Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

Schadenfreude.

The events of 2003, 2008 and 2017 are all no doubt defining moments of recent international history. But what is the relationship among them? What is the relationship of the economic crisis of 2008 to the geopolitical disaster of 2003 and to America’s political crisis following the election of November 2016? What arc of historical transition do those three points stake out? What does that arc mean for Europe, for Asia? How does it relate to the minor but no less shattering trajectory traced by the United Kingdom from Iraq to the crisis of the City of London in 2008 and Brexit in 2016?

The contention of this book is that the speakers at the UN in September 2008 were right.

The financial crisis and the economic, political and geopolitical responses to that crisis are essential to understanding the changing face of the world today. But to understand their significance we have to do two things. We have to place the banking crisis in its wider political and geopolitical context. And, at the same time, we have to get inside its inner workings. We have to do what the UN Genera...

This is a necessarily technical and at times perhaps somewhat coldhearted business. There is a chilly remoteness to much of the material that this book will be dealing with. This is a choice. Tracing the inner workings of the Davos mind-set is not the only way to understand how power and money operated in the course of the crisis. One can try to reconstruct their logic from the boot prints they left on those they impacted or through the conformist and contradictory market-oriented ...

which attempts to show how the circulation of power and money was understood to function—and not to function—from within. And this particular black box is worth prizing open, because, as this book will show, the simple idea, the idea that was so prevalent in 2008, the idea that this was basically an American crisis, or even an Anglo-Saxon crisis, and ...

the idea of an “all-American crisis” obscures the reality of profound interconnection.14 In so doing, it also misdirects criticism and righteous anger. In fact, the crisis was not merely American but global and, above all, North Atlantic in its genesis. And in a contentious and problematic way it had the effect of recentering the world financial economy on the United States as the only state capable of meeting the challenge it posed.15 That capacity is an effect of structure—the United States is the only state that can generate dollars. But it is also a matter of action, of policy choices—positive in the American case, disastrously negative in the case of Europe. Clarifying the scale of this interdependence and the ultimate dependence of the global financial system on the dollar is important not just for the sake of getting the history right. It matters also because it throws new light on the perilous situation created by the Trump administration’s declaration of independence from an interconnected and multipolar world.

America’s twin deficits—its budget deficit and its trade deficit—and their implications for America’s dependence on foreign

borrowing. The debts run up by the Bush administration were the bomb that was expected to go off.

The contention of this book is that to view the 2008 crisis and its aftermath chiefly through its impact on America is to fundamentally misunderstand and underestimate its economic and historical significance.

Ground zero was America’s housing market, for sure. Millions of American households were among those hit earliest and hardest. But that disaster was not the crisis that had been widely anticipated before 2008, namely, a crisis of the American state and its public finances. The risk of the Chinese-American meltdown, which so many feared, was contained. Instead, it was a financial crisis triggered by the humdrum market for American real estate that threatened the world economy. The crisis spilled far beyond America. It shook the financial systems of some of the most advanced economies in the world—the City of London, East Asia, Eastern Europe and Russia. And it went on doing so. Contrary to the narrative popular on both sides of the Atlantic, the eurozone crisis is not a separate and distinct event, but follows directly from the shock of 2008. The redescription of the crisis as one internal to the eurozone and centered on the politics of public debt was itself an act of politics. In the years after 2010, it would become the object of something akin to a transatlantic culture war in economic policy, a minefield that any history of the epoch must carefully navigate.

If mapping this misunderstanding, charting the global financial crisis outward from its hub in the North Atlantic and presenting the continuity between 2008 and 2012, is the first challenge of this book, the second is to account for...

The impact of the crisis was uneven but global in its reach, and by the vigor of their reactions, emerging market governments spectacularly ...

the two that struggled most with the crisis of 2008 were Russia and South Korea. What they had in common apart from booming exports was deep financial integration with Europe and the United States. That would prove to be the key. What they experienced was not just a collapse in exports but a “sudden stop” in the funding of their banking sectors.17 As a result, countries with trade surpluses and huge currency reserves—supposedly the essentials of national economic self-reliance—suffered acute currency crises.

huge shortfall in dollar funding for Europe’s oversized banks.

a dollar glut but an acute dollar-funding shortage. The dollar did not plunge, it rose.

government deficits and current account imbalances are poor predictors of the force and speed with which modern financial crises can strike.23 This can be grasped only if we focus on the shocking adjustments that can take place within this interlocking matrix of financial accounts.

implosion in interbank credit.

None of the leading central banks had gauged the risk ahead of time. They did not foresee how globalized finance might be interconnected with the American mortgage boom. The Fed and the Treasury misjudged the scale of the fallout from the bankruptcy of Lehman on September 15. Never before, not even in the 1930s, had such a large and interconnected system come so close to total implosion. But once the scale of the risk became evident, the US authorities scrambled. As we shall see in Part II, not only did the Europeans and Americans bail out their ailing banks at a national level. The US Federal Reserve engaged in a truly spectacular innovation. It established itself as liquidity provider of last resort to the global banking system. It provided dollars to all comers in New York, whether banks were American or not. Through so-called liquidity swap lines, the Fed licensed a hand-picked group of core central banks to issue dollar credits on demand. In a huge burst of transatlantic activity, with the European Central Bank (ECB) in the lead, they pumped trillions of dollars into the European banking system.

Since 2008, it is not just the rise of Asia that is shifting the global corporate hierarchy. It is the decline of Europe.

The inexorable slide of corporate Europe down the global rankings is clear for all to see.

the world economy is not run by medium-sized “Mittelstand” entrepreneurs but by a few thousand massive corporations, with interlocking shareholdings controlled by a tiny group of asset managers. In that battlefield of corporate competition, the crises of 2008–2013 brought European capital a historic defeat. No doubt there are many factors contributing to this, but a crucial one is the condition of Europe’s own economy. Exports matter,

there is no substitute for a profitabl...

Distance in time, historians like to tell themselves, is a tonic. It permits the detachment and sense of perspective that are commonly touted as virtues of the discipline. But that depends on where time takes you.

History writing does not escape the history it attempts to reconstruct. The more pertinent question to ask is not how much time must pass before history can be written, but what has happened in the interim and what, at the time of writing, is expected to happen next. This book, for one, would have been easier to write and might be clearer in its conclusions if it had been finished even closer to the time of the events it begins by describing. It may be easier to write a book like this ten years from now, though given the current train of events, that may be unduly optimistic. Certainly, the tenth anniversary of 2008 is not a comfortable vantage point

Among the many symptoms of unease and crisis that have afflicted us in the wake of Donald Trump’s victory is the extraordinary uncouth variety of postfactual politics that he personifies. He doesn’t tell the truth. He doesn’t make sense. He doesn’t speak coherently. Power appears to have become unmoored from the basic values of reason, logical consistency and factual evidence. What has caused this degeneration? One can cite a complex of factors. Certainly unscrupulous political demagoguery, the debasement of popular culture and the self-enclosed world of cable TV and social media are part of the problem, as is Trump’s personality. But to attribute our current state of postfactuality to Trump and his cohorts is to succumb only to further delusion.51 As this book will show, what the history of the

crisis demonstrates are truly deep-seated and persistent difficulties in dealing “factually” with our current situation. It isn’t just those denounced as populists who have a problem with truth. It goes far wider and far deeper and it affects the center as much as the margins of mainstream politics. We do not need to go back to the notoriously misleading and incoherent case made for the war against Iraq and its fawning media coverage. It was the current president of the European Commission who announced in the spring of 2011: “When it becomes serious, you have to lie.”52 At least, one might say, he knows what he’s doing. If we believe Jean-Claude Juncker, a posttruth approach to public discourse is simply what the governance of capitalism currently demands.

The loss of credibility is flagrant and it is comprehensive. The damage goes deep. To say that liberals should simply “pick yourself up, dust yourself off, and start all over again,” as the Depression-era song goes, that if America has failed we should look for leadership to a fresh-faced president of France or the relentlessly reliable chancellor of Germany, is either simple-minded or disingenuous. It does no justice to the scale of the disasters since 2008, or to the failure of the lopsided politics prevailing in both Europe and America to offer an adequate response to the crisis. It does no justice to the extent of our political impasse, with the center and the Right having failed and the Left massively obstructed and self-obstructing. Nor does it acknowledge that some losses are irreparable and th...

The Republicans had convinced themselves that surpluses tended

to encourage more government spending. Their approach was the obverse, what Republican strategists of the Reagan era first dubbed “starving the beast.”7 By entrenching tax cuts and courting a fiscal crisis they would create an irresistible imperative to slash spending, curb entitlements to social welfare and shrink the footprint of government. The problem was that the spending cuts that were supposed to follow the tax cuts never happened.

The Bush administration’s deficits were financed overwhelmingly by bond buying from abroad. As Orszag and Rubin’s paper remarked, United States Treasurys were still seen as the safest investment in the world. There was no chance of default or a sudden burst of inflation. “But if that expectation were to change and investors had difficulty seeing how the policy process could avoid extreme steps, the consequences could be much more severe than traditional estimates suggest.” Nor was it just the Clinton crowd that worried. In 2003 the nonpartisan Congressional Budget Office saw fit to remind its audience of an extreme scenario in which foreign investors stopped buying US securities, the dollar plunged and interest rates and inflation shot up. “Amid the anticipation of declining profits and rising inflation and interest rates, stock markets could collapse and consumers might suddenly reduce their consumption. Moreover, economic problems in the United States could spill over to the rest of the world and seriously weaken the economies of US trading partners.”

The scale of America’s deficits made it vulnerable to bond market pressure. The fact that foreign investors might suddenly turn away from

Treasurys evoked the nightmare of a sudden stop to external financing of America’s imbalances. But it was the identity of the foreign investors that infused the scenario with real terror.

In April 2006, when Obama spoke about keeping our “debt out of the hands of foreign nations,” everyone knew it was China and its Communist regime that he was talking about.

By the mid-1990s Washington had abandoned any frontal challenge to the Chinese Communist regime over human rights, the rule of law or democracy. Instead, globalists of both the Democratic and Republican parties wagered that the powerful and impersonal force of commercial integration would in due time make China into a biddable and congenial “stakeholder” in the world order.16

China’s growth was spectacular. Huge profits were to be made for American investors. American manufacturers like GM would stake their future on China.17 After a brief storm over the Taiwan Strait in 1995–1996, diplomatic relations calmed. But China’s sheer size made it a contender.

If Washington was betting on international trade and globalization to “Westernize” China, the Chinese Communist Party took the other side of the bet.19 The party’s leaders wagered that supercharged growth would not weaken them but would consolidate their position as the successful helmsmen of their nation’s spectacular comeback. Beijing took advantage of trading opportunities. But it never subscribed to fully open markets. It decided who would invest and on what terms. It controlled movement of funds in and out. That, in turn, allowed the People’s Bank of China to fix its exchange rate, and since 1994 it had done so by pegging against the dollar.

The appearance of stability offered by a fixed exchange rate encouraged a large inflow of foreign funds, which helped to stoke up domestic economic activity, creating an unbalanced trade account funded from abroad. Banks that acted as the conduit for foreign funds boomed. This set up the crisis.22 When international investors lost confidence, the result was a devastating sudden stop. Then the central bank’s foreign exchange reserves would drain and it would have no option but to let the currency peg go. Stability would give way to a disastrous devaluation. Those who got their money out first would be saved. Those who had borrowed in foreign currency would face bankruptcy.

without American backing the Argentinian position became untenable;

China had no intention of becoming either the victim of a sudden stop or the needy recipient of US assistance.26 To reverse the balance of risk,

when Beijing pegged its exchange rate it chose one that was not too high, but too low. This was what Japan and Germany had done in the 1950s and 1960s.27 It was a recipe for export-led growth, but it created tensions of its own. Undervaluing the currency made imports more expensive than they needed to be, which lowered the Chinese standard of living. When it ran a trade surplus with the United States and bought American government bonds, poor China was exporting capital to rich America, funding American consumers to buy the products of its huge new factories. Moreover, maintaining the artificially low peg was a battle in its own right. With China’s trade surplus with the United States surging from $83 billion in 2000 to $227 billion in 2009, to hold the value of the yuan down the Chinese central bank had to continually buy dollars and sell its own currency. To do so it printed yuan. In the normal course of things this would have unleashed domestic inflation, wiping out any competitive advantage and triggering social unrest. So, to “sterilize” the effects of its own intervention, the People’s Bank of China required all Chinese banks to hold large and growing precautionary reserves, effectively removing the currency from circulation. It was a profoundly unbalanced situation and one that could be sustained only because of the extremely tight relationship between the Chinese regime and the business elite, a relationship built on common affiliation to the Communist Party, coerc...

With so many currencies fixed against the dollar, without the possibility of adjusting export competitiveness by means of devaluation or appreciation, it was no surprise that the world economy polarized into export surplus and import deficit countries. In the first three months of 2005 alone, the United States ran a current account deficit—an excess of outward payments on trade in goods and services and investment income—of almost $200 billion. For the year it came to $792 billion and was showing signs of further deterioration in 2006. For those on the surplus side of the “global imbalances,” so-called sovereign wealth funds (SWF) became huge repositories of capital.

China’s State Administration of Foreign Exchange looked for safe and predictable returns. Its safe assets of choice were long-dated US government debt and securities guaranteed by the US government.

was the United States, the world’s great deficit economy, that would see its currency devalue and its interest rates surge as foreign investors abandoned American assets.

To ease these imbalances, the obvious solution, as the Hamilton Project demanded, was fiscal restraint. Reduce the federal deficit, squeeze domestic demand, reduce the import of Chinese goods and Chinese money. But the Bush administration didn’t seem to care. In 2004 former Treasury secretary Paul O’Neill, fired from the cabinet in 2002, released his revealing exposé of the early Bush administration. It contained a nugget that haunted the economic policy community. In November 2002 O’Neill tried to warn Vice President Dick Cheney that the surging “budget deficits . . . posed a threat to the economy.” Only for Cheney to cut him off with the following remark: “You know . . . Reagan proved deficits don’t matter.” The Republicans had won the congressional midterms; tax cuts were the Republican “due.” Within the month O’Neill was fired.36 From the perspective of the Rubinite Democrats, this was not just economically illiterate, it was also a political scandal. Following in the footsteps of George Bush senior, they had spent agonizing years working off Reagan’s deficits. If Cheney’s version of Republicanism prevailed, it undermined the basis for turn taking in America’s two-party system. How could the Democrats conduct responsible “national” economic policy if the Republicans viewed the economy as a resource to be milked for the benefit of its privileged constituency? As Brad DeLong, deputy assistant secretary for economic policy in the Clinton-era Treasury, ruefully remarked: “...

Since the early 2000s the American economy had been buoyed not only by huge fiscal deficits but by a sustained surge in house prices. Now, in some of the most challenged neighborhoods in the country, tens of thousands of families who had recently taken out home loans were failing to make payments. In marginal ethnic minority communities in cities like Cincinnati and Cleveland, but also in ribbon developments in the sunshine states, mortgages were failing en masse. America’s housing market bull run was about to come to a juddering halt. And as it did so, it would precipitate a global crisis.

How could this domestic drama shake the world’s financial system and precipitate a global crisis? The simple answer is that real estate may be mundane, and

but they account for a huge share of total marketable wealth worldwide. By one estimate, the share of American real estate in global wealth is as much as 20 percent.1 American homes account for 9 percent of the total. At the time of the crisis 70 percent of American households owned their own home—more than 80 million in total. Those same households were the greatest source of demand for the world economy. In 2007 American consumers bought c. 16 percent of global output, and nothing made them feel better than surging real estate prices. As America’s home prices almost doubled in the ten years leading to 2006, this raised household wealth by $6.5 trillion, delivering a giant boost not just to the United States but to the world economy.2 As US consumer spending surged toward $10 trillion, it added $937 billion to global demand between 2000 and 2007.3

Real estate is not only the largest single form of wealth, it is also the most important form of collateral for borrowing.

It is mortgage debt that both amplifies the broader economic cycle and links the house price cycle to the financial crisis.5 Between the 1990s and the outbreak of the crisis in 2007, American housing finance was turned into a dynamic and destabilizing force by a fourfold transformation—the