Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

As a result of the debt restructuring of 2012, Greece’s public debt was reduced from 350 billion to 285 billion euros, a 19 percent reduction. The really dramatic transformation was not in the quantity of debt but in who it was owed to: 80 percent was now owed to public creditors—the EFSF, the ECB or the IMF. In effect, Greece swapped a reduction of its obligations to private creditors of 161.6 billion euros for an increase in obligations to public creditors of 98.8 billion euros.

The bond market was no longer the principal arbiter of Greece’s financial fate. But for that it substituted the full weight of the troika, the IMF, the EU, the ECB and the national governments of Europe.

Whereas in 2009 Greece’s GDP had stood at roughly 240 billion euros, in the course of 2012 it would slump to 191.1 billion euros.13 If Greece’s debts had been unsustainable in 2009, in 2012, even allowing for the concessions granted by the official creditors, it clearly still was. In the interim, Greek society had been battered beyond recognition.

As the election now scheduled for May 2012 approached, the euro system was discreetly sluicing billions in cash into Greece to preserve a veneer of normality. In total, 28.5 billion euros were quietly airlifted into Greece to disguise the size of the bank run.

The emphasis on the paradox of thrift in the G20 briefing for Mexico City was the first sign of a major shift in Fund thinking on fiscal policy.20 In the summer of 2012 its staff revisited the forecasts they had made in the spring of 2010 as the eurozone crisis began and discovered that they had systematically underestimated the negative impact of budget cuts.

Whereas they had started the crisis believing that the multiplier was on average around 0.5, they now concluded that from 2010 forward it had been in excess of 1.21 This meant that cutting government spending by 1 euro, as the austerity programs demanded, would reduce economic activity by more than 1 euro. So the share of the state in economic activity actually increased rather than decreased, as the programs presupposed. It was a staggering admission. Bad economics and faulty empirical assumptions had led the IMF to advocate a policy that destroyed the economic prospects for a generation of young people in Southern Europe.

In any case, by June 2012 Greece was no longer the main concern. If some concerted collective action plan was not put in place, Spain was in mortal danger and Italy would soon follow.

On June 28, 2012, the European Council convened in Brussels in an atmosphere of “deep crisis.”42 Spain was clearly sliding toward the abyss. Three days earlier Madrid had formally applied for 100 billion euros in external assistance to recapitalize and restructure its banks. To stop the impending disaster, there was no alternative but for the council to approve the creation of a banking union. This would provide for the direct recapitalization of banks, independent of their home country governments, once an effective overall supervisory regime was established. Finally, a structural solution adequate to the crisis was coming into view.

And there was “another message” that Draghi wanted investors to hear: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro.” Then, pausing for effect, he added: “And believe me, it will be enough.”

Draghi had had “nothing precise in mind,” said an official at the ECB’s headquarters in Frankfurt. “It was a rash remark.” As Reuters put it: Draghi’s “words were a gamble. . . . [T]he speech was just the beginning.”

In fact, German opposition to Draghi’s initiative was fierce.56 Some insiders are convinced that it was not until the German government’s joint meeting with its Chinese counterparts on August 30 that Merkel and Schäuble were finally committed to backing the ECB’s initiative and holding Greece in the currency zone.57 Chinese prime minister Wen Jiabao certainly made clear that he held the major European countries, Germany and France, responsible for the destiny of the eurozone and that continued Chinese purchases of European bonds depended on their taking effective action.

The ECB formalized its new role as a conditional lender of last resort, under the title of Outright Monetary Transactions (OMT).61 But this was a strictly conditional promise. The ECB would go into action only if the country in question had agreed on an austerity and aid program approved by the ESM.

They heard one single and simple message. Here was a powerful central banker and he was saying that he would do “whatever it takes.” Finally, a European policy maker had realized what was needed. He was speaking the language of the financial Powell Doctrine, in the City of London, to an audience of investors, in English. What Draghi was signaling was that Europe, finally, “got it.”

He spoke the magic words. The markets stabilized. The eurozone was saved by its belated Americanization.

Twelve months on from Obama’s second election victory, at an IMF event in November 2013, Summers warned: “[M]y lesson from this crisis, and my overarching lesson, which I have to say I think the world has under-internalized, is that it is not over until it is over, and that time is surely not right now.”71 He could not have known how right he would turn out to be.

What if the inadequate recovery was not simply down to policy failure? What if there was a deeper problem, a chronic shortfall in the demand for investment relative to the supply of savings, resulting in a sustained condition of “secular stagnation”?

In an astonishing makeover of America’s recent economic history Summers proposed that for at least two decades American economic growth had been on weak foundations. To achieve no more than a “normal” rate of growth it had depended on “abnormal” financial bubbles.

To address the chronic shortfall in investment, what Summers advocated was a new era of government activism. The United States would not match China, of course. Nor was that appropriate. But the conditions were right for a big burst of public investment. This would rebuild America’s infrastructure, and in so doing it would address the more fundamental questions posed by Detroit.

From the latest round of tax releases they calculated that of the growth generated by the economic recovery since 2009, 95 percent had been monopolized by the top 1 percent. That tiny fraction of the population saw their incomes rebound from the trough of the recession by 31.4 percent.16 Meanwhile, 99 percent of Americans had experienced virtually no gain in income since the crisis.

The slow growth in GDP that worried Summers, in fact, hid two radically divergent realities. Whereas a tiny elite were doing extremely well, for average Americans the secular stagnation thesis that Summers advanced as a tentative academic hypothesis was simply the lived reality of the last forty years.

Could the national economy any longer be plausibly presented as a project common to all Americans?

Great Graph

Already in 2007 deaths from drug overdose had overtaken road accidents as a major cause of death in the United States.

So globalization was supplemented by the thesis of skills-biased technological change.24 This postulated that, independent of globalization and foreign trade, the trend in technological development had offered disproportionate benefits to those with higher skills in every walk of life and across the entire American economy, whether exposed to trade or not.

Nor was this by accident. Every conceivable source of leverage and influence had been exploited by those with money to maximize their advantage. As billionaire investor Warren Buffett famously put it: “Actually, there’s been class warfare going on for the last 20 years, and my class has won.”

It was a sign of both Buffett’s personal decency and the utter lopsidedness of the balance of power in twenty-first-century America that a program of social improvement should consist of well-meaning billionaires volunteering to pay a bit more for the greater good of American society.

As the Occupy slogan of 2011 put it, “The system isn’t broken, it’s rigged.”

In many ways the liberal centrists were the last to know. They, of all the segments of political opinion, had the most invested in the idea that America’s social ills were amenable to technocratic remedy and that the state was a suitable instrument for making such change. It was precisely the conversion of commentators of this ilk to a more radical view that marked how serious the sense of crisis had become.

“What do the pre- and postcrisis consensuses have in common?” Krugman asked in December 2013.32 “Both were economically destructive: Deregulation helped make the crisis possible, and the premature turn to fiscal austerity has done more than anything else to hobble recovery. Both consensuses, however, corresponded to the interests and prejudices of an economic elite whose political influence had surged along with its wealth.

Even on what may look like purely technocratic issues, class and inequality end up shaping—and distorting—the debate.” This from a Nobel Prize–winning economist who in the 1980s and 1990s had counted squarely in the mainstream.

Reich now recognized was that much of this was “insufficient,” if not “beside the point,” because it overlooked a “critically important phenomenon: the increasing concentration of political power in a corporate and financial elite that has been able to influence the rules by which the economy runs. . . . The problem is not the size of government but whom the government is for.”

As the recession of 2008–2009 receded, what came ever more to the fore was a tendency toward concentration and oligopoly that went far beyond Wall Street.

In three giant merger waves, cresting in 2000, 2006 and 2015, with the antitrust authorities looking on, American capitalism remade itself in a more concentrated and monopolistic mode.

“Americans mythologize competition and credit it with saving us from socialist bread lines,” but Thiel knew better. As far as he was concerned, “[C]apitalism and competition are opposites. Capitalism is premised on the accumulation of capital, but under perfect competition, all profits get competed away. The lesson for entrepreneurs is clear . . . [c]ompetition is for losers.”

A polite European social democrat like Thomas Piketty inferred from his inequality data that what the world needed was a global wealth tax. This was the message of his remarkable global bestseller, Capital in the Twenty-First Century, which redefined the public debate about inequality in 2014.

The tax proposal wasn’t wrong. It just sidestepped the reason it was needed in the first place, the brutal struggle for privilege and power, which for decades had enabled those at the top to accumulate huge wealth, untroubled by any serious effort at redistribution.

As one cynical observer put it, “It’s easier to get face time in Washington as a deficit hawk than as a corporate hack.”

To the Taliban of the Right, it was clear that Romney had lost because he was a moderate, compromising on immigration and health care.

Though a disaster was avoided, it is important not to normalize what had happened. The radical right wing of the Republican Party, xenophobic nationalists, many of them evangelical zealots, motivated by a worldview fashioned by the alt-right, or Pat Buchanan’s extreme America-first nationalism, a group whose hard core accounted for 10 percent of the House of Representatives, had threatened to paralyze the most important nation-state in the global system.

At the G20 the Americans were embarrassed to report that funding for the IMF was being held hostage by Republican opponents of abortion who wanted contraception excluded from Obamacare.63 What if the Republican zealots targeted Fed independence or trade policy next?

Was one of the unintended side effects of the stability generated by the Fed to free politics from market constraints and thus enable Republican extremism?

After successive phases of QE, it was the Fed that held long-term securities that were matched against short-term liabilities such as cash and deposits by American and European banks.

In 2008 the Fed had embarked on a vertiginous tightrope walk from which there was no way back to the certainties of the great moderation.

By its bond-purchasing program, which pushed up bond prices and depressed yields, the Fed incentivized investors to shift out of bonds and to place their funds in higher-risk, higher-return assets. How far this impulse actually went to explain the stock market boom is debatable.

Any investor who was willing to take a gamble on exchange rate movements could borrow cheaply in dollars and invest in high-yielding emerging markets. Assuming the dollar did not sharply appreciate before the debt was due, it would be a profitable carry trade.4 By the middle of 2015, governments and businesses outside America would pile up $9.8 trillion of debts denominated in dollars.

In September 2012 Zambia issued its first dollar-denominated bond. With a modest 5.6 percent coupon, a $750 million offering attracted more than $11 billion in bids.

A year later a state-backed tuna-fishing venture in Mozambique raised $850 million.

At Jan 2019 being investigated for fraud and bribery

As the IMF pointed out, given that the largest five hundred asset management companies had more than $70 trillion in their portfolios, a 1 percent reallocation implied a flow in or out of an asset class of $700 billion. This was enough either to swamp or to starve the emerging markets.

By 2013 many emerging markets had gone beyond the war of words to adopt capital controls. Brazil, South Korea, Thailand, Indonesia all took steps to slow the inflow of funds and curb the appreciation of their currencies.

Despite weeks of preparation, Bernanke’s statement triggered a full-scale “taper tantrum.” In a matter of seconds yields surged from 2.17 to 2.3 percent. Two days later they had risen to 2.55 percent and would peak at 2.66 percent. These were small changes in absolute terms, but amounted to an increase in interest costs of almost 25 percent and inflicted a correspondingly serious capital loss on bondholders. US equity markets reacted in sympathy, losing 4.3 percent in a matter of days.