The Spectre at the Feast

Capitalist Crisis and the Politics of Recession

Palgrave Macmillan

Contents

From Boom to Bust

The long economic upswing that culminated in the financial crash of 2008 began in the 1980s in the United States and in the United Kingdom, and was underpinned by a new growth model, which had the financial markets at its core, and the ambition to make every citizen an independent financial subject. This model pinpointed the route out of the stagflation of the 1970s, which eventually was to give rise to a new prosperity and renew the economic ascendancy of the United States. It accompanied and helped make possible a major restructuring of the global economy, involving a shift in many of the leading economies from manufacturing to services, an acceleration of the trends towards globalization, the introduction of new information technologies, the adoption of neo-liberal ideas across the whole field of public policy and a reorganization of the state.

The early signs, however, were not propitious. The major crisis of the 1970s had created deep problems of stagflation, which persisted long into the 1980s. Inflation rose again to over 20 per cent in the UK in 1980 and 13 per cent in the US, and unemployment climbed sharply. In the UK it reached 11 per cent or 3 million by 1982 and stayed there until 1986. In the US it reached 9.7 per cent in 1982. But relief was at hand. The first major upswing of the new era got under way in the second half of the 1980s, particularly after 1986, and both unemployment and inflation fell. This first upswing was to be cut short by the recession of the early 1990s, but although painful this was relatively short-lived, and after 1992 growth resumed in earnest. The boom was under way.

One of the significant changes given credit for laying the foundations of the boom and the financial growth model at its heart were the new doctrines of monetarism and supply-side economics that came to prominence in the 1970s and 1980s, particularly in Anglo-America, and the institutional and policy changes which they helped inspire and for which they provided the rationale. Rebuilding the foundations of sound money after the turmoil of the 1970s was a priority for the Thatcher Government, elected in 1979, and also for the Reagan Administration, elected in 1980. The Thatcher Government pursued a tough monetary and fiscal policy in its early years, which brought down inflation but at the cost of a doubling of unemployment. The political purpose of the government was not just to create monetary stability but also to defeat the special interests in the shape of public sector trade unions and local governments, which constantly threatened to undermine it. A bruising series of conflicts ensued, which eventually created the political conditions in Britain for the introduction of the new supply-side economics. In the US there was a sharp recession at the beginning of the 1980s, as a result of a severe monetary squeeze by the Federal Reserve, but then followed an experiment with supply-side economics, in a bid to return the economy to growth. Some of this was inadvertent. The government slashed taxes but could not get Congressional approval for its spending cuts. It went ahead with the tax cuts anyway and in some areas, particularly the military budget, spending increased. The result was a ballooning deficit, leading to the $3 trillion debt made famous by Ross Perot in his campaign for a balanced budget in the 1992 presidential race. This was only the beginning. By 2007 the US national debt had reached $5 trillion (see Figure 1.1).

Officially both the Reagan and the Thatcher governments were monetarist. But this did not mean that they sought to go back to a pre-Keynesian era in political economy. In one sense both remained fundamentally Keynesian in their policy stance, This was partly because monetarism in the strict technical sense could not be made to work, as the Thatcher Government discovered. Every measure of control of money was quickly subverted by the markets. But it was also because when it came to it there was little political appetite for trying to restore sound money by making the state truly limited, and giving up all the direct and indirect levers that had been developed for influencing the economy. The rhetoric was often antiKeynesian, but much of the practice fitted neatly within a Keynesian framework. But this was Keynesianism with a difference. It was what Colin Crouch has aptly called 'privatized Keynesianism'. This new financial growth model used tax cuts to stimulate the economy, and it promoted privatization of public assets and deregulation of the private sector, particularly the financial sector. It sought to expand credit, not restrict it, and to enlist the financial sector as the most important driver of growth and competition in the economy. It led to the rise of the investment banks and the rating agencies to their commanding position in the global economy at the beginning of the twenty-first century, and the proliferation of new financial vehicles and instruments, a readiness to 'leverage' every asset whether in the public or private sector, and to make all citizens and organizations 'financial subjects'. Leveraging meant simply using existing assets and income to borrow in order to invest in other assets which promised a higher return. Applied to individuals and companies this meant taking on ever larger burdens of debt, in relation to what they already owned or earned, to be redeemed against future earnings or, in the case of government organizations, taxes. The ingenuity of the financial sector was set to work to create new ways of spreading risks, new ways of expanding credit, new ways to encourage individuals, companies and governments to borrow, employing new devices such as financial derivatives and credit default swaps, and in this way to keep spending, asset prices and jobs continually rising. The credit rating which individuals, companies and governments received became very important in determining the amount of credit they could obtain, and great ingenuity went into devising ways in which high credit ratings could be given to those who would once have been judged to be poor credit risks. In this way credit could continue to expand, drawing in more and more citizens and companies. If it worked everyone could become rich painlessly. As one advertising slogan suggested, it took the waiting out of wanting.

One of the most important conditions for this new financial growth model to become fully established was the deregulation of the financial markets. This had been proceeding steadily for some time, but in the 1980s it was given a major boost. In the UK, the so-called 'Big Bang' of 1986 swept away many of the restrictions, which had determined the kind of banks which could locate in London and how they traded. The City of London had once been the preserve of a relatively small and cohesive financial elite, whose businesses were founded on close personal connections and trust. In throwing open the City to competition, the Thatcher Government was pursuing what it believed to be the right policy for all parts of the economy. Exposure to international competition with no guarantees from the government was tough medicine but considered the best way the City could sustain and develop its international role.

The financial revolution in London and New York in the 1980s was to have profound consequences. The main driver was the US financial sector, and the re-establishment of its global dominance. An important part of its global reach was being able to create a network of other financial centres around the world in which American banks and their subsidiaries could operate freely. This network included Hong Kong, Tokyo, Singapore and London. The traditional willingness of the British to treat the City of London as an 'offshore island' with more freedom to operate independently than most other national financial centres, made London the ideal partner for Wall Street. Within twenty years the financial sector in London had become one of the UK's largest employers and export earners, and in comparative terms was large in relation to the rest of the economy. Some smaller economies, like Iceland and Switzerland, went even further, but among the large economies, none rivalled Britain for the relative size of its financial sector. It accounted for 5 per cent of gross domestic product (GDP) and over a million employees, and gave Britain the largest trade surplus in financial services in the world. (In 2003 it totalled $25.3 billion, more than twice as much again as the next largest surplus, that of Switzerland.) The British government actively encouraged the growth of the financial sector and the service sector more generally to replace the gap left by the decline of manufacturing and the older industrial towns and cities.

Susan Strange called this new financial growth model 'casino capitalism'. It created a rapidly expanding financial sector, which was increasingly separate from the rest of the economy, intensely competitive, fast moving, nimble and innovative, brilliant at calculating margins and exploiting opportunities. Its business was trading in financial claims, and as the boom developed speculation became an ever more important part of its activities. As Keynes remarked in The General Theory of Employment, Interest and Money, published in 1936:

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes the byproduct of the activities of a casino, the job is likely to be ill-done. (Keynes, 1973, p. 159)

Casino capitalism was to flourish, particularly in what later became known as the Anglosphere economies, consisting of the United States, Canada, Britain, Ireland, Australia and New Zealand, and particularly in the heart of the Anglosphere – the United States and Britain, or Anglo-America. These countries not only shared a common language, but common political and legal traditions, and a form of capitalism noted for its emphasis on flexible labour markets, shareholder value and highly developed financial sectors.

The alternative to casino capitalism in the 1980s was the model of capitalism represented by Germany and Japan, with its emphasis on long-term investment in capacity and skills, the nurturing of successful businesses, life-long relationships with employees and the subordination of finance to those ends. The short-termism in the Anglosphere economies induced by the increasing dependence of companies on the financial markets and by their need to focus relentlessly on increasing shareholder value appeared for a time during the 1980s to make the financial growth model look distinctly inferior to the investment growth model. Japan and Germany were regarded by many as having devised a much more effective and sustainable form of capitalism, which would finally consign the Anglosphere model to the scrapheap, and oblige them to adopt German and Japanese institutions.

That is not what happened. The Japanese economy stalled at the beginning of the 1990s because of the bursting of its own local financial bubble that had been allowed to form in property prices. The uncertain response by the Japanese authorities to this crisis pushed Japan into a deflationary spiral from which it did not properly emerge for ten years. It retained its position as the world's second largest economy, but its growth rate declined sharply, and it no longer looked like an economy that was about to overtake the United States, or that could offer a successful model to the rest of the world. Germany was preoccupied in the 1990s with the absorption of the East German economy following reunification, which proved much more protracted and complex than had been envisaged. German growth slowed, and its attraction as an alternative model sharply decreased. After the end of the recession at the beginning of the 1990s and the extraction of sterling from the European Exchange Rate Mechanism in 1992, the financial growth model of the Anglo-Saxons began to sweep all before it. The European and the Japanese banks became deeply integrated into the complex financial web which was spun in the 1990s. There was still resistance in many countries to accepting the full Anglo-American medicine of flexibility, deregulation, tax cuts and privatization, but the hegemony of Anglo-American finance was not contested. Everyone queued up to join this particular part of the feast.

A second major factor which made the boom possible was the emergence of China, India, Brazil and other rising economic powers in the 1990s. The dramatic leap, in particular, of Chinese economic growth in the 1990s, propelled by the movement of rural workers into the cities on the eastern coastal strip, made possible a supply of cheap manufactured goods which kept inflation low in the rich countries. The high savings ratio in China created large surpluses, which were lent to western governments and western banks, and helped create the credit to allow consumers to continue buying the goods China was producing. The bringing into play of such vast populations in both world production and world trade was a transformative event for the global economy, and helped create the conditions in which the financial growth model could succeed for such a long time, despite the numerous bubbles and instabilities, and the huge imbalances in surpluses and deficits which piled up inexorably. The low inflation and the seemingly endless expansion of credit brought a mood of euphoria to the markets, which after a time seemed to infect the regulators as well.

As the boom developed there were numerous fears expressed that it was unsustainable, and that the build-up of consumer debt and current account deficits, particularly in the United States and the United Kingdom, and the vast surpluses elsewhere which were being used to finance them, would at some stage require a correction. By 2008 there were $3 trillion held in the Sovereign Wealth Funds of China, Saudi Arabia and Russia, a sum higher than the GDP of the United Kingdom, the world's fifth largest economy. Consumer debt in the UK reached £1.44 billion in June 2008, higher than total UK output. Household, banking and corporate debt combined reached 350 per cent of US GDP and 300 per cent of UK GDP. With remarkable prescience, the Pope had declared in 1985 that the foundations of the world economy were unstable and would lead at some point to a collapse. Unfortunately, the warning was rather too general to be of immediate use in the financial markets, and the heavens did not fall. Some academics and some financial journalists warned that the boom could not continue indefinitely, but their advice was not heeded. This was partly because those with very real knowledge and concern about the risks that were being run could always be accused of crying 'wolf' when the crisis did not then materialize, or did not spread. The more knowledgeable critics suffered too from being lumped together with some of those offering 'independent' financial advice. There were a series of financial newsletters in the years running up to the crash with doom-laden predictions of 'Apocalypse Now'. Sooner or later one of them had to be right. Whenever one of the bubbles burst, or was deliberately collapsed, there was an outpouring of dire warnings that this time the end really was nigh. But the markets steadied themselves and growth resumed. Everyone involved in the markets and in regulating the markets had a sense that it was too good to last. But, while it lasted, no-one was inclined to act the sheriff. No-one wanted to turn off the fuel that was powering the boom. No-one wanted to think about the crash.

The Credit Crunch

The boom was powered from many different sources, and there was not one bubble but several. Once the financial growth model got into its stride, it spewed out bubbles. There were bubbles in different kinds of financial assets and in commodities. But the most important bubbles were in dot.com shares, which burst in 2000, and subsequently in housing (see Figure 1.2).

It was the bursting of the housing bubble that brought the whole global financial structure crashing down in 2008 and plunged the world into recession in 2009. The problem began in the US housing market. The federal authorities raised interest rates from 1 per cent in 2004 to 5.35 per cent in 2006, and they went on climbing, peaking at 6 per cent in 2007. This was a steep rise but not unusual. It represented the kind of active monetary policy which all central banks had become used to conducting, aiming to stabilize their economies and keep them growing. The Federal Reserve judged that credit conditions were too lax now that the economy had recovered from the mini recession it had suffered in 2001–2, after the bursting of the dot.com bubble, and that credit should become tighter to reduce the risk of inflation. This meant restricting the flow of credit in key areas like housing. This was a normal operation, which had been performed many times before. It had the desired result. The squeeze on credit made house prices start to fall, as the supply of new mortgages dried up and some of those with mortgages were forced to default. This too had happened many times before and in itself was no cause for alarm. It was part of the normal housing cycle. A period of greater tightness in the market, and a downward adjustment of prices would be followed by the return of buyers to the market, as credit became more freely available again, and prices would resume their upward march.