Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

if we listen closely it is clear that the quagmire of Iraq haunted the Washington policy-making elite in the early 2000s, awakening nightmarish memories of Vietnam and the crisis of American power and authority of the 1930s. The rise of China added to the sense of menace.

to take the loudly proclaimed transatlantic alienation of the early 2000s at face value as a description of economic or geopolitical reality would be self-deceiving in a double sense.60 The idea that “social Europe” had deviated in any essential way from the logic of turbocharged “financial capitalism” as exemplified by America was an illusion.

Furthermore, whatever the differences over Iraq, Europe’s pose of geopolitical innocence is a historically recent phenomenon. Though it balked at Iraq, France remains a hardened postcolonial war fighter. Nor does Europe only do “small wars.” As recently as the 1980s the European members of NATO had been active participants in winning the cold war and making the victory stick.

At its peak, the Bundeswehr had a standing strength of 500,000, with a mobilization strength of 1.3 million. The deployment of nuclear-armed cruise and Pershing missiles to Europe in 1983 was a transatlantic effort that bonded a generation of Atlanticists in the face of concerted opposition from the Left in both Europe and the United States.

though the EU might prefer to deny the fact, in the post–cold war world, it was far from geopolitically inert. It entertained complex relations with its neighbors in the Mediterranean and in Eastern Europe that could not easily be disentangled from the hard power of the NATO alliance or coercive border policing.

whereas the EU kept its distance from the Middle East imbroglio and refused to see the rise of China as a geopolitical threat, it would be on Europe’s doorstep that a violent great power confrontation would erupt, and it did so just as the world banking system began to unravel.

Like China it held a huge reserve of dollars, but unlike China its financial and economic interrelationship with the United States was indirect. Russia did not earn its dollars by exporting to the United States.

There were no fond memories of a “Nixon-Kissinger” moment in the Kremlin. It was not by accident, therefore, that it would be Russia’s president Vladimir Putin, the cold war KGB operative, who would pose the question that China and America preferred not to speak out loud. What, Putin demanded to know, were the implications of a rebalanced and reintegrated world economy for the geopolitical order?

Though Germans might give more credit to Gorbachev and détente diplomacy, and Americans more to Reagan and Star Wars, the Atlantic alliance was united in victory. No one benefited more from the end of the cold war than a newly reunified Germany, and it was German-American cooperation that secured the win. In 1990 French president François Mitterrand favored a conciliatory vision of embracing the former Soviet bloc in a common European security policy that would supersede NATO as well as the Warsaw pact.1 But neither Helmut Kohl nor George Bush wanted anything to do with that. The West had won. It would set the terms for Europe’s reunification.

On “Black Tuesday,” October 11, 1994, in one single session of frantic currency trading, the ruble lost more than a quarter of its value against the dollar. It was not until 1995 that Russia’s economy stabilized.

But in August 1998 Yeltsin’s government lost its grip. On August 17 Moscow devalued and declared a ninety-day moratorium on the payment of foreign debts owed by Russian banks. The ruble went into free fall, plunging from 7 to the dollar to 21. The cost of imports surged. Russians who had borrowed abroad faced bankruptcy. Then on August 19 the Russian government defaulted on its ruble-denominated domestic debts. By October 1998, with 40 percent of the population counted as living below the subsistence minimum, Moscow was reduced to appealing to the international community for assistance to pay for food imports.

As the new millennium began, dollars made up 87 percent of the value of all currency in circulation in Russia. Outside the United States, Russia was the largest dollar economy in the world. International investors in Russia were required to pay their local taxes in American currency. Russia became the ultimate experiment in dollarization, a nuclear-armed, former superpower with a currency supplied from Washington.

With the exception of newly independent Ukraine, Russia was the worst hit of the post-Soviet countries, but the early 1990s were tough across the former Eastern bloc.

Inflation, unemployment and social inequality rocketed as real wages plunged and Communist-era welfare systems disintegrated. In the Baltic states, the hit to the wage level in the 1990s was staggering. Wages fell by 60 percent in Estonia and 70 percent in Lithuania.

The double expansion of EU and NATO was not a coordinated affair. It was driven as much by the East Europeans themselves as by Washington, Berlin and Paris. Poland, Hungary, the Czechs and the Slovaks—the Visegrád group—began pushing for NATO membership as early as February 1991.

Focusing only on the military dimension, NATO could move more quickly. Already in 1999 the Poles, Hungarians and Czechs were admitted as full members. The really big bang came in 2004. On April 1, 2004, Bulgaria, Estonia, Latvia, Lithuania, Slovakia, Slovenia and Romania joined NATO. A month later all but Bulgaria and Romania also joined the EU.

Eastern Europe opted overwhelmingly for war and US defense secretary Donald Rumsfeld did not hesitate to rub salt in the wounds, playing the “new Europe” against the “old,” leaving France and Germany resentful and isolated.9 Habermas and Derrida’s 2003 vision of a distinct “European identity” was directed as much against the East Europeans as it was against the Anglo-Americans.

Prodi talked as though the EU would soon emerge as a fully featured state, combining both soft and hard power. But, in fact, the geopolitical configuration of the post–cold war world was more uncertain and ramshackle than that.

Not only was European military cooperation factious and frowned upon by Washington, but the European states all took the peace dividend. In light of Russia’s weakness, what reason was there not to run down their substantial cold war military establishments?

It also left the East Europeans all the more dependent on the Americans, whose military preponderance grew ever more massive as the new century progressed. At the same time, after the first round of financial assistance in the early 1990s, the United States played no more than a peripheral role in shaping the wider integration of Eastern Europe.

The incorporation of Eastern Europe into the EU and NATO was an encompassing geopolitical, political and bureaucratic process. But the first mover was not officialdom, but West European business.11 With wages less than one quarter of those prevailing in Germany in the 1990s, the attraction of the highly skilled East European labor force was irresistible.

Within a decade of the fall of communism, around half of all East European manufacturing capacity was in the hands of European multinationals.12 East European motor vehicle production, which soon accounted for 15 percent of European output, was 90 percent foreign owned, with VW’s acquisition of Škoda as the emblematic case.

If private capital led the way, it was followed by a rising tide of public funding. All over Eastern Europe, highways and public buildings were emblazoned with the blue badge of the EU and its ring of stars. Though the initial levels of spending were quite modest, after 2000 through the Cohesion Fund, the European Regional Development Fund and the EU’s agricultural subsidy schemes, tens of billions of euros flowed from West to East.

The takeover of Eastern Europe’s industrial base in the 1990s was just the beginning. By the end of 2008 Western-owned banks in the post-Soviet economies had extended $1.3 trillion in credits.

Across Eastern Europe, financial integration went “all the way down.” To an extraordinary extent, foreign currency loans were used to finance mortgages, credit cards and car loans. In Hungary, the most extreme case, between 2003 and 2008, the entire 130 percent increase in household debt was made up of foreign currency credit.

By the early 2000s, many of the former Soviet republics seemed locked in a time warp. As Gorbachev’s foreign minister, Eduard Shevardnadze had been a darling of the West. By the early 2000s his personal regime in Georgia was so riddled with corruption that it could not borrow even from the IMF.

The “color revolutions” in Georgia and Ukraine in 2003 and 2004 were driven, above all, by the determination not to fall further behind and miss out on the dramatic changes going on farther west.15 The title of the main Ukrainian protest group PORA translates as “It’s time.” Its symbol was a ticking clock.16 The post-Soviet laggards had no more time to lose.

What they had in common were the optimistic expectation of convergence with the EU and, in due course, eurozone membership. And these hopes were not merely paper dreams. The preemptive adaptation of Eastern Europe economies to EU conditions changed their way of doing business, how markets operated and who owned what.

Thanks to active involvement by the Bank of England and the ECB, the Eastern European states were, by the early twenty-first century, equipped with Westernized central banks, staffed by professional economists.

The result was that Eastern Europe reproduced on Europe’s doorstep the configuration of overoptimistic expansion that had led to the emerging market crises of the 1990s. Success stories of market reform and privatization, combined with freedom of capital movement and relative stability of exchange rates, led to a huge inward surge of capital. Capital inflow led to upward pressure on exchange rates. All the indicators looked good. But the entire constellation—the booming domestic economy, the appreciating exchange rate, the rising reserves—could all be traced back to a common factor: the huge inward surge of foreign capital.

So anxious were they to preserve secrecy and avoid a panic that the IMF’s IT department created a separate SimulationMail e-mail system to avoid notes from the game leaking to the outside.21 Hungary’s own central bank duplicated the simulation. Its results, it breezily informed a conference at the ECB in the summer of 2007, were reassuring. If there was one note of caution, it was a reminder that 60 percent of Hungary’s banking sector was in the hands of Belgian, Austrian, Italian and German banks.

In early 2008 the IMF noted that Latvia’s economy was overheating so badly that its imports exceeded its exports by an amount equivalent to 20 percent of GDP.

Any public pronouncement on irrational exuberance in the Baltic was blocked by the Europeans on the IMF board. They wanted to keep the Baltics on track for euro membership and did not want to risk an IMF warning unleashing a chain reaction of uncertainty across Eastern Europe.

To say that this was a transformation in the fortunes of tiny Latvia would be an understatement. It was a vision both expansive and fragile. It depended on two crucial conditions—the continuation of Latvia’s feverish economic boom and the acquiescence of its hulking neighbor to the east.

Vladimir Putin, who was confirmed as president by a landslide election victory in May 2000, will forever claim credit for Russia’s restoration. In fact, the turnaround in Russia’s financial fortunes already had been initiated in 1999 by austere former Communist Yevgeny Primakov, Putin’s political mentor. The collapse in the external value of the ruble jolted Russia’s export industries into life and curbed imports.

the key driver of the recovery was the global boom in oil and other commodities, which began months after Putin took office in the latter half of 2000. From $9.57 per barrel in 1998, the spot price of Urals crude would soar by 2008 to $94 per barrel.

In October 2003 respectable opinion in the West looked on aghast as Mikhail B. Khodorkovsky—who, in the 1990s, had installed himself as the billionaire owner of private oil giant Yukos in a particularly egregious privatization deal—was arrested and imprisoned on charges of tax evasion.26 A year later, Yukos’s main assets were snapped up in a fire sale by a shell company that turned out to be a front for state-owned Rosneft.

In 2006 threats of prosecution forced Anglo-Dutch oil major Shell to sell its valuable Sakhalin assets to Gazprom.

Though Rosneft and Gazprom were never merged, together they gave the Russian state a powerful corporate underpinning. By one calculation the share of government-owned firms in oil production in Russia rose from 19 percent in 2004 to 50 percent in 2008.

By 2007 the percentage of the population below the subsistence minimum had fallen to 14 percent. And this was no longer the feverish, dollarized speculation of old. Prices were stable and were no longer set in dollars. Taxes were paid in rubles. The Russian parliament passed a law imposing fines on public officials who lapsed into the bad old habits of using dollars as a unit of account.28 On one occasion even Putin found himself embarrassingly caught out.

Russia could thus seem the very model of a national economic powerhouse, with a huge trade surplus, surging foreign reserves and a strong state. But the paradox of Russia’s position was that its new prosperity was associated not with independence from the world economy but with entanglement with it.

Money was even more liquid and the pipelines connecting the offshore banking system were ready laid.

Russia’s oligarchs behaved like the masters of a 1970s petrostate, harboring their wealth in offshore havens like Cyprus, from where it cycled back to London and its convenient eurodollar accounts. From the early 2000s the pattern was further complicated by a large flow of funds back to Russia. In 2007 this peaked at an annual total of $180.7 billion, of which only $27.8 billion was foreign direct investment (FDI).

To prevent a sharp appreciation, Russia’s central bank, like that of China’s, found itself having to sterilize the dollar inflow by buying it up with freshly minted rubles. Having driven dollars out of domestic circulation, Moscow was now assuming an unfamiliar position as a de facto creditor to the United States.

The growth of the Polish and Baltic economies and the development of Ukraine, Georgia and Russia did not preclude each other. European exports to Russia flourished and all of Europe relied heavily on Russian gas. The question was whether a shared and interconnected prosperity could be given a common political meaning.

Under Bush, Washington never took Russia seriously as an ally and refused to treat Moscow’s brutal war in Chechnya as part of the common fight against terrorism and “Islamic extremism.” Rebuffed by Washington, the divisions over the Iraq War provided Russia with leverage.

Germany’s preference for détente with Russia was a source of alienation also between Berlin and the East Europeans. When Germany and Russia signed the first Nord Stream pipeline deal in 2005, enormously increasing the flow of Gazprom’s gas to the West, it was denounced by Poland’s foreign minister as a second coming of the Hitler-Stalin Pact that had sealed Poland’s fate in 1939.

By early 2006 Warsaw and Washington were calling for a new division of NATO to confront Russia on its chosen terrain of energy security.

In April 2006 at the meeting of the IMF and the World Bank in Washington, with central bankers Mario Draghi, Ben Bernanke and Jean-Claude Trichet looking on, Putin’s finance minister, Alexei Kudrin, shook hands with the American Treasury secretary. Kudrin had come to announce the repayment of a large tranche of international debt still owed to the Paris Club of creditors from the bad old days of the 1990s.

The dollar, Kudrin declared, was in danger of forfeiting its status as the “universal or absolute reserve currency.”34 It was simply too uncertain in value. “Whether it is the U.S. dollar exchange rate or the U.S. trade balance, it definitely causes concerns with regard to the dollar’s status as a reserve currency.”

Lol then Obama owned you