What attracted so much capital to New York, prior to 2008? The Global Minotaur’s charms

My last post introduced readers to the Global Minotaur, the dynamic by which America’s twin deficits became a mighty ‘beast’ that performed to crucial functions after 1971: First, they provided Japan and Europe with the requisite demand for their industrial surpluses. Secondly, to finance these deficits (US government and trade deficits), the United States managed to create the circumstances under which the rest of the world willingly sent its capital surpluses over to New York as if in order to finance America’s twin surpluses. These tribures to the Global Minotaur acted as a global Surplus Recycling Mechanism (see here for a theoretical explanation of that mechanism) up to the Crash of 2008. In today’s post, I ask a simple question: What exactly was it that attracted the world’s capital to the US? Granted that this tsunami of capital was essential for the survival of the Global Minotaur, how come capital flew to New York voluntarily during a period of expanding US deficits? The reason is what I call The Minotaur’s Four Charismas:

The Minotaur’s four charismas

Reserve Currency status

While the Global Plan lasted, it did not matter much which currency one held, since the exchange rates vis-à-vis the dollar were almost fixed and the exchange rate between the dollar and gold was welded at $35 to an ounce of the gleaming metal. Nevertheless, oil magnates, German industrialists, French winemakers and Japanese bankers preferred to store their cash in dollars simply because of capital controls; that is, restrictions on how much cash one could convert to dollars or other currencies at any one time.

Once Bretton Woods was no longer, the psychological shock caused by the idea that currencies would soon be allowed to float freely created a stampede toward the dollar. To this day, whenever a crisis looms, capital flees to the greenback. This is exactly why the Crash of 2008 led to a mass inflow of foreign capital to the dollar, even though the crisis had begun in Wall Street.

Furthermore, the United States is the only country whose currency’s demand does not just reflect an increase in the demand of goods and services it produces. Whenever a Nigerian driver puts petrol in her car, or a Chinese factory purchases Australian coal, the demand for US dollars rises. Why? Because, even if no American companies are involved, primary commodity sales are denominated in dollars. Therefore, every transaction involving oil or coal results in additional demand for the US dollar.

In a December 2008 radio interview, Paul Volcker put it bluntly: The “external financing constraints were something that ordinary countries had to worry about, not the unquestioned leader of the free world, whose currency everybody wanted.” The dollar’s exorbitant privilege empowers US authorities to run deficits that would have other countries buckle under in no time. This is why a crisis that starts in the United States may well act as a magnet for migrating foreign capital.

Rising energy costs

As this point was made earlier, in explaining America’s acquiescence to the OPEC-led oil price increases, a brief summary will suffice here: In the early 1970s the US economy imported 32.5% of its oil, Europe imported almost all of it and Japan imported every single drop. Increasing energy prices damaged Germany’s and Japan’s relative competitiveness vis-à-vis the United States. Moreover, the oil trade was intimately linked to US multinationals and, thus, the higher oil prices meant a larger revenue base for them, higher profits, and a strengthening of their capacity to diversify internationally. As for non-US producers, the dollar’s reserve currency status, coupled with Volcker’s huge interest rates, magnetised their petrol dollars to New York where they metamorphosised into shares or US government bonds.

Interestingly, it was not long before Japanese and German industries reacted to the shock along innovative paths that transformed their industrial production in ways that clawed back some of the relative gains that the United States had snatched from them by making energy so expensive. For instance, both Japan and Germany shifted their investment plans away from energy intensive activities toward more high tech endeavours (e.g. electronics). And even in the sectors that would always be reliant on oil and its byproducts, e.g. the car industry, they produced a new generation of small, efficient cars which competed ruthlessly with American produced cars.

Nevertheless, despite the conflicting effects, the Global Minotaur‘s brilliance deserves to be marvelled at: Guess what the German and Japanese did with the profits from their new energy-conscious, innovative products: They invested them in, or through, Wall Street!

Cheapened, productive labour

The American Dream may have always been based on a shared fiction. But the reality of more than a century of rising living standards was never in dispute. Things changed in the 1970s. The fear inspired by the collapse of Bretton Woods, the hike in oil prices, and the impending loss of the Vietnam War polarised society and created a playing field on which the strong do as they please and the weak bear their burdens stoically.

With energy prices rising, long queues forming at petrol stations, and factories suspending production due to lack of raw materials or electricity, a new setting emerged in which all prior deals were off. Trades unions, incensed with across-the-board price rises, started demanding higher money wages for their members. Employers were beginning to imagine a labour market without trades unions. The scene was, in other words, ripe for a confrontation. In this new conflictual environment, corporate America discerned a wonderful opportunity to put a lid of real wages and to strive for simultaneous increases in productivity. Table 1 (see Three tables)  reports on their amazing success.

It is clear from Table 1 (see Three tables) that, from 1973 onwards, something spectacular happened in the United States: In a country priding itself over the fact that, at least since the 1850s, real wages were rising steadily, thus giving every generation of workers the hope that their children would be better off than they were, real wages stagnated. To this day, they have not even recovered their 1973 real purchasing power.

Meanwhile, labour productivity accelerated. The employment of new technologies, the intensification of labour processes (often helped by the rising fear of unemployment), and the increasing direct investment from abroad (e.g. German and Japanese firms that sought to boost their profitability by shifting operations to the US) gave rise to the impressive labour productivity curve. Unsurprisingly, US labour costs per unit of output hardly grew between 1985 and 1990, a period during which when America’s main competitors saw them increase by double digit percentages. Beyond 1990, American’s labour costs simply maintained their advantage.

	1985-1990	1990-1998
USA	1.6	0.2
Japan	10.8	1.3
West Germany	15.9	0.3
Britain	11.4	1.8

Average annual rate of change in labour unit costs (in $)

What happens when real wages fall, labour costs per unit of output remain stagnant, and productivity is booming? Profits reach for the sky! This is precisely what happened after 1973. US corporate domestic profits rose, and rose, and rose. Increasing US profitability is the third reason why foreign (non-US) capital willingly fell on the Global Minotaur‘s lap, migrating at great speed and in unprecedented volume from Frankfurt, Riyadh, Tokyo, Paris and Milan to New York. See Table 3 in Three tables)

Geopolitical might

Power concentrates the mind of the weak. And nuclear power concentrates it better. The very fact that the United States led the West not only in economic but also in geostrategic terms cannot be neglected when studying the mechanism by which capital readily migrated to nourish the Global Minotaur. Of course if foreign capital had no expectation of accumulating faster once it made the journey via New York to the US Treasury or to some American company or financial institution, nothing could have enticed it do so. Nonetheless, geopolitical and military power played a role in shoring up the expectation of such a gain.

Examples of the way in which US policy sought to enlist America’s geopolitical might to the Global Minotaur‘s needs are not difficult to come by. In 1974 Henry Kissinger circulated National Security Study Memorandum 200 (NSSM-200). Under the cloak of the West’s opposition to Soviet encroachments, the Memorandum staked a naked claim, on behalf of the United States and US multinationals, over the mineral wealth of the Third World. Many years later, during a Congressional hearing on Afghanistan in 1998, John Maresca, Vice President of oil giant UNOCAL, outlined a rationale for a future US invasion of Afghanistan. His argument turned on Chinese economic development which has to be, in his view, both abetted and controlled. Maresca implied that, unlike Japan and Europe, China will not willingly liberalise its capital and money markets and, therefore, the flow of capital from China to the USA will be impeded. In simpler words, profits by Chinese, Japanese, European and, of course, US companies operating in China will not be readily transferable to the Global Minotaur, Maresca lamented. So, what should be done? The best way to overcome China’s recalcitrance, Maresca explained, would be to monopolise the supply of energy in its vicinity.

Tantalisingly, while American geopolitical power was crucial to the Minotaur‘s maintenance, the Minotaur often returned the favour. Indeed, a persuasive case can be made that it played a major part in the defeat of America’s greatest foes: The Soviet Union, its satellites, as well as the non-aligned Third World regimes that had become too uppity in the 1960s. Key to this triumph was not so much the successful prosecution of the arms race but, rather, the humble US interest rates; the very same rates whose phenomenal rise under Paul Volcker had assisted the Global Minotaur‘s birth.

Arguably, the chain of events that led to the implosion of communism in Poland and Yugoslavia began in the 70s with the sharp rise in interest rates soon after these countries had accepted offers of substantial loans from Western financial institutions. Similarly with Third World countries in which national liberation movements had grabbed power, often against the West’s better efforts.

From the early 1960s till 1972, western banks, constrained by the Global Plan‘s low interest rates and tough regulatory regime, travelled far and wide, bearing offers of large loans to Third World nations but also to Soviet satellites (e.g. Poland and Bulgaria) as well as to communist countries that were detached or semi-detached from Moscow (Yugoslavia and Romania). The loans were used to underwrite much needed new infrastructure, education, health systems, fledgling industrial sectors etc. In this way, by the mid-1970s, most Third World economies, and a number of Eastern European ones, were extremely vulnerable to interest rate rises.

So, when interest soared, as part of Volcker’s strategic “disintegration in the world economy”, communist regimes in Warsaw, Bucharest and Belgrade began to feel the pressure. Once they realised their grave dependency on the ‘capitalist enemy’, they gave their all to repay the debts as quickly as possible. They imposed particularly harsh austerity measures on their own workforce,[1] the result being mass discontent, major unrest and the first stirrings of organised opposition, e.g. the Polish trades union Solidarnosc which was soon to spearhead a chain of events leading to the first collapse of a communist regime.

In the meantime, and for similar reasons, the Third World Debt Crisis erupted. The IMF happily offered to lend money to governments for the purposes of repaying the Western banks, but at an exorbitant price: The dismantling of much of their public sector (including schools and clinics), the shrinking of the newly founded state institutions, and the wholesale transfer of valuable public assets (e.g. water boards, telecommunications etc.) to Western companies. It is not at all an exaggeration to suggest that the Third World Debt Crisis was the colonised world’s second historic disaster (after colonisation and the slave trade); in fact, it was a disaster from which most Third World countries never quite recovered.

In short, the interest rate rise that was part and parcel of the Global Minotaur‘s own rise to prominence proved more effective in destroying the enemies of US foreign policy around the globe than any military operation the US could ever mount.