Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

The absence of a euro-dollar or a sterling-dollar currency crisis was one of the remarkable features of 2008. It was no accident. It was the swap lines that did the trick. What the Fed had done for money markets, the central banks now did for the global provision of dollar bank funding. They absorbed the currency mismatch of the European bank balance sheets directly onto their own accounts. Compensating public action ensured that private imbalances did not spill over into a general crisis.

Only in June 2009 did the Fed begin publishing regular reports on the uptake of swap lines. The fuller records of the Fed’s emergency programs, on which this chapter is based, were not opened to the public until December 2010 and March 2011. They were produced as a result of the Dodd-Frank legislation of 2010 and a Freedom of Information suit brought by the Bloomberg news organization and contested by the Fed and the New York Clearing House Association, a banking lobby group, all the way to the Supreme Court.32 In defense of its secrecy, the Fed argued that revealing the information demanded by Bloomberg would jeopardize its efforts to calm financial markets, because full disclosure would reveal which banks were most in need of its liquidity assistance. The courts ruled in favor of Bloomberg and the Fed grudgingly complied.

Impt

What the Fed was struggling to contain in 2008 were not two separate American and European crises but one gigantic storm in the dollar-based North Atlantic financial system.

Summary

Clearly, the dollar-based financial system had experienced an existential crisis. For avowed skeptics and critics of American power it was an unmissable opportunity to score points against Anglo-Saxon finance. But given the extraordinarily heavy dependence of both individual banks, such as Deutsche and Paribas, on Fed support and the huge swap line facility provided to the ECB, it is hard to see how either Steinbrück or Sarkozy could have been more out of touch with reality. By the early twenty-first century, the dollar’s dominance did not rest on the Bretton Woods Agreement of 1944 or the institutions, like the IMF, that issued from it. The foundation of the global dollar was the private banking and financial market network, materialized in the Wall Street–City of London nexus. This was a cocreation of American and European finance, deliberately erected beyond state control. What happened in the fall of 2008 was not the relativization of the dollar, but the reverse, a dramatic reassertion of the pivotal role of America’s central bank. Far from withering away, the Fed’s response gave an entirely new dimension to the global dollar.

Savage

Steinbrück and Sarkozy may perhaps be forgiven for failing to recognize the significance of the moment, because the Fed had acted without fanfare and without seeking public legitimacy either at home or abroad. The sporadic global debate about alternatives to the dollar was the price that the Fed paid for keeping its stabilization campaign below the radar. On Capitol Hill, while controversy swirled around TARP, there was silence about the Fed’s gigantic global liquidity effort. As one senior New York Fed official remarked, it was as if a “guardian angel was watching over us.”37 If some members of Congress understood what was going on, they thought better of discussing the Fed’s actions openly. The reality of global financial policy disappeared in a “spiral of silence,” in which it suited both the Fed and its collaborators to bury the reality of massive and explicitly hierarchical interdependence.

Impt

By October 2008 the Fed’s swap line facilities defined a relationship of dependence and interdependence between the US central bank and an exclusive club of privileged central bank counterparties. But that posed a question. Who was in and who was out? What were the criteria of membership in the swap line club?1 On October 28, 2008, Nathan Sheets, the director of the Division of International Finance at the Fed, set out a short list of three criteria.2 The recipients of swap lines must be: Of significant economic and financial mass so that there can be spillover to the US. Well-managed with ‘prudent’ policies so that the problems they have encountered are clearly the result of contagion from US and ‘other advanced economies’ and therefore warrant US assistance. The problem faced by local banks should be one of dollar funding stress so that swap lines would actually make a difference.” Ultimately, the Fed had to justify its measures in terms of benefits to the US economy. There were economies that were too small to warrant action. There were countries that were experiencing stress as a result of a collapse of trade or commodity prices that could not be helped by swap lines. But it was point 2, with its stress on “prudent policy,” that offered the scope for political discrimination. What was a prudent policy was very much in the eye of the beholder.

By the third quarter of 2008, Russia’s banks, raw material producers and industrial conglomerates had run up external debts of $540 billion, half owed by Russian industrial corporations and the rest by banks. This debt mountain matched Russia’s official reserves and was roughly equivalent to Lehman’s balance sheet. A substantial fraction was short-term debt. Having adopted the market-based banking model, Russia’s banks were particularly at risk, needing to refinance as much as $72 billion due by the end of 2008.9 Apart from the banks, the list of stressed dollar borrowers included all the major Russian oligopolies: Gazprom ($55 billion), Rosneft ($23 billion), Rusal ($11.2 billion), TNK-BP ($7.5 billion), Evraz ($6.4 billion), Norilsk ($6.3 billion) and Lukoil ($6 billion). Collapsing commodity prices slashed their revenues and a slide in the ruble would put even heavier pressure on those that billed in local currency rather than dollars—a major issue for Gazprom, Russia’s largest gas supplier.

But putting events in Russia side by side with those in the United States or Europe, one is struck less by the self-dealing of Russian crisis management than by the frankness with which the question of power was ventilated in Russia and the obvious willingness of President Medvedev and Prime Minister Putin to use the occasion to shift the balance in their favor. Since the breakup of oil conglomerate Yukos in 2003, none of the oligarchs had dared to challenge the Kremlin. Now Medvedev and Putin were turning the screw. They offered financial protection, but they exacted a price.

The cornerstone of the Kremlin’s crisis-fighting strategy was to prevent a death spiral of devaluation and bankruptcy. In the first phase of the crisis, the central bank deployed its ample foreign currency reserves to stem the fall in the ruble. As a result, as oil prices plunged by 64 percent between October and December 2008, the ruble lost only 6 percent against the dollar.12 Only in January did Moscow let the ruble go, allowing it to devalue by 34 percent before stabilizing in February. Like any successful rearguard action, it came at a price. The central bank burned $212 billion of its reserves, 35 percent of the total, to slow the slide. But by so doing it bought time, allowing dollar-exposed borrowers to pull in their horns and giving the state some time to launch its own response.13

Wow!

A key element of this program was a demand from the Kremlin that the oligarchs sink a large part of their fortunes into stabilizing the stock market. There were rumors of an “all-night mandatory meeting held in the Kremlin” on September 16, the day of the AIG rescue, at which “oligarchs were ordered to plunge cash into their own faltering stocks, buy collapsing financial institutions directly, or simply fork over the cash and/or shares.”14 Following this “bail-in” of the oligarchs, the government targeted takeovers and bailouts at the smallest and weakest Russian banks. Coordination was provided by state-owned Vneshekonombank (VEB), where Putin, as Russian prime minister, served as chairman of the board. Five billion dollars was used to take over Sviaz Bank, Globex bank and Sobinbank. Then the deposit insurance fund was recapitalized and the insurance limit raised to $28,000. A $50 billion central bank facility put VEB bank in a position to act as the backstop, with a further $35.4 billion in subordinated debt available at tough rates for troubled oligarch enterprises. The loans would be repayable within a year and otherwise convertible into controlling shares.15 It was not a government takeover, but a conditional threat and a stark demonstration of where power lay.

In the wake of the oil price shock, the Russian federal budget was reset on the assumption of an average oil price of $41 per barrel by contrast with the June 2008 budget, which had assumed $95 per barrel. With tax revenues plunging, Putin, as prime minister, took credit for a large fiscal stimulus. A quarter of the government’s 9.7 trillion ruble budget was dedicated to crisis spending on work creation, industrial subsidies and tax cuts. Relative to the size of its economy, commonly compared with that of Spain and roughly comparable to that of Texas, the Russian crisis response was one of the largest in the world, dwarfing those undertaken by West European governments.18 It was heavily skewed toward the largest, best-connected corporations that were included in a list of 295 nationally important corporations and 1,148 regionally important firms. It was a top-down, corporatist stimulus, and Moscow made clear that it expected the oligarchs to reciprocate. Indeed, it was unafraid to call them out by name. On one notable occasion, Putin singled out four of them as follows: “Vladimir Potanin (Interros Holding), Leonid Lebedev (Sintez Group), Mikhail Prokhorov (Onexim Group), and Viktor Vekselberg (Renova Group) . . . I have known all of you for many years; in essence, we have been working jointly. Let me repeat that during the difficult conditions of the crisis we have made every effort to support you in the various directions of your business. The crisis is waning. It’s not y...

In its way, it was effective. It demonstrated leadership. It humbled the oligarchs. It rallied Russian social interests around the state that provided for them. It kept Prime Minister Putin in the limelight. But was it a long-term strategy for growth? Liberal economists were skeptical. So too was Medvedev, who had succeeded Putin as president in 2008. Even before the crisis, the expert advisers that Medvedev cultivated in his personal entourage had been calling for a new course.22 In the wake of the crisis their message was even louder. What had made Russia so vulnerable in 2008 was its lopsided integration into the world economy: on the one hand, its excessive reliance on oil and gas; on the other hand, the corrupt culture of capital flight, in which Russian oligarchs sluiced money in and out of the country through the off-shore banking system. How else could one account for the bizarre anomaly that made tiny Cyprus into one of Russia’s main sources of foreign investment? What Russia needed was modernization. As Medvedev remarked on September 10, 2009: “Can a primitive economy based on raw materials and economic corruption lead us into the future?”23 Two-fisted crisis fighting was not enough. A mere recovery from the shock of 2008 would lead “nowhere. We need to get out of the crisis by reforming our own economy.”24 What Russia needed was economic transformation, and for that it needed not less but more interaction with the world economy, and above all with its technologi...

The most extreme case was Latvia. One year into the crisis, in October 2009, the IMF’s forecast for Latvia’s GDP in 2010 was 39 percent lower than it had been in October 2007. Over the same two-year period, Estonia’s and Lithuania’s GDP expectations were revised downward by a whopping one-third. Slovenia, the Czech Republic, Slovakia, Hungary, Bulgaria and Romania all experienced downward shocks of between 15 and 18 percent, more than twice that suffered by the United States. In the adjoining post-Soviet Commonwealth of Independent States (CIS), the downward revision of growth expectations ranged from 18 percent for Russia to 32 percent for Armenia. The pattern was not uniform. Poland, notably, escaped largely unscathed.26 But all the most severe casualties of the 2008–2009 crisis are to be found among the transition economies of the former Eastern bloc.

Geez

Whereas Russia had reacted to its humiliation in the 1990s by accumulating a substantial currency reserve, the East European states had no such defense. For them security lay in integration with the West, or at least so they imagined. With the Fed having used swap lines to stabilize a core group of economies in which American interests were undeniable, one might have expected the ECB to extend similar support to the East European neighbors of the eurozone. Certainly this was the expectation of the Fed. If one applied the three criteria set out by Nathan Sheets to Eastern Europe, the case for ECB assistance was clear-cut.31 The East Europeans were EU members and aspired to future eurozone membership. As such, the respectability of their economic policy was vouched for in general terms. The crisis in Eastern Europe was immediately caused by a sudden stop in foreign credit supply. And the eurozone’s own banks were deeply involved and stood to suffer substantial losses. The risk of blowback was acute. As Sheets remarked to the FOMC: “I think it is very appropriate for all the European EMEs to report to the ECB for their liquidity needs.”32 But whereas the Fed had effectively licensed the ECB to issue dollars, the ECB had no intention of extending equivalent privileges to Poland or Romania. With Sweden and Denmark the ECB established publicly announced swap lines. Their banks would supply liquidity to Eastern Europe. Meanwhile, the central banks of Poland and Hungary were fobbe...

Derp

The first and most desperate application for assistance from within the EU was Hungary’s.35 On October 27, 2008, Budapest reached agreement with the IMF and the EU (as opposed to the ECB) on a $25 billion loan package. At 20 percent of Hungarian precrisis GDP, it was a very substantial commitment and an unusually generous multiple of Hungary’s IMF capital quota.36 The IMF considered the program to be unusually lenient. Unsurprisingly, the Hungarians did not see it in such favorable terms. Hungarian politics polarized as the austerity program bit. The nationalist daily Magyar Hírlap described Hungary as being slowly garroted by a “credit noose around our necks.”37 For the extremists of Hungary’s Far Right it was a short step back in time from the “neocolonialism” of the EU and the IMF to the Treaty of Trianon, which had eviscerated Hungary after World War I. In 2010 the right-wing Fidesz party would reap the benefits with a crushing electoral victory, setting Hungary on the path to a self-declared illiberal democracy.

For the IMF, the standard prescription for a country in Latvia’s position was a one-off devaluation followed by debt restructuring or rescheduling. But the European Commission dug in its heels. Latvia was en route to eurozone membership. It must stay the course. If it needed to rebalance its current account it must do so through deflation and austerity. The results for Latvia were drastic. By the summer of 2009 house prices had plunged by 50 percent. Civil servants, including one-third of the country’s teachers, were fired and public salaries were slashed by 35 percent. Unemployment surged from 5 to 20 percent.53 Remarkably, Latvia clung on, as did its neighbors. In mounting its defense, Latvia received aid totaling 32 percent of its precrisis GDP: 3.1 billion euros came from the European Commission; the IMF provided 1.7 billion; 0.8 billion came from the World Bank and the European Bank for Reconstruction and Development; and 1.9 billion came from Sweden, Denmark, Finland, Norway and Estonia.54 They all preferred to fight the crisis in Latvia rather than bailing out their banks at home. Significantly, the ECB absented itself from the crisis-fighting coalition.

Arghhhhhh

Faced with the double crisis of 2008 the reaction of Eastern Europe was not uniform. The Baltics stayed the course. Hungarian nationalism rebelled. But nowhere was the double shock more jarring than in Ukraine. The coincidence of the escalation of geopolitical tension between Russia and the West with the financial crisis dealt a shuddering blow to its fragile polity. The route to the Ukraine crisis of 2013 was twisted. But the path that it would travel down was mapped out already five years earlier.

In 2008 Chinese opinion was alarmed to discover that their prized portfolio of dollar assets contained not just actual Treasurys but GSE debt, issued to finance the expansion of American mortgage lending. As in Russia, public opinion in China was indignant. Why was poor China financing America’s excess? As a sign of its impatience, Beijing allowed its spokesmen to make dramatic and unusually frank statements. If the United States allowed the GSE to fail it would be a “catastrophe,” China let it be known.3 Toward the end of 2008 the Atlantic magazine garnered an interview with a fast-talking manager of China’s sovereign wealth fund.4 The result was a startling insight into a topsy-turvy world. Over recent months, Gao Xiqing remarked, the world had watched as America, “after months and months of struggling with your own ideology, with your own pride, your self-righteousness,” had finally applied “one of the great gifts of Americans, which is that you’re pragmatic.” The Fed and the Treasury had intervened on a massive scale to stabilize the financial economy, so now, Gao quipped, when the Chinese looked to the United States, what they saw was not capitalist democracy, but “socialism with American characteristics.”

China’s total holding of US securities continued to rise from $922 billion in June 2007 to $1,464 billion two years later.6 Nor was this surprising. Panic and crisis, turned US Treasurys into the most desirable asset in the world. Everyone wanted safety. Treasury prices were rising, so too was the dollar. If China had wanted to diversify out of its dollar assets, this was the moment to do it. There was insatiable global demand for safe dollar assets. But what the crisis revealed was that China’s options were limited. What other safe assets were there to buy? For China to have bought Japanese bonds would have created an entanglement that was potentially even more explosive. European bond markets weren’t deep enough. China and America were locked together willy-nilly. Their interdependence was structurally conditioned and this went not only for foreign investments, but for trade too.

As a result, net exports accounted for a smaller share of Chinese GDP growth before 2008 than one might imagine. In fact, no more than one third of China’s growth from 1990 was driven by exports, with two thirds coming from domestic demand.7 This was a very different balance from that of a truly export-dependent economy, of which Germany was the quintessential example. With slow domestic investment and consumption, the vast majority of Germany’s growth after 2000 was accounted for by foreign demand. In China, far and away the main driver of growth was its enormous wave of domestic investment. As China’s cities expanded and its infrastructure modernized at a staggering rate, the physical reconstruction of the country sucked the entire Chinese economy up with it.

Ever watchful for signs of domestic social unrest, Beijing knew that it had to react. Already on November 5 the State Council convened an emergency meeting to agree on a 4 trillion yuan ($586 billion) spending program. This amounted to a remarkable 12.5 percent of 2008 GDP. It was supplemental to existing investment plans and was to be disbursed by the end of 2010. It was the first truly large-scale fiscal response to the crisis worldwide. On Sunday, November 9, 2008, as the plan was revealed to the press, the State Council declared: “Over the past two months, the global financial crisis has been intensifying daily. . . . In expanding investment, we must be fast and heavy-handed.”12 And the declaration by the State Council was given additional force by a party instruction, Central Document No. 18, which called for a “package plan to counter the global financial crisis.” 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.”

In the words of a leading American analyst, Document No. 18 “added to the sense of urgency, communicating the sense that it was OK to overturn ordinary obstacles to spending the money.” Over the days that followed, across China, provincial party meetings were hurriedly convened to “seize the favorable opportunity created by expansionary fiscal policy and the ‘appropriately loose’ monetary policy,” as one Shandong committee declared. On the evening of November 11 in Wugong County in Shaanxi Province, a “County Leadership Small Group for Implementing Central Document No. 18” was convened, to make the most of “an extremely rare and precious opportunity.” The aim, the county leadership group declared, was to “concentrate our forces and act quickly, strengthen our links with the provincial and municipal authorities, and make sure that more keypoint investment projects come to our county. . . . Getting more project funding is our top current task.” Within a year this party-led mobilization got 50 percent of China’s stimulus projects under way.

Christ that's fast

The gigantic surge in stimulus spending also paid for what is perhaps the most spectacular infrastructure project of the last generation anywhere in the world, the construction of China’s high-speed rail network (HSR). In the first phase of Chinese growth, priority had been given to motorization and highway construction. Now rail came to the fore. 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. Not only did China pioneer ultrafast trains capable of cruising at 360 kilometers per hour. The economies of scale opened up by the gigantic construction program also made China into the technological leader in rail-line and viaduct construction.19 Gigantic snail-like machines would lay the track in a continuous length, mile after mile, across endless arrays of standardized, prefabricated concrete pillars. According to World Bank estimates, even allowing for lower labor and land costs, China’s costs of construction were a fraction of those in Europe and North America.

Amazing

Following the spectacular 2008 Olympics, the promptness and scale of China’s fiscal stimulus was further proof of the mobilizing capacity of the Communist regime. Compared with the sluggishness of many Western states, it is hard to avoid invidious comparisons. Both as presidential candidate and newly inaugurated president, Barack Obama referred frequently to China’s great strides in infrastructure.20 But 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. Was the stimulus a spectacular demonstration of state power, or further proof of the addiction of the Chinese power elite to an unsustainable growth model?21

The aims of China’s leadership were thus clear. And it is tempting to imagine these priorities being rolled out across the country by an all-powerful one-party state. But 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.27 The regime thus operates through decentralization and indirect mechanisms, which amplify its power and extend its reach, but also distort and distend Beijing’s intentions.

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. It was precisely this nexus that over the last generation had combined to supercharge China’s spectacular economic growth. But it was that same combination that also went a long way to explaining the lopsided character of China’s growth. 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.

Geez

Together in the first quarter of 2009 credit issuance came to 4.6 trillion yuan, with the top four being responsible for 3.433 trillion yuan. 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.” These SPVs were endowed with parcels of municipal land against which they borrowed to fund development projects.33 Between 2008 and 2010 local government debt would rocket from 1 trillion RMB ($146 billion) to an estimated 10 trillion RMB ($1.7 trillion).

Big Bang: China’s Bank Lending and Fiscal Stimulus Programs, 2008–2010 Stimulus (RMB billions) 2008 2009 2010 Fiscal deficit 111 950 650 Net new bank loans 252 5070 1936 Net new bond finance 251 467 -232 Total 614 6487 2354 Stimulus (% GDP) Fiscal deficit 0.4% 2.8% 1.6% Net new bank loans 0.8% 15.1% 4.9% Net new bond finance 0.8% 1.4% -0.6% Total 2.0% 19.3% 5.9% Source: C. Wong, “The Fiscal Stimulus Program and Problems

The rate of investment in the Chinese economy surged toward 50 percent of GDP, a level rarely, if ever, seen before. It was enough to offset even the worst shock to global trade.37 At 9.1 percent, China’s growth rate in 2009 was barely lower than it had been in 2008 and vastly higher than anywhere else in the world. And given the size to which the Chinese economy had expanded, this was decisive. In 2009, for the first time in the modern era, it was the movement of the Chinese economy that carried the entire world economy. 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.

Wow

Drivers of World Growth (in percentage points) Source: S. Barnett, “China: Size Matters,” IMF (blog), https://blogs.imf.org/2014/03/26/china-size-matters/.

Wow

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. If we replace a narrowly Western view with a one-eyed focus on China, we fail to grasp the drama and complexity of the transition to a truly multipolar world. 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.

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. “We are collateral damage in a crisis that is not our doing,” observed one professor at Korea University in Seoul. “We live in an unfair world.”6 But 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.7 After the shock of the 1990s the South Korean central bank had made sure to accumulate ample foreign reserves—$240 billion by the summer of 2008. But this did not cancel out the vulnerabilities in the Korean 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.

Abhisit immediately embarked on a stimulus program. The first phase, announced in January 2009, amounted to 116.7 billion baht, or 1.3 percent of GDP, with priority given to popular consumption, including “saving the nation checks” distributed by way of the Social Security Administration, bonuses for senior citizens and subsidies for public education. At the same time, the Bank of Thailand slashed interest rates to 1.25 percent—compared with the 12.5 percent they had reached during the 1998 crisis—and directed six government-owned banks to rush loans, especially to small businesses. But the January plan was only the beginning. 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.

This was “the biggest economic stimulus initiative Malaysia has ever taken,” which, when tax cuts and guarantees were included, amounted to 9 percent of GDP.16 It was marketed as a major step toward rejuvenating the New Economic Model, which had supposedly guided Malaysia’s development since independence. 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.

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. And this new resilience was acknowledged in Washington. One of the reasons why Fed officials advocated a swap line for South Korea was that they did not believe Seoul was willing to have recourse to the IMF any longer. Better to welcome South Korea discreetly to the top table rather than to risk a politicized clash that might upset fragile global markets.22 The Asian economies rebounded quickly and they would soon attract new foreign capital flows. In addition, two of them, South Korea and Indonesia, emerged from the crisis as full members of a new organization designed specifically to reflect the complex reality of a multipolar global economy.

The G20 owed its existence to an initiative launched in December 1999 by then US Treasury secretary Larry Summers and Canadian prime minister Paul Martin. Their vision was to create a forum for global governance that was more representative than the Bretton Woods institutions, such as the IMF and the World Bank, but not so unmanageable as the United Nations. Twenty members seemed like a round number. As the story is told, the list was drawn up by Summers’s assistant, Timothy Geithner (then in charge of international affairs at the Treasury), and Caio Koch-Weser, former managing director at the World Bank and then at the German finance ministry.

For new members of the elite circle, such as Australia, Brazil, Korea and Indonesia, the G20 was an exciting departure. For the United States it promised at least minimal coordination across the major economies. For China it was a convenient mechanism for gaining global influence without having to accept an excessive burden of responsibility. But the G20 was far from meeting with universal approval. As The Sunday Morning Herald reported, 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.” They were strong words, but to a degree beside the point. 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 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. There was no pretense of equality within the G20, let alone with states beyond. But the members of the G20 did at least recognize one another as elements of the global economic system that were too significant to ignore. At the UN the exclusivity of the G20 provoked something of a countermovement. But when in 2009 the UN General Assembly convened its own committee on the global economic crisis, the G20 ignored it.

The knock on the UN was that it was either an empty talking shop or a stage for global grandstanding. Creating an expanded council of the “big 20” with all the principals in the room promised a more businesslike approach. But would global governance à la G20 be any different? The first G20 meeting in Washington on November 15, 2008, was not encouraging. The time allowed was too short. The leaders went around the table delivering prepared statements. After the twenty participants had each had their fifteen minutes, the allotted five hours were up. The statements were of varying levels of discipline, relevance and sophistication. The Germans, Australians and Canadians were on point. Sarkozy grandstanded and demanded action on the Doha trade round, despite the fact that France’s defense of European agriculture was one of the greatest obstacles to progress on world trade liberalization. Italy’s Prime Minister Berlusconi had nothing to say about the economy, but he did at least offer warm wishes to the outgoing President Bush. For a “global” forum there were still too many Europeans around the table.27 Brazil and Argentina enjoyed their moment in the spotlight. They had axes to grind and wanted to fire off parting shots in the direction of President Bush.

Meetings!

Rather than any substantive discussion, the leaders gave their approval to a laundry list of ninety-five precommitments, including an agreement to a second gathering in the spring.

The London G20 was not mere theater. The incorporation of a key group of emerging markets into global economic policy was a genuine innovation. The ratification of the IMF deal was to prove particularly important. In the years to come it would prove to be a vital resource, ironically enough, for Europe. But if this was the future of global governance, perhaps the gibes about the Congress of Vienna were not entirely wide of the mark. It was exciting for London to be hosting America’s glamorous new president, and the faded fixtures of 1990s Cool Britannia were out in force. The message of confidence issuing from the meeting, the huge boost to IMF resources, was good news, above all, for financial markets in London, New York, Tokyo, Shanghai, the media that served them and the audience of investors around the world, large and small. But when talking IMF quotas or tax havens, public participation was not welcomed by the British or the Americans, let alone the Chinese or the Saudis. As a political event the summit was an airtight cabal of executive power, housed in the cavernous bunkers of the ExCeL conference center, shielded from tens of thousands of protesters by a gigantic police mobilization.50 In the course of the confrontations in the City of London, a homeless newspaper vendor was fatally injured by the police, adding fuel to indignant protests about repressive police tactics. Inside the conference hall, Gordon Brown proved that he was perfectly suited to the role of Tr...

Given that resistance from France and Germany had kept any firm fiscal policy commitments off the G20 agenda at London, it was something of a surprise that the final communiqué spoke in grandiose terms of $5 trillion in fiscal expansion that would save millions of jobs and “accelerate the transition to a green economy.”55 Where that enormous figure came from is something of a mystery. Over the weeks that followed it was left to outside agencies such as the IMF to do the work of compiling data about the emergency spending programs that had been launched around the world. The results were striking. In total, between 2008 and 2010, crisis-fighting expenditure would come to $1.87 trillion, or $2.4 trillion in PPP-adjusted terms—counting only discretionary spending and emergency tax-cutting measures. It was not $5 trillion, but it was nevertheless historically unprecedented. What was even more striking was the distribution of this spending. Whichever way one measured it, in 2009 and 2010, Asia and the emerging markets produced the most dramatic response to the crisis. Russia, Indonesia, Korea, Turkey, Brazil and Argentina were now in a position to launch truly substantial fiscal responses.56 According to the IMF’s figures, in 2009 Russia’s discretionary crisis response more or less matched that of Germany or exceeded it in PPP terms.57 And these figures were a serious understatement of China’s effort. They did not include the huge lending boom. By comparison, despite the size o...

Wow

But if this was the case, if the stimulus worked, why didn’t the Obama administration ask for more?13 There were political risks in asking for a figure bigger than $1 trillion. But there were risks to undershooting as well. By 2010, America’s unemployment was still stuck above 10 percent. Foreclosures and forced sales were destroying entire communities. Millions of young people left schools and colleges without jobs. Men and women in the prime of life were shut out of the workforce. Many would not return. In the elections of 2010 and 2012 the Democrats fought on the back foot against the backdrop of a limping economy and resurgent Republican activism. They retained the presidency but lost control of Congress. Obama’s administration never built the constituency of Democrats-for-life that was shaped by Roosevelt’s New Deal. Given that they commanded majorities in both the House and the Senate in 2009, why did the Obama team not set the bar higher and pitch for an even larger number? If maximum force was the best approach to financial stabilization, why, when it came to fiscal policy, was the approach so penny-pinching? Part of the answer is that the transition team did not fully grasp the scale of the tsunami that was descending on the US economy. From preparatory documents circulated within the transition team in early January 2009, we know that the worst-case scenario envisioned by Obama’s staff was for unemployment to reach 9 percent with no stimulus.14 In fact, even with...

Automatic stabilizers are the unsung heroes of modern fiscal policy. In the United States, no more than one third of federal government spending is discretionary. The rest is made up of mandatory expenditures required by existing “entitlements,” social programs such as unemployment and disability benefits, or retirement pensions. These tend to increase during a recession. Likewise, tax revenue flows into Treasury coffers at preexisting rates of taxation and contribution levels, driven not by political decisions but by the fluctuating fortunes of the economy. Dominated by these nondiscretionary flows, modern state budgets have a powerful stabilizing effect on the economy. As economic activity declines and the economy calls for stimulus, tax revenue falls, entitlement spending increases and the government deficit automatically expands.

According to calculations by the IMF, if the US economy had been at full employment in 2009, the crisis-fighting policies adopted by the Bush and Obama administrations would have been enough to produce a deficit of 6.2 percent of GDP—this was the discretionary deficit. The actual general government deficit was 12.5 percent of GDP.22 More than half the support provided to aggregate demand was automatic or quasi-automatic. And this was typical of all advanced economies. According to the IMF’s calculations, of the vast increase in public debt in the developed world over the course of the crisis, just under half was due simply to the reduction in revenue produced by the contraction of the tax base.

So serious were the rumblings and so painful were the memories of the Clinton era that in May 2009 Obama asked budget director Orszag to prepare a contingency plan.24 The budget director’s response was drastic. In the case of a bond market panic, the administration should severely hike taxes. The report was intended to be for the eyes of the president only. When Rahm Emanuel leaked it to Summers it provoked a towering fury. Summers threatened to resign and demanded that in the future he must have complete control of all economic policy input to the president. For all his rumpled, academic persona, Summers had a keen eye for power and could sense a new agenda of fiscal consolidation forming within the administration. This was a threat to his personal position. But it also violated his instincts as a “new Keynesian” economist. Summers might have censored Romer’s stimulus proposal, but he did not believe in the power of the “confidence fairies.”25 To be talking about budget cuts in the early summer of 2009, when the United States was about to hit the trough of the most severe recession since the early 1930s, was wildly premature. If confidence was the issue, the best way to restore it was to engineer a solid recovery.

Oof orszag

In the eurozone things were more complicated. There too the automatic stabilizers kicked in and deficits ballooned. Debt issuance surged. But unlike in the UK or the United States, the ECB is barred from buying newly issued government securities. After Lehman, however, Trichet was in no mood to take risks. Though the ECB did not purchase newly issued government debt, what it did do was to repo sovereign euro bonds.27 As the eurozone deficits ballooned, the ECB operated what was known informally as the “grand bargain.”28 It supplied hundreds of billions of euros in cheap liquidity to Europe’s banks in the form of the so-called Long-Term Refinancing Operation initiated in May 2009.29 The banks then bought sovereign bonds. On average, the rate Europe’s banks paid to the ECB on the CTRO funding was only a third of the yield they earned on their bond holdings. All told, in the eurozone in 2009 the banks loaded up on 400 billion euros’ worth of sovereign debt.30 It was easy and apparently safe profit, and it was Europe’s most stressed banks, including Germany’s bankrupt Hypo Real Estate and Franco-Belgian Dexia, that were keenest to take advantage. Seeking to maximize their return, they put the ECB’s funds into the riskier peripheral bonds from Portugal and Greece that were offering a marginally higher yield. As in the UK and the United States, this helped to stabilize the government debt market, but there was a crucial difference. In the United States and the UK the central ban...

What could go wrong ?