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Neoliberalism Is Broken
When Lehman Brothers collapsed, on 15 September 2008, my cameraman made me walk several times through the clutter of limos, satellite trucks, bodyguards and sacked bankers outside its New York HQ, so he could film me amid the chaos.
As I watch those rushes nearly seven years later – with the world still reeling from the consequences of that day – the question arises: what does that guy in front of the camera know now that he did not know then?
I knew that a recession had begun: I’d just trekked across America filming the closure of 600 Starbucks branches. I knew there was stress in the global finance system: I’d reported concerns that a major bank was about to go bust six weeks before it happened.1 I knew the US housing market was destroyed: I’d seen homes in Detroit on sale for $8,000 cash. I knew, in addition to all this, that I did not like capitalism.
But I had no idea that capitalism in its present form was about to self-destruct.
The 2008 crash wiped 13 per cent off global production and 20 per cent off global trade. It took global growth negative – on a scale where anything below +3 per cent is counted as a recession. In the West, it produced a depression phase longer than in 1929–33 and even now, amid a pallid recovery, has got mainstream economists terrified about the prospect of long-term stagnation.
But the post-Lehman depression is not the real problem. The real problem is what comes next. And to understand that we have to look beyond the immediate causes of the 2008 crash to their structural roots.
When the global finance system collapsed in 2008, it didn’t take long to discover the proximate cause: the debts hidden in mispriced products known as ‘structured investment vehicles’; the network of offshore and unregulated companies known – once it had started to implode – as the ‘shadow banking system’.2 Then, as the prosecutions began, we were able to see the scale of the criminality that had become normal in the run-up to the crisis.3
Ultimately, though, we were all flying blind. And that’s because there is no model of a neoliberal economic crisis. Even if you don’t buy the whole ideology – the end of history, the world is flat, friction-free capitalism – the basic idea behind the system is that markets correct themselves. The possibility that neoliberalism could collapse under its own contradictions was then, and remains now, unacceptable to most.
Seven years on, the system has been stabilized. By running government debts close to 100 per cent of GDP, and by printing money worth around a sixth of the world’s output, America, Britain, Europe and Japan injected a shot of adrenaline to counteract the seizure. They saved the banks by burying their bad debt; some of it was written off, some assumed as sovereign debt, some buried inside entities made safe simply by central banks staking their credibility on them.
Then, through austerity programmes, they transferred the pain away from people who’d invested money stupidly, punishing instead welfare recipients, public sector workers, pensioners and, above all, future generations. In the worst-hit countries, the pension system has been destroyed, the retirement age is being hiked so that those currently leaving university will retire at seventy, and education is being privatized so that graduates will face a lifetime of high debt. Services are being dismantled and infrastructure projects put on hold.
Yet even now many people fail to grasp the true meaning of the word ‘austerity’. Austerity is not seven years of spending cuts, as in the UK, or even the social catastrophe inflicted on Greece. Tidjane Thiam, the CEO of Prudential, spelled out the true meaning of austerity at the Davos forum in 2012. Unions are the ‘enemy of young people’, he said, and the minimum wage is ‘a machine to destroy jobs’. Workers’ rights and decent wages stand in the way of capitalism’s revival and, says the millionaire finance guy without embarrassment, must go.4
This is the real austerity project: to drive down wages and living standards in the West for decades, until they meet those of the middle class in China and India on the way up.
Meanwhile, lacking any alternative model, the conditions for another crisis are being assembled. Real wages have fallen or remained stagnant in Japan, the southern Eurozone, the USA and the UK.5 The shadow banking system has been reassembled, and is now bigger than it was in 2008.6 The combined global debt of banks, households, companies and states has risen by $57 trillion since the crisis, and stands at nearly three times global GDP.7 New rules demanding banks hold more reserves have been watered down and delayed. And the 1 per cent has got richer.
If there is another financial frenzy followed by another collapse, there can be no second bailout. With government debts at a post-war high and welfare systems in some countries crippled, there are no more bullets left in the clip – at least not of the kind fired in 2009–10. The bailout of Cyprus in 2013 was the test bed for what happens if a major bank or a state goes bust again. For savers, everything in the bank over €100,000 was wiped out.
Here’s a summary of what I’ve learned since the day Lehman died: the next generation will be poorer than this one; the old economic model is broken and cannot revive growth without reviving financial fragility. The markets that day were sending us a message about the future of capitalism – but it’s a message that, at the time, I only partially understood.
‘ANOTHER DRUG WE’RE ON…’
In future, we should look for the emoticons, the smileys and digital winks in emails that the finance guys use when they know they’re doing wrong.
‘It’s another drug we’re on,’ admits the Lehman executive running the infamous Repo 105 tactic in an email. The tactic involved hiding debts away from Lehman’s balance sheet by temporarily ‘selling’ them and then buying them back once the bank’s quarterly report had been submitted. Another Lehman exec is asked: is the tactic legal, do other banks do it, and is it disguising holes in our balance sheet? He emails back: ‘Yes, no and yes:).’8
At the ratings agency Standard & Poor’s, where they’ve knowingly mispriced risk, one guy messages another: ‘Let’s hope we are all wealthy and retired by the time this house of cards falters,’ adding the emoticon ‘:O)’.9
Meanwhile, at Goldman Sachs in London, trader Fabrice Tourre jokes:
More and more leverage in the system, the entire system is about to crumble any moment … the only potential survivor the fabulous Fab … standing in the middle of all these complex, highly levered, exotic trades he created without necessarily understanding all the implications of those monstrosities!!!
As more evidence of criminality and corruption emerges, there is always this knowing informality among bankers as they break the rules. ‘Done, for you big boy,’ writes one Barclays employee to another as they manipulate LIBOR, the rate at which banks lend to each other, the most important interest rate on the planet.10
We should listen carefully to the tone in these emails – the irony, the dishonesty, the repeated use of smileys, slang and manic punctuation. It is evidence of systemic self-deception. At the heart of the finance system, which is itself the heart of the neoliberal world, they knew it didn’t work.
John Maynard Keynes once called money ‘a link between the present and the future’.11 He meant that what we do with money today is a signal of how we think things are going to change in years to come. What we did with money in the run-up to 2008 was to massively expand its volume: the global money supply rose from $25 trillion to $70 trillion in the seven years before the crash – incomparably faster than growth in the real economy. When money expands at this rate, it is a sign that we think the future is going to be spectacularly richer than the present. The crisis was simply a feedback signal from the future: we were wrong.
All the global elite could do once the crisis exploded was put more chips on the roulette table. Finding them, to the tune of $12 trillion in quantitative easing, was no problem since they themselves were the cashiers at the casino. But they had to spread their bets more evenly for a while, and become less reckless.12
That, effectively, is what the policy of the world has been since 2008. You print so much money that the cost of borrowing it for banks becomes zero, or even negative. When real interest rates turn negative, savers – who can only keep their money safe by buying government bonds – are effectively forced to forgo any income from their savings. That, in turn, stimulates the revival of property, commodity, gold and stock markets by forcing savers to move their money into these more risky areas. The outcome to date has been a shallow recovery – but the strategic problems remain.
Growth in the developed world is slow. America has recovered only by carrying a $17 trillion Federal debt. Trillions of printed dollars, yen, pounds and now Euros are still in circulation. The debts of Western households remain unpaid. Entire ghost towns of speculative property – from Spain to China – continue unsold. The Eurozone – probably the most important and fragile economic construct in the world – remains stagnant, generating a level of political friction between classes and countries that could blow it apart.
Unless the future delivers spectacular riches, none of this is sustainable. But the kind of economy that’s emerging from the crisis cannot produce such wealth. So we’re at a strategic moment, both for the neoliberal model and, as I will show in chapter 2, for capitalism itself.
If we rewind the tape to New York in September 2008, you can see what was rational about the optimism that drove the boom. In my footage from that day there’s a crowd of people outside the Lehman HQ taking photographs on their Nokias, Motorolas and Sony Ericssons. The handsets are long obsolete, the market dominance of those brand names already gone.
The rapid advance in digital technology that drove the pre-2007 boom has barely paused for breath during the slump. In the years since Lehman collapsed, the iPhone conquered the world and was itself surpassed by the Android smartphone. Tablets and e-books took off. Social networking – barely talked about back then – has become a central part of people’s lives. Facebook had 100 million users when Lehman went bust; it has 1.3 billion users at time of writing and is bigger than the entire global internet was in 2008.13
And technological progress is not confined to the digital sphere. In those seven years, despite a global financial crisis and a massive earthquake, Toyota has manufactured 5 million hybrid cars – five times the number it had made before the crisis hit. In 2008, there were 15,000 megawatts of solar power capacity in the world; by 2014 there were ten times that.14
This, then, has been a depression like no other. We have seen crisis and stagnation combined with the rapid rollout of new technologies in a way that just didn’t happen in the 1930s. And in policy terms it has been the 1930s in reverse. Instead of exacerbating the crisis, as they did in the 1930s, the global elite reached for policy tools to cushion the real economy – often in defiance of what their own economic theories told them to do. And in key emerging market countries, rising demand for commodities together with the global monetary stimulus turned the first years after 2008 into a bonanza.
The combined impact of technological progress, policy stimulus and the resilience of the emerging markets has produced a depression much milder in human terms than that of the 1930s. But as a turning point, this is bigger than the 1930s. To understand why, we have to explore the chain of cause and effect.
For both left- and right-wing economists, the immediate cause of the collapse is seen as ‘cheap money’: the decision by Western states to deregulate banking and loosen credit after the dotcom crash in 2001. It created the opportunity for the structured finance bubble – and the motive for all the crimes: bankers were effectively told by politicians that it was their duty to get rich, through speculative finance, so that their wealth could trickle down to the rest of us.
Once you acknowledge the centrality of cheap money, that leads to a deeper problem: ‘global imbalances’ – the division of labour that allowed countries such as the USA to live on credit and run high deficits while China, Germany, Japan and the other exporting countries took the flip side of the deal. Certainly these imbalances lay behind the glut of credit in Western economies. But why did they exist? Why did Chinese households save 25 per cent of their wages and lend them via the global finance system to American workers who saved nothing?
In the 2000s, economists debated rival explanations: either over-saving by the parsimonious people of Asia was to blame, or over-borrowing by the profligate people of the West. Either way, the imbalances were a fact of life. Dig for any deeper cause and you get to the hard bedrock of globalization itself, and in mainstream economics globalization cannot be questioned; it’s just there.
The ‘bad banking plus imbalanced growth’ thesis became the explanation for the collapse. Put the banks right, manage the debts down, rebalance the world and things will be all right. That is the assumption that has guided policy since 2008.
Yet the persistence of low growth has now driven even mainstream economists beyond such complacency. Larry Summers, Treasury Secretary under Bill Clinton and an architect of bank deregulation, shook the economics world in 2013 by warning that the West faced ‘secular stagnation’ – that is, low growth for the foreseeable future. ‘Unfortunately,’ he admitted, low growth ‘has been present for a long time, but has been masked by unsustainable finances’.15 Veteran US economist Robert Gordon went further, predicting persistent low growth in the USA for the next twenty-five years, as a result of lower productivity, an ageing population, high debts and growing inequality.16 Remorselessly, capitalism’s failure to revive has moved concerns away from the scenario of a ten-year stagnation caused by overhanging debts, towards one where the system never regains its dynamism. Ever.
To understand what is rational about these premonitions of doom, we need critically to examine four things that at first allowed neoliberalism to flourish but which have begun to destroy it. They are:
1. ‘Fiat money’, which allowed every slowdown to be met with credit loosening, and the whole developed world to live on debt.
2. Financialization, which replaced the stagnant incomes of the developed world workforce with credit.
3. The global imbalances, and the risks remaining in the vast debts and currency reserves of major countries.
4. Information technology, which allowed everything else to happen, but whose future contribution to growth is in doubt.
The destiny of neoliberalism depends on whether these four things persist. The long-range destiny of capitalism depends on what happens if they don’t. Let’s look at them in detail.
In 1837, the newly declared Republic of Texas issued its first banknotes. There are still a few preserved, crisp and clean, in the state’s museums. Lacking a gold reserve, the new country promised to pay the bearer of these notes 10 per cent interest a year. By 1839, the value of a Texan dollar had fallen to 40 US cents. By 1842 the notes were so unpopular that the Texan government refused to let people pay their taxes with them. Shortly afterwards people began demanding the USA should annex Texas. By 1845, when this finally happened, the Texas dollar had recovered much of its value. The USA then wrote off $10 million of Texan public debt in 1850.
The episode is seen as a textbook case of what happens with ‘fiat money’ – that is, money not backed by gold. The Latin word ‘fiat’ means the same as it does in the biblical phrase fiat lux – let there be light; it means ‘let there be money’ created out of nowhere. In Texas, there was land, cattle and trade – but not enough of them to warrant printing $4 million and incurring a public debt of $10 million. The paper money collapsed and ultimately the Texan Republic disappeared.
In August 1971, the USA itself decided to repeat the experiment – this time using the whole world as its laboratory. Richard Nixon unilaterally scrapped an agreement that pegged all other currencies to the dollar and the dollar to gold. From then on, the global currency system was based on fiat money.
In the late 1960s the future Federal Reserve boss Alan Greenspan had denounced the proposed move away from gold as a plot by ‘welfare statists’ to finance government spending by confiscating people’s money.17 But then, like the rest of America’s elite, he realized that it would first allow the USA, effectively, to confiscate other countries’ money – setting the scene for Washington to indulge in three decades of currency manipulation. The result enabled America to accumulate, at the time of writing, a $6 trillion debt with the rest of the world.18
This move to a pure paper currency was the precondition for every other phase of the neoliberal project. So it took the American right a long time to figure out they didn’t like it. Today, however, right-wing economics has become one long howl of rage against fiat money. Its critics believe it is the ultimate source of boom and bust – and they are partly right.
The move away from gold and fixed exchange rates allowed three fundamental reflexes of the neoliberal era to kick in: the expanded creation of money by banks, the assumption that all crises can be resolved, and the idea that profits generated out of speculation can go on rising for ever. These reflexes have become so ingrained in the thinking of millions that, when they no longer worked, it induced paralysis.
It is news to some people that banks ‘create’ money, but they always have done: they have always lent out more cash than there was in the safe. In the pre-1971 system, though, there were legal limits to such money creation. In the USA, for savings that could be withdrawn at any time, banks had to hold $20 in cash against every $100 of deposits. Even if one in every five people rushed to the bank to take all their money out, there would still be enough.19
At every stage in its design, the neoliberal project removed those limits. The first Basel Accord, in 1988, set the reserves needed against $100 of loans to $8. By the time of Basel II in 2004, both deposits and loans had become too complex to balance with a single percentage figure. So they changed the rules: you had to ‘weight’ your capital according to its quality – and that quality was to be decided by a ratings agency. You had to reveal the financial engineering used to calculate your risks. And you had to take account of ‘market risk’: in other words, what is going on outside the walls of the bank.
Basel II was an open invitation to game the system – and that’s what the bankers and their lawyers did. The ratings agencies misvalued the assets; the law firms designed complex vehicles to get around the transparency rules. As for the market risk, even as America veered into recession in late 2007, the Federal Reserve’s Open Market Committee – the room in which they’re supposed to know everything – stank of complacency. Tim Geithner, then boss of the New York Fed, predicted: ‘Consumer spending slows a bit, and businesses react by scaling back growth in hiring and investment, and this produces several quarters of growth modestly below trend.’20
This total failure to measure market risk correctly was not blind optimism; it was supported by experience. When faced with a downturn, the Fed would always slash interest rates, enabling banks to lend even more money against fewer assets. This formed the second basic reflex of neoliberalism: the assumption that all crises were solvable.
From 1987 until 2000, under Greenspan’s leadership, the Fed met every downturn with a rate cut. The effect was not only to make investing a one-way bet – since the Fed would always counteract a stock market crash. It was to reduce, over time, the risk of holding equities.21 The price of shares, which in theory represents a guess as to the future profitability of a firm, came increasingly to represent a guess as to the future policy of the Federal Reserve. The ratio of share prices to earnings (annual profits) for the top 500 companies in the USA, which had meandered between 10x and 25x since the year 1870, now spiked to 35x and 45x earnings.22
If money is a ‘link to the future’, then by 2000 it was signalling a future rosier than at any time in history. The trigger for the dotcom crash of 2001 was Greenspan’s decision to raise interest rates in order to choke off what he called ‘irrational exuberance’. But following 9/11 and the Enron bankruptcy in 2001, and with the onset of a brief recession, rates were slashed again. And now it was overtly political: irrational exuberance was OK once your country was simultaneously at war with Iraq and Afghanistan, and once confidence in the corporate system had been rocked by scandal after scandal.
This time, the Fed’s move was backed with an explicit promise: the government would print money rather than allow prolonged recession and deflation. ‘The U. S. government has a technology, called a printing press,’ said Fed board member Ben Bernanke in 2002. ‘Under a paper-money system, a determined government can always generate higher spending and hence positive inflation.’23
When financial conditions are positive and predictable, the profits of banks themselves are always going to be high. Banking became an ever-changing tactical game focused on skimming money off your competitors, your customers and your business clients. This created the third basic reflex of neoliberalism: the widespread illusion that you can generate money out of money alone.
Though they had reduced the percentage of capital banks were required to keep on hand, the US authorities had maintained the strict partition between Main Street lending banks and investment banks imposed in the 1930s by the Glass-Steagall Act. But by the late 1990s, in a rush of mergers and acquisitions, the investment bank sector was going global, making a mockery of the rules. It was Treasury Secretary Larry Summers who, in 1999, through the repeal of Glass-Steagall, opened the banking system to the attentions of those adept at exotic, opaque and offshore forms of finance.
Fiat money, then, contributed to the crisis by creating wave after wave of false signals from the future: the Fed will always save us, shares are not risky and banks can make high profits out of low-risk business.
Nothing demonstrates the continuity between pre- and post-crisis policy better than quantitative easing (QE). In 2009, having wavered before the enormity of the task, Bernanke – together with his UK counterpart Mervyn King, governor of the Bank of England – started the presses rolling. In November 2008 China had already begun printing money in the more direct form of ‘soft’ bank loans from the state-owned banks to businesses (i.e. loans that nobody expected to be repaid). Now the Fed would print $4 trillion over the next four years – buying up the stressed debts of state-backed mortgage lenders, then government bonds, then mortgage debt, to the tune of $80 billion a month. The combined impact was to flush money into the economy, via rising share prices and revived house prices, which meant that it was first flushed into the pockets of those who were already rich.
Japan had pioneered the money-printing solution after its own housing bubble collapsed in 1990. As its economy floundered, premier Shinzo Abe was forced to restart the printing presses in 2012. Europe – forbidden to print money by rules designed to stop the Euro being debased – waited until 2015, as deflation and stagnation took hold, before pledging to print €1.6 trillion.
I calculate the combined amount of money printed globally, including that pledged by the ECB, at around $12 trillion – one sixth of global GDP.24
It worked, in that it prevented a depression. But it was the disease being used as a cure for the disease: cheap money being used to fix a crisis caused by cheap money.
What happens next depends on what you think money actually is. The opponents of fiat money predict disaster. In fact, books denouncing paper money have become as common as those denouncing banks. With a limited amount of real economic goods but an unlimited amount of money, goes the argument, all paper money systems eventually go the way of nineteenth-century Texas. The 2008 crisis was just the tremor in advance of the earthquake.
As to solutions, they come mainly in millenarian form. There will be, writes former JP Morgan manager Detlev Shlichter, a ‘transfer in wealth of historic proportions’ from those holding paper assets – whether in bank accounts or pension funds – to those holding real ones, above all gold. Out of the ruins, he predicts, will come a system where all loans have to be backed by cash in the bank, known as ‘100 per cent reserve banking’, together with a new Gold Standard. This will require a massive one-off hike in the price of gold, as the value of all the gold in the world has to rise to make it equal to the world’s wealth. (A similar rationale stands behind the Bitcoin movement, which is an attempt to create a digital currency, not backed by any state and with a limited number of digital coins.)
This proposed new world of ‘real’ money would come at a massive economic cost. If bank reserves have to match loans made, there can be no expansion of the economy through credit, and there can be little space for derivatives markets, where complexity – in normal times – aids resilience to problems such as drought, crop failure, the recall of faulty motor cars etc. In a world where banks hold reserves equivalent to 100 per cent of their deposits, there would have to be repeated stop-go business cycles and high unemployment. And simple maths shows us that we would go into a deflation spiral: ‘in an economy with an unchanged money supply but rising productivity … prices will on trend decline’, says Schlichter.25
That’s the preferred option of the right-wing money fundamentalists. Their big fear is that, in order to keep fiat money alive, the state will nationalize the banks, write off the debts, seize control of the finance system and kill for ever the spirit of free enterprise.
As we’ll see, it may come to that. But their reasoning contains a fundamental flaw: they don’t understand what money actually is.
In the popular version of economics, money is just a convenient means of exchange, invented because in early societies swapping a handful of potatoes for a raccoon skin was too random. In fact, as the anthropologist David Graeber has shown, there is no evidence that early human societies used barter, or that money emerged from it.26 They used something much more powerful. They used trust.
Money is created by states and always has been; it is not something that exists independently of governments. Money is always the ‘promise to pay’ by a government. Its value is not reliant on the intrinsic worth of a metal; it is a measure of people’s trust in the permanence of the state.
Fiat money in Texas would have worked if people thought the state would exist for ever. But nobody, not even the Alamo-era settlers, did. As soon as they realized Texas was going to join the USA, the value of the Texan buck revived.
Once you get your head around this, the true nature of neoliberalism’s problem becomes clear. The problem is not ‘Damn, we printed too much money against the real stuff in the economy!’ It is, though few will admit it, ‘Damn, nobody believes in our state any more.’ The entire system is dependent on the credibility of the state that issues the notes. And in the modern global economy that credibility rests not just on single states but on a multilayered system of debts, payment mechanisms, informal currency pegs, formal currency unions like the Euro, and huge reserves of foreign exchange accumulated by states as insurance in case the system collapses.
The real problem with fiat money comes if, or when, this multilateral system falls apart. But that lies in the future. For now, what we know is that fiat money – when combined with free-market economics – is a machine for producing boom-and-bust cycles. Left to run unsupervised, it could – before we’ve even considered the other destabilizing factors – push the world economy towards long-term stagnation.
Go to any of the British towns devastated by industrial decline and you’ll see the same streetscape: payday loan stores, pawnbrokers and shops selling household goods on credit at hyper-inflated interest rates. Next to the pawnbrokers you’ll probably find that other gold mine of the poverty-stricken town: the employment agency. Look in the window and you’ll see ads for jobs at the minimum wage – but which require more than minimum skill. Press operatives, carers on night shift, distribution centre workers: jobs that used to pay decent wages now pay as little as legally possible. Somewhere else, out of the limelight, you will come across people picking up the pieces: food banks run by churches and charities; Citizens’ Advice Bureaux whose main business has become advising those swamped by debt.
Just one generation earlier these streets were home to thriving real businesses. I remember the main street of my home town, Leigh, in northwest England, in the 1970s, thronged on Saturday mornings with prosperous working-class families. There was full employment, high wages and high productivity. There were numerous street-corner banks. It was a world of work, saving and great social solidarity.
Smashing that solidarity, forcing wages down, destroying the social fabric of these towns was done – originally – to clear the ground for the free-market system. For the first decade, the result was simply crime, unemployment, urban decay and a massive deterioration in public health.
But then came financialization.
The urban landscape of today – outlets providing expensive money, cheap labour and free food – is the visual symbol of what neoliberalism has achieved. Stagnant wages were replaced by borrowing: our lives were financialized.
‘Financialization’ is a long word; if I could use one with fewer syllables I would, because it is at the heart of the neoliberal project and it needs to be better understood. Economists use the term to describe four specific changes that began in the 1980s:
1. Companies turned away from banks and went to the open financial markets to fund expansion.
2. Banks turned to consumers as a new source of profit, and to a set of high-risk, complex activities that we call investment banking.
3. Consumers became direct participants in the financial markets: credit cards, overdrafts, mortgages, student loans and motor car loans became part of everyday life. A growing proportion of profit in the economy is now being made not by employing workers, or providing goods and services that they buy with their wages, but by lending to them.
4. All simple forms of finance now generate a market in complex finance higher up the chain: every house buyer or car driver is generating a knowable financial return somewhere in the system. Your mobile phone contract, gym membership, household energy – all your regular payments – are packaged into financial instruments, generating steady interest for an investor, long before you decide to buy them. And then somebody you have never met places a bet on whether you will make the payments.
The system may not be specifically designed to keep wages low and productive investment weak – neoliberal politicians constantly claim to be promoting high-value work and productivity – but judged by the results, financialization and low wages are like precarious work and food banks: they go together.
The real wages of production workers in the USA have, according to the government, stagnated since 1973. Over the same period, the amount of debt in the US economy has doubled, to 300 per cent of GDP. Meanwhile, the share of US GDP produced by finance, insurance and real-estate industries has risen from 15 to 24 per cent – making it bigger than manufacturing and close to the size of the service sector.27
Financialization also changed the relationship between companies and banks. From the 1980s onwards, the short-term quarterly profit figure became the stick finance used to beat to death the old corporate business models: companies making too little profit were forced to move jobs offshore, to merge, to attempt monopolistic do-or-die strategies, to fragment their operations into various outsourced departments – and to relentlessly slash wages.
The fiction at the heart of neoliberalism is that everybody can enjoy the consumer lifestyle without wages rising. You can borrow, but you can never go bust: if you borrow to buy a home, its value will always rise. And there will always be inflation – so if you borrow to buy a car, the value of the remaining debt is eroded by the time you need a new vehicle, leaving you plenty of scope to borrow more.
Widespread access to the finance system suited everybody: liberal politicians in the USA could point to the growing number of poor, black and Hispanic families with mortgages; bankers and finance companies got rich from selling loans to people who could not afford them. Plus it created the vast service industry that’s grown up around the wealthy – the florists, yoga teachers, yacht builders and so on, who provide a kind of fake-tanned Downton Abbey for the rich of the twenty-first century. And it suited the ordinary Joe, too: after all, who is going to turn down cheap money?
But financialization created inherent problems; problems that triggered the crisis, but were not resolved by it.
While paper money is unlimited, wages are real. You can go on creating money for ever but if a declining share of it flows to workers, and yet a growing part of profits is generated out of their mortgages and credit cards, you are eventually going to hit a wall. At some point, the expansion of financial profit through providing loans to stressed consumers will break, and snap back. That is exactly what happened when the US subprime mortgage bubble collapsed.
From 2001 to 2006, US mortgage lending grew from $2.2 trillion a year to just below $3 trillion: significant but not outrageous. But subprime lending – i.e. lending to poor people at high real interest rates – grew from $160 billion to $600 billion. And ‘adjustable mortgages’ – which start cheap and become more expensive as time goes on – came from nowhere to make up 48 per cent of all loans issued in the last three years of the boom. This market for risky, complex, doomed-to-fail borrowing did not exist until investment banks created it.28
That illustrates another inherent problem with financialization: it breaks the link between lending and saving.29Banks on Main Street always hold less money than they lend. We’ve seen how deregulation encouraged them to hold less in reserve and to play the system. But this new process – whereby every stream of interest gets wrapped up into a more complex product, distributed between investors – means ordinary banks are forced into the short-term money market just to run their normal operations.
This drove a fatal shift in the psychology of banking. The long-term nature of their lending (on twenty-five-year mortgages or never-cleared credit cards) got pulled further and further away from the short-term nature of their borrowing. Thus, over and above all the scams and mispricing, financialization creates within banking a structural tendency towards the kind of instant crisis of liquidity – i.e. ready cash – that destroyed Lehman Brothers.
In financialized societies, a banking crisis does not usually see the masses rush to take their money out – for the simple reason that they do not have much money in there to start with. It is banks that have money in the bank – i.e. in other banks – and, as we found in 2008, much of it is in the form of worthless paper.
The problems described here can be solved only if we stop financialization. Allow it to continue and over time more and more of the money in the finance system becomes fictional, and more of its institutions become reliant on short-term borrowing.
But no politician or regulator was prepared to dismantle the system. Instead they have put it back together, primed it with $12 trillion of money created out of thin air, and set it going again. This ensures the same conditions that caused the boom-bust cycle will – should any significant growth occur – create another one.
The historian Ferdinand Braudel suggested that the decline of all economic superpowers begins with a spectacular turn to finance. Surveying the fall of the Netherlands as a trading empire in the seventeenth century, he wrote: ‘Every capitalist development of this order seems, by reaching the stage of financial capitalism, to have in some sense announced its maturity: it [is] a sign of autumn.’30
Proponents of the ‘financial autumn’ theory point to the same pattern in the Genoese Republic – the main financial centre of the late Middle Ages – then the Netherlands, and then London towards the end of the British Empire. But in each of these examples, the pattern was for the dominant power to become lender to the world. Under neoliberalism, this has been reversed. The USA – and the West in general – have become the borrowers, not the lenders. This is a break in the long-term pattern.
So, too, is wage stagnation. The big financial empires of the past 500 years were making profits from unequal trade, slavery and usury, which were then used to finance decent lifestyles at home. The USA, under neoliberalism, boosted profits by impoverishing its own citizens.
The truth is, as finance has seeped into our daily lives, we are no longer slaves only to the machine, to the 9-to-5 routine, we’ve become slaves to interest payments. We no longer just generate profits for our bosses through our work, but also profits for financial middlemen through our borrowing. A single mum on benefits, forced into the world of payday loans and buying household goods on credit, can be generating a much higher profit rate for capital than an auto industry worker with a steady job.
Once every human being can generate a financial profit just by consuming – and the poorest can generate the most – a profound change begins in capitalism’s attitude to work. We’ll explore this later, in Part II. For now, to summarize: financialization is a permanent feature of neoliberalism. Like fiat money, it leads to breakdown – but the system can’t do without it.
THE IMBALANCED WORLD
The inevitable result of neoliberalism was the rise of so-called ‘global imbalances’ – in trade, saving and investment. For countries that smashed organized labour, offshored large parts of their productive industries and fuelled consumption with rising credit, the outcome was always going to be trade deficits, high government debts and instability in the financial sector. The gurus of neoliberalism urged everybody to follow the Anglo-Saxon model, but in reality the system relied on some key countries choosing not to.
Asia’s trade surplus with the rest of the world, Germany’s surplus with Europe, the oil exporters’ relentless accumulation of other people’s debts – none of these were anomalies. They are what allowed the USA, Britain and southern Europe to borrow beyond their means.
In other words, we must understand from the outset that neoliberalism can exist only because certain key countries do not practise it. Germany, China and Japan pursue what their critics call ‘neo-mercantilism’: manipulating their trade, investment and currency positions to accumulate a large pile of other countries’ cash. These surplus countries used to be seen as economic laggards, but in the post-crisis world they are among the few economies left standing. Germany’s ability to dictate the terms of humiliation to Greece, in the living memory of people who’d seen the swastika fly from the Acropolis, shows the power of being a producer, exporter and lender once neoliberalism breaks down.
The main measure of global imbalance is the current account – the difference between imports and exports of goods, services and investments. The world’s current account imbalance grew steadily through the 1990s then took off rapidly after 2000, rising from 1 per cent of world GDP to 3 per cent in 2006. The main deficit countries were America and most of Europe; the countries in surplus were China, the rest of Asia, Germany and Japan, and the oil producers.31
Why do we care? Because the imbalances produced the flammable material for the 2008 crisis by loading the finance systems of America, Britain and Europe with unsustainable debts. It forced countries like Greece, which had no power to export their way out of crisis, into a death spiral of austerity. And it left most neoliberalized countries with unpayable mountains of government debt.
In the wake of the 2008 crisis, the current account imbalance has fallen back – from 3 per cent of global GDP to 1.5 per cent. The IMF’s most recent projection sees no danger of a second spike but the conditions for this are stark: that China does not return to its old rate of growth, nor America to its old rate of borrowing and spending. As economists Florence Pisani and Anton Brender put it: ‘The only force that could finally rein in the continuous deepening of the global imbalances was the collapse of globalised finance.’32
Post-2008, the shrinking current account deficit has persuaded some economists that the risk posed by the imbalances is over.33 But in the meantime another key measure of imbalance in the world has grown: the stock of money held by the surplus countries in other currencies – known as foreign exchange reserves.
While China has seen growth fall back to 7 per cent and its trade surplus with the West reduced, its foreign exchange reserve pile has actually doubled since 2008 – and by mid-2014 stood at $4 trillion.34 Global foreign exchange reserves had likewise grown from under $8 trillion to approaching $12 trillion by late 2014.35
The imbalances always posed two distinct dangers. First, that they would flood Western economies with so much credit that the finance system collapsed. This happened. Second, more strategically, that all the pent-up risk and instability in the world gets pooled into an arrangement between states, over debt and exchange rates, which then collapses. This danger still exists.
If the USA cannot go on financing its debts, then at some point the dollar will collapse – indeed the mere perception that this might happen would be enough to collapse it. Nevertheless, the mutual dependence of China and the USA and, at a smaller scale, of Germany with the rest of the Eurozone ensures the trigger is never pulled.
All that’s happened since 2008, via the build-up of foreign exchange reserves, has to be seen as the surplus countries taking out ever larger insurance policies against an American collapse.
If the world were made up only of economic forces, this outcome would be OK: low or stagnant growth in the deficit countries, a gradual rise in the value of the Chinese RMB against the dollar, a gradual erosion of the US debt by inflation – and a smaller trade deficit for the USA because fracking reduces its dependency on foreign oil.
But the world is made up of classes, religions and nations. The 2014 Euro elections saw parties pledged to rip up the global system win 25 per cent or more – in Denmark, France, Greece and Britain. In 2015, as I write, the far left victory in Greece has thrown the cohesion of the Eurozone into doubt. Plus, the diplomatic crisis over Ukraine has seen the first serious trade and financial sanctions imposed on Russia by the West since globalization began. The Middle East is on fire, from Islamabad to Istanbul, while military rivalries between China and Japan are more intense than at any time since 1945 and underpinned by an intense currency war.
All that would be needed to blow the whole thing apart is for one or more country to ‘head for the exit’, using protectionism, currency manipulation or debt default. Since the most important nation, the USA, now has a Republican Party rhetorically committed to all three of these things, the chances of this are high.
The imbalances were fundamental to the very nature of globalization and were thrown into reverse only by financial collapse.
Let’s spell out what this means: the current form of globalization has a design fault. When it produces high growth it can do so only by fuelling unsustainable distortions, which are corrected by financial crisis. To reduce the distortions – the imbalances – you have to suppress the normal form of neoliberal growth.
THE INFO-TECH REVOLUTION
The one positive factor to set against all the negatives outlined so far is the tech revolution, which was produced by neoliberalism and has stormed ahead in defiance of the economic crisis. ‘The information society,’ writes the philosopher Luciano Floridi, ‘has been brought about by the fastest growing technology in history. No previous generation has ever been exposed to such an extraordinary acceleration of technical power over reality, with corresponding social changes and ethical responsibilities.’36
It was the increase in computing power that enabled a complex global finance system. It underpinned the growth of the money supply as digital systems replaced the need for cash. It enabled the physical redistribution of production and supply to the emerging markets, where labour was cheap. It de-skilled the engineering worker, made the labour of semi-skilled workers redundant and accelerated the growth of low-skilled service work.
But though info-tech has become, as Floridi writes, ‘the characteristic technology of our time’, its emergence takes the form of a disappearing act. Mainframes are born then disappear to be replaced by servers, which also disappear from corporate HQs and now sit in vast air-conditioned sheds elsewhere. The silicon chip gets smaller; the add-on devices that once cluttered our workspaces – modems, hard drives, floppy disks – become smaller, scarcer, and then disappear. Proprietary software gets built by corporate IT departments and is then replaced by off-the-peg versions at one-tenth of the price. And soon, too, the IT departments disappear, to be replaced by call centres in Mumbai. The PC becomes the laptop. The laptop shrinks and gets more powerful but is superseded by the smartphone and the tablet.
At first, this new technology was mapped on to the old structures of capitalism. In the 1990s, the folklore in IT was that the most expensive software – the enterprise resource package – ‘moulds like putty, sets like concrete’. By the time you had computerized your production line, innovation elsewhere meant you had to rip it out and start again.
But after around 2004, with the rise of the internet and mobile data, technology began to enable new business models: we called it Web 2.0. It also started to produce tangible new behaviours among large numbers of people. It became normal to pay with plastic; normal to put your whole private life online for ever; normal to go online to get a payday loan at 1,000 per cent interest.
At first, the exhilarating rush of new technology was taken as justifying all the pain we’d gone through to get free markets. The British miners had to be smashed so that we could have Facebook; telecoms had to be privatized so that we could all have 3G mobile phones. That was the implicit rationale.
Above all, however, it was the change in human terms that was critical. The most vital component of neoliberalism – the individualized worker and consumer, creating themselves anew as ‘human capital’ every morning and competing ferociously with each other – would have been impossible without network technology. Sociologist Michel Foucault’s prediction of what it would make us – ‘entrepreneurs of the self’ – looks all the more visionary because it was made when the only thing resembling the internet was a green-screen network, owned by the French state, called Minitel.37
The promise was that new technology would produce an information economy and a knowledge society. These have emerged but not in the form envisaged. In the old dystopias – as with the rogue computer Hal, in 2001: A Space Odyssey – it is the technology that rebels. In reality, the network has allowed humans to rebel.
It enabled them first of all to produce and consume knowledge independently of the channels formed in the era of industrial capitalism. That’s why we noticed the disruptions first in the news industry, in music and the sudden loss of the state’s monopoly over political propaganda and ideology.
Next, it began to undermine traditional concepts of property and privacy. Wikileaks and the controversy over the mass surveillance data collected by the NSA are just the latest phase of a war over who can own and store information. But the biggest impact of all is only now being understood.
The ‘network effect’ was first theorized by Bell Telephone boss Theodore Vail 100 years ago. Vail realized that networks create something extra, for free. In addition to utility for the user of a telephone and revenue for the owner, he noticed a third thing: the more people join the network, the more useful it becomes to everybody.
The problem comes when you try to measure and capture that third thing. Robert Metcalfe, the inventor of the Ethernet switch, claimed in 1980 that a network’s value is ‘the number of users squared’. So while the cost of building a network rises in a straight line, its value rises in an exponential curve.38 By implication the art of doing business in a knowledge economy is to capture everything between the straight line and the rising curve.
But how do we measure value? In terms of money saved, revenue earned or profits accrued? In 2013, the OECD’s economists agreed that it could not be captured by traditional market metrics. ‘While the Internet’s impact on market transactions and value added has been undoubtedly far-reaching,’ they wrote, ‘its effect on non-market interactions … is even more profound.’39
Economists have tended to ignore non-market interactions: they are, by definition, non-economic – as insignificant as a smile passed between two customers in the Starbucks queue. As to the network effect, they assumed its benefits would be quantified into lower prices and distributed between producers and consumers. But in the space of less than thirty years, network technologies have opened whole areas of economic life to the possibility of collaboration and production beyond the market.
On 15 September 2008, the Nokias and Motorolas pointed at Lehman Brothers HQ, and the free wifi signal in the Starbucks opposite, were in their own way just as significant as the bank that had collapsed. They were conveying the ultimate market signal from the future to the present: that an information economy may not be compatible with a market economy – or at least not one dominated and regulated by market forces primarily.
That, I will argue, is the root cause of the collapse, fibrillation and zombie state of neoliberalism. All the money created, all the velocity and momentum of finance built up during the last twenty-five years have to be set against the possibility that capitalism – a system based on markets, property ownership and exchange – cannot capture the ‘value’ generated by the new technology. In other words, it is increasingly evident that information goods conflict fundamentally with market mechanisms.
THE ZOMBIE SYSTEM
Let’s imagine an escape route for capitalism. During the next decade, central banks withdraw from QE in an orderly way. They refrain from using the printed money to write off their own government debts; the private market for government bonds, suppressed for a decade, revives. Plus, governments agree to suppress financial mania for all time: they pledge to raise interest rates in response to all future bubbles; they remove for ever the implicit guarantee of bank bailouts. All other markets – for credit, for shares, for derivatives – would then correct, to reflect the increased risk of financial capitalism. Capital would be reallocated to productive investment and away from speculative finance.
Ultimately, the world would have to return to exchange rates pegged against a new global currency managed by the IMF, with the Chinese RMB becoming a fully tradable reserve currency like the dollar. That would address the systemic threat posed by fiat money – the lack of credibility arising from the danger that globalization will break up. But the price would be a permanent end to the global imbalances: the currencies of surplus countries would rise, and China, India and the rest would have to give up their cheap labour advantage.
At the same time, financialization would have to be reversed. You would need a shift of political power away from banks and the politicians who support them, towards a policy favouring the onshoring of industry and services back to the West in order to create high-wage employment across the developed world. As a result, financial complexity would shrink, wages would grow, and the financial sector’s share of GDP would be reduced, as would our reliance on credit.
The most far-sighted among the global elite know this is the only answer: stabilization of fiat money, a retreat from financialization, and an end to the imbalances. But there are enormous social and political obstacles.
In the first place, the rich are opposed to increased wages and regulated finance; they want the opposite. Secondly, there would be winners and losers at a national level: the German ruling elite benefit from the debt-colonization of Greece and Spain; the Chinese ruling elite benefit from being the gatekeeper to a cheap labour economy of 1.4 billion people. They have a vested interest in blocking the escape route.
But here’s the biggest problem: for this scenario to work, huge, unpayable sovereign debts would have to be written down, together with a large proportion of the world’s household and corporate debts.
There is, however, no global system to achieve this. Write America’s debts down and Chinese savers lose; the result would be to break the essential deal between Asia and the West: you borrow, we lend. Write off the Greek debt to the EU and it is German taxpayers who lose tens of billions, again, breaching an essential deal.
The outcome of this best-case scenario, even if the transition could be managed peacefully, would be a complete breakdown of globalization.
And, of course, it cannot be managed peacefully.
Russia has, since 2014, become a power dedicated to disrupting the Western economies, not cooperating with them. China – for all the soft power it has begun to project – cannot do what America did at the end of the Second World War: absorb the world’s debts, set explicit rules and create a new global currency system.
Meanwhile, in the West, there is no sign of any strategy resembling the one outlined above. There is talk of it – from the lionizing of the French economist Thomas Piketty to the Bundesbank’s calls in 2014 for higher wages in Europe. But in practice, the mainstream parties remain wedded to neoliberalism.
And without the escape route, the prospect looks more and more like long-term stagnation.
In 2014, the OECD released its projections for the world economy in the years between now and 2060.40 World growth will slow to 2.7 per cent, said the Paris-based think tank, because the catch-up effects boosting growth in the developing world – growing population, education, urbanization – will peter out. Even before that, near-stagnation in advanced economies indicates average global growth of just 3 per cent over the next fifty years, significantly below the pre-crisis average.
Meanwhile, because semi-skilled jobs will become automated, leaving only high- and low-paid ones, global inequality will rise by 40 per cent. By 2060, countries such as Sweden will have the levels of inequality currently seen in the USA: think Gary, Indiana in the suburbs of Stockholm. There is also the very real risk that climate change will begin to destroy capital, coastal land and agriculture, shaving up to 2.5 per cent off world GDP, and 6 per cent in south-east Asia.
But the bleakest part of the OECD report lies not in what it projects but what it assumes: a rapid rise in productivity due to information technology. Three-quarters of all the growth to 2060 is expected to come from increased productivity. However, that assumption is, as the report states euphemistically, ‘high compared with recent history’.
In fact, as I will explore in chapter 5, there is no certainty at all that the information revolution of the past twenty years will turn into the kind of growth and productivity that can be measured in market terms. In that case there is substantial risk that the meagre 3 per cent annual growth projected by the OECD over the next fifty years will be closer to 0.75.
Then there’s the migration problem. To make the OECD’s central growth scenario work, Europe and the USA have to absorb 50 million migrants each between now and 2060, with the rest of the developed world assimilating another 30 million. Without them, the workforce and the tax base of the West shrinks so badly that states go bust. The risk – as signalled by a 25 per cent vote for the Front National in France and armed right-wingers haranguing migrant kids on California’s border with Mexico – is that the populations of the developed world will not accept it.
Allow yourself to imagine the world of 2060 as the OECD predicts it: Los Angeles and Detroit look like Manila today – abject slums alongside guarded skyscrapers; Stockholm and Copenhagen look like the destroyed cities of the American rust belt; the middle-income job has disappeared. Capitalism will be in its fourth decade of stagnation.
Even to achieve this glittering future, says the OECD, we have to make labour ‘more flexible’ and the economy more globalized. We will have to privatize higher education – for the cost of expanding it to meet the demand for graduates would bankrupt many states – and assimilate tens of millions of migrants into the developed world.
And as we struggle with all this, it is likely that the current means of financing the state will evaporate. The OECD points out that the polarization of populations into high-and-low-income groups will render income taxes ineffective. We will need – as Thomas Piketty suggests – to tax wealth instead. The problem here is that assets – whether they be a star racehorse, a secret bank account or the copyright on the Nike swoosh – tend to be held in jurisdictions dedicated to avoiding wealth taxes, even if anybody had the will to raise them, which they currently don’t.
If things do not change, says the OECD, it is realistic to expect stagnation in the West, a slowing pace of growth in emerging markets and the likely bankruptcy of many states.
So what’s more likely is that at some point one or more countries will quit globalization, via protectionism, debt write-offs and currency manipulation. Or that a de-globalization crisis originating in diplomatic and military conflict spills over into the world economy and produces the same results.
The lesson from the OECD’s report is that we need a complete system redesign. The most highly educated generation in the history of the human race, and the best connected, will not accept a future of high inequality and stagnant growth.
Instead of a chaotic race to de-globalize the world, and decades of stagnation combined with rising inequality, we need a new economic model. To design it will involve more than an effort of utopian thinking. Keynes’s genius in the mid-1930s was to understand what the crisis had revealed about the existing system: that a workable new model would have to be built around the permanent inefficiencies of the old one, which mainstream economics could not see.
This time the problem is even bigger.
The central premise of this book is that, alongside the long-term stagnation problem arising from the financial crisis and demographics, information technology has robbed market forces of their ability to create dynamism. Instead, it is creating the conditions for a postcapitalist economy. It may not be possible to ‘rescue’ capitalism, as Keynes did with radical policy solutions, because its technological foundations have changed.
So before we demand a ‘Green New Deal’, or state-owned banks, or free college education, or long-term zero interest rates, we have to understand how they might fit into the kind of economy that is emerging. And we are very badly equipped to do this. An order has been disrupted but conventional economics has no idea of the magnitude of the disruption.
To go forward we need a mental image smaller than ‘the financial autumn of a failing empire’, but bigger than a theory of boom-bust cycles. We need a theory that explains why, in the evolution of capitalism over the past two centuries, big moments of metamorphosis have occurred, and how exactly technological change recharges the batteries of capitalist growth.
We need, in short, a theory that fits the current crisis into a picture of capitalism’s overall destiny. The search for it will take us beyond conventional economics, and way beyond conventional Marxism. It begins in a Russian prison cell in 1938.
Copyright © 2015 by Paul Mason