Before the Crash of 2008, the dominant view amongst the world’s policy-making elites was that global imbalances were not a problem. The great and the good in Washington and in London, in Paris and in Frankfurt, at Davos and on the golf courses where deals of note are struck, dismissed as economically-illiterate moaning-minnies all those who dared warn against large current account imbalances. Caught up in the soothing fiction of the ‘Great Moderation’, and the toxic fantasy that finance had invented ‘riskless risk’, the powers-that-be were adamant that we were living in a ‘new paradigm’.
In this ‘new paradigm’ of their over-excited imagination, risk was being dispersed (through financialisation) from the global financial centres to the rest of the world, net capital was flowing the other way (from the Periphery to the capitalism’s Metropoles), and the result was sustainably unbalanced current and capital accounts. In short, from the gilded perspective of the true believers in some fictional ‘Great Moderation’, untrammelled markets had produced, at a planetary scale, a virtuous, sustainable, and highly lucrative ‘equilibrium imbalance’. After the Crash of 2008, their tune changed. And it changed even more radically when, two years later, the Eurozone’s never-ending crisis followed suit. Suddenly, it became fashionable to blame, retrospectively, the hitherto benign global imbalances for the crisis. America’s pre-crisis gargantuan current account deficit, amounting to 6% of the planet’s largest national income, as well as China’s 10% of GDP current account surplus, were no longer thought of as innocuous. Similarly, within the Eurozone, Germany’s and Holland’s pre-2008 combined €35 billion-plus current account surplus, juxtaposed against Portugal’s, Greece’s and Spain’s combined current account deficit of €31 billion, metamorphosed from ‘natural’ repercussions of creating a common currency area to sources of local and global instability. In short, the crisis of 2008 turned imbalances from symptoms of the neoliberal ‘Great Moderation’ to the villains of the piece.
Six years have passed since those heady days and it is now clear that the global imbalances are waning. America’s current account deficit has fallen from 6% to less than 3% of GDP while China’s current account surplus has diminished from a breathtaking 10% to a reasonable 2.5%. Even within the long suffering Eurozone, quasi-insolvent nations like Spain and Italy are eliminating their current account deficits, despite the rise and rise of Germany’s surplus. Perused from a planetary perspective, German surpluses and Turkey’s or India’s deficits seem like minor problems that should perhaps be of concern to Europeans or Asians though not to the world at large. From this perspective, the world seems better balanced now than at any time since the 1980s. But is it so?
In what follows, I wish to pose three intertwined questions:
- Is the world re-balancing?
- Was the Crash of 2008 crisis caused by global imbalances?
- Or was it the laxity in financial regulation that caused the global imbalances in the first place?
While there are important kernels of truth in the phrasing of each of these questions, the answer to every one of them is a resounding ‘no’.
Are we witnessing a new global balance?
Judged only in terms of current account imbalances, there is no doubt that the yawning discrepancies have fallen considerably. Against the false belief that the Chinese currency remained pegged to the dollar, the remnibi rose by 40% in relation to the greenback at a time when American consumers cut down on their consumption, boosted their savings ratios (despite the low interest rates) and, generally, de-leveraged. Meanwhile, the Chinese government’s cranking up of investment funding on infrastructure increased further the demand of capital goods (from places like Germany, the US, the Netherlands). The imbalance in China’s trade with the West was, thus, ‘corrected’ substantially both through exchange rate flexibility and by behavioural changes domestically and overseas (involving US consumers but also the Chinese government).
Besides China and the USA, other trading blocs are seeing a drop in the absolute value of their ratio of current account to GDP too. Even the Eurozone, which is being brutally forced by austerity to respond to its deep crisis in a mercantilist manner, features only a modest current account surplus of 1.5% of GDP. The question however remains: Is this evidence of a world economy that is re-balancing?
Before 2008, conventional (Washington-consensus) wisdom was imploring us to recognise that the world was in equilibrium; an equilibrium created by two counter-balancing forces: one force was the tsunami of goods that sailed across the oceans to flood (mainly) the Anglosphere (i.e. the US, UK, and Australian markets) with a multitude of consumer delights, the other force being the torrent of capital that gushed in the opposite direction. If we considered the current account imbalances together with the capital account imbalances, these two types of imbalances were, we were being told, cancelling each other out, yielding a harmonious, dynamically stable global equilibrium.
Of course, it was all utter non-sense. The ‘equilibrium imbalance’ thesis was neglecting the simple truth that the equilibrium in question was intrinsically unstable. For reasons that Hyman Minsky, John Maynard Keynes, Karl Marx and Friedrich von Hayek would have explained perfectly adequately, Wall Street, the City of London and Frankfurt were always going to build pyramids of toxic money on top of that splendid ‘equilibrium imbalance’. Which is precisely what they kept doing until our ‘equilibrium imbalance’ was destabilised, crashing into a pulp in the Fall of 2008.
Today, a new error is taking its cue from that older one. As it was spectacularly wrong to imagine that the pre-2008 situation was a form of ‘equilibrium imbalance’, so too now, it is dramatically mistaken to think that the ‘re-balancing’ we are witnessing, vis-à-vis current accounts, is a case of ‘equilibrium balance’. It is no such thing.
Exhibit A is the mountain of cash on which corporations in the US and in Europe are sitting, too terrorised by the prospect of low aggregate demand to invest . We now have it on good authority that some $2 trillion of surpluses are slushing around within corporate America. Similarly, in the UK another $700 billion is circling around within the circuits of finance, refusing to channel itself into any productive investment. And a further $2 trillion is ‘lost’ in the no man’s land of idle savings that circulate in the rest of the world. In short, nearly $5 trillion of excess savings is not, I submit, a sign of a world in the process of ‘re-balancing’.
Come to think of it, every crisis manifests itself in two distinct mountains: one of debt and losses, the other of idle, fearful savings. Unless these mountains start ‘eliminating’ one another; unless the excess savings stop being idle and begin to turn into the investments that stand a chance of producing the incomes which can uniquely extinguish the mountain of debts and the losses, it is offensive even to speak of a new ‘balance’; of a world that is ‘re-balancing’. We now live deep inside Keynes’ Paradox of Thrift, a realm in which Presbyterian prudence by everyone produces less income all around and poisons the world’s debt dynamics, labour markets, democracies. We inhabit a world which saves more that 25% of planetary income but which, at the same time, wastes a large part of it by letting it fester in a glut of self-fulfilling negative expectations regarding future demand.
To conclude, while current accounts are more or less re-balancing, this ‘new balance’ is pregnant with the most catastrophic of instabilities: the one that comes from long-term global stagnation and from a level of aggregate demand too low to create a modicum of equilibrium between global savings and global investment into the things that we need (e.g. technological advances in energy technology), the education that we deserve, the health that decency dictates.
Was the Crash of 2008 caused by global imbalances? Or was it the laxity in financial regulation that caused the global imbalances?
In a recent piece entitled ‘Requiem for Global Imbalances’, Barry Eichengreen argued that global imbalances were not the cause of the 2008 meltdown. In this I am in full agreement. But I beg to differ from his answer as to what actually caused it: “The principal culprits in the crisis”, Eichngreen writes “… were lax supervision and regulation of US financial institutions and markets, which allowed unsound practices and financial excesses to build up. China did not cause the financial crisis; America did (with help from other advanced economies).”
Why do I disagree? Had lax supervision and the phony revolving-door type of regulation of Wall Street not turned finance into “a bubble on a whirlpool of speculation” – to quote John Maynard Keynes’ General Theory? Most certainly. And did this whirlpool not culminate in 2008 into a cataclysm that brought down the West’s financial centres? Of course it did. Was this natural repercussion of lax regulation not the reason politicians and central bankers felt obliged to bail out the bankers, along with their banks, at the expense of the multitude that were left saddled with negative equity, with the impact of hideous austerity drives, and with the long term repercussions of what Larry Summers recently referred to as ‘secular stagnation’? Absolutely! So, why am I disagreeing with Eichengreen that “the principal culprits in the crisis were… lax supervision and regulation of US financial institutions and markets”?
The reason is that, in my estimation, any account of the crisis that fails to pose the following questions is dangerously incomplete: What explains the laxity in supervision or the gutless regulation of Wall Street? Why were banks kept on a tighter leash in the 1960s? Was there a steady loss of character by the regulators so that, by the 1980s, quasi-corrupt officials were turning a blind eye to the horrors committed in the name of financialisation by the latter’s priesthood? Is greed a fairly new human condition; one that was relatively absent from Wall Street prior to 1980? Even if all this were so, how do we explain the steady loss of character? Why did greed dominate when it did? What are the deeper causes of the, obvious, triumph of corrupt practices and of the evident moral decline amongst the regulators?
On the true causes of lax regulation and global imbalances
In 1971 US policy makers reached an audacious strategic decision: Faced with the rising twin deficits that were building up in the late 1960s (the budget deficit of the US government and the trade deficit of the American economy), Washington decided to turn a blind eye to them. To allow the deficits to rise and rise, rather than to impose the type of stringent austerity (as the Germans would have done) whose effect would be to shrink both the US deficits (budget and current account deficits) and America’s capacity to project hegemonic power around the world.
The question, of course, was: Who would pay for the red ink on America’s current account and federal budget? In my book The Global Minotaur (2011/13) I propose a simple answer: The rest of the world! How? By means of a permanent influx of capital ceaselessly funding America’s even increasing twin deficits. Why would investors from around the world send their money to Wall Street to finance American deficits? The answer is: Because Washington would pursue policies that predictably deliver to non-US investors, who chose to put their money in Wall Street, higher and safer returns than elsewhere.
If my hypothesis is correct, the twin deficits of the US economy, in conjunction with Wall Street, operated for decades like a giant vacuum cleaner, absorbing other people’s surplus goods and capital. While that ‘arrangement’ was the embodiment of the grossest imbalance imaginable at a global scale, and required what Paul Volcker described vividly in 1978 as the prior “controlled disintegration of the world economy”, nonetheless it did give rise to something resembling global balance; an international system of rapidly accelerating asymmetrical financial and trade flows capable of putting on a semblance of stability and steady growth. In other words, it begat what we now call ‘global imbalances’.
Interestingly, these imbalances were no accident, assuming that my hypothesis holds water. Fuelled by America’s twin deficits, they served the dual purpose of: (a) maintaining (indeed increasing) US hegemony, while (b) allowing global capitalism to achieve something resembling equilibrium. On the one hand the world’s leading surplus economies (e.g. Germany, Japan and, later, China) kept churning out goods that American consumers gobbled up. In this sense, the expansion of US deficits generated the increases in aggregate demand that kept the factories of the surplus countries in Asia and Europe going. On the other hand, almost 70% of the profits made globally by capitalists domiciled in Eurasian countries were then transferred back to the United States, in the form of capital flows to Wall Street. But for Wall Street to act as this ‘magnet’ of other people’s capital returns, it had to be unshackled from the US government’s 1960s-style stringent regulations. Once finance was unshackled, greed had a field day.
And here is the rub: Wall Street’s greed, as well as the laxity of regulation on behalf of the US government, are usually taken as ‘givens’; as socio-political processes somewhat exogenous to the dynamics of US capitalism and are explained, if at all, by a pop-sociology or ‘cultural studies’ of sorts . In sharp contrast, my argument is that the laxity of regulation, the so-called ‘revolving doors’ (that saw regulators turn bankers and vice versa), as well as the increasing greed of Wall Street personnel, were all by-products of a remarkable phenomenon: of the emergence of the first global hegemon whose strength grew in proportion to its… deficits; deficits that had to be financed by a constant influx of foreign capital in Wall Street; which in turn necessitated authorities that turned a blind eye upon Wall Street’s shenanigans.
What was it that tripped up the Bretton Woods system, causing it to lose its footing and to collapse on 15th August 1971? The answer is: the US government’s inability to exercise self-restraint vis-à-vis its own capacity to exploit its exorbitant privilege; its ability, as custodian of the world’s reserve currency, to print global public money at will so as to finance (without substantial new taxes) a stupendous military-industrial complex, the Vietnam war, Lyndon Johnson’s, otherwise splendid, Great Society policies etc..
And what was it that brought us the Crash of 2008? Again, it was an American failure at self-restraint. Only this time, it was not the US government’s failure (even if a case can be made that it happened on the US government’s watch) but of the private sector in general and of the banks in particular: The American financial sector failed spectacularly to exercise self-restraint vis-à-vis its capacity to exploit its newfangled exorbitant privilege: its ability, as custodian of global financialisation, to print global private money at will; a capacity that was functional to the maintenance of American hegemony and, therefore, one that was at odds with any serious type of regulatory constraint upon the bankers.
Global imbalances were not the cause of the Crash of 2008. However, their diminution is, equally, no sign that the world is re-balancing. A quick look at excess savings and excess labour, in the United States, in Europe and in Asia, reveals the inconvenient truth that the world is out of kilter. As it was analytically feeble to argue, prior to 2008, that global capitalism was in a state of ‘equilibrium imbalance’, it is today inane (even insulting) to claim that we are shifting toward a state of ‘equilibrium balance’ – see also M. Pettis’ excellent book The Great Re-balancing (2013). Before 2008, the observed unbalanced equilibrium was pregnant with the instability brewing, by necessity, inside the circuits of finance. Today, once more, the observed tendency towards balance (at least in current accounts) is a symptom of vicious underground forces that are begetting disequilibrium, despondency and discontent in the core of our societies.
B. Eichengreen (2014). ‘Requiem for Global Imbalances’, Project Syndicate at project-syndicate.org, 13th January 2014; last accessed 27th January 2014, at URL: http://www.project-syndicate.org/commentary/barry-eichengreen-notes-that-a-decade-after-external-imbalances-emerged-as-a-supposed-threat-to-the-global-economy–the-problem-has-disappeared
M. Pettis (2013). The Great Re-Balancing: Trade, conflict and the perilous road ahead for the world economy, New Jersey: Princeton University Press
Y. Varoufakis (2011/2013). The Global Minotaur: America, Europe and the Future of the World Economy, London and New York: Zed Books (second edition, 2013)