Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

The word used to refer to the crisis-fighting measures was the old Mao-era term jihua, or plan, rather than the newfangled word for softer government programs or initiatives, guihua, which had come into widespread currency since 2006.13 Instructions to the press required reporting to “stay upbeat, to avoid panic and contribute to consumer confidence.”

On April 7, 2009, Beijing announced that health insurance coverage would be extended from 30 to 90 percent of China’s population and that central funds would be allocated to pay for the construction of two thousand county hospitals and five thousand township-level clinical centers. It was the largest expansion in health-care provision in world history to date and it was “inextricably interwoven with the stimulus package.” Beijing was happy to approve spending on hospitals, clinics and public insurance subsidies “because concerns about short-run deficits” had “evaporated. . . . The economic crisis . . . opened a window in which a more aggressive fiscal approach to social policy has become possible.”

After “borrowing” technology from the pioneers of HSR—Japan, Germany and France—China embarked on a program that dwarfed all previous efforts. Between 2008 and 2014 the network of rail lines suitable for traffic at speeds of 250 kilometers per hour or more was expanded from 1,000 kilometers to 11,000 kilometers. Journey times from Beijing to Shanghai were cut to 4.5 hours for an 819-mile trip, compared with the 7 hours that the Acela—the pride of America’s Amtrak—takes to cover the 454 miles from Boston to Washington, DC.

this well-deserved credit should not obscure the tensions that lurked beneath the surface. In China the stimulus was deeply controversial. To many observers it seemed that, driven by a crisis in the West, the Chinese economy was being sucked in precisely the wrong direction.

After a decade of superrapid growth, the Chinese had had enough of heavy industrial development.22 But investment-driven heavy industrial growth is a hard habit to break. Five years later, in March 2007, in a remarkably frank assessment delivered to the National People’s Congress, Premier Wen Jiabao warned that “the biggest problem with China’s economy” was still that growth was “unstable, unbalanced, uncoordinated, and unsustainable.”

China’s 220 million rural households were offered state-funded discounts on the purchase of two large household appliances, such as televisions, air conditioners, washing machines and refrigerators.25 As the average rural household earned less than 16,000 renminbi (RMB—though used interchangeably with yuan, RMB refers to the Chinese currency as such, whereas yuan are the units in which sums are measured) in 2008, buying a computer or color TV for 7,000 RMB was a big step.

in practice, Chinese central government is stretched thinly across the giant bulk and complexity of the world’s most populous nation. Though responsibility for revenue collection falls heavily on central government, government expenditure directly controlled from Beijing has amounted to no more than 4 to 5 percent of GDP since the 1990s, a very small figure by comparison with its American or European counterparts. In China, 80 percent of government spending is done at the regional and local levels, where expenditure has surged between 1994 and 2008 from 8 to 18 percent of GDP, even as China’s national income quintupled.

It was the decentralized nature of the state apparatus that made the mobilization of the Communist Party and its nationwide apparatus so vital. Central Document No. 18 energized the networks that linked the Communist Party, local government and business interests.

To meet a central target or quota, there was always some regional highway connection, housing complex, bridge or industrial park to be built and profits to be made doing so. When the stimulus was launched it was precisely this chain reaction that worried those who advocated a more balanced model of growth. The centrally ordained stimulus would unleash the bulldozers of the infrastructure machine. The results confirmed the critics’ worst fears.

In Hubei province, with a population of 57 million and a regional GDP of $225 billion in 2009, there were projects under construction by 2010 notionally costed at $363 billion.28 A further $390 billion and $450 billion were planned for 2011 and 2012. Taken at face value, this meant that a single Chinese province with a population the size of the UK and a GDP the size of Greece was engaging in a program of investment larger than any stimulus ever attempted in the United States.

Clearly the impetus for spending was massive. But from an economic point of view the vital question was how it was to be financed. This is the key question in any fiscal policy “stimulus.” If spending is paid for by tax increases, this negates any increase in purchasing power. Borrowing by issuing bonds will soak up private savings, which may divert the portfolios of private wealth holders away from other investments. Credit creation is the one surefire way to fund stimulus spending if the aim is immediately to revive an underemployed economy. Beijing’s stimulus was particularly effective precisely because it combined huge government spending with a spectacular loosening of monetary policy.

When it wants to control credit, the People’s Bank of China (PBoC) not only sets the interest rates. It set quotas for credit issuance for each of the major banks.

To further manipulate the credit flow it can use higher or lower reserve ratios and greater degrees of “sterilization” of its foreign exchange interventions. All of these mechanisms were once commonplace in the West as well, legacies of the World War II era. But from the 1970s onward, direct regulation of bank credit was progressively abandoned in the West. In facing the 2008 crisis these tools of banking control gave Beijing remarkable leverage.

More new credit was issued in three months than the official fiscal stimulus would provide for the next two years. Meanwhile, provincial and city governments were enjoined to work with local banks. The main mechanism for financing their local spending were so-called city investment companies, or local government financing vehicles—the “shock troops of the stimulus.”

At the height of the stimulus drive, in the first half of 2009, 7.37 trillion RMB were issued in new loans. This was a 50 percent increase on the year before, which had also been a year of booming economic activity. By the end of the year the total volume of lending hit 9.6 trillion yuan.

When the entire complex is accounted for, this was an intervention comparable in scale to anything ever undertaken in the Mao era, or under Soviet communism. The Western capitalist economies had witnessed such huge mobilizations only in times of war.

Together with the huge liquidity stimulus delivered by the US Federal Reserve, China’s combined fiscal and financial stimulus was the main force counteracting the global crisis. Though they were not coordinated policies, they made real the vision of a G2: China and America leading the world.

Given the geopolitical conclusions that are apt to be drawn from China’s “overtaking” of the United States, it is worth noting that the 2008 mobilization was not part of any master plan. It was a hyperactive response to an unforeseen emergency that struck China from the outside.

It unleashed forces within China that took its economy in directions that the Beijing leadership had been struggling to counteract and that were widely unpopular in China. And the dramatic impact of the stimulus had consequences that were political and geopolitical as well as economic.

As the twenty-first century began Chinese audiences were hooked on a massive diet of TV and film offerings preoccupied with the question of the rise and fall of great powers.38 On the Internet there was a spectacular surge in public discussion of “Chinese greatness” and the “China model.”

Because of the decentralized nature of power, those coalitions came in different colorations, ranging from Shanghai’s hypermodernity to the neo-Maoism of Bo Xilai’s “Chongqing Model.” What was striking, however, was that these were overwhelmingly civilian coalitions. Unlike other historical examples of great growth spurts, China’s stimulus was not a military-industrial push.

In 2005–2006 the Chinese military formulated a major technological modernization program.41 But this was merely a recognition of how far China lagged behind. The army was oversized and underpowered in technological terms. A society entering into mass affluence as rapidly as China was doing does not offer a congenial habitat for the underpaid profession of soldiering.

though it was increasing rapidly in absolute terms, as a share of GDP, China’s military spending remained flat at 2 percent throughout the crisis—half the level that the United States had sustained since 9/11.

Given Beijing’s response to the crisis of 2008, its emergence as a decisive force in world affairs was undeniable. As was the other realization taught by 2008: If China was not export dependent, it was massively interdependent with the West.

China’s stimulus benefited all its trading partners, from Australia to Brazil.1 Across the world the share of China trade increased.2 But, having recognized the scale and significance of the Chinese effort, it is important not to fall into the trap of allowing it to overshadow everything else.

Ten years on from the emerging market debt crises of 1997–1998, what was impressive about 2008 was the policy response across the emerging economies. At the UN General Assembly meeting in New York in September 2008 it was the Latin Americans who were the most vociferous. But in responding to the crisis, it was “emerging Asia” that set the pace.

In terms of economic policy, the East Asian economies were model students. Learning the lessons commonly prescribed after the crises of the 1990s, they adopted tight fiscal policies and built up huge currency reserves. Indonesia, where the 1998 crisis had triggered the fall of Suharto’s dictatorship, went so far as to adopt a fiscal straitjacket modeled on the EU’s Maastricht criteria.

Most at risk in 2008 was South Korea, whose famous corporate export champions, the chaebol—Daewoo, Hyundai, Samsung—and their giant steel plants, shipyards and car factories suffered a shuddering blow.

however real this sense of victimization, it does not capture the complex reality of South Korea’s situation. What set South Korea apart in Asia, and gave it a vulnerability akin to that of Eastern Europe or Russia, was the global integration of its financial system.

Unlike in Europe, subprime wasn’t the issue. South Korean holding of toxic US mortgage securities amounted to only $850 million.8 The problem was not on the asset, but on the funding, side of the balance sheet. Since the early 2000s, Seoul had promoted itself as a regional financial hub for Northeast Asia. It had liberalized currency and capital flows. A large part of South Korean banking was owned by foreign investors, and Korea’s banks had shifted to the unstable new model of wholesale funding, borrowing short term on global dollar markets to invest long term at higher interest rates in Korea.

When short-term dollar lending markets shut down across the world and the dollar surged, the logic of the won-dollar carry trade went abruptly into reverse. As Korean businesses scrambled to cover their dollar exposure, a disastrous cycle ensued. Preemptive buying of dollars led to an immediate collapse in the value of the won. When national currency holdings slid perilously close to the psychological threshold of $200 billion, that added to the panic.

The cost for Korean borrowers of insuring dollar bonds against default (CDS premiums) surged from 20 basis points (0.2 percent of the value of the loan) in the summer of 2007 to 700 by October 2008.11 Adding 7 percent to the interest burden of a bank bond ruled out further borrowing for the foreseeable future. Even banks with government backing, such as Woori, found themselves shut out of repo markets.

In Thailand the financial meltdown coincided with an escalating political crisis that culminated in huge demonstrations, the occupation of the Bangkok airport by middle-class protesters and, in December 2008, the removal by judicial means of the government headed by the People’s Power Party, affiliated with the exiled oligarch and ex–prime minister Thaksin Shinawatra.

In Malaysia’s case the export dependence was even greater: 103 percent of GDP.13 That the value of exports exceeded GDP was possible because Malaysia, even more than China, was an assembly hub for global manufacturers fed by imported raw materials and subcomponents.

For those Asian economies hit mainly by the export shock, the policy response was simple: fiscal and monetary stimulus. None of the reactions was on the scale of China, but they were impressive nevertheless.

As the severity of the crisis deepened, Abhisit upped the scale of the stimulus to a remarkable 17 percent of 2009 GDP—$40 billion—to be spent over the next four years. In 2009 the budget deficit surged from 1 percent to 5.6 percent of GDP.

Compared with its massively export-dependent neighbors, Indonesia enjoyed a degree of insulation from the global shock. But it was also by far the largest state in the region and it was extremely difficult for its central government to deploy resources effectively across its sprawling island territories.

Jakarta opted for a stimulus based largely on tax cuts rather than on government spending.15 This meant that out of Indonesia’s working population of 97 million and its teeming mass of 48 million small businesses, only the 10 million workers and 200,000 firms that were registered for tax would benefit. But within that sector the impact was considerable.

Fueled by foreign investment and the petrochemical boom, Malaysia hoped to catapult to the status of a fully developed economy on a par with Singapore, its enviable neighbor. There were tax cuts and reductions in interest rates by the central bank, but the main drivers of the program were the finance ministry and the Khazanah Nasional, Malaysia’s sovereign wealth fund. One of the main vehicles for their lending was 1Malaysia Development Berhad (1MDB), a fund designed to channel gulf petrodollars into Malaysian national development and to act as a counterpart for infrastructure development projects by China’s electricity grid, called State Grid.

Oooooh dear

Only later, thanks to investigations by the Wall Street Journal and the New York Times, would it emerge that 1MDB was not just a vehicle for Malaysian economic development and mouthwatering fees for Goldman. It also served as a conduit for billion-dollar corruption on the part of Malaysia’s prime minister.

What set South Korea apart was the emergency in its financial sector. To help offset the closing of dollar funding markets, the Korean state was forced in October 2008 to provide $100 billion in foreign loan guarantees and at least $30 billion in other liquidity and support measures.

Major Korean exporters, such as steelmaker Posco, Hyundai Motor and Samsung Electronics, flushed hundreds of millions of dollars into the Seoul exchanges so as to ease pressure on the won.

what was most effective in stopping the run against was help from the outside.19 On October 30 the Bank of Korea announced the opening of a $30 billion swap line with the Fed, allowing it to auction dollars in generous amounts. With the foreign exchanges no longer in panic mode, Seoul could set about restoring the banking sector. In early 2009 the South Korean government issued a further $55 billion in liquidity backstops for interbank lending and set aside $23 billion for restructuring banks and nonperforming loans. It then added a $7.8 billion bond market stabilization fund and a $31.3 billion fund for corporate restructuring. Meanwhile, President Lee was true to his nickname—“the Bulldozer”—kicking off 2009 with a gigantic construction program, budgeted at $94 billion over a four-year period.

Across East and Southeast Asia, the response to the 2008 crisis set down a historical marker. Against the backdrop of their humiliating reliance on the IMF and the Clinton administration in the 1997 crisis, countries like Thailand, Malaysia and South Korea had reached a new level of autonomy. No more than in China or in the West was this merely a matter of technocratic competence, though they had plenty of that. Major stimulus efforts were political through and through. But whatever the local interests that mobilized in each case, the policy responses of the Asian emerging markets were effective.

Once the list had been approved by the G8, the invitations were then dispatched to the relevant finance ministries and central banks. There was no prior discussion or consultation. The rich countries decided to form a bigger club and asked twelve new members to join. It was global governance made simple.

What the White House wanted to avoid was a global assembly in New York under UN auspices, which was sure to be packed with critics of the Bush administration.

Coward

On his way out of office, Bush’s administration, which had given unilateralism a bad name, would reluctantly inaugurate a new chapter in global multilateralism.

for Norway’s foreign minister Jonas Gahr Støre, the formation of an oligarchy of globally significant states was one of the greatest setbacks to international organization since World War II.25 In his words, “The spirit of the Congress of Vienna [1814–1815], where great powers assembled to effectively govern the world, has no place in the contemporary international community. The G20 is sorely lacking in legitimacy and must change.”

The Congress of Vienna was a reactionary convention reinstating the ancien régime in the wake of the French Revolution and Napoleon. The G20 was an exclusive club, for sure, but it was a new club, with new members, whose promotion to global prominence a small European state like Norway might well resent.

The G20 was a reflection of the new world created since the 1970s by globalized economic growth. The nations represented at the G20 might represent only 10 percent of UN member states and 60 percent of the world’s population, but they were responsible for 80 percent of trade and 85 percent of global GDP and their share was increasing.