Crashed by Tooze

Over the summer of 2015 the Fed prevaricated, but at the September FOMC meeting the question could no longer be dodged. The majority of analysts expected the Fed to move rates up a notch. But then came the shock devaluation of the yuan and the second slide in the Shanghai Stock Exchange. Whatever the limitations on the Fed’s mandates, markets were global. They could not ignore the threat from China. On August 24 America’s Dow Jones lost 1,000 points and the Fed pulled back. The normalization of US monetary policy was put on hold and Janet Yellen made no secret of the board’s reasoning. Instability in China was the key. In the press conference on September 18, 2015, as she explained the FOMC’s decision, journalists counted Yellen making six references to China and ten to “global” factors. Unlike in 2013, when it had been India and Turkey under pressure, the risk of spillback from China to the United States was too important to be ignored. Indeed, the effect of Chinese deflation on the world economy was so powerful that there was no need for the Fed to pile on with its own interest rate increase. ...

Germany’s savings appear as the counterpart to Spain’s trade deficit. ​But accounting identity is not the same as causal relationship. It wasn’t Germany’s excess savings, or its exports, that produced the boom in Spain. It was the lopsided credit-fueled boom that produced the demand imbalances, the trade flows and the savings imbalances. Europe’s banking system provided elastic intermediation. Had Germany’s domestic economy been in more robust shape, Germany’s demand for imports would have been larger, and the trade imbalances within the eurozone might have been smaller. A somewhat larger fraction of the Spanish economy might have been directed toward producing goods for export to Germany rather than supplying the domestic boom. But there is no reason to think that a smaller flow of net savings from a more rapidly growing Germany would have done much to slow the credit-fueled upswing in Ireland or Spain. In modern finance, credit is not a fixed sum constrained by the “fundamentals” of the “real economy.” It is an elastic quantity, which in an asset price boom can easily become self-expanding on a transnational scale. ...

52 percent of the mortgage-backed securities sold to the Fed under QE were sold by foreign banks, with Europeans far in the lead. ...

During the height of the crisis in 2008–2009, the West was, frankly, neglectful of Eastern Europe, despite the fact that talk of NATO expansion had led to a war with Russia in Georgia only weeks before the outbreak of the crisis in August 2008. In 2009, significantly, it was veterans of the George H. W. Bush administration who were warning that Eastern and Western Europe were once more at risk of dividing. Then, in 2013, the EU sleepwalked into confrontation with Putin ​over Ukraine. And all of this at a moment when the Obama administration was pushing TPP, seen in Beijing as aggressive containment, and Japan and China were confronting each other over rocky islands in the East China Sea.

No doubt the Trump administration is unpredictable, but it was on Obama’s watch, with Hillary Clinton as secretary of state, that relations with Russia and China escalated to this degree. ...

Against the backdrop of the TARP debacle and the shambles in Europe, Gordon Brown’s scheme looked like a breakthrough. From New York, Paul Krugman lavished praise on Britain’s Labour government. Britain’s Social Democrats had figured out how to rescue financial capitalism. It certainly helped that the Labour government was less averse to nationalization than Hank Paulson was. Less charitably it might be said that since the 1990s, New Labour, like the Democrats in the United States, had entered into an enthusiastic partnership with the City of London. It was, therefore, ​no coincidence that it was now Labour in Britain and the Democrats in the United States who were showing such energy in the struggle to fix the banking crisis. It was a monster they had helped to create ...

With the Republicans deeply divided, on September 24 McCain suspended his campaign and announced he was returning to Washington to take the lead in “fixing” the crisis. In the Treasury and the White House this caused panic. The markets were in a febrile mood. No one knew what McCain had in mind. What was certain was that it would stir up the Republican base. Startled at the news, Paulson screamed into his Motorola, demanding that the White House get a grip on “their” candidate. Bernanke was so alarmed by the intensity of the political power play that he thought it better to withdraw to the safety of the Fed. In the end it took interventions by the White House chief of staff and major Republican donors, including Henry Kravis, the private equity billionaire, J.P. Morgan vice chair James Lee and John Thain of Merrill Lynch, to hold McCain in line. But this left McCain tongue-tied, torn between the demands of “the system” and the populist groundswell that Palin was rallying to his cause. In the climactic meeting of the two candidates with the Bush administration on September 25, a meeting called at McCain’s request, the Republican candidate literally had nothing to say. ...

[T]he United States was set back on track. The leadership of American finance renewed itself. Even when viewed narrowly in accounting terms, many of the Treasury and Fed support programs made a profit for the American taxpayer. The benefits of preventing a second Great Depression were vast. [..] But its economic merits are not so obvious as its proponents presume. And it offered no comfort to the advocates of laissez-faire.

Gone were the days when economic policy was about shrinking the state to set free the spontaneous order of market liberty. No longer did wisdom lie in devising predictable rules to curtail the arbitrary discretion of policy makers. [..T]here was a political price to pay. The crisis fighting of 2008–2009 scrambled American politics. The Bush administration lost the backing of much of the congressional Republican Party. The crisis snapped the fragile bond between the GOP’s managerial, big-business elite and its right- wing mass base. As the popular wing of the party, backed by maverick oligarch donors, moved increasingly toward indignant anti-establishment opposition, mainline conservatives like Bernanke and Paulson were left to complain that it was not they who left the party, but the party that left them. The Bush administration’s crisis-fighting effort was carried by the Democratic Party’s majorities in Congress. [..T]he fracture of the American Right would in due course have profound consequences both for America and for the wider world.