Introduction – The neoliberal economic paradigm is the type of economic governance introduced by the Reagan and Thatcher governments in the USA and UK (and later extended to other parts of the world), with the privatisation and delocalisation of industry, the deregulation of finance and the gradual dismantling of the welfare state.
Most people are familiar with the term ‘neoliberal’ but don’t quite grasp its full meaning in economic terms. Neoliberalism is generally understood as a mostly misguided economic ideology, translating into a series of policies that ended up increasing poverty and inequality. What is not generally understood is how consistently all the neoliberal policies interlock together and how effectively they all concur to form a very powerful wealth extraction mechanism.
In this essay I will try to give a comprehensive overview of the subject. I will start by tracing back how this economic paradigm came to replace the previous one and dominate the scene, I will then describe how it works, why it is unsustainable and how it unfolded. Finally I will make the case that the financial collapse of 2008 really marked the end of its useful life and the start of a very uncertain phase of transition.
Preliminary considerations – It is impossible to fully understand the functioning of this economic paradigm without first gaining a basic understanding of the main aspects of the previous economic architecture, the Keynesian paradigm; primarily because neoliberalism was largely made possible by the wealth accumulated under the Keynesian paradigm, but also because it represents a reversal of it in economic terms, and a reaction to it in political terms. Therefore, whereas the Keynesian paradigm was focused on creating value in the real economy and distributing it more equally across all layers of society, and achieved these aims by means of financial repression and state management of the economy, the neoliberal paradigm reversed these arrangements by de-regulating finance and thus disabling the power of the states to control their economies, by scaling down production and by redistributing wealth from the bottom to the top layers of society. It is also important to understand that the coming into existence of neoliberalism was made possible by the very economic conditions resulting from 30 years of real economic growth under the previous paradigm: high wages, high inflation, low debt, a thriving middle class and a thriving public sector with accumulated wealth. The neoliberal paradigm, by transferring the accumulated wealth towards the top layers of society, reversed all these conditions and in doing so, it managed to solve, in favour of the ruling elite, the two main political problems resulting from the previous economic arrangements: growing influence and power of the workers/citizens at home and loss of American economic hegemony in the international arena.
As the Keynesian paradigm provided the economic basis (the wealth, that is) from which neoliberalism could take off, we need to first understand it in very basic terms, if we want to understand the neoliberal one. The first aspect to point out is that the Keynesian paradigm, in turn, was made possible, from a political (but also economic) point of view, by the failure of the previous system of governance, the liberal paradigm, which ended with the combined disasters of the 1929 financial collapse, the Great Depression and two world wars. Therefore, as the disasters caused by the liberal paradigm paved the way for an abrupt change of direction, so the wealth produced by the Keynesian one paved the way for another change of direction, and resulted in the wealth sucking mechanism represented by the neoliberal paradigm. Incidentally, this teaches us that we need to understand these periodic swings of the pendulum of world economic governance if we want to make sense of where we are now, after 40 years of neoliberal economics and the obvious unravelling of the current world order since the financial collapse of 2008. After pointing out these important aspects relative to the succession of different systems of economic governance, we can now turn to a brief summary of the Keynesian paradigm.
The Keynesian paradigm: from the Bretton Woods Agreement (1944) to the ‘closing of the gold window’ (1971)
Due to the memory of the Great Depression, the devastation caused by World War I and II, and the presence of a rival superpower (the Soviet Union), the priorities at the end of WWII were: to rebuild the countries destroyed by the war, to rebuild a viable capitalist economic block, and to avoid another financial collapses which might prove fatal for capitalism, given the presence of the communist block and the militancy of the masses both in the West and in other countries. Therefore the main objective of economic policy became maintaining near full employment and to achieve this aim governments would have to a) spend into the real economy (what we now call QE for the people) in order to keep aggregate demand high enough to sustain full employment, b) create safety nets (the welfare state) for society that would act as automatic stabilisers of aggregate demand and living conditions, c) for what concerns long term economic management, build up infrastructure and support strategic industrial productions. In other words, it was understood that the way to avoid widespread unemployment (and consequent social unrest with potentially far reaching and undesirable results) was by building up a viable economy by means of industrial policy, a well functioning welfare state and management of economic cycles (aggregate demand management) with counter-cyclical spending. For that purpose a regulatory framework was created under the Bretton Woods Agreement of 1944 that enabled the states of the Western block to manage their economies and fence them off from unfettered market forces.
The first important aspect of this regulatory framework was regulation of the financial markets (also called in economic jargon ‘financial repression’): a raft of measures (separation of retail banking from investment banking, restriction of cross border capital movements, strict limits on bank creation of credit money, caps or ceilings on interest rates, requirement for financial institutions to hold a substantial amount of their country’s public debt, at the going interest rate decided by the government) produced the effect of creating a state controlled economic space, in which governments were able to pursue the economic policies they desired without having to worry about keeping the financial markets happy for fear of capital flights. In addition, they produced the effect of channelling money into productive investments, as interest rates on relatively safe financial titles such as government bonds were held below inflation.
Ultimately state action aimed at maintaining viable national economies and welfare provisions was supported by a favourable international framework at the top of which was the hegemonic power, the USA, committed to promoting economic growth with its virtually unlimited spending capacity, due to the fact that its fiat currency, the dollar, replaced gold at the centre of the new international monetary system. The Bretton Woods monetary system therefore is the second aspect of the regulatory framework that supported the Keynesian economic paradigm, by coordinating the policies pursued by the individual states and striving to keep trade balanced. Although the currency union that was created with the Bretton Woods Agreement was in itself a highly unstable arrangement (as all currency unions are, due to lack of exchange rate flexibility), the hegemonic power was committed to maintaining the system in equilibrium by both recycling its initially massive trade surpluses into the economies of the partner countries (with the Marshall plan and later with investments) and by creating money in order to act as the importer of last resort. Also the rules of the agreement, as well as informal pressure, were designed to push surplus countries to reduce their trade surpluses by pursuing loose monetary and fiscal policies.
Pursuing expansive monetary and fiscal policies (what we now call QE for the people) did work in terms of maintaining high levels of employment and achieving high rates of GDP growth (for Western Europe at an average of more than 4% per year between 1948 and 1973) with the result of a massive improvement in the standards of living of the advanced western countries. However, this arrangement unfortunately did present some structural weaknesses that tended to result in two major problems: 1) high inflation due to strong unions (made strong by full employment) constantly pressing for higher salaries and strong corporations (made strong by high consumer demand) responding with price increases; 2) high trade deficits on the part of the less competitive countries (as trade deficits tend to be increased by expansive monetary and fiscal policies). The problem of trade deficits was kept in check by the hegemonic power recycling its surplus money into its partner countries (with aid and investments) for as long as it had the most competitive industry and a credible international currency (up until the mid/late 60’s) while the problem of inflation was resolved by a spectacular increase in productivity due to technological progress, itself a legacy of the war and the war management of the economy. Technological progress meant constant increases in productivity high enough to accommodate both rising wages and reasonable (although less than ideal from the point of view of the ruling classes) rates of profit. These spectacular increases in productivity lasted until the mid 60’s, then they started to taper off while union demands remained the same, as the bargaining power of the workers was still strong.
Roughly at the same time as productivity rises started to taper off, endangering price stability, American economic hegemony also came to an end. As the US had helped and supported the reconstruction of the industrial capacity of its former enemies and now allies (for fear of the communist block gaining influence on them) it didn’t take long until they were again able to compete, with the consequence that by the end of the 60’s the US had lost its economic hegemony. By 1971 its trade surpluses had turned into very large deficits and the problem was compounded by the exorbitant expenditures caused by the Vietnam War. By that time the US had been creating a disproportionate amount of dollars to pay its way in the world, and the trust in its ability to convert them into gold upon request by foreign central banks at $35 per ounce (as established by the Bretton Woods Agreement) was pretty much lost. There was a run on the dollar with France and Britain being the most vocal about demanding their equivalent in gold, and president Nixon did the only thing he could do under the circumstances, to ‘close the gold window’, basically defaulting on the promise to convert dollars into gold. This marked the end of the Bretton Woods monetary system with the immediate return to floating exchange rates as well as the gradual crumbling down of all the other arrangements that had sustained the Keynesian paradigm. A period of high economic instability (not unlike the one we are experiencing now, in the wake of the 2008 financial collapse) started in 1971 and lasted for about 10-15 years as a new governance of the world economy was being worked out.
Transition issues – economic and political – After the 1971 collapse of the monetary union, the rational thing to do from a strictly economic point of view, would have been to call another Bretton Woods style conference and negotiate a new and more egalitarian international monetary system, with reduced dominance of the dollar and more space for other currencies in proportion to their economic strength, with new rules and new ways of cooperating (perhaps even along the lines suggested by Keynes himself at the Bretton Woods conference, by creating an international currency named Bancor with annexed trade balancing mechanism penalising trade surplus countries). But obviously the hegemonic power had no intention to re-negotiate with its ‘allies’ the relative positions of the various currencies as international reserves, and thus proceeded to implement a different type of economic order that would enable it to retain the dollar standard by attracting other countries’ surplus money into its financial system – that is, by basing the dominance of the dollar no longer on trade account surpluses but on capital account surpluses.
This new economic order, the neoliberal paradigm, although very unsustainable, as we will see, had the advantage that it would allow the ruling elite of the West to kill two birds with one stone and solve the twin political problems that it was facing: 1) putting back in a subordinate place the working and middle classes which, as a result of the increased security and prosperity that they had come to enjoy, were now demanding a more substantial political role, and 2) maintaining American hegemonic position in world affairs. It is important to understand that the very conditions which allowed the coming into existence of the neoliberal paradigm were provided precisely by the economic situation inherited after 30 years of economic growth (high inflation, high wages, low debt, accumulated wealth both in private and public hands) as well as by the collapse of the Soviet Union which, ending the presence of a rival superpower, ended all necessity to make concessions to the masses and to non compliant states. It is important to note as well, that after 40 years of neoliberal economics these conditions have now been reversed, as we now have low or negative (in some countries) inflation, low wages, high debt, and again the rising of rival powers, mainly China in economic terms and Russia in military terms. The economic and geopolitical pendulum has swung again. But we now need to go back to 1971 and see how the ruling elite in the USA implemented the transition to a new economic paradigm.
The logic of the neoliberal paradigm & the reversal of capital flows
Maintaining the dollar standard -The main challenge that the USA faced was to maintain the dollar (no longer backed by trade surpluses and the gold deriving from them) as the main international exchange and reserve currency. The first step in order to continue imposing its currency was the petro-dollar agreement of 1974 with which Saudi Arabia, and soon afterwards the other OPEC countries, committed to accept only dollars in payment for their oil exports while the USA committed to defend with military force the governments of these countries. This arrangement basically forced all countries to hold high amounts of dollar reserves in order to trade oil (as well as other commodities whose trade would also remain in dollars for convenience purposes) in the international markets. The high demand for dollars that this requirement generated (allowing the USA to create a high amount of money for the world economy) was still not enough for hegemonic purposes. Thus it was necessary to take a second step: to start dismantling the Bretton Woods regulatory framework (especially for what concerned financial regulation) in order to be able to attract into the Western financial centres (mainly Wall Street and the City + the network of off shore safe havens) the huge amounts of capital needed to finance the enormous trade and government deficits which the US policy makers were hell bent on maintaining and increasing, in order to maintain their hegemonic position. Whereas the previous economic paradigm had been based on controlling the world economy from a position of economic strength, by redistributing the US trade surpluses into its partner countries in order to sustain their economic growth, the new paradigm would be based on controlling the world economy by attracting other countries’ surplus money and redistributing it. Attracting capital means getting into debt, therefore the new economic paradigm would be based on debt. The financial flows attracted into Wall Street (+ additional money created by the financial markets) would still be redistributed around the world to facilitate economic stability and often growth, but it would be a very different – and unsustainable – type of growth, as it would be based on the financial economy rather than the real one, and based on debt. The engineering of this reversal of financial flows was a complex operation, steered by Paul Volcker and described at length by Yanis Varoufakis in his book ‘The Global Minotaur’. This is a brief summary of how it was done, taken from the book.
Paul Volcker and his logic of ‘controlled disintegration’ -The United States had not wanted the collapse of the BW economic architecture. However, once this country lost its trade surplus position, its policy makers wasted no energy in trying to mend the system. This would have required scaling down the weight of the dollar within the international monetary system, keeping their government spending and their imports in check and living within their means, a move that would have dramatically curtailed their hegemonic position. Paul Volcker, appointed in 1970 by President Nixon as Under Secretary of the Treasury for International Monetary Affairs, along with his task force, were the main people responsible for designing and implementing a series of measures which would steer the world economy into a new economic paradigm. The main task that they had was to engineer the reversal of global capital flows in favour of the United States and away from the two economic zones, Germany (along with Western Europe) and Japan, which were now becoming economically hegemonic, and therefore more attractive (= able to generate higher returns) for international capital.
The US policy makers understood that reserve currency status allowed them to run large deficits, as there was huge international demand for dollars, which were used as means of exchange (for international trade) and as currency reserves (for central banks). This fact, along with their dominance of the world financial markets, allowed the United States to pay for their deficits by a combination of creating money and attracting ever increasing amounts of foreign capitals to Wall Street. From now on, the USA would consciously expand its twin deficits (trade deficit and government deficit) in order to further entrench their hegemony, and would finance them by attracting to the United States the majority of the capital generated by the countries with trade surpluses (at the time mainly Germany, Japan, and the oil exporting countries). This would fling the world economy into a chaotic and ultimately unsustainable (because it exacerbated trade imbalances, leading many countries to de-industrialisaton and eventually bankruptcy) yet strangely controlled flux. This new arrangement would stabilize the world economic system (after a transition period of turmoil in the 70’s and early 80’s) by attracting into the USA other countries’ capital surpluses, and allowing the hegemonic power to re-lend this money (+ the additional money created on the basis of it) around the world in order to maintain a sufficient level of world aggregate demand required for the system as a whole to function properly (that is, well enough to maintain social control and international hegemony).
To attract the amounts of capital needed for the purpose of feeding the twin deficits and maintaining American hegemony (and also feeding the deficits of other countries and allowing them to live unsustainably), a series of measures would have to be taken which Paul Volcker himself called the ‘controlled disintegration of the world economy’ as the old compact (based on real growth and redistribution of wealth towards the bottom of society) was being dismantled and a new one (based on financial growth, shifting production in low cost countries, and redistribution of wealth towards the top layers of society) was being assembled – ultimately unsustainable but quite viable for some time.
Whereas in the old economic order production was central and technological progress (what we could call a ‘race to the top’) was crucial in order to achieve improving standards of living for the masses and good returns for capitalists at the same time, in the new economic order the financial centres would become central and attracting capital (rather than upgrading technology) would become the main focus. In order to attract capital each country that adopted neoliberalism would have to generate good returns; hence the new economic paradigm would be based on finding ever more ingenious ways of reducing costs (first and foremost wages, but also taxes and regulations, R&D expenditures, welfare provisions etc.) by opening up national borders to the free circulation of capitals, goods and people, thus putting workers and states in competition against each other and this way forcing them to lower their wages, taxes and regulations (what has been called the ‘race to the bottom’). This arrangement facilitated the extraction of value from the world economy and the concentration of it in the financial centres. This is the overall logic of the neoliberal paradigm, now we need to look at how this logic actually played out over time.
Engineering the reversal of capital flows -The new paradigm went through different phases, and the first one consisted in engineering the reversal of financial flows towards the US financial system. In order to do this it was necessary to produce higher returns in the US economy as compared to Germany and Japan, the US main competitors, and this was achieved mainly by increasing interest rates, and by obtaining higher profits for American corporations. The successive phases consisted in maintaining high returns on capital invested in the main financial centres (Wall Street and the City) with various strategies – but let’s start with the first phase (as narrated in ‘The Global Minotaur’).
We are in the post 1971 world, the time of interregnum between two paradigms characterized by economic instability. After the ‘closing of the gold window’ the price of gold skyrocketed and along with it many other prices. The first to rise were oil prices, increased by the OPEC countries after the real value of their revenues collapsed, given the devaluation of the dollar in terms of gold. This increased dramatically the costs of production but, although it was not ideal for any country, the USA managed to get a competitive advantage out of this situation. The oil price increases damaged European and Japanese industries (which had to import almost 100% of their oil) a lot more than it did American industries, which only imported 32.5% of the oil they used.
Along with the price of gold and the price of oil, the prices of other primary commodities also increased dramatically. This resulted in sharply increasing costs of production across the world, ushering in a period of high inflation combined with a deep economic downturn, otherwise known as stagflation (a contraction of the words stagnation and inflation – a very unusual pair, as normally prices rise in conditions of economic buoyancy). By then the priorities of US economic policy could be reversed, as the communist block and workers militancy constituted no longer a serious threat. A new economic dogma started to take hold, postulating that the number one economic problem was inflation and the other (conflicting) main objective of economic policy, reducing unemployment, was de-facto relegated to a secondary role. Paul Volcker, nominated chairman of the Fed in 1979, dramatically stepped up interest rates, (which had already been rising during the 70’s) to 11% in 1979 when he took his position, and then to an incredible 20% in 1981, and soon afterwards to a peak of 21.5%. While this brutal monetary policy did tame inflation (pushing it down from 13.5 % in 1981 to 3.2% two years later) its harmful effects on employment and capital accumulation were profound, both domestically and internationally. High interest rates had the predictable effect of draining investment from productive activities (the real economy) into speculative ones (the financial economy) and the resulting unemployment was instrumental in giving corporate America a wonderful opportunity to put a lid on real wages (more so than in other countries where union power was stronger). At the same time, productivity kept on rising, due to technological advances. The combination of low wages and high productivity (and lower rise in production costs) took the profits of American corporations to the sky, thus attracting huge amounts of capital to Wall Street.
To sum up, the reversal of capital flows was achieved with this combination of measures:
1) improved competitiveness of US firms in relation to their German and Japanese competitors, which in turn was achieved by a) lower rise in their costs of production (mainly the cost of oil) and b) lower wages for American workers. The combination of these two factors resulted in higher profits for American corporations, which attracted foreign capital to Wall Street to buy shares.
2) high interest rates – this was an end in itself, as it served to attract large capital flows into the United States (to buy mainly US Treasury bonds), and it was also instrumental in achieving lower wages by causing an economic slump, with consequent rise in unemployment which greatly weakened workers’ bargaining power.
The two main economic variables that were directly or indirectly manipulated by US policy makers to achieve this reversal of capital flows were oil prices (increased by the OPEC countries but not without the consent of their new ‘protectors’) and interest rates.
Political considerations – We can see that, having solved the problem of maintaining world hegemony (via petro-dollar agreement + reversal of global capital flows = keeping the dollar standard in place), the measures taken to reverse capital flows also allowed the elite to start solving the problem of workers’ (and middle class) power, as they resulted in increased unemployment, this way considerably weakening the workers’ bargaining position, as well as their role and status in society.
General overview of the structure and evolution of the neoliberal paradigm
We must now look at the neoliberal paradigm in broad schematic outlines: we have seen that the first move towards its introduction consisted of a series of interest rate hikes in the early 80’s (initiated by the USA and followed in various measures by other countries), which took them way above the rate of inflation, thus producing very attractive rewards for financial capital. This caused a shift of investments into financial activities, the concurrent dismissal of productive ones and the consequent increase of unemployment. While keeping on targeting inflation suppression during the rest of the 80’s and beyond (objective achieved by keeping social spending in check and interest rates higher than inflation, thus preventing a full economic recovery after the slump of the early 80’s and maintaining unemployment on a higher structural level), the successive measures taken were: deregulation of the financial markets, delocalisation of production to places where labour was cheaper, privatisation of public industry and the gradual dismantling of the welfare state (privatisation of public housing, public pensions, and public services). The main thing to understand about the neoliberal economic paradigm is that it is based on consumption not supported by an adequate level of production, a situation that produces high structural unemployment, leading to two major consequences: a) gradual reduction of wages as a share of GDP and the consequent rise in profit rates, b) persistent trade deficits with the consequent necessity to attract capital in order to pay for imports. An unsustainable situation that has been sustained for a long time in the USA and UK (until 2008), thanks to the functioning of Wall Street and the City of London (and also the respective housing markets) as magnets for foreign capital. (In other countries it has led to recurrent financial collapses, all managed by the hegemonic financial centres to their advantage via the structural adjustment programs imposed by the IMF.)
To sum up the basic aspects of the neoliberal paradigm:
- Interest rates are kept higher than inflation, finance de-regulated gradually over time and production de-localised with consequent trade deficits and the necessity to attract foreign capitals.
- Delocalised production in turn has led to a permanent increase in structural unemployment (= an economy that functions below full capacity), instrumental in achieving lower wages and thus higher profits
- In turn, higher profits contributed to attracting more capital to the stock market, thus enabling this unsustainable economic arrangement to remain in place for a long time. High profits in this paradigm are generated by a) shifting production to countries where labour is cheaper, b) lowering wages at home via increased structural unemployment, c) delocalisation and a new focus on short term profits allowed to save on many other costs of production such as R&D, infrastructure, education, public subsidies to keep industry competitive – by saving on all these costs the whole economy could be handed over to the financial markets for rent extraction.
- Government policy has always been heavily involved in sustaining the neoliberal paradigm by a) contracting social spending (in order to keep unemployment relatively high, wages low, and therefore generate high profits, but also in order to keep trade deficits in check) and b) selling off public enterprises and gradually over time also the welfare state at prices below their market value (to generate high returns in the financial markets).
Other important features:
The obverse side: surplus countries – it has to be kept in mind that this economic paradigm could only exist because there are countries that have not adopted it and actually have been doing the very opposite, striving to keep their production costs always lower than their competitors (mainly by compressing wages and keeping government spending in check, but also by manipulating their currencies and with technological improvements), this way increasing their exports and accumulating trade surpluses (this strategy is called ‘neo-mercantilism’) and sending the money deriving from them to the financial markets. Wall Street and the City would then transform this cash into household debt to be re-distributed around the world, enabling the deficit countries to buy the exports of the surplus countries (this is called ‘vendor financing’), and thus reproducing the economic cycle for a long time. Therefore, what made possible for a number of countries (mainly the USA, UK and most of Europe) to delocalise production and keep wages low and profits high while accumulating trade deficits, was that a number of countries did exactly the reverse, they accumulated trade surpluses and invested the money in the financial markets.
The main measure of the global imbalances that this economic arrangement generates is the current account of each nation, the difference between exports and imports of goods, services and investments. The world’s current account imbalances grew steadily through the 1990’s, then took off rapidly after 2000, rising from 1% of world GDP to 3 % in 2006 (data from Post Capitalism p. 21). The main surplus countries are China, most of Asia, Germany, Japan and the oil producers. It is to be noted that the ‘foreign’ money flowing to the financial centres also includes profits produced by big corporations in the neoliberal countries, stashed away in safe havens and then recycled via the shadow banking system into the deficit countries. Thus it’s not all foreign money that flows to the financial markets, but from the point of view of the national accounts it is. These imbalances loaded the financial systems of the USA, UK and southern Europe with unsustainable debt. After the 2008 financial collapse, it forced these countries into an unsustainable spiral of bank bailouts, increased government debt, and austerity.
Important distinction among neoliberal countries: core vs periphery – We will be looking at the neoliberal paradigm mainly from the point of view of the countries hosting the global financial centres (USA and UK) but it must be kept in mind that neoliberalism was gradually spread out to many other countries as well, most notably Western Europe, but also ex-communist countries, many third world countries and the Asian Tigers. The patterns followed by these countries differ in various ways and it would be too complicated to describe them all (many of these cases have been described by Joseph Stiglitz in ‘Globalisation and its Discontents’ and Naomi Klein in ‘The Shock Doctrine’). It is important to highlight one basic difference between the leading or ‘core’ countries (the USA and UK – but also Canada, Australia and New Zealand, all countries whose assets, including real estate, are highly sought after by foreign investors, thus keeping their currencies strong and allowing them to create money when necessary) and the others, the ‘periphery’: while neoliberalism was and is unsustainable for all, the pattern for the ‘periphery’ is to have recurrent financial crashes ending up with bankruptcy and sale of assets at bargain prices (thus generating further gains for Wall Street and The City), while the ‘core’ countries were able to create money and bail out their banking systems when they collapsed in 2008, a much less painful solution which reflects the pecking order in the international monetary system. This is an important distinction worth highlighting: core countries, that acquire debts denominated in their own currencies, are able to resolve financial collapses with a balancing act: creation of bail out money for their financial economy, with consequent inflation of asset prices, combined with austerity for their real economy (to maintain the credibility of their currencies) while peripheral countries (that tend to get into debt in a foreign currency, normally US dollars) are more or less ‘forced’ to resolve their financial collapses with austerity only, which causes deflation, widespread bankruptcy and eventually results in having to sell off both public and private assets.
The importance of producing returns for capital – As mentioned, the first and foremost downside of the neoliberal paradigm is the emergence of constant trade deficits and thus the accumulation of foreign debt. The only way to sustain this unsustainable situation is to attract enough capital from the trade surplus countries (and thus balance the balance of payments), and in order to do this the main focus of economic policy has to be producing high returns. These high returns have been produced with high interest rates (especially in the 80’s), with high short term profits (obtained by delocalizing production & asset stripping – this effect, leading to rising share prices, was particularly strong in the 90’s) with the selling off of public assets (therefore tapping into public wealth – this has been happening throughout), by driving many countries bankrupt (tapping into foreign wealth – this as well happened throughout the unfolding of the neoliberal paradigm) and increasingly by getting most of the Western population into debt, thus tapping into the private wealth accumulated during the years of the Keynesian paradigm. This phenomenon had an explosion in the run up to 2008 and was accompanied by the formation of real estate bubbles in many countries.
The centrality of Credit – The reason why debt has been spreading like a disease in all layers of society has to do also with the second (related) flaw in this economic paradigm: as a result of stagnating salaries, households have insufficient income to buy the goods they produce + a good amount of imports (insufficient aggregate demand in economic jargon), situation which would keep the economy constantly on the verge of recession. To remedy this fatal flaw, a comprehensive reform of the banking system of the neoliberal countries was passed, allowing for consumer credit to be generously provided in order to make up for the insufficient spending capacity in their real economy. Easy credit generated an additional source of returns for the financial centres (and further on for the surplus countries), further contributing to keeping the neoliberal mechanism going. However, over time, burdened with debt and lacking an adequate level of production (and the technological breakthroughs that normally go with it), the rate of economic growth inescapably declined. With low growth, the debt accumulated became unsustainable (= difficult to service, let alone to repay) putting the neoliberal countries and their banking systems, but also the global financial centres, under a permanent risk of financial collapse. After the turn of the millennium the governments and financial systems of the core countries escalated their creation of credit and toxic financial titles to stave off the impending disaster, but eventually the crash did take place, as it is widely known, in 2008.
This is a general overview of how the neoliberal paradigm was structured and how it unfolded over time, now we must go into more detail, keeping in mind that we are looking at it mainly from the point of view of the countries hosting the main financial centres. We left off with the reversal of financial flows in the early 80’s, now we must look at what happened in the rest of the decade.
The initial phase of the neoliberal paradigm – The Reagan and Thatcher years
This part has been summed up from ‘The Global Minotaur’: Ronald Reagan entered the White House in 1981 with the new (back then) narrative of ‘trickle down’ economics: unimpeded individual initiative as the engine of growth, balanced budgets, the withering of big government (except for Defense). Accordingly, he passed large tax breaks for the highest earners, reductions in social programs and most notably, the removal of many restraints on Wall Street. However, after a few months of trying to balance the budget, and once unemployment skyrocketed in 1981, Reagan performed an abrupt U-turn and, instead of shrinking the government, he put his foot down on the accelerator of military spending. This proved a boon for the large industrial network connected to the arms industry. The twin deficits ballooned, unemployment shrank, foreign capital rushed into New York to buy safe American debt in a time of general uncertainty, allowing Wall Street to create private money on the back of it, as we will see later.
Margaret Thatcher won office in the UK on a similar political manifesto (trickle down economics). She engineered the de-industrialisation of Britain, ‘ridding’ the country of many of its traditional industrial sectors and the bothersome trade unions in the process. Together with the mining and steel industries, millions of full time jobs disappeared forever and whole areas of Britain started to resemble the Third World. But real wages per hour did not drop. This is part of the explanation of why she won the 1983 and 1987 elections: the 4.5 million new jobless people were too gloomy and disgruntled to bother to vote and, at the same time, the workers who did hang on to their jobs saw their income rise thanks to two ‘bonuses’: 1) being able to buy at very low prices the council houses in which they had been living, and 2) being able to buy shares in newly privatized companies (such as BT, British Gas, TSB Trustee Savings Bank) at far below the estimated market prices. Both these moves encouraged the still employed segments of the working class to consent to an economy that put all its eggs in the basket of speculation, either on house prices or on share prices. Meanwhile, the co-opted workers immediately sold their shares to the conglomerates and they did the same thing with their council homes, in an attempt to move to better neighbourhoods and make some extra cash in the process. The newly privatized housing allowed the banks to increase mortgage lending and credit card facilities. This marked the start of a by now familiar growth model, fuelled by the housing bubble and the related consumer spending. Meanwhile the City of London’s traditional strength in the realm of finance, its deregulation under the Thatcher government (known as the Big Bang) and the City’s links with Wall Street all ensured that a significant portion of the foreign capital flight to the United States passed through the City. This gave its banks access to large sums of money, even if for a short period of time, on the back of which they could create more money through speculation. Together with the proceeds from domestic privatizations of UK industries and the nation’s stock of social housing, as well as the mountain of money created over time as mortgages and consumer debt, these financial streams merged into a potent torrent that allowed the City of London to prosper.
To sum up the Reagan & Thatcher years: the impulse for the growth experienced during those years was given by military spending (funded from money creation and foreign capitals) in the case of the USA and by privatizations of national wealth (+ passing money on its way to Wall Street) in the case of the UK. On the back of these streams of money Wall Street and the City created, over the years, yet more money, in the form of financial titles (derivatives and other types of speculations) and in the form of consumer credit backed up by the housing bubble as collateral.
Spreading neoliberalism to the ‘periphery’ – After the USA and the UK this paradigm started to be spread elsewhere. In many Third World countries it was introduced by getting the targeted governments into debt in a foreign currency (dollars) by various means (described at length by John Perkins in his book ‘Confessions of an Economic Hit Man), then suddenly, due to a variety of external factors, there would be a substantial increase in interest rates and a credit crunch leading to default, at this stage the IMF would step in with its infamous conditional bail-out loans that would force the unfortunate country to adopt the full spectrum of neoliberal measures via the so called Structural Adjustment Programs. For more advanced countries the means adopted were more subtle and consisted of political influence mixed with economic pressure (being the USA the main importing market for most countries) but also covert actions, ranging from seriously embarrassing and eventually forcing to resign non compliant governments with scandals of various types and the consequent judicial actions, all the way to producing regime change by organizing and directing social unrest (what later came to be known as ‘colour revolutions’). In other cases more extreme measures were taken, such as military coups and wars. In Western Europe it was the Maastricht treaty and the introduction of the single currency that ushered in the neoliberal paradigm, but some reforms had already been passed in the 80’s.
In parallel to the above developments, starting from the 80’s the neoliberal economic ideology (also known as ‘trickle down’ economics) also started to become dominant in universities, the media and political circles. The new ideology consisted in praising free enterprise as the engine of economic growth, giving credit to the belief that concentrating wealth in few hands would result in increased investments and job creation and, above all, relentlessly demonizing government spending, depicted as the cause of most if not all economic problems. Under the spell of this new ideology, and with the cooperation of subservient governments obtained in the ways previously mentioned, a number of reforms that dismantled the Keynesian paradigm started to be passed everywhere. The most important ones were:
- Independence of the Central Banks from government policy – that is, the central banks are no longer obliged to buy the bonds issued by their own treasury departments. This way governments are forced to borrow money from the financial markets, rather than being able to create it via their Central banks, in order to finance their expenditures (social services but also investments in upgrading their industrial structure, crucial for the long term viability of any economy). This forces governments to keep their spending in check and allows the central banks (formally independent but in reality controlled and often owned by the transnational financial elite) to decide interest rates according to the needs of the financial markets rather than the needs of the people. Slowly but surely the financial markets start to rule economic policy.
- Accordingly, targeting inflation reduction (via austerity and increased interest rates) becomes the first and foremost objective of monetary and fiscal policy, with annexed tolerance for higher rates of structural unemployment, necessary to keep prices in check (via the reduction of wage demands – this is known in economics as the Phillips curve trade off).
- Financial deregulation: basically the abolition of all the measures with which the Keynesian paradigm enforced financial repression. Limits to cross border capital movements are removed, reserve requirements that limit credit creation are lowered and then eliminated etc. etc., all the way to the icing on the cake: the removal of the separation between retail and investment banking which completely opens up the floodgates for financial abuse.
- Abolition of solidarity in international trade: no longer any pressure is exerted on trade surplus countries to keep their trade surpluses in check by adopting expansive monetary and fiscal policies in order to increase their imports and this way help the balance of payments of their trading partners.
- The remit of the international institutions (IMF, World Bank, WTO) radically changes to facilitate the new economic paradigm. Most notably the IMF no longer needs to promote balanced trade but instead is allowed to let trade deficits and the consequent debts get out of control, only to then step in as debt collector of last resort. The familiar pattern becomes that the IMF lends to near bankrupt countries enough money to pay back the financial markets for their unsustainable loans and then imposes on them its infamous Structural Adjustment Programs in order to a) get its money back from the debtor countries and b) gain control over their economic policies and institutions in the bargain.
- Privatizations of public assets along the lines pioneered by Margaret Thatcher in the UK. Most important is the privatization of public banks, which further disables the capacity of the states to create money, to spend it into the real economy and to upgrade their industrial structure.
Financial collapse in the ‘periphery’ – These measures tend to produce a very vicious dynamic in the international economy: weaker economies are increasingly unable to create money and keep interest rates low on their public debt, so as to enable public spending for the purpose of upgrading their technologies. Without such upgrades they become less and less competitive over time, this leads to de-industrialisation and increased trade deficits. The financial markets readily plug the hole in their balance of payments and in their aggregate demand for a while by offering abundant loans for consumption and for real estate bubbles (generally not for upgrading technology, as these investments don’t generate quick returns, and normally need to be undertaken with public money) while making good profits for the financial centres in the process. Eventually the unfortunate countries go bankrupt and are put under administration by the IMF, forced to sell off assets and often reduced to debt colonies. Even stronger countries (such as the Asian Tigers) have fallen prey to this vicious pattern, via opening up their banking systems to the financial markets, letting them inflate asset bubbles only to then go bust when transnational capitals suddenly left.
We now need to take a closer look at the reforms of the banking and financial systems of the neoliberal countries. These reforms turned out to be very instrumental to the circulation of capital which has been keeping the whole unsustainable neoliberal set-up going strong for decades (up until the 2008 crash, and even after it…).
The middle phase: centrality of credit & financialisation
We have seen that there are two main weak points in the neoliberal set-up based on delocalisation: trade deficits, resolved by attracting capital to the deficit countries (but at the cost of having to generate a constant flow of returns for such capital, and thus opening up the economy for rent extraction) and stagnating salaries causing a chronic lack of aggregate demand and therefore constant risk of recession which could easily degenerate into a deflationary spiral. Both problems are temporarily ‘resolved’ by providing abundant consumer credit.
In order to provide this credit, financial deregulation is introduced step by step, and with it also a radical transformation of the banking system which is re-tooled to convey credit in various forms from the financial centres to the wider economy. This is briefly what happened: Banks 1a) slowly dismiss giving credit for production and turn instead to giving credit for consumption; at the same time they 1b) no longer source their money mainly from savers (with stagnating salaries people have no money to save) and source their funding from the financial markets instead. In addition and complementary to this 2a), larger companies turn away from banks and re-orient themselves towards the financial markets to fund expansion (2b while small companies are left progressively high and dry by the banks). This means that the creation and circulation of money changes completely. To understand this change, we must make a comparison with the previous economic paradigm.
Money creation and circulation under the Keynesian paradigm (production based economy) – As this paradigm is based on production, new money is created directly into the real economy and savings (+ pension contributions) are recycled (by the banking system and by the state) as well into the real economy, to produce goods and services. For what concerns savings: they come from families as a result of salaries (therefore as a result of production), are put into the banks or taken by the state in the form of pension contributions, or in exchange for government bonds, then lent to national businesses for production or to the government (to produce public services). Therefore the creation of money is aimed at facilitating the production process, and savings derive from salaries, are recycled by the banking system (and by the state) again into the production cycle (by lending to businesses and to the state that will provide goods and services, pay salaries and so on. To the extent that technologies are improved as part of the production process, higher salaries and better standards of living can also be achieved sustainably. (Production à salariesà savings & pension contributions à banks & state à businesses & state à production of goods & services à salaries…)
Money creation and circulation under the Neoliberal paradigm (finance based economy) – Wages are low and most people have little or no savings, except for pension contributions, which are increasingly privatised and handed over to the financial markets. As we have seen, the money available in the financial markets comes originally from the trade surplus countries (but it also includes profits produced in the neoliberal countries but stashed away in safe havens and conveyed to the financial centres via the shadow banking system). In addition, more money is created by the financial centres and the banking systems, mainly of the ‘core’ countries. To simplify, we can say that all this money is concentrated in the financial markets, then redistributed to large corporations and to the banks and finally to the consumers (and to the states). (Money from trade surplus countries –> financial centres + creation of additional debt money –> large corporations & banks –> consumers (also states) –> buying goods and services (supporting production) in the domestic economy and thus avoiding recessions + buying imports from surplus countries thus closing the loop). Under this paradigm money is concentrated in the financial markets, and enough of it is redistributed to the real economy (businesses, families and states) as debt, in order to support a reasonable level of economic activity, so as to avoid excessive unemployment. It is a consumer focused economy, which doesn’t spend enough on improving technologies, because all the surplus value produced is conveyed to the financial markets (extraction of economic rent). In the previous paradigm the surplus money stayed with businesses (profits) or was conveyed to the state (taxes, pension contributions, bond purchases) and to the banks (savings) and then lent out to businesses to be reinvested back into production. Having to rely on a productive apparatus, rather than on easy credit, meant that states and businesses had to keep up with the competition and spend money on improving technologies, on education, organisation etc., thus generating real growth.
This is an illustration of the two different worlds by Paul Mason (‘Post-Capitalism’ p. 15-16): Go to any British town devastated by industrial decline and you will 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 will find that other gold mine of the poverty-stricken town: the employment agency. In the window you will see ads for jobs at the minimum wage but requiring more than minimum skill..…Just one generation earlier these streets were home to thriving real businesses, with prosperous working class families, full employment, high wages and high productivity. There were numerous street-corner banks, it was a world of working, 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 financialisation. The urban landscape today: outlets providing expensive money, cheap labour and free food (provided by food banks and charities) is the visual symbol of what neoliberalism has achieved. Stagnant wages were integrated by borrowing, our lives were financialised.
This is financialisation, summed up along the lines described by Paul Mason in ‘Post-Capitalism’ (p. 16-17):
1a – Banks gradually reduce lending for production and turn to consumers as a new source of profits. As the productive economy gets downsized, a comprehensive reform of the banking system is passed. Mortgage credit (in the UK previously limited in its total amount by keeping it reserved for building societies only) is deregulated, opening the floodgates of money creation for mortgages (further facilitated by lowering and eventually abolishing fractional reserve requirements, which imposed a limit to the amounts of credit that banks could create). At the end of this process of credit expansion, real estate accounts for approximately 70 per cent of bank lending in the USA and UK, it is by far the largest market for banks. The new business model (credit for consumption replacing credit for production) allows banks to merge and their total number is reduced, as they no longer need to be spread out over the territory to assess and monitor business projects. The new model is more profitable because it requires less work (rather than assessing a business project which requires knowledge of the territory and attention to specific situations, assessing the creditworthiness of a consumer is a task that can be standardised, automated and conducted from a remote location) and carries seemingly less risk as, in the case of mortgages, the housing stock functions as collateral. This is an illusion, as debt not backed up by production and rising salaries carries a systemic risk, but the banks are able to get away with this because they are able to sell their mortgages and consumer loans to the financial markets that turn them into securities and pass them on to a wider public.
1b – Banks turn to the financial markets as a source of funding by selling on to them their loans and mortgages. What happens next is that the financial markets repackage these loans in the form of financial instruments and sell them on to investors far and wide, thus shifting the risk to a much wider environment, like spreading around toxic waste. All simple forms of finance produced by banks (but also other institutions) now generate a market in more 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 (Post Capitalism p. 17).
The financialisation of credits lends itself to further gimmicks in the form of slicing up, re-mixing and repackaging mortgages and consumer loans into more complex financial products. This is called, with a blatant euphemism, financial innovation – when in reality it is nothing short of legalised fraud. These further gimmicks were resorted to in ever greater amounts after the turn of the millennium, when the amount of debt in the economy had reached clearly unsustainable levels. Financial innovation allowed to disguise the real risks and to carry on with the pretence of normality until 2008 (as we will see later).
Even without financial innovation, once converted into securities the loans and mortgages granted by the banks loose their individuality, their connection to specific situations (and risk profiles) and become abstract pieces of paper associated with a given rating (more or less arbitrarily assigned by self appointed rating agencies…) and carrying a specific yield, which is the only thing that really interests investors. This facilitates the circulation of toxic titles, as their yields tend to be high compared to the perceived risk but not when compared to the REAL one. There are two main problems inherent in financialisation:
- It breaks the link between lending and saving. Banks on Main street always hold less money than they lend (deregulation allowed to hold less and less reserves and to play the system) but this new process – whereby every stream of interest gets wrapped up into a financial product, distributed among investors – means ordinary banks are forced into the short term money market just to run their normal operations. With the consequence that the long term nature of their lending (25 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, financialization creates within banking a structural tendency towards the kind of instant crisis of liquidity which destroyed Lehman Brothers (Post Capitalism p. 18)
- The risk of each financial product is hidden to various degrees (depending on the amounts of financial innovation applied) and spread around into the wider financial system where it can build up undetected until it reaches dangerous proportions. Therefore, over and above the tendency to generate liquidity crises, financialization leads to potential insolvency hiding everywhere and undermining the whole financial system to such an extent that a few defaults in a limited area, (such as the infamous subprime mortgage crisis which initially started with a few defaults concentrated in a few US states) have the potential to unleash a complete financial Armageddon.
We need to consider also the obverse side of this change in the business model of banks: consumers became direct participants in the financial markets. Credit cards, overdrafts, mortgages, student loans and motorcar 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. 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 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. (Post Capitalism p. 19-20).
[To sum up: There is a structural transformation of the banking system. In the past banks used to grant mainly business loans and with them they had to assess and monitor the relative projects, and bear the relative risks. With the new paradigm banks are allowed to transform their (mainly consumer) loans into abstract pieces of paper (financial titles) then offload and disperse them in the wider environment like toxic waste (this has been called ‘money manager capitalism’ or ‘coupon pool capitalism’).]
The second aspect of financialisation:
2a) As banks reduce their lending to productive businesses, companies have to turn to the open financial markets to fund expansion. This changes the relationship between companies and their creditors: no longer banks, used to assessing and monitoring the viability of the project and long-term expectations but the impersonal financial markets. The management funds and the investors that buy the shares normally don’t have any interest in the company issuing them and are only interested in their yield. Hence companies are forced to increasingly bend over backwards to produce a quarterly dividend, at the expense of long term viability. Investors in the stock market don’t need to care about long term viability because when the returns start to decline they can always sell on the shares. From the 1980’s onward 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. It is a vicious cycle in which delocalisation and financialisation reinforce each other. (Post Capitalism p. 17) (delocalisation = trade deficits = necessity to attract capital = necessity to produce returns –> banking reform –> drying up of credit to businesses –> financialisation of businesses –> short term view of the shareholders –> cost cutting & asset stripping –> more delocalisation)
There is another perverse aspect: once their shares are up for sale, companies are at risk of becoming targets of hostile takeovers. Having created the risk (by drying up the amount of credit available for productive businesses and forcing them to financialise), banks also play a crucial role in turning it into reality. In the words of Michael Hudson*: banks create credit freely and supply it to corporate raiders for leveraged buyouts or to buy the public domain being privatised. Thus financial managers have taken over industrial companies to create what Hyman Minsky has called ‘money manager capitalism’. Financial operators (corporate raiders) are using credit as a weapon to strip corporate assets on behalf of bankers and bondholders….The plan is to capitalise the targeted enterprise’s cash flow (earning before interests, taxes, depreciation and amortisation) into payments to the bankers and bondholders who advance the credit to buy out existing shareholders (or government agencies in the case of public enterprises, or public infrastructure and monopolies being privatised). Another variant of this pattern is the appropriation of workers’ savings via pension funds and mutual funds, that is, turning over wage set-asides to professional money managers to buy stocks and junk bonds with which they could make financial gains by steering them to inflate stock and bond prices (and indeed, pension-fund savings did fuel a stock market run-up from the 1960s onward). In addition, these savings provided corporate raiders and other financial managers with funds to use to buy up companies and asset strip them – basically turning workers’ pension savings against the workers and against industrial capital itself. Pension fund managers played a large role in the junk bonding of industry in the 1980s. And finding themselves graded on their performance every three months, they back corporate raiders who seek to gain by downsizing and outsourcing labour. They typically find their fortune (and even job survival) to lie in using pension savings not in ways that increase employment, improve working conditions or invest in productive capital formation, but in making gains purely by financial means – corporate looting that strips assets to pay dividends and increase short-term stock prices, or simply to pay off creditors. (It is interesting to note how Hudson here highlights the fact that workers are on both sides of the equation, as pension fund holders seeking high yields, and as employees made redundant in order to produce such yields, thus creating a very alienated and schizophrenic economy. Many commentators have pointed out how transforming ordinary people into investors and landlords has gone a long way towards creating mass consent for a system which ultimately assets strips the whole society).
2b) businesses that are unable to access funds from the financial markets increasingly struggle to make ends meet and tend to die off, merge or are bought up. This leads to concentration of production.
To sum up: in the old system production is central: money is created as a result of it and to facilitate further production and technological upgrades. The national economy strives to be self sufficient and the government coordinates and supports the private sector (banks and businesses) – all three work together (creating money, recycling savings and upgrading technology) in order to maintain a sustainable economic trajectory. In the new system production is relegated to a secondary role and the financial markets become central. They collect the money from the surplus countries, multiply it and redistribute it. States, businesses and consumers alike are dependent on them and have to produce returns in order to keep the money coming: gradually they are stripped of their assets and made ever more dependent. The banking system is re-tooled to become the transmission mechanism of the lifeblood of the system, credit, from the Financial Markets to the wider economy. While in the old system the state had a central role, in the new system the Financial Markets are central, and the state is subject to them. Its legal and institutional apparatus is used as a transmission/enforcement mechanism on behalf of the Financial Markets (besides being asset stripped). The old system is a productive model, the new system an extractive one, and much of the wealth extracted is pre-existent, produced under the old system. Another big part is produced by the exploited workers of the surplus countries, of course.
The mature phase of Neoliberalism: hyper-financialisation & boom and bust cycles
Once financialisation had managed to spread debt well past the limits of sustainability, we can say that the neoliberal paradigm reached its mature phase, and this happened roughly at the turn of the millennium. At that point in the neoliberal countries the new type of economy, in which production is relegated to a secondary place, had largely replaced the old one. As noted before, this arrangement allows substantial savings in the short run (first and foremost on wages, but also on everything that goes with sustaining production such as R&D, infrastructure, education etc.) and thus the possibility to generate good returns for the financial markets and therefore to get abundantly financed by them. The easy credit flowing from the financial markets fuels an ephemeral economic growth based on consumer debt, often accompanied by the familiar phenomenon of real estate bubbles. What tends to happen in most neoliberal countries is a boom and bust cycle known in economics as the ‘Minsky cycle’, from the name of the economist (Hyman Minsky) who first studied and theorised this type of pattern which occurred frequently also in the more distant past, especially at the times of the liberal economic paradigm.
The cycle unfolds as follows: it starts with a situation of low debt and good prospects for the economy (real or presumed). In this situation banks are willing to lend for consumption and mortgages (often the two are closely intertwined, as people tend to re-mortgage and use the extra money for consumption purposes). As a result of increased availability of mortgage credit, land and house prices rise, households are forced to take out larger mortgage loans to get on the housing ladder, while existing homeowners are able to borrow against the value of their homes to boost their consumer spending. These increased loans boost banks’ profits and capital. This enables banks to issue more loans, which further push prices up, facilitating further re-mortgaging and consumer spending. (Often speculative money from abroad also jumps in the band wagon of real estate investment, further reinforcing the upward trend). It all looks safe on paper, as the value of the collateral for these loans, the housing stock, is increasing. Even for the consumer loans that are unsecured, the economic upturn (rising GDP) resulting precisely from consumer spending due to those loans, provides more opportunities for employment and salary increases, therefore making defaults more unlikely. This leads to a booming economy based on debt, resulting in asset prices rising fast, and outpacing by far any salary increases. At some point, however, both the banks and their customers start to realise that the debts are unsustainable (as the ratio of debts to salaries is increasing too fast) and the process goes into reverse. As banks start to lend less and/or consumers start to spend less in order to repay their loans, the prospects for the economy start to decline, prompting banks to lend even less and people to spend even less. As a result asset prices start to go down, further inducing banks towards reducing the value of their outstanding credits (credit crunch), as the value of the collateral is going down. This situation can easily spin out of control and cause a recession, with a few defaults which further induce banks to restrict credit even more and consumers to spend even less, causing further recession, further unemployment, further defaults with consequent deflation of asset prices, negative equity and so on, until the risk of a financial collapse becomes real.
Boom and bust in the periphery – The above pattern occurred in many of the ‘peripheral’ countries, as large amounts of credit were injected in their economies thanks to deregulated cross border capital movements, which were often facilitated by agreements to peg the local currencies to the US dollar in order to reduce the risks for foreign lenders. Pegging the local currencies to a stronger one leads to an overvalued exchange rate, which causes distortions in the economy: loss of industrial production (as tradable goods are no longer competitive in the international markets and businesses producing them tend to shut down) often replaced by a construction boom (real estate is not subject to foreign competition as it can’t be transported), leading to a consumption (and real estate) based economic upturn financed with debt, which eventually ends up with a financial collapse/balance of payments crisis. As mentioned before, these crises were normally managed by the IMF in such a way as to convey further capitals and profits (and economic control) to the main financial centres. These crises punctuated the history of neoliberalism throughout the 80’s, 90’s and 2000’s and their fall out (asset stripping and capital flights) contributed to the further fattening of the financial markets, but were generally dismissed by the media and mainstream economic analysts as the effect of economic mismanagement by corrupt governments, rather than a systemic feature of the neoliberal paradigm chosen or, more often, imposed on the unfortunate countries in question.
Boom and bust in the core countries – Conversely, in the countries that have the ‘privilege’ of owing debts denominated in their own currencies, policy makers adopted a different strategy: they made sure that the downside of the cycle was delayed as long as possible, by boosting the amount of credit available in the economy with expedient upon expedient.
We already mentioned the relaxation and eventual abolition of reserve requirements (from above 20% in most countries during the 70’s to only 8% with the Basel I accord of 1988, and then pretty much abolished with the Basel II accord of 2004). This opened the floodgates of debt money creation. Then starting from the early 2000’s a major acceleration was given to this process, by opening up the floodgates of toxic asset creation, by means of what was called ‘financial innovation’. As the debts had become clearly unsustainable, creative finance came to the rescue by using the securitisation of loans to alter the perception of risk. We already mentioned that every stream of income (obviously mortgages and car loans, but also utility bills, gym membership etc. etc.) gets wrapped up into a more complex financial product. Increasingly the practice took hold of slicing up and re-combining these loans into more complex and opaque financial products, containing safer and less safe slices, which would then be sold on to a wide range of investors (banks and governments, management funds, pension funds, local authorities, private wealthy individuals etc. etc.) scattered far and wide around the world, thus dispersing and hiding the risk. This allowed the quantity of money created as mortgages and consumer credit to soar by lowering interest rates (as the perceived risk was low), by raising loan to income ratios, and by expanding the pool of customers to include people with low or insecure incomes (subprime borrowers). 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 grew from $160 to 600 billion. And ‘adjustable mortgages’, which start with low interest and become more expensive as time goes on, came from almost zero to 49 percent of all loans issued in the last 3 years before 2008. This market for risky, complex, doomed-to-fail borrowing did not exist until investment banks created it (Post Capitalism p. 18). Further down the line, when even more debt was needed to avoid a downturn (but also to gain easy money to the financial operators, as the abuse of the system is also part of the problem), more toxic assets, called derivatives, were generated on the basis of the existing ones, in which risk would be further hidden behind complex calculations. In the run up to 2008 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. We thus have an explosion of private money creation in the form of credit and increasingly in the form of toxic assets, only very loosely related to some imaginary growth supposedly taking place (or about to take place) in the real economy…
The role of government – Behind this apparent madness (and greed) of the financial operators there was always the ‘invisible hand’ of government support. By repealing the Glass Steagall Act in 1999 (the separation of investment banking from retail banking) the American government gave the financial sector an implicit guarantee. Allowing to mix speculative activities (the purview of investment banking) with a basic public service, running the payment system of the country and storing people’s savings (the purview of retail banking) meant a free licence to create toxic assets because, if things should get out of control, it was obvious to all concerned that the government would have no choice but to bail out the financial system.
For the entire duration of the neoliberal paradigm, there has always been another great help from the ‘invisible hand’ of the central authorities, in this case the Federal Reserve (and other central banks): a long stretch of loose monetary policy which has become known as ‘The Great Moderation’ (so called because it smoothed out, or moderated economic cycles). In the words of Paul Mason (Post Capitalism p.12): 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. 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 34x and 45x earnings. If money is a ‘link to the future’ [quotation from Keynes] 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: 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 US 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 [asset price] inflation.’ Therefore with very loose monetary policy the USA (and the UK as well) monetary authorities managed to keep the prices of financial assets (and real estate) high and rising and avoided a crisis of confidence that might easily spin off into a financial crash. Essentially the central banks managed to interrupt, by progressively lowering interest rates, all attempts by the private sector to lower its debt-to-income ratio and bring it to a more sustainable level. Financial operators knew that the financial markets had increasingly become a Ponzi scheme, but they kept on selling and buying their toxic financial products for as long as there was money to be made (at this stage mainly in the form of capital gains deriving from asset price inflation), in the knowledge that it could not last for much longer.
To keep this unstable arrangement in place for as long as possible governments tended to lend another helping hand by accompanying loose monetary policy with a tighter fiscal policy (that is, low government spending in the real economy to stabilise the system by keeping trade deficits in check and inflation low), along with further privatisations of public assets to generate more revenues for investors. We could say that the policy adopted to prolong the life of the neoliberal paradigm as long as possible was a combination of overabundant fiat money for the financial markets, and ‘gold standard’ for the real economy (that is, maintaining the value/credibility of the neoliberal currencies by making them scarce, rather than by backing them up with increased production).
However, lack of growth and stagnating salaries in the real economy (also due also the fact that the only major technological breakthrough generated in this time, the IT and communication revolution, has not created but destroyed good jobs), eventually led to the inescapable moment of truth: a few ‘subprime’ borrowers (people with low paid and unstable jobs, a feature which had been rising steadily in the neoliberal economy….) started to default on their mortgages and the whole house of cards came down in 2008. Household debt had become too large, and a few defaults in the USA had the power to set off a chain of reactions that the central banks were no longer able to offset with further interest rate cuts.
The post-2008 phase: the neoliberal paradigm on life support – Secular Stagnation
Bail outs – The bankruptcy of the main neoliberal financial centres was avoided by means of the so called ‘bail outs’ provided first by the US and UK, then by other governments. In other words, having let private debt inflate to breaking point, neoliberal governments had to take a large part (the defaulted part) of it off the balance sheets of their banking systems and convert it into safer public debt. The Eurozone governments (including the German and French ones) proceeded to do the same but some countries didn’t have enough money and needed help – this marked the start of the Eurozone crisis. Overall, this major failure of the financial system was digested and absorbed by both the financial markets and the general public without excessive fuss, the media made a bit of clamour about the ‘banksters’ for some time, and there was some talk of re-regulation but eventually it was watered down. In the end there was neither a serious investigation and debate over what had happened, nor any substantial U-turn in policy measures. Quite the opposite, the monetary authorities carried on with business as usual. This is how Paul Mason describes what took place (Post Capitalism p. 13):
Post bail-out policy part I: Quantitative Easing – 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 [the infamous Fanny Mae and Freddy Mac], 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 euros. [Paul Mason estimates] the total amount of money printed globally, including that pledged by the ECB, at around $12 trillion – one sixth of global GDP. It worked, in that it prevented 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 happened is that, having allowed government debt to increase out of proportion due to the 2008 bank bail outs, now with the Quantitative Easing (QE) program (worth £375 billion in the UK) it was being brought back to a more reasonable level, and the money thus created ended up in the balance sheets of the banking system, allowing them to offset their toxic assets. In addition, the Fed and other central banks directly bought from private banks another portion of their toxic assets. The injection of new money managed to stabilize the system and avoid a major depression, but now the king was really naked: what the operators had known for quite a while (that this boom fuelled by a credit binge could not go on for much longer) was now obvious to anybody who wanted to see it. This is why, despite the media making no mention of its real gravity (and tending to blame only ‘bad apples’ for what had happened), the financial collapse of 2008 truly represents a watershed, a colossal and game changing default, although the authorities and the media have been treating it as an incident, however serious and caused by widespread corruption, but in any case only an incident, not a physiological collapse. It was patched up and covered up with tons of money creation not unlike the 1971 default (the so-called ‘closing of the gold window’ that was as well resolved with money creation – mainly of the positive type, however, not credit money) but the creditors (the surplus countries) were not fooled.
Post bail out policy part II: more Great Moderation – In the following years, in order to allay any fears that might cause another, this time truly terminal collapse, our policy makers had no other alternative but to resume their long standing policy of Great Moderation, this time with a twist. Having already lowered their base interest rates to nearly to zero, in order to push an already overleveraged economy to get into more debt, they had to resort to additional incentives and subsidies (such as the ‘Help to Buy’ scheme in the UK). With all this help (QE + near zero interest rates + various direct incentives) a few years after 2008 lending resumed at a sustained pace, thus generating more asset price inflation, for the joy of those foreign investors who might otherwise leave the scene (and for the grief of ordinary people such as first time buyers priced out of the housing market). Yet these investors are only lingering on for as long as the ‘fake’ (by now clearly debased) money keeps on coming and for as long as a viable alternative is not ready yet. In other words, neoliberalism is now being kept on life support, and quite literally living on borrowed time.
Secular Stagnation – to understand why neoliberalism has reached the end of the road we need to go back to the division between surplus (or neomercantilist) countries and deficit (or neoliberal) ones. As mentioned before, what made possible for a number of countries to delocalise production and keep wages low and profits high while accumulating trade deficits and unsustainable debts, was that a number of countries did exactly the reverse, they accumulated trade surpluses and invested the relative profits in the financial markets, with the somewhat misguided belief that they would be able to obtain good rates of return and the safety of their assets as well.
With the 2008 financial collapse this tidy arrangement, which keeps wages low across the board (thus redistributing wealth to the top layers of society), and good rates of return (higher than economic growth) for financial capital globally, has broken down as low growth and high debt in the deficit countries makes lending to their consumers no longer safe. The media have talked quite a bit about the ‘banksters’ and their abuses, but never mention the obverse side of the picture: the creditor countries. What has happened is that on the quiet, without screaming default or forcefully asking for their money back (except from countries such as Greece and the other PIIGS) during the post-2008 years they have sensibly reduced financing consumer spending of their trading partners and started buying safe assets instead. This is how Paul Mason puts it (Post Capitalism p. 21): in the wake of the 2008 crisis, the [global] current account imbalance has fallen back – from 3 per cent of global GDP to 1.5 per cent. …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…..Post 2008, the shrinking current account deficit has persuaded some economists that the risk posed by the imbalances is over. 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. Global foreign exchange reserves had likewise grown from under $8 trillion to approaching $12 trillion by late 2014.
The [trade] imbalances always posed two distinct dangers. First, that they would flood the 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. [Paul Mason here refers to the collapse of the current, dollar dominated, international monetary system]. If the USA cannot go on financing its debts [mainly with QE now that toxic assets are no longer trusted and real growth is nowhere in sight] then at some point the dollar will collapse. 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.
There are several issues touched upon by Paul Mason here: 1) trade imbalances (and therefore the instability of the system) are being reduced, but at the price of prolonged stagnation; 2) the danger of a new collapse, which would result in a new and this time lethal debasement of the currencies involved, with the necessity to renegotiate a new international monetary system (involving a new geopolitical hegemony), is being staved off with all possible means by the neoliberal core countries, but it still exists and cannot be eliminated; 3) the vested interests (or ‘mutual dependence’) that the neomercantilist countries still have in the current system (and their desire for an orderly transition) makes sure that the trigger is not pulled by the creditors for the moment; 4) by building up their reserves the surplus countries are taking up insurance policies against the collapse of the system but, what Paul Mason doesn’t mention, at the same time they are also working in various ways towards its replacement; Now we need to examine these points one by one.
1) Basically the surplus countries no longer trust their debtors and therefore are cutting down on the purchase of financial titles representing consumer credit to neoliberal countries. This results in decreased exports and therefore a long standing economic slow down for both deficit and surplus countries, what has been called by Larry Summers (Treasury Secretary under the Bill Clinton Administration) ‘Secular Stagnation’. This is in all likelihood the last phase of the neoliberal paradigm, as proper growth cannot be revived by an economy based on downsizing production, therefore we can say that the system is now simply being kept on ‘life support’ (with injections of debased money in the centre and punctuated by various bankruptcies in the periphery).
2) At the same time the ‘core’ neoliberal countries (or rather the elites ruling them) have a strong vested interest in maintaining the current economic paradigm (and the relative geopolitical order) in place. They strive to maintain it on ‘life support’, with the familiar combination of a) loose monetary policy (low interest rates, QE etc.) for the financial market,s to keep investors happy mainly with capital gains (asset price inflation) and thus avoid capital flights and b) austerity for the real economy, whose main objective is to keep imports, and therefore trade deficits, under control, and this way maintain the credibility of the current international monetary arrangements (the dollar standard). Austerity is imposed more strictly to the periphery (with its corollary of asset price deflation, bankruptcy and sale of assets to repay creditors). There is another, more ominous and non-economic measure that is being applied to keep neoliberalism on life support: c) making sure that there is no alternative (i.e. destabilising both politically and militarily those countries, such as the ones with strategic positions along the BRI projects, that might coagulate around Russia and China to set up an alternative trading and monetary block). We have thus entered a phase of transition, in which the austerity that has been implemented to various degrees in the deficit countries, while reducing trade imbalances (current accounts deficits diminished from 3% of global GDP in 2008 to 1.5% in 2015) also reduces the volume of economic activity across the board, causing recessions, poverty, and failure of public and private finance in various states. This prolonged recession of the world economy (or secular stagnation) is not likely to end until the economic paradigm is changed.
3) there is an additional factor, coming from the neomercantilist countries, which also contributes to keeping neoliberalism on ‘life support’: their vested interest in the current system (as their elites, but also their governments, have huge amounts of money invested in it) and in an orderly transition. But we must not lose sight of the fact that, although at the moment they are co-operating in keeping the current monetary system in place, at the same time they are also working on the creation of an alternative. (A serious danger for the elites, but a possible source of political opportunity for the Western masses.)
4) Thus we are currently mired in a situation in which deficit countries are forced to stagnate, with high social costs, in order to reduce their trade deficits while surplus countries are no longer exporting as much as they did before and are sitting on a pile of cash, invested less and less in the stock market (in the likes of subprime mortgages, derivatives etc.) and kept instead either in real assets (buying up prime real estate, as well as public and private assets of the neoliberal countries, but also the so called ‘land grab’ in third world countries, and finally more liquid assets such as art, or even crypto-currencies) or in assets that are, officially or unofficially, part of the international monetary system: foreign exchange reserves (government bonds) and gold reserves . We have what Mark Blyth (professor of International Political Economy at Brown University, USA) has called a global saving glut. This is the obverse side of the mountain of debt in the real economy (governments, businesses and households) of the deficit countries. Thus we have a mountain of ‘savings’ in the financial economy, stored in safe assets and unable (for well justified lack of trust) to go back into the real economy in the form of investment in productive capacity, so as to reproduce the world economic cycle (GDP) to its previous levels. In other words, the world economy has stalled, and it’s not possible to restart it while maintaining the neoliberal paradigm in place.
This is because neoliberalism has a fatal flaw in its very design: being based on delocalisation of industry, with consequent trade deficits translating into ever growing levels of household debts and government debt, when it produces high growth it can do so only by fuelling unsustainable imbalances, which are then corrected by financial crises. The only way to reduce trade imbalances is to compress the normal form of neoliberal growth: debt fuelled growth. This paradigm is great to achieve wealth redistribution towards the top and it has succeeded brilliantly, but it is inherently unstable and prone to collapse. It seems to have now fully exploited the potential granted by the situation it inherited from the previous economic order: starting from high interest rates and low debt, interest rates have now been lowered to nearly zero (and in some cases below zero) and debt is at an all time high, the real economies of the debtor countries are not growing and thus unable to take on more debt: we seem to have reached the end of the road. The neoliberal paradigm is broken and cannot revive growth without reviving financial fragility. What are the options then?
Basically since 2008, and with considerable acceleration since 2016 (the year of Brexit and the election of Donald Trump) we have entered a phase of transition like the one entered after 1971. Back then there was a default on the promise to convert dollars into gold, now there has been a default on the fraudulent promises of the US dominated financial system. Both ended up with inflation, in the first case consumer price inflation, as the Keynesian paradigm was based on the real economy, in our current case asset price inflation, as neoliberalism is based on the financial economy. The big difference is that while post 1971 American hegemony was still alive and well (only its economic hegemony had come to an end) and therefore its policy makers were able to engineer a new paradigm which would allow them to maintain control of the world economy by controlling its financial flows, nowadays American hegemony seems to have spent all its potential (economic, financial and increasingly also military and geopolitical). In addition, while political opposition to the status quo (what has been dubbed as ‘populism’) is growing in the neoliberal countries (and not only them), the surplus countries are working on creating an alternative. Therefore the current phase of transition is seeing (and will continue to see for some time) various antagonistic forces (social classes as well as countries) pulling in different directions, giving rise to dangers and opportunities alike, and with the final results still very open and unpredictable. We will examine the transition in the next chapter.
A final assessment of neoliberalism
From the very beginning of this essay I emphasised the unsustainability of this economic paradigm as, being based on dismissing production and living on debt, it was bound to eventually hit a wall. At this point the reader might wonder what might have been the point of the whole endeavour. Why pour so much effort in the design of such a clever wealth and power concentration mechanism, as well as in its slow, gradual and painstaking implementation if in the end if was all doomed to failure?
The answer to this question is political: the end game of neoliberalism is not neoliberalism itself, the end game is full control of the world economy and of formerly sovereign states. To understand this you don’t need to be a conspiracy theorist but only to analyse the evidence, as any good investigator would do. Under this paradigm based on debt slowly but surely small businesses and small banks close down and economic activity gets centralised in a small number of ever larger units, whose shares are traded in the financial markets. States are unable to create money, to keep their productive apparatus up to date, and to control their own economies. The Financial Markets sit at the heart of a globalised economy in which productive units have been decimated, state intervention has been disabled, and the lifeblood that keeps the world economy alive can only be pumped by them, the Glorious Financial Markets – along with their side-kicks, the central banks of the core countries. The only glitch in this design is its dependence on the surplus countries. If they are small and not very well connected they can be kept at bay. If they are big they could be surrounded, destabilised and perhaps even fragmented. End of the story. Or rather ‘The End of History’. Unfortunately for the architects of neoliberalism, things have not quite worked out that way: history seems to be alive and well, and we now need to turn to the next chapter, the possible transition to a new paradigm and to a new world order.