An Unbalancing Act

 ‘Everything in moderation’ is a mantra most commonly trotted out by those trying valiantly to cut down after a long Christmas season, often while staring glumly at a treadmill on January 1st. Luckily this is still some time away, and yet this and its sister phrase ‘too much of a good thing’ are lessons sorely needed in today’s global monetary system. Enjoying yourself a little too much is a natural part of life, but the world economy went on a 40 year binge and is still hungover after the party ended in 2008.

If you were to ask the average voter what caused the financial crash, most are likely to plump for some mix of greed and incompetence. Bank bosses have been castigated for fee-seeking gluttony, reckless lending and failure to heed the risks to their institutions. Regulators have been accused of sleeping on watch. The seriously misinformed might even blame the Labour party. Few would pin the blame on a global trade imbalance stretching back to the end of the Vietnam War. In two brilliant books, the much maligned Greek finance minister, Yanis Varafoukis, espouses the view that it was in fact this imbalance that was at the root of the crash, and these last years spent in the economic doldrums.

In his book, Varafoukis describes how the imbalances began when the postwar US hegemony could no longer be based on America’s deft recycling of its economic surpluses to Europe and Asia. Simply because its surpluses, by the end of the 1960s, had turned into deficits. The USA’s twin budget and trade deficits  operated for decades like a ‘giant vacuum cleaner’, absorbing other people’s surplus goods and capital. While Varafoukis viewed that arrangement as the embodiment of ‘the grossest imbalance imaginable at a planetary scale’, it did give rise to something resembling global balance. It was an international system of ever growing asymmetrical financial and trade flows capable of putting on a semblance of stability and steady growth, a façade that was known as ‘the Great Moderation’.

This stability meant that the world’s leading surplus economies kept churning out the goods while America consumed them. Thus the large current account deficits run by the US were mirrored by the surpluses of Emerging Asia, Germany and the major oil exporters. These surpluses in Asia were channelled into ever larger piles of foreign exchange reserves, with US Treasuries and other US securities being the assets of choice. China in particular invested large amounts of its foreign exchange reserves in US securities, including long term Treasury debt, US Agency debt, long term corporate debt, securities and short term debt. In June 2008 China held $1.2 trillion of US securities, second only to Japan. As a result almost 70% of the profits made globally by these countries ended up being transferred back to the United States, in the form of capital flows to Wall Street. Varafoukis then asserts that this imbalance was maintained through the United States ‘exorbitant privilege’ of the dollars world reserve currency status, along with a dominance of its energy sector and its Cold War geostrategic might. Perversely this reserve currency status meant that, in a time of crisis such as 2008, capital flew into Wall Street anyway.

To maintain the sheer volume of capital flows needed to keep the US trade deficit financed, America required a financial system far more complex than that which existed in the early 70’s. When the mid-20th century global economy was set up at Bretton Woods, the US was gripped by a New Deal fear of international financial chaos, hence finance was under strict political control during this era. President Richard Nixon’s announcement of the end of the Bretton Woods system, so-called ‘Nixon Shock’ of 1971, marked the beginning of a new age of international finance. But by releasing the financialized profit desires of Wall Street from tight regulation the USA was able to maintain its global dominance as a deficit economy. The banks were then able to effectively channel the net exporters’ surplus earnings back to the net importers, further financing those trade imbalances.

This age of financialization was conveniently supported by an economic ideology developed decades earlier by economists such as Milton Friedman and Friedrich Hayek, one that ascribed an all-encompassing faith in markets to resolve economic issues. When, in the 1970’s, New-Deal Keynesian policies began to fall apart and economic crises struck on both sides of the Atlantic, neoliberal ideas began to enter the mainstream.

This unwavering faith in markets is sometimes referred to as market fundamentalism, sometimes as neoliberalism. It is characterised by tax cuts for the rich, elimination of trade unions, deregulation, privatisation, outsourcing and competition in public services. Through the IMF, the World Bank, the Maastricht treaty and the World Trade Organisation, neoliberal policies were imposed across most of the world. Yet this system has led to widening inequality, stagnating wages, and a disenfranchised middle class who are starting to let their frustrations known through the rise of Donald Trump and Britain’s recent decision to leave the European Union.

The fateful combination of neoliberalism and financilization led the post-Nixon global monetary architecture to be inherently unstable and inherently disconnected from sustainable human and economic realities. Interest rates-the price of money-move inversely to the amount of capital in an economy. Resultantly, the strong cross border capital flows required to maintain America’s twin deficits pushed down interest rates in many countries. The lowering of long term interest rates in western economies encouraged growing levels of credit. The ease of access to credit helped to facilitate consumption booms and housing bubbles, which were especially severe in the US, Spain, Ireland and UK. Up to 2007, this growth in consumption and private spending pulled in ever more imports from abroad. More imports from abroad added to the trade surplus of Asian economies, leading to more excess savings that were recycled to the West. So the cycle continued and the imbalances grew deeper.

Neoliberal policy, enshrined in the repeal of the Glass-Steagall Act, led to ineffective financial regulation and supervision. Failures in credit-rating and securitization (the creation of financial instruments from household loans) transformed bad mortgages into toxic financial assets. When Securitizers lowered the credit quality of the mortgages they securitized, then credit-rating agencies erroneously rated these securities as safe investments, investors sought out these securitised products because they appeared to be relatively safe.

Then collapse of the US sub-prime mortgage market and the reversal of the housing boom in other industrialized economies led to a ripple effect around the world economy. With a globalized system, the credit crunch hit the entire real economy, quickly turning a global financial crisis into a global economic crisis. Eight years on, despite the various appearances of recovery, the mechanisms and institutions that used to keep the global economic order in some sort of functional balance have all but failed. 

Neoliberalism and financialization have so effectively defined political “realism” that Britain’s public discourse simply refuses to recognize that we will witness an unravelling of the prevailing global order if we just keep going as we are. Neoliberalism’s triumph also reflects a failure of the left. When laissez-faire economics led to catastrophe in 1929, Keynes devised his General Theory to replace it. When Keynesian demand management failed in the 70s, Friedman had an alternative ready. It’s not enough to oppose a broken system. A coherent alternative has to be proposed.

Daniel Sharp, President