Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

The devastating financial crisis raging just a short walk away on Wall Street merited only two brief paragraphs at the end of the president’s speech. The “turbulence” was, as far as Bush was concerned, an American challenge to be handled by the American government, not a matter for multilateral action.

For decades, Latin America had been lectured that “the market would solve everything.” Now Wall Street was failing and President Bush was promising that the US Treasury would come to the rescue.

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?

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.

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.

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.

China’s response to the financial crisis it imported from the West was of world historic proportions, dramatically accelerating the shift in the global balance of economic activity toward East Asia.

Among the emerging markets, 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.

Hidden below the radar and barely discussed in public, what threatened the stability of the North Atlantic economy in the fall of 2008 was a huge shortfall in dollar funding for Europe’s oversized banks.

But when it comes to analyzing the onset of financial crises in an age of deep globalization, the standard macroeconomic approach has its limits.

What drives global trade are not the relationships between national economies but multinational corporations coordinating far-flung “value chains.”21 The same is true for the global business of money.

we need to analyze the global economy not in terms of an “island model” of international economic interaction—national economy to national economy—but through the “interlocking matrix” of corporate balance sheets—bank to bank.

For all the pressure that classic “macroeconomic imbalances”—in budgets and trade—can exert, a modern global bank run moves far more money far more abruptly.

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.

In fact, neoliberalism’s regime of restraint and discipline operated under a proviso. In the event of a major financial crisis that threatened “systemic” interests, it turned out that we lived in an age not of limited but of big government, of massive executive action, of interventionism that had more in common with military operations or emergency medicine than with law-bound governance.

But rather than retreating from liberalization, by the early 1980s any restriction on global capital flows was lifted. It was precisely to tame the forces of indiscipline unleashed by the end of metallic money that the market revolution and the new neoliberal “logic of discipline” were inaugurated.

They would do whatever it took to prevent a collapse of credit. They would do whatever it took to keep the financial system afloat. And because the modern banking system is both global and based on dollars, that meant unprecedented transnational action by the American state.

The Fed’s liquidity provision was spectacular. It was of historic and lasting significance. Among technical experts it is commonly agreed that the swap lines with which the Fed pumped dollars into the world economy were perhaps the decisive innovation of the crisis.30 But in public discourse these actions have remained far below the radar.

By contrast, the new macrofinancial economics, with its relentless focus on the “interlocking matrix” of corporate balance sheets, strips away all the comforting euphemisms. National economic aggregates are replaced by a focus on corporate balance sheets, where the real action in the financial system is.

The financial system does not, in fact, consist of “national monetary flows.” Nor is it made up of a mass of tiny, anonymous, microscopic firms—the ideal of “perfect competition” and the economic analogue to the individual citizen. The overwhelming majority of private credit creation is done by a tight-knit corporate oligarchy—the key cells in Shin’s interlocking matrix. At a global level twenty to thirty banks matter. Allowing for nationally significant banks, the number worldwide is perhaps a hundred big financial firms.

However unprecedented and effective the Fed’s actions might have been, even for those politicians whose support for globalization was unfailing, its practical implications were barely speakable.

under america first no support

In the eurozone, led by France and Germany, the 2008 financial crisis has vanished down a memory hole, closed over by the “sovereign debt crisis” of 2010 and after.33 There is no appetite for acknowledging the dependence on the US Federal Reserve and little sense of obligation or deference either.

The sustainability of public debts may be a problem in the long term. Greece was insolvent. But excessive public debt was not the common denominator of the wider eurozone crisis. The common denominator was the dangerous fragility of an overleveraged financial system, excessively reliant on short-term market-based funding.

As one leading EU expert closely associated with the EU’s bailout programs has put it: “If we had taken the banks under central supervision then already [in 2008], we would have solved the problem at a stroke.”

How do we account for the strange morphing of a crisis of lenders in 2008 into a crisis of borrowers after 2010? It is hard not to suspect sleight of hand. While Europe’s taxpayers were put through the mill, the banks and other lenders got paid out of money pumped into the bailout countries. It is a short step from there to concluding that the hidden logic of the eurozone crisis after 2010 was a repetition of the 2008 bank bailouts, but this time in disguise.

As its protagonists were well aware, America’s crisis fighting exhibited massive inequity.38 People on welfare scraped by while bankers carried on their well-upholstered lives.

It was one of the worst self-inflicted economic disasters on record. That tiny Greece, with an economy that amounts to 1–1.5 percent of EU GDP, should have been made the pivot for this disaster twists European history into the image of bitter caricature.

The story told here is not that of a successful political conjuring trick, in which EU elites neatly veiled their efforts to protect the interests of European big business. The story told here is of a train wreck, a shambles of conflicting visions, a dispiriting drama of missed opportunities, of failures of leadership and failures of collective action.

Since 2008, it is not just the rise of Asia that is shifting the global corporate hierarchy. It is the decline of Europe.40 This might ring oddly to Europeans used to hearing boasts of Germany’s trade surplus. But as Germany’s own most perceptive economists point out, those surpluses are as much the result of repressed imports as of roaring export success.41 The inexorable slide of corporate Europe down the global rankings is clear for all to see.

The future will be decided between the survivors of the crisis in the United States and the newcomers of Asia.44 They may choose to locate in the City of London, but after Brexit even that cannot be taken for granted. Wall Street, Hong Kong and Shanghai may simply bypass Europe.

It was not until July 2012, with insistent urging from Washington and the rest of G20, that Europe stabilized, and it did so by means of what was generally taken to be the belated “Americanization” of the ECB.

If we are to understand the last ten years historically, we have to take this moment of renewed complacency seriously.

Precisely because the crisis had been contained so early and effectively, it had produced a false sense of stability. That in turn had sapped the energy necessary for fundamental reform.

What all of these narratives took for granted—both the more and the less pessimistic versions—was the fact that the 2008–2012 crisis was over. That was also the basis on which this book was begun.

Because it is only if we get to grips with the inner workings of the dollar-based financial system and its fragility that we can understand the risks that lurk in the situation of 2017.

What we have to reckon with now is that, contrary to the basic assumption of 2012–2013, the crisis was not in fact over. What we face is not repetition but mutation and metastasis.

As the remarkable escalation of the debate about inequality in the United States has starkly exposed, centrist liberals struggle to give convincing answers for the long-term problems of modern capitalist democracy.

And though the “Western alliance” is still in being, it is increasingly uncoordinated. In 2014 Japan lurched toward confrontation with China. And the EU—the colossus that “does not do geopolitics”—“sleepwalked” into conflict with Russia over Ukraine.

Against the Left, preying on its reasonableness, the brutal tactics of containment did their job. Against the Right they did not, as Brexit, Poland and Hungary were to prove.

Things could be worse, of course. A ten-year anniversary of 1929 would have been published in 1939. We are not there, at least not yet. But this is undoubtedly a moment more uncomfortable and disconcerting than could have been imagined before the crisis began.

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.

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.

To do that there is no substitute for digging into the workings of the financial machine. It is there that we will find both the mechanism that tore the world apart and the reason why that disintegration came as such a surprise.

Twelve months ahead of the financial crisis, two and a half years before Obama took office, the launch of the Hamilton Project presents the worldview of some of his most influential advisers in microcosm. It reveals both what they could see and what they could not.

Bob [Rubin] and I have had a running debate now for about a year about how do we, in fact, deal with the losers in a globalized economy. There has been a tendency in the past for us to say, well, look, we have got to grow the pie, and we will retrain those who need retraining. But, in fact, we have never taken that side of the equation as seriously as we need to take it.

As Clinton’s Treasury secretary, Robert Rubin’s great boast was to have turned the deficits of the Reagan era into substantial budget surpluses. Since then under the Republicans, America was headed fast in the wrong direction.

The Clinton administration had midwifed China into globalization. In November 1995, Washington encouraged Beijing’s application to join the newly founded World Trade Organization (WTO). America had done this before, of course, with Western Europe after 1945, with Japan and East Asia in the 1950s and 1960s and with Eastern Europe in the 1990s.

The global monetary system was hierarchical with the key currency, the dollar, at the top of the pyramid.20 The twenty-first century began with a network of dollar-linked currencies accounting for c. 65 percent of the world economy (weighted by GDP).21 Those currencies that were not pegged to the dollar tended to be hooked to the euro.

Despite a $22 billion loan from the IMF, without American backing the Argentinian position became untenable; 80 percent of Argentine private debt was in dollars, whereas only 25 percent of Argentina’s economy was export oriented.

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.