 was plenty to be going along with. As a strategist for Citigroup told the Financial Times, “Everything revolves around monetary policy. It’s not the underlying economics that’s driving things, it’s central bank liquidity.”3 In 2008 the Fed had intervened to stop the market from imploding. It had pumped trillions into the financial system. Now the markets hung on its every word.