This was Yanis Varoufakis´s keynote address at the OECD on 14 September. Although a long read, it is a good analysis of the past, present, and what could be the future.
2008 marked globalised capitalism’s near death experience. A decade later we have no right to be looking at those events as part of our economic history. The reason? We are still entangled in the crisis that the events of 2008 sparked off. They remain very much at the centre of our present. The same crisis is taking different shapes in different places, migrating from continent to continent, from country to country. It morphs from an unemployment-generator to a deflation-machine, to another banking crisis, to a maximiser of trade and capital global imbalances. It depletes middle class savings in Germany and Holland, suppresses wages across the West, causes credit bubbles in China, keeps Greece and Europe’s periphery in a permanent Great Depression, it fuels Brexit and discontent in middle America, in Europe. Last but not least, it jeopardises the life prospects of millions of people across the so-called Emerging Countries.
Moreover, I shall be arguing, 2008’s causes are intact, the imbalances that triggered it are getting worse and, tragically, democratic politics – the only antidote to this crisis and the next – are in a state of disrepair as a result of the never ending crisis that 2008 bestowed upon us. But, lest you fear a talk dripping with gloom and doom is in the offing, let me promise that I shall conclude – when turning from discussing 2008 to the lessons for beyond 2018 – with an upbeat message: Yes, we can! We can put 2008 behind us in a manner that strengthens democracy and brings shared green prosperity for a majority of people in a majority of countries.
ON THE NATURE AND CAUSES OF 2008
2008 was our generation’s 1929. The globalised financial system collapsed and was only propped up by two massive interventions: First, the institutions of the American state backstopped the world’s banks and their offshore dollarised business centred in London, Frankfurt and here in Paris – the Fed with its gigantic swap lines primarily but also the US Treasury. One European central banker, accurately, referred to Europe’s central banks in 2008 (the ECB, the Central Bank of Switzerland and the Bank of England in particular) as having become the 13th branch of the US Federal Reserve system. Secondly, China – whose authorities pumped up credit and investment magnificently in a judicious attempt on the one hand to replace domestic aggregate demand (lost to the free falling Chine exports) and, on the other, to buy time for Europe and the US to get their act together.
While the world of finance was saved from itself by the American and Chinese states, financialisation’s near death experience had repercussions that were felt everywhere. The aggregate effect on output and trade was greater, in the first couple of years, than that of the Crash of 1929. The certainties created by decades of establishment thinking – for instance that markets are self-regulating and politics largely irrelevant – were gone, along with around $40 trillion of equity globally, $14 trillion of household wealth in the US alone, 700,000 US jobs every month, countless repossessed homes everywhere. Even McDonald’s, for goodness’ sake, could not secure an overdraft from Bank of America!
Meanwhile the response of governments that had hitherto clinged tenaciously onto fiscal conservatism, as perhaps the 20th century’s last surviving ideology, caused many eyebrows to lift in puzzlement. Once they realised it was not enough to pour of trillions of dollars, euros, yen etc. into a financial system which had been, until a few months before swimming in profits and liquidity, our Presidents and Prime Ministers, men and women with impeccable anti-statist free-market credentials, embarked upon a spree of nationalising banks, insurance companies and automakers that put even Lenin’s exploits to shame.
Here, in continental Europe, where we had created an odd monetary union featuring a central bank without a state to have its back, and 19 governments responsible for bailing out national banks but without a central bank to have their back, the result was a remarkably self-defeating policy of contractionary contraction, that lasted from 2008 to 2015, which caused a historic defeat for European capitalism – one that, despite the various proclamations that the crisis has ended, is still with us, depressing real investment as well as productivity and poisoning our democracies by making them vulnerable to orchestrated xenophobia and a moral panic around the issue of migration.
So, what caused the events of 2008? After 2008, even those who had argued that 2008 was impossible are now experts in what caused it. Such is life. But let’s look at the various explanations:
- Growing trade imbalances
- Financialisation creating a toxic dynamic: the narrative of riskless risk producing massive systemic risk that fed on itself
- Toxic economic theory aiding and abetting toxic finance; e.g. the Efficient Market Hypothesis, Rational Expectations Hypothesis, the so-called Real Business Cycle Model – Regulatory capture
- The entry of 2 billion workers (from the former communist states, China and India) into the global proletariat
- The global savings glut that these developments engendered
- Central Banks fighting the wrong war against price, not asset, inflation).
All these explanations are true and apt. But, I want to argue that all of these explanations are themselves symptoms of a deeper cause: an underlying global macro dynamic that has been unfolding since the 1940s. In short, my argument is that these developments, that precipitated 2008, were caused by the nature of the transformation of the US from an hegemonic economy whose surplus was used, by political means, to stabilise Europe and Japan to a deficit economy whose hegemony grew as a result of stabilising global aggregate demand via its growing twin deficits.
To see this, we need to begin at the beginning – in 1944 and the Bretton Woods Conference. As the war was drawing to a close, the New Dealers’ administration in Washington understood that the only way of avoiding the Great Depression’s return, once the guns had been silenced, was to recycle America’s surpluses to Europe and to Japan, and thus generate abroad the demand that would keep American factories producing all the gleaming new consumer products that American industry would switch to at war’s end.
The result was the project of dollarising Europe, of founding the European Union as a cartel of heavy industry, and of building up Japan – all within the context of a global currency union that was the Bretton Woods system and its underlying new philosophy according to which money was co-owned by those who had it and the global community that backed it. A system featuring fixed exchange rates regime anchored on the US dollar, almost constant interest rates, boring banks (operating under severe capital controls) and American-led management of aggregate demand for global capitalism’s goods and services.
This dazzling design brought us a Golden Age of low unemployment, low inflation, high growth and massively diminished inequality. Alas, by the late 1960s the foundations of Bretton Woods were disintegrating. The US surplus, which was the bedrock of the global monetary system, disappeared. This, combined with the bankers’ perennial attempt to unschackle themselves from the constraints placed upon them, created the offshore Eurodollar market that was to become, later, after Bretton Woods was jettisoned in 1971, the basis for financialisation. Indeed, by 1968, America had lost its surpluses, slipped into a burgeoning twin deficit and could, therefore, no longer stabilise the global system it had created by recycling surpluses it no longer had. Never too slow to accept reality, Washington killed off its finest creation: On August 15th, 1971 President Nixon announced the ejection of Europe and Japan from the dollar zone.
President Nixon’s decision was founded on the Americans’ refreshing lack of deficit-phobia. Unwilling to rein in the deficits by imposing austerity (that would shrink the United States’ capacity to project hegemonic power around the world), Washington stepped on the accelerator boosting its deficits. Thus American markets worked like a giant vacuum cleaner absorbing massive net exports from Germany, Japan and, later China – ushering in the second phase of post-war growth (1980-2008). And how were the expanding American deficits paid? By a tsunami of other people’s money (around 70% of the profits of European, Japanese and Chinese net exporters) enthusiastically rushing into Wall seeking refuge and higher returns, a sea change that was aided by three developments: (i) US wage growth that was lower than that in Europe and Japan (thus, boosting returns to foreign capital flooding into the US); (ii) Paul Volcker’s 20%+ interest rates; and (iii) the Wall Street-City of London dollarised financialisation that occasioned self-reinforcing financial paper gains.
By the mid-1980s, the United States were absorbing a large portion of the Rest of the World’s surplus industrial products while Wall Street would administer the foreign capital flooding into the US in three ways. First, it provided credit to American consumers (whose wages stagnated). Secondly, it channelled direct investment into US corporations and, of course, thirdly, it financed the purchase of US Treasury Bills (i.e. funded the American government deficits).
But for Wall Street to act as this ‘magnet’ of other people’s capital, and perform the role of recycling other people’s surpluses so as to pay for America’s deficits, it had to be unshackled from the New Deal and Bretton Woods era stringent regulations. Put differently, the eurodollar, unregulated financial market that had grown up in the City of London had to take over the rest of the world, becoming the dominant financial model in NYC, here in Paris, in Frankfurt and in the Far East. Institutionalised greed, wholesale de-regulation, the infamous ‘revolving doors’, the exotic derivatives etc. were mere symptoms of this brave new global recycling mechanism. And, after 1991, an additional two billion workers entered the global workforce producing new output that boosted the already imbalanced trade flows, capitalism had entered a new phase. It is what became known as Globalisation.
In Globalisation’s wake, the EU created its common currency. The reason the EU needed a common currency was that, as all cartels, it had to keep the prices of its main oligopolistic industries stable across Europe’s single market. To do this, it was necessary to fix exchange rates within its jurisdiction, as they had been fixed during the Bretton Woods era. However, from 1972 to the early 1990s each EU attempt to fix European exchange rates had failed spectacularly. Eventually, the EU decided to go the whole hog: to establish a single currency. This it did within the supportive environment of (grossly imbalanced yet temporarily impressive) global stability that the US-anchored Global Surplus Recycling Mechanism maintained. To get around the political hurdles presented by the Bundesbank’s understandable reluctance to sacrifice the DM, we ended up with the paradox of the ECB supplying a single currency to the banks of nineteen countries, whose governments would have to salvage these banks, at a time of crisis, without a central bank that could support them!
Meanwhile, Wall Street, the City and the French and German banks were taking advantage of their central position in the US-anchored global recycling system to build colossal pyramids of private money on the back of the net profits flowing into the United States from the Rest of the World. This added much energy to the recycling scheme, as it fuelled an ever-accelerating level of demand within the United States, in Europe and Asia. It also brought about the astonishing de-coupling of financial capital flows from the underlying trade flows.
To explain what I mean by the ‘astonishing de-coupling of financial capital flows from the underlying trade flows’, recall the heady days of August 2007 when the rot set in. My German friends, to this date, tell me that they don’t get it: How is it that Deutsche Bank, and the rest of the German banks, went, effectively, bust? How can any economic sector go, within 24 hours, from making zillions to insolvency, demanding massive taxpayer bailouts. The answer is as simple as it is devastating.
Consider Germany’s banks and exporters back in the summer of 2007. Germany’s national accounts confirm Germany’s large trade surplus with the United States. In the month of August of 2007, to give an example, German net export income from the United States was a cool $5 billion. Germany’s national accounts registered this surplus as well as a counter-balancing outflow of capital from Germany to the US. However, Germany’s national accounts do not show was the real behind-the-scenes drama, the real action.
From the early 1990s and until 2007, Frankfurt’s bankers were dying to buy the lucrative dollar denominated derivatives Wall Street and the City manufactured and did so with dollars that they were borrowing from… Wall Street. In August 2007, the price of these derivatives began to fall, underlying debts were going back and, thus, Wall Street institutions faced large margin calls. German bankers became apoplectic when their panicking New York pals began to call in their dollar debts. They needed dollars in a hurry but no one would buy the mountain of US toxic derivatives they had purchased. This is how, from one moment to the next, German banks swimming in oceans of paper profit found themselves in desperate need of dollars they did not have. Could Germany’s bankers not borrow dollars from Germany’s exporters to meet their dollar obligations? They could, but how would the $5 billion the latter had earned during that August help when the German bankers’ outstanding debt to Wall Street, that the Americans were now calling in, exceeded $1000 billion? This is what I mean by the astonishing decoupling of economics from finance, of trade flows from capital flows.
In summary, what had happened, globally, was that imbalanced dollar-denominated financial flows, which had initially grown on the back of the US trade deficit, ‘succeeded’ in de-coupling themselves from the underlying economic values and trade volumes. It would not be far-fetched to say that they almost achieved escape velocity and nearly left Planet Earth behind – before crashing down violently in 2008.
From that moment onwards, politicians went into overdrive to shift the losses from those who created them (the bankers) onto the shoulders of middle class debtors, waged labourers, the unemployed, those on disability payments and the taxpayers who could not afford to set up off-shore accounting units. In Europe, in particular, our leadership not only failed to temper the eurozone crisis but, by implementing to this day fraudulent insolvency concealment, delivered a historic defeat for European capitalism.
The dominant narrative on what went wrong had no basis in macroeconomics and was, thus, allowed to obscure the reality that the eurosystem had been designed not to have any shock absorbers to absorb the shockwave from Wall Street. Consequently, one proud nation was turned against another by a ruling class determined to disguise: (A) a crisis caused by an alliance of Northern and Southern bankers and other rent-seeking oligarchs, into (B) a clash caused by the profligate Southerners and ant-like Northerners, or as as crisis of over-generous German, Greek, Italian etc. social welfare systems. The political repercussions of this inane handling of an inevitable crisis are evident to all – and so I shall desist from saying anything more about it – even though my life is, these days, devoted to fighting against the Nationalist International that has grown out of this mess.
But let’s set aside these by now well-known developments. The question is: Where are we now?
While America’s trade deficit returned to its pre-crisis levels within a couple of years, it was no longer enough to stabilise global demand. The pre-crisis mechanism by which Wall Street and the City converted – and supercharged – the US trade deficit into fixed capital investments around the world has broken down. Sure, the Fed and other Central Banks tried to make amends with tsunamis of QE-induced liquidity. But that only pushed up asset prices in the West; e.g. giving US corporations an opportunity to buy back their shares while saving their own profits in offshore accounts. Where monies did flow, in the Emerging Markets, investment grew but was vulnerable both to the deflationary forces Europe continually exports (courtesy of its domestic austerity drive) and to the expectation of tapering and higher long-term interest rates in the United States. Perhaps the only pillar of global demand was China, although its capacity to maintain that boost was circumscribed by the constant threat of its credit bubble bursting.
In short, Wall Street’s pre-2008 capacity to continue ‘closing’ the global recycling loop vanished – and has not been replaced yet. America’s banks can no longer harness the United States’ twin deficits for the purposes of financing enough demand within America to keep the net exports of the Rest of the World going. This is why the world today remains in the clasps of the same crisis that began in 2008.
HAVE ANY LESSONS BEEN LEARNT?
Not really. Global capitalism behaved like a reckless driver who, having been caught for speeding, sticks to the speed limit for a while but soon floors the accelerator as if nothing had happened.
DEBT: 40% up since 2007, to 217% of global GDP
BANK REGULATION: Tougher national rules set out to constrain the banks’ balance sheets, causing a shift of financial intermediation from banks to capital markets, mainly with fixed income dollar denominated instruments. But, by making banks safer, market-making has been impaired or shifted to the shadow banking system which has grown from $28 trillion in 2010 to $45 trillion in 2018. Risk has not been eliminated, just taken out of sight and dispersed geographically; e.g. American banks dominate more than ever (the five larger US banks that were considered Too Big To Fail are now even bigger – accounting for 47% of all US banking assets, up from 44% in 2007), Asia’s new banking giants have rapidly expanded and it is the British and European banks that contracted – as US authorities required European competitors such as Barclays and Deutsche Bank to provide more capital to their US operations or to leave.
EMERGING MARKETS LOSE THEIR CAPACITY TO ADJUST VIA DEPRECIATION: It is well known that QE-monies flowed into Emerging Markets. Indeed, over the past decade, dollar-denominated loans to EM borrowers grew by 17% every year, flowing into China, Brazil, Chile, Turkey, Argentina, Indonesia etc. $3.7 trillion all up. This is now causing the troubles we all read about. Worse still, devaluation seems to make no difference (as Argentinians will not keep their money in pesos even if offered 100% interest rates). Even when the government has enough foreign currency reserves to cover its dollar liabilities, the appreciation of the dollar causes domestic corporates that labour under large dollar debts to retrench at home, thus blunting the capacity of depreciation to boost domestic economic activity.
A SENSE OF INJUSTICE: $321 billion fines were imposed on bankers. It was a tiny percent of the liquidity and public assets sunk into them by taxpayers. Remarkably, unlike the 1980s when a much smaller banking crisis erupted in the US (the Savings and Loans scandal), which saw more than one thousand bankers jailed, no arrests were made for financial crimes related directly with the toxic activities of financiers which led to 2008.
NO PLANS FOR THE NEXT EPISODE: No plan is in place for when the new tail risks hit; a domino effect that may begin in a variety of ways (e.g. Italian public debt scare, a Chinese credit bubble meltdown) and made more ominous by the Trump strategy of inciting a coordination failure at the global level, by Brexit in Europe, by the generalised poisoning of democratic processes.
WHAT NEXT? The need for a Progressive International and a sketch of the International New Deal it must campaign for
The 2008 crisis begat the Great Recession, which begat the Great Deflation, which gave rise to the Comprehensive Dissolution of any semblance of Global Governance. The European Union is, sadly, at an advanced stage of disintegration, with the migration debacle fronting for the underlying macroeconomic imbalances that are inconsistent with the euro’s institutional framework. The United States has adopted the strategy of shifting to bilateral negotiations; a framework within which neither the European Union nor the Chinese economy can continue as at present. The current trends will, almost certainly, lead to: (a) Europe exporting greater deflation and instability to the rest of the world; and (b) China reducing its unsustainable levels of investment by more than 10% of GDP, which in conjunction with a maximum growth rate of 6% and a savings ratio of 40%, leads to the safe prediction of a capital outflow from China that will exceed 10% of GDP. While particular economies will be able to do reasonably well in such an environment, the global economy will suffer and tensions will multiply. If to this picture we add the pressures from the next crisis (i.e. the deflationary effects of AI and automation), the future looks bleak.
Can the future be brighter? Yes, of course it can. Recently, together with Bernie Sanders, we issued a call for a Progressive International to campaign for an International New Deal, a brand new Bretton Woods. What would that mean in practice? Here are three examples of what that would mean:
- A Large-scale Green Investment Program by which to put to useful purpose the global glut of savings
This would be equivalent to an International New Deal, borrowing from Franklin D. Roosevelt’s plan the basic idea of mobilising idle private money for public purpose. But rather than through tax-and-spend programs at the level of national economies, this should be administered by a multilateral partnership of central banks (like the Fed, the European Central Bank and others) and public investment banks (like the World Bank, Germany’s KfW Development Bank, the Asian Infrastructure Investment Bank and so on). Under the auspices and direction of, say, the IMF, the OECD even (!), the investment banks could issue bonds in a coordinated fashion, which these central banks would be ready to purchase, if necessary. By this means, the available pool of global savings would provide the funds for major investments in the jobs, the regions, the health and education projects and the green technologies that humanity needs.
- Fair trade deals, based on minimum living wages for poor countries and a job guarantee scheme for the deprived regions of the richer countries
To illustrate that tariffs are not the best way of protecting our workers, since they mostly enrich local oligarchies, we should campaign for trade agreements that commit governments of poorer countries to legislating minimum living wages for their workers and governments of the richer countries to legislate a job guarantee scheme for deprived regions – so that communities can be revived in richer and poorer countries at once.
- A New International Monetary System – a global trade & capital clearing union
The task here is to rebalance trade and create an International Wealth Fund to fund programs to alleviate poverty, develop human capital, support marginalized communities and invest in the Green Transition across the world, and not just in the developing world but also in the rustbelts of the United States and Europe.
While keeping their own currencies, and central banks, members of the New Bretton Woods would agree to denominate all payments in a common accounting unit, let’s call it the Kosmos (K) – a common digital currency to be issued and regulated by the IMF on the basis of a transparent digital distributed ledger and an algorithm that would adjust the Ks total supply in a pre-agreed manner to the volume of world trade, all of which will be denominated in K units. Foreign exchange markets would function as they do now and the exchange rate between K and various currencies would vary in the same way that the IMF’s Special Drawing Rights do viz. the dollar, the euro, the yen etc. The difference, of course, would be that, under this system, member-states would allow all payments to each other to pass through their central bank’s K-account. Further, to exploit the system’s full potential for keeping imbalances under check, two stabilising transfers would be introduced.
The supply of K will be run on the basis of simple, automated rules which boost global K supply at times of a global slowdown, minimise politicians’ and bureaucrats’ discretionary power, regulate heavily the financial sector’s dealing in Ks and keep global trade and capital imbalances in check using two instruments:
- The Levy: A trade imbalance levy to be charged annually to each central bank’s K-account in proportion to its current account deficit or surplus and paid into a common Wealth Fund
- The Charge: Private financial institutions to pay a ‘surge’ fee into the same Fund in proportion to any surge of capital flows out of a country, reminiscent of the congestion price-hike that companies like Uber charge their customers at times of peak traffic
The Levy’s rationale is to motivate governments of surplus countries to boost domestic spending and investment while systematically reducing the international spending power of deficit countries. Foreign exchange markets will factor this in, adjusting exchange rates faster in response to current account imbalances and cancelling out much of the capital flows which today support chronically unbalanced trade. As for the Charge, it will automatically penalise speculative herd-like capital inflows or outflows without, however, handing discretionary power to bureaucrats or introducing inflexible capital controls.
Suddenly, through the Common Fund, the world will have acquired, without the need for any subscribed capital, a Global Sovereign Wealth Fund by which to fund programs to alleviate poverty, develop human capital, support marginalised communities and invest in the Green Transition across the world, and not just in the developing world but also in the deprived areas of United States and Europe.
2008 was a wakeup call that fell on deaf ears. The world in 2018 is more precarious than it was in 2007. Finance continues to suck the oxygen out of the creative workers, corporations massively under-invest in the things humanity needs, the majority of people face diminishing life prospects in an uberising labour market, and democratic politics is being poisoned both by the inane establishment’s business-as-usual fixation and the increasingly triumphant xenophobic Nationalist International. Only a Progressive International campaigning for the International New Deal outlined here can inspire hope of the future.