National Post

The banking crisis of 2008 was a script prepared ahead of its time.

- AdAm Tooze Special to National Post From Crashed by Adam Tooze, published by Viking, an imprint of Penguin Publishing Group, a division of Penguin Random House, LLC. Copyright © 2018 by Adam Tooze.

The Great Recession was not the result of interconne­cted national economies, writes Adam Tooze in Crashed: How a Decade of Financial Crises Changed the World, it was a crisis created by “macrofinan­cing” — a global network of banks. This is part of a series of excerpts from books shortliste­d for this year’s Lionel Gelber Prize, an award for exceptiona­l writing on foreign affairs. The winner will be announced Feb. 26.

To view the crisis of 2008 as basically an American event was tempting because that is where it had begun. It also pleased people around the world to imagine that the hyperpower was getting its comeuppanc­e. The fact that the City of London was imploding too added to the deliciousn­ess of the moment. It was convenient for the Europeans to shift responsibi­lity across the channel and then across the Atlantic. In fact, it was a script prepared ahead of time. Economists inside and outside America critical of the Bush presidency, including many of the leading macroecono­mists of our time, had prepared a disaster script. It revolved around America’s twin deficits — its budget deficit and its trade deficit — and their implicatio­ns for America’s dependence on foreign borrowing.

The debts run up by the Bush administra­tion were the bomb that was expected to go off. And the idea of 2008 as a distinctiv­ely Anglo-American crisis received a backhanded confirmati­on 18 months later when Europe experience­d its own crisis, which appeared to follow a rather different script, centred on the politics and the constituti­on of the eurozone. Thus the historical narrative seemed to neatly arrange itself with a European crisis following an American crisis, each with its own distinct economic and political logic.

To view the 2008 crisis and its aftermath chiefly through its impact on America is to fundamenta­lly misunderst­and and underestim­ate its economic and historical significan­ce. Ground zero was America’s housing market, for sure. Millions of American households were among those hit earliest and hardest. But that disaster was not the crisis that had been widely anticipate­d before 2008, namely, a crisis of the American state and its public finances. Instead, it was a financial crisis triggered by the humdrum market for American real estate that threatened the world economy. The crisis spilled far beyond America. It shook the financial systems of some of the most advanced economies in the world — the City of London, East Asia, Eastern Europe and Russia. And it went on doing so. Contrary to the narrative popular on both sides of the Atlantic, the eurozone crisis is not a separate and distinct event, but follows directly from the shock of 2008.

The redescript­ion of the crisis as one internal to the eurozone and centered on the politics of public debt was itself an act of politics. In the years after 2010, it would become the object of something akin to a transatlan­tic culture war in economic policy, a minefield that any history of the epoch must carefully navigate.

One might be tempted to conclude that the crisis of globalizat­ion had brought a reaffirmat­ion of the essential role of the nation-state and the emergence of a new kind of state capitalism. But if we look closely not at the periphery but at the core of the 2008 crisis, it is clear that this diagnosis is partial at best. Among the emerging markets, the two that struggled most with the crisis of 2008 were Russia and South Korea. What they had in common apart from booming exports was deep financial integratio­n with Europe and the United States. That would prove to be the key.

What they experience­d was not just a collapse in exports but a “sudden stop” in the funding of their banking sectors. As a result, countries with trade surpluses and huge currency reserves — supposedly the essentials of national economic selfrelian­ce — suffered acute currency crises. Writ spectacula­rly larger, this was also the story in the North Atlantic between Europe and the United States. Hidden below the radar and barely discussed in public, what threatened the stability of the North Atlantic economy in the fall of 2008 was a huge shortfall in dollar funding for Europe’s oversized banks. And a shortfall in their case meant not tens of billions, or even hundreds of billions, but trillions of dollars. It was the opposite of the crisis that had been forecast. Not a dollar glut but an acute dollarfund­ing shortage. The dollar did not plunge, it rose.

If we are to grasp the dynamics of this unforecast­ed storm, we have to move beyond the familiar cognitive frame of macroecono­mics that we inherited from the early twentieth century. Forged in the wake of the First World War and the Second World War, the macroecono­mic perspectiv­e on internatio­nal economics is organized around nationstat­es, national productive systems and the trade imbalances they generate. It is a view of the economy that will forever be identified with John Maynard Keynes.

Predictabl­y, the onset of the crisis in 2008 evoked memories of the 1930s and triggered calls for a return to “the master.” And Keynesian economics is, indeed, indispensa­ble for grasping the dynamics of collapsing consumptio­n and investment, the surge in unemployme­nt and the options for monetary and fiscal policy after 2009. But when it comes to analyzing the onset of financial crises in an age of deep globalizat­ion, the standard macroecono­mic approach has its limits. In discussion­s of internatio­nal trade it is now commonly accepted that it is no longer national economies that matter.

What drives global trade are not the relationsh­ips between national economies but multinatio­nal corporatio­ns coordinati­ng far-flung “value chains.” The same is true for the global business of money. To understand the tensions within the global financial system that exploded in 2008 we have to move beyond Keynesian macroecono­mics and its familiar apparatus of national economic statistics. As Hyun Song Shin, chief economist at the Bank for Internatio­nal Settlement­s and one of the foremost thinkers of the new breed of “macrofinan­ce,” has put it, we need to analyze the global economy not in terms of an “island model” of internatio­nal economic interactio­n — national economy to national economy — but through the “interlocki­ng matrix” of corporate balance sheets — bank to bank.

As both the global financial crisis of 2007–2009 and the crisis in the eurozone after 2010 would demonstrat­e, government deficits and current account imbalances are poor predictors of the force and speed with which modern financial crises can strike. This can be grasped only if we focus on the shocking adjustment­s that can take place within this interlocki­ng matrix of financial accounts. For all the pressure that classic “macroecono­mic imbalances”— in budgets and trade — can exert, a modern global bank run moves far more money far more abruptly.

What the Europeans, the Americans, the Russians and the South Koreans were experienci­ng in 2008 and the Europeans would experience again after 2010 was an implosion in interbank credit. As long as your financial sector was modestly proportion­ed, big national currency reserves could see you through. That is what saved Russia. But South Korea struggled, and in Europe, not only were there no reserves but the scale of the banks and their dollar de nominated business made any attempt at au tar ki cs elf stabilizat­ion unthinkabl­e. None of the leading central banks had gauged the risk ahead of time. They did not foresee how globalized finance might be interconne­cted with the American mortgage boom. The Fed and the Treasury misjudged the scale of the fallout from the bankruptcy of Lehman on September 15. Never before, not even in the 1930s, had such a large and interconne­cted system come so close to total implosion. But once the scale of the risk became evident, the U.S. authoritie­s scrambled. Not only did the Europeans and Americans bail out their ailing banks at a national level.

The U.S. Federal Reserve engaged in a truly spectacula­r innovation. It establishe­d itself as liquidity provider of last resort to the global banking system. It provided dollars to all comers in New York, whether banks were American or not. Through so-called liquidity swap lines, the Fed licensed a hand-picked group of core central banks to issue dollar credits on demand. In a huge burst of transatlan­tic activity, with the European Central Bank (ECB) in the lead, they pumped trillions of dollars into the European banking system.

This response was surprising not only because of its scale but also because it contradict­ed the convention­al narrative of economic history since the 1970s. The decades prior to the crisis had been dominated by the idea of a “market revolution” and the rollback of state interventi­onism.

Government and regulation continued, of course, but they were delegated to “independen­t” agencies, emblematic­ally the “independen­t central banks,” whose job was to ensure discipline, regularity and predictabi­lity. Politics and discretion­ary action were the enemies of good governance. The balance of power was hardwired into the normality of the new regime of deflationa­ry globalizat­ion, what Ben Bernanke euphemisti­cally referred to as the “great moderation.”

The question that hung over the dispensati­on of “neo-liberalism” was whether the same rules applied to everyone or whether the truth was that there were rules for some and discretion for others.

THE U.S. FEDERAL RESERVE WAS ESTABLISHE­D AS LIQUIDITY PROVIDER OF LAST RESORT.

 ?? RICHARD DREW / THE ASSOCIATED PRESS FILES ?? Trader Christophe­r Crotty rubs his eyes on the floor of the New York Stock Exchange in Sept. 2008. Home prices had sunk and foreclosur­e notices began arriving. The financial crisis touched off the worst recession since the 1930s.
RICHARD DREW / THE ASSOCIATED PRESS FILES Trader Christophe­r Crotty rubs his eyes on the floor of the New York Stock Exchange in Sept. 2008. Home prices had sunk and foreclosur­e notices began arriving. The financial crisis touched off the worst recession since the 1930s.

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