Exploring the Global Financial Crisis 9781626370814

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Exploring the Global Financial Crisis

Advances in International Political Economy Series Editors

Alan W. Cafruny and Herman M. Schwartz

Chris May Lancaster University

International Advisory Board

Nicola Phillips University of Sheffield

Claire Cutler University of Victoria Robert Jessop Lancaster University

Henk Overbeek Free University of Amsterdam

Magnus Ryner Kings College, University of London

Heiki Patomaki University of Helsinki

Bob Denemark University of Delaware

Leonard Seabrooke Copenhagen Business School

Leila Simona Talani Kings College, University of London

Linda Weiss University of Sydney

Mark Beeson University of Western Australia

Jacqui Best University of Ottawa

David Rapkin University of Nebraska

Diana Tussie Facultad Latinoamericana de Ciencias Sociales, Buenos Aires

Jim Mittelman American University

Johnna Montgomerie University of Manchester

Exploring the Global Financial Crisis edited by

Alan W. Cafruny Herman M. Schwartz

b o u l d e r l o n d o n

Published in the United States of America in 2013 by Lynne Rienner Publishers, Inc. 1800 30th Street, Boulder, Colorado 80301 www.rienner.com and in the United Kingdom by Lynne Rienner Publishers, Inc. 3 Henrietta Street, Covent Garden, London WC2E 8LU © 2013 by Lynne Rienner Publishers, Inc. All rights reserved

Library of Congress Cataloging-in-Publication Data Exploring the global financial crisis/edited by Alan W. Cafruny, Herman M. Schwartz. (Advances in international political economy) Includes bibliographical references and index. ISBN 978-1-58826-860-0 (alk. paper) 1. Financial crises. 2. Global Financial Crisis, 2008–2009. I. Cafruny, Alan W. II. Schwartz, Herman M., 1958– HB3722.E984 2012 330.9'0511—dc23 2012025376 British Cataloguing in Publication Data A Cataloguing in Publication record for this book is available from the British Library.

Printed and bound in the United States of America The paper used in this publication meets the requirements of the American National Standard for Permanence of Paper for Printed Library Materials Z39.48-1992. 5

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Contents

1 Exploring the Global Financial Crisis, Alan W. Cafruny and Herman M. Schwartz

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Part 1 The Crisis in the Global Economy

2 The Crisis of the Eurozone, Alan W. Cafruny and Leila Simona Talani

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3 The Dollar and East Asia—the Endgame? R. Taggart Murphy

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4 The Missing Crisis in Latin America, Peter Kingstone

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5 Migration and Remittances, Ariane Chebel d’Appollonia

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Part 2 The Crisis and US Hegemony

6 China and the United States in the Battle for Jobs and Growth, Herman M. Schwartz

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7 Oil and the Sino-American Rivalry, Timothy Lehmann

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8 Can the Euro Rival the US Dollar? Hubert Zimmermann

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Part 3 Critical Views of the Crisis

9 The Crisis of Home-Centered Consumer Capitalism in the United States, Maria N. Ivanova

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10 Working Classes and Transnational Change, Magnus Ryner and Matt Davies

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11 Why Does It Happen Again and Again? Anastasia Nesvetailova

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References The Contributors Index About the Book

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1 Exploring the Global Financial Crisis Alan W. Cafruny and Herman M. Schwartz

In July 2007 IKB Deutsche Industriebank, a relatively small German financial firm, collapsed as a result of losses incurred by borrowing short term to invest in complex, long-term derivatives built on US mortgages. At a time when many commentators were celebrating the emergence of a new economy characterized by efficient and self-correcting financial markets, IKB Deutsche’s collapse appeared to be an idiosyncratic or nonsystemic event. Even the chronically sluggish European economy was showing signs of life amid the long capital markets boom that followed the bursting of the hightech bubble at the beginning of the decade. The German state and banks rallied to the firm’s defense, ultimately providing 5 billion euros in emergency lines of credit. Yet the implosion of the US housing market that started just one month later showed that, far from being idiosyncratic, IKB Deutsche Industriebank’s troubles were a prelude to the most prolonged and serious global financial crisis since the Great Depression. In August 2007 the global securitization market for US mortgages began to lock up. Many European banks had bet heavily on the US subprime market. As the crisis deepened, major banks on both sides of the Atlantic began to fail, disproving assertions that the European economy was “de-coupling” from the United States (International Monetary Fund 2007). As global trade and financial flows plummeted, observers drew comparisons to the Great Depression. By the summer of 2008, one of the largest British mortgage lenders, Northern Rock, went bankrupt and was taken under government control. The fall of Lehman Brothers Bank in September 2008 pushed global stock markets into free fall as the US government bought AIG, the United States’ leading insurer; nationalized mortgage giants Fannie Mae and Freddie Mac; and took a controlling interest in Chrysler and General Motors. In Britain, contemporary news photos showed the public lined up in front of Northern Rock’s branches, evoking the classic bank panics of the 1930s. Inside the boardrooms of the large

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financial firms a similar dynamic was unfolding: like anxious depositors, these firms started to reclaim their deposits, triggering a massive and selffulfilling wave of bankruptcy among international financial firms. Speaking to an emergency meeting of EU ministers on the same day that the Dutch government nationalized Fortis’s Netherlands operations, French Prime Minister François Fillon warned that the world was “on the edge of the abyss” (Guardian 2008). In 1931 the collapse of Austria’s Credit-Anstalt had triggered a similar crisis. Central banks responded feebly, and by 1932, banks were collapsing everywhere in the face of depositor runs. The depth and severity of the Great Depression then provoked a national and international politics of extremes. Nationalist and imperial responses to mass unemployment and rural poverty led to the collapse of international flows of goods, capital, and people. Struggles to maintain global market shares and to export surplus capacity provoked the deliberate use of currency devaluations to promote exports and the formation of closed trading blocs. Economic disarray led ineluctably to fascism and war, causing the deaths of 100 million people in World War II. With the specter of 1931 hovering over them, central banks in the United States, China, and the eurozone responded to the fall of Lehman Brothers Bank in September 2008 with massive emergency lending. The United States and China implemented unprecedented fiscal stimulus programs while individual European countries responded with more modest but still significant fiscal expansion. The US Federal Reserve also provided nearly $600 billion in dollar-denominated loans to non-US banks so that they could meet dollar-denominated obligations to their creditors. By the end of 2009, financial markets appeared to have been stabilized and world stock markets began to reverse their downward slide. Global trade began to recover, and the crisis-driven trend toward fragmented global financial markets was halted. State policy has thus far prevented the global economy from going completely off the cliff. Yet, if a full-fledged global depression has thus far been avoided, four years after the start of the crisis there is little evidence that the world economy will return to normal. Unemployment has skyrocketed, developed-country fiscal deficits will exceed normal levels for years to come, capacity utilization remains well under normal levels, and property markets in the United States and much of Europe remain depressed. Stock markets around the world are experiencing massive volatility. Many large eurozone banks in particular are undercapitalized, and some are thought to be effectively insolvent. Depression has been avoided only by a massive releveraging of the public sector. But this releveraging has inhibited governments from undertaking new fiscal measures and discouraged many central banks from reflating asset prices that, given the present political inclination toward austerity, appear to provide the only means of promoting recovery.

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Bank of America’s near-death experience in 2011 and the lack of significant financial regulation on both sides of the Atlantic showed that “too-big-tofail” banks still threaten the global economy. Likewise, European banks’ vulnerability to default by tiny Greece showed how weak their capital bases were. The tendency toward growing inequality and declining real wages within most of the OECD countries, not least the United States, has been greatly exacerbated by the crisis, further constraining demand and growth. Four years into the crisis, signs appeared that economic disarray was provoking mass political unrest. Financial Times columnist Gideon Rachman (2011) declared 2011 “the year of global indignation” as witnessed in the Arab Spring, riots and sit-ins in Athens and Madrid, months of student and worker marches in Chile, protests in Tel Aviv, looting in Great Britain, anticorruption demonstrations in India, and growing protests in China. Likewise, the political gridlock resulting from the wave of Tea Party Republicans in the United States both reflected and amplified economic disorder. While the Tea Party’s origins clearly lay in massive and expensive organizational efforts by a handful of billionaires and multimillionaires, its appeal resonated among many voters amid severe economic stress and profound uncertainty about the future. On the other side, the Occupy Wall Street protests focused attention on America’s worsening income inequality. Thus, the key underlying causes for the crisis persist. The global imbalance between Chinese production and US consumption has moderated but is still above sustainable levels. The cost of financial bailouts added a new and massive layer of sovereign debt on top of unprecedented levels of consumer debt. As a result, the eurozone has been brought to the brink of crisis. In the United States, fiscal stimulus is politically unfeasible. Unconventional expansive monetary policy by the United States has had uncertain effects even as it risks precipitating trade wars with Brazil, China, and other emerging-market nations whose currency is appreciating against the dollar. Within the financial industry, the number and scope of disruptions—from the savings and loan crisis of the mid-1980s, to the Asian financial crisis of the late 1990s, to the bursting of the Internet bubble at the turn of the millennium, and to the present generalized crisis—have increased in proportion to the growth of the financial sector in relation to the broader economy. Yet the existing and inadequate national and international regulation of banking remains essentially unchanged: since 2007 the size of the big banks has grown even as they “stare into the abyss” (Economist 2011, 1). With revenue and employment falling in tandem, more and more states have begun to experiment with mercantilist trade and financial policies. Even if further catastrophic shocks to the global financial system can be averted—and there is no certainty of that—it remains unclear what will give the global economy traction again. Indeed, there appears to be no way back. Compared to every other crisis since the 1930s, this crisis is bigger, broader, and more central. Where prior crises were more narrowly financial

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or economic, and indeed often contained in one part of the financial sector, this crisis was simultaneously financial and economic. Where prior crises mostly affected developing countries or a few developed countries (and even then only via currency crises), this one emerged in the developed countries, including the United States. Finally, where prior crises were resolved through the actions of advanced countries’ governments and central banks, in this crisis such actions have further destabilized the global economy by converting banking crises into more generalized crises of sovereign debt, as the travails of the eurozone and Standard and Poor’s downgrading of US Treasury bonds illustrates. In short, the old normal is dead, replaced by a period of protracted or even permanent crisis.

The Study of IPE: From the Crisis of Bretton Woods to the Global Financial Crisis As many of the chapters in this volume suggest, the present crisis developed in part as a result of the policies and actions that were undertaken to overcome the crisis of the Bretton Woods system that erupted in the late 1960s and culminated with Washington’s abandonment of the dollar-gold system that was its linchpin in 1971. If the present crisis greatly overshadows that of the Bretton Woods system in its potential severity, it is worth noting that the global political and economic turbulence of the late Bretton Woods era led to the founding of the subdiscipline of international political economy (IPE) and gave rise to novel theoretical perspectives and questions that have preoccupied scholarship for the past generation. Indeed, prior to the crisis of Bretton Woods, scholarship within the field of international relations paid little attention to the interrelationship between politics and economics. With the exception of a few heretical Keynesians and Marxists, development theory and policy was considered the province of neoclassical economics. Given the assumption of comparative advantage—an international economy essentially devoid of power relations—economic development or modernization was a subject for specialists in comparative politics, because impediments to development were by definition internal. The study of international relations itself largely bracketed economics and production as factors causing both power and conflict. The economic shocks of the late 1960s and early 1970s profoundly challenged these prevailing assumptions and disciplinary conventions. The collapse of the Bretton Woods system showed that global trade and finance were not technical matters but rather organically connected to international power relations. Dependency theorists rejected modernization theory in favor of models that assumed that center-periphery relations remained exploitative even after decolonization. The search for a new international economic order (NIEO) was predicated on the assumption of a highly

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unequal international division of labor characterized by trade and financial relations of dependency and subordination. The stagflation that afflicted much of the North and the ensuing global debt crisis of the South revealed an international economy subject to political disarray, as what could be seen retrospectively as the brief interlude of a golden age gave way to great tension and uncertainty. The specter of political conflict among advanced capitalist states reemerged. The theoretical perspectives that informed mainstream analyses of the crisis of Bretton Woods corresponded closely to US policymakers’ mental map of the world. That mental map was formed during and immediately after World War II as those policymakers sought to reconstruct the world economy in accordance with US interests. US Secretary of State Cordell Hull, perhaps the most influential theoretician of post–World War II US foreign economic policy, had understood the Great Depression as a leadership crisis—the interregnum between British and American hegemony—that led inexorably to protectionist trade blocs and war. The pioneers of the new subfield of international political economy in the 1970s applied Hull’s insights to the gathering international economic storms. Focusing primarily on international trade, they thematized the decline of US power and, with it, the problem of leadership for openness and stability (Kindleberger 1973; Gilpin 1975; Krasner 1976). The implication of their approach was that the emergent multipolar world was encouraging mercantilist tendencies that would prove difficult to contain. Reacting to the implicit determinism of this essentially neorealist analysis, others argued that even in the absence of a single global leader, international regimes could promote cooperation and thereby maintain openness and cooperation in a multilateral world (Keohane 1984; Ikenberry 2011). Beyond the mainstream, a range of alternative analytic perspectives challenged many of the assumptions behind the dominant narrative of decline. Critics of the thesis of US hegemonic decline located the source of global economic disarray not in the decline of US power and leadership but rather in the more forceful and self-interested exercise of US power, especially in the sphere of monetary relations (Calleo 1982; Strange 1982).1 A vigorous Marxist tradition developed and for a brief period enjoyed considerable status within the discipline of IPE. Marxists defined the crisis not primarily in terms of US hegemonic decline and uneven development, but rather in terms of the contradictions inherent in post–World War II Fordist regulation and inexorable tendencies toward overaccumulation (Harvey 1982; Magdoff and Sweezy 1987). Yet by the mid-1990s, new and largely unanticipated developments in the international political economy appeared to confound many of these theories and perspectives. Contrary to the expectations of many, a new era of trade liberalization emerged as a result of the Uruguay Round of the General Agreement on Tariffs and Trade (GATT), subsequent establishment

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of the World Trade Organization (WTO), and a host of regional and bilateral free trade agreements, including most prominently the Single European Market and the North American Free Trade Agreement. The deregulation of capital markets in the United States and Britain ultimately set in motion a corresponding massive increase in global capital mobility, as states either followed suit voluntarily or as a result of IMF-supervised structural adjustment programs. The debt crisis of the developing countries that resulted from the Volcker shocks of 1979 and ensuing monetarism ultimately produced neither greater third-world militancy nor an NIEO but rather acquiescence to the Washington Consensus. The hallmark of the Washington Consensus was the imposition of harsh austerity on debtors. Notwithstanding the human suffering caused by these policies, the gradual industrialization across significant sections of the global South, and most notably the rise of BRICs (Brazil, Russia, India, and China), appeared to confound the expectations of dependency theorists. The new era of globalization was enhanced first by the entry of 1.2 billion Chinese into the global market economy and then another 300 million more from the former Soviet bloc. These developments, alongside growing migration flows from the South to the North, reinforced the triumph of neoliberalism at the expense of the more embedded form of post–World War II capitalism (Gill and Law 1988). Finally, the thesis of declining US hegemony appeared to be premature; far from being in decline, US structural power appeared to have been prolonged and, in some respects even deepened as a result of “Bretton Woods II.” Because of the depth and attractiveness of its capital markets, the United States could run unending deficits while consuming 25 percent of world output and as much as 75 percent of global capital flows by generating increasingly larger trade deficits with impunity. Whereas the crises of the 1930s and 1970s occurred in the context of intellectual concerns with public goods, political economy, and society, the triumph of neoliberalism of the 1980s represented a return to individualism, as Marx and Keynes were marginalized by reassertion of micro foundations of economic, political, and even cultural life (Rodgers 2011).

To Infinity and Beyond This entire edifice arguably came crashing down in the summer of 2008. The crash suggested that, contrary to the champions of the new economy and globalization, the structural problems that led to the demise of the Bretton Woods system had not in fact been resolved but rather were simply postponed, only to reappear in more acute forms. Hence, the old questions raised by a previous generation of IPE scholars have reasserted themselves. In addition, a host of new questions has emerged about an international political economy that is infinitely more complex than that of a generation

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ago. In what ways does the current crisis of the recent lesser depression resemble the Great Depression in terms of opening up the possibility for reshaping global institutions and practices surrounding the flow of goods, capital, and people? How have conflicts over employment and access to resources among different nations been transformed by the crisis? Why are some regional economies doing better than others? Is the global role of the dollar being challenged, and if so, by what currency? Will economic decline generate massive social movements like those of the 1930s, thereby reasserting the power of labor on a national or international basis, or will we see something closer to the antilabor “white armies” of the 1920s and 1930s? What will happen to the eurozone and the European project? Is it possible to regulate the growing power of finance? Does the crisis originate primarily in the realm of ideas—among policymakers who are in Keynes’s words “in thrall to the ideas of some long-dead economist”—or is it more deeply rooted in the conflicts among social forces generated by the structure of capitalism itself? We have encouraged our authors, where possible, to make comparisons with the 1930s in their elaboration of different aspects of the present crisis.

Plan of the Book The first part of the book explores different regional experiences of and responses to the crisis. Alan Cafruny and Leila Talani focus on the broader transatlantic and geopolitical implications of the crisis of the eurozone. If in important respects the Economic and Monetary Union (EMU) represented a Franco-German bargain, the eurozone has also served to deepen Europe’s neoliberal turn while also supporting Germany’s covert mercantilism. In this context, the massive austerity that is being inflicted on the southern European countries is likely to condemn the entire eurozone to years of stagnation, accelerating the trend toward nationalism. R. Taggart Murphy explores the options of China and Japan, the two largest holders of US debt. During the 1990s Japan entered into prolonged stagnation, in part as a result of its support for the dollar. China has in some respects pursued a similar trajectory, purchasing US securities to prop the dollar while exporting to the United States and suppressing domestic consumption. Will China follow Japan in the descent toward stagnation? Murphy argues that the present US-China relationship is unsustainable, but that the endgame is unpredictable. Peter Kingstone argues that prudence and luck have helped Latin America avoid the worst of the downturn. China’s insatiable demand for raw materials provided the luck, though it exposes Latin America to the risk of a downturn if China’s stimulus-driven economy slows down. But two decades of painful economic reforms also put the major Latin American

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economies on a sounder footing in advance of the crisis. The most important change was the transformation of public debt from foreign currency– denominated debt to a local currency basis. Latin America thus avoided the currency-driven increase in debt that historically crippled its economies in global downturns. Flows of people are often ignored in IPE’s holy trinity of money, trade, and multinationals. Ariane Chebel d’Appollonia shows that the lesser depression has only slowed, not halted, migration, unlike the collapse of the 1930s. While the flow of migrants has slowed and their remittances slowed even more, both remain robust. Partly this reflects the differences between stocks and flows. While the flow of migrants has slowed, the stock of immigrants in host countries remains quite large. Being at the bottom of the labor market, they have disproportionately suffered unemployment in the crisis. Yet they continue to support home-country consumption through a vast flow of remittances. The next section assesses US hegemony in the aftermath of the crisis, focusing on employment, oil, and money. Herman Schwartz argues the USChina relationship has shifted from a symbiotic relationship with respect to employment to a conflictual one. Chinese trade surplus recycling into the US housing market meant that US and Chinese employment could grow together in the 1990s and early 2000s. But from the mid-2000s—well before the crisis—this symbiosis reversed itself as Chinese exports began to erode the mid-level technology industry in the United States. Because these Chinese exports were produced with increasingly capital-intense production techniques, they also eroded Chinese manufacturing employment. The lesser depression has only intensified this conflict. China has doubled down on its huge investment bet in export-oriented production, yet the United States cannot hope to absorb this output without further declines in employment. On the other hand, US efforts to stimulate its economy through quantitative easing (the Fed’s so-called QE2 and QE3) will restrain imports by lowering the exchange rate of the dollar, harming employment growth in China. The flip side of the conflict over employment is a conflict over natural resources, of which oil remains the most important. Timothy Lehmann argues that notwithstanding dramatic developments in biofuels and solar technology, many of which have originated in China, petrochemicals will remain at the center of global energy rivalry for decades to come. US hegemony was constructed on the basis of its control over the petrochemical core in the Middle East. Such a foundation suggests that Sino-American rivalry is likely to persist as the United States seeks to maintain China’s subordinate role while China attempts to entice oil-rich countries into its own orbit. Hubert Zimmermann investigates the possibility that the euro can replace the US dollar as the international reserve currency. He comes to a

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contradictory conclusion, in the good sense of contradiction. The existence of the euro has helped Europe weather the crisis precisely because it allowed the European Central Bank (ECB) to expand the monetary base and extend the same kind of cheap credit that the Fed was able to create in the teeth of the storm. Yet this very behavior reduces the euro’s ability to replace the dollar, by showing that it too is not immune to political pressure for expanded liquidity. The euro is not some gigantic version of a Swiss franc or gold bar. The final part of the book presents some critical perspectives on the origins of and responses to the crisis. Maria Ivanova examines the role that housing played in the post–Great Depression US economy. She argues that housing became increasingly important in sustaining US growth as the economy shifted out of a Fordist growth pattern into a post-Fordist pattern characterized by slow-growing income for the bulk of the population and the underlying tendency toward overaccumulation. The collapse of the housing bubble means that the United States needs a new source of growth, but Ivanova is pessimistic that one can be found. The implication of her analysis is that monetary alchemy in the form of Keynesian demand management will not be sufficient to bring the economy out of crisis. As in the Great Depression, renewed growth requires a new, socially validated redistribution of income toward the average consumer or worker. Anastasia Nesvetailova complements Ivanova’s analysis by showing how unsustainable levels of credit creation funded demand in the 2000s. Using Hyman Minsky’s theory about the inherent instability of capitalist finance, Nesvetailova shows how innovation led to increasingly risky speculative behavior in credit markets. Illiquid assets were liquefied, allowing enormous increases in lending against those assets. These loans (and the related impaired assets) are at the heart of the crisis. Nesvetailova argues that current regulatory responses are unlikely to resolve the most important systemic risks around global finance. Finally, massive social movements marked the Great Depression. Both the left and the right were able to draw on historic repertoires of protest and violence. Those repertoires are exhausted in most developed countries. Yet the lesser depression has seen new forms of social protest in both rich and poor polities. The US Tea Party movement represents a common form of elite-funded right-wing populism, akin to but so far less violent than similar movements in Australia and Canada during the 1930s. Magnus Ryner and Matt Davies analyze whether a left populism is still possible in today’s world. They make a strong argument that class still matters, but that the apparently undifferentiated capital and labor of the nineteenth century that Marx analyzed is gone (if it ever existed). Instead, different kinds of capital and labor now confront each other over a thoroughly transnational battlefield. Different production relations in different parts of the world create

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different class structures and thus different possibilities for collective action. But the increasing salience of self-employment makes them pessimistic about the chances for even regional, let alone global social movement from below. Our volume aims at but does not achieve a comprehensive presentation of the issues. Indeed, we recognize that firm answers to the questions that we and our authors raise are not possible at the present time. Put aside the quip attributed to Zhou Enlai about the significance of the French Revolution (“too soon to tell”) and the fact that sharp debates persist about the origins and response to the Great Depression. We are still too close to the crisis—indeed, still in the middle if not, to paraphrase Winston Churchill, merely at the end of the beginning. Nevertheless, it is essential to begin assessing how the international political economy is changing. Like a person in an unlit room at night, our choice is to stand still and go nowhere, or to reach out with hands and feet and feel our way past what is in front of us, perhaps discerning not only that there are obstacles to the resolution of the crisis but what those obstacles are.

Notes The authors wish to thank Karen Farrell for her help in preparing the manuscript. 1. The nature and extent of US hegemonic power was the subject of volume 5 of the IPE Yearbook (David Rapkin, ed. Studies in Global Leadership and Hegemony [Boulder, CO: Lynne Rienner, 1990]).

PART 1

The Crisis in the Global Economy

2 The Crisis of the Eurozone Alan W. Cafruny and Leila Simona Talani

With the successful launch of the third stage of the Economic and Monetary Union (EMU) in 1999, Europe’s prospects for closer regional integration and autonomy seemed limitless. In some quarters, to be sure, reservations were raised about the structural and institutional flaws in the EMU design. However, these reservations received very little attention from official Europe and the academic establishment. From a wide variety of theoretical perspectives, scholars anticipated a “European century,” spearheaded by a single currency, geographical enlargement, and a Lisbon strategy that would “make Europe the most competitive and dynamic knowledge-based economy in the world” (European Union 2000). Many observers proclaimed that the euro would soon replace the dollar as the principal international reserve currency and that European soft power was destined to challenge a US hegemon in the throes of terminal decline.1 Yet the financial crisis that erupted in the US subprime mortgage markets in 2007 leapt across the Atlantic with devastating effects. The first casualty was European banks that, taking advantage of financial deregulation, had made massive, highly leveraged purchases of US mortgage-backed securities (Bernanke 2011). But the banking crisis threw a spotlight on the deeper and more chronic problems and contradictions of EMU—most important the disjunction between a supranational currency and national fiscal policies in the context of uneven development and growing imbalances. More generally, the crisis suggested that Europe’s second phase of integration—beginning with the Single European Act (SEA) (1986), and culminating with EMU and its associated Lisbon “competitiveness project” (2001), was not the culmination of a natural or inevitable advance in regional integration, as proclaimed by much of official Europe, but rather a deeply political project that consolidated neoliberal policies, intensified interstate and intercapitalist class rivalries inside the EU, and ultimately served to reinforce Europe’s dependence on the US superpower (Cafruny and Ryner 2007). Just one decade into the century that had opened with so much opti-

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mism and fanfare, Europe was facing what EU Council President Herman Van Rompuy called a “survival crisis” (Spiegel 2010b) that has laid to rest dreams of a superpower status, postmodern or otherwise. In the first section of this chapter we provide an overview of the proximate and underlying causes of the global financial crisis. Although the crisis erupted in the newly deregulated US financial sector, it ultimately reflected a deeper, systemic crisis in the real economy that served as an essential counterpart to European mercantilism. In the next section we show that the neoliberal aspects of EU integration have resulted in a deepening of the circuits of transatlantic capital and trade, increasing Europe’s exposure to the crisis. The third part of the chapter explores the internal contradictions in the EMU project and how these contradictions sharpened as a result of the global financial crisis. The fourth section describes the EU’s record of crisis management and reform, emphasizing the lead role played by the US Treasury and Federal Reserve Bank in crisis management and the limits and self-defeating aspects of the generalized austerity policies that have been demanded of the peripheral members of the eurozone. The last section explores the broader, geopolitical implications of the crisis for Europe.

Origins of the Global Financial Crisis The financial crisis that hit the global economy unexpectedly in August 2007 produced consequences comparable to those experienced during the Great Depression. Unlike the previous financial crises in the 1990s and early 2000s, it originated in the very heart of the global economy, the United States, and spread first and foremost to the most developed countries in Europe and Asia (Stiglitz 2010). Although originating in the US housing markets, the problems found a very fertile terrain in the uncontrolled possibility of newly deregulated financial markets to develop and sell new financial instruments that allowed the banking sector to expand enormously its capacity to extend loans and provide mortgages to the least solvent clients. The speculative bubble exploded when the increase in interest rates made it impossible for subprime mortgages to be repaid and many borrowers defaulted. From that moment onward, the crisis spread rapidly from the housing market to the banking and financial sectors and then into the rest of the economy. Whereas the immediate causes of the banking meltdown can be ascribed to regulatory failure (see, for example, Financial Crisis Inquiry Commission 2010), much scholarship concerning the underlying causes of the global financial crisis has focused on two analytically distinct but related aspects: widening global imbalances and US macroeconomic policies. Each of these perspectives captures important dimensions of the crisis. The former highlights the problems and conflicts caused by growing Asian (especially Chinese) and northern European (especially German) trade sur-

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pluses and the corresponding US current account deficit (Smith 2010; Munchau 2011a; Davies 2010; Stiglitz 2010; De Grauwe 2010; Dumas 2010). Favored, not surprisingly, by the United States as well as other deficit countries, the focus on global imbalances suggests that the resolution of the crisis lies in exchange-rate adjustments of surplus countries (or, in the case of Germany, “internal revaluation”); it seeks to identify the obstacles to currency adjustments arising from domestic political structures and ideological factors (see, e.g., Hung 2009; Bibow 2009; Munchau 2011b). The focus on the US current account deficit, favored by China and Germany, emphasizes the causal role played by rising current account deficits (Woods 2009; Goodhart 2009; Huertas 2010; Gup 2010) and calls for “internal devaluation” by deficit countries. Yet the historical trajectory and depth of the crisis suggest the limitations of interpretations that focus primarily on policy failure, myopia, or domestic structural rigidities and indicate the need for a deeper and more comprehensive analysis. The US subprime mortgage crisis was neither temporally nor spatially an isolated incident, and the permissive interest rate and deregulatory policies that facilitated it served as proximate but not underlying causes. The twin tendencies toward financialization and growing indebtedness in the United States—the most immediate manifestations of the crisis— resulted from the strategies by which the United States extricated itself from the contradictions of the Bretton Woods system and prolonged the global role of the dollar and US hegemony. The relative stability of the Bretton Woods system derived from the United States’ ability to recycle its own surpluses while the leading states were able and willing to maintain more or less full employment via active macroeconomic management. By the late 1960s, the system was becoming increasingly unstable as a result of the growth of the mercantilist powers of Europe and Japan and their increasing penetration of the US market. The US surplus turned into a deficit just as spending for domestic programs and the Vietnam War soared, resulting in inflation. As the US gold supply hemorrhaged, the purchasing power of the dollar fell and the commitment to pay out gold at thirty-five dollars per ounce became untenable. The collapse of Bretton Woods coincided with an attendant crisis of deepening stagnation and declining rates of growth and corporate profitability (Brenner 2006; Harvey 2007; Gamble 2009; Callinicos 2010; Ivanova 2011c). The rate of growth of real US GDP had been decreasing throughout the post–World War II period. A further indication of stagnation has been the long-range decline of capacity utilization in manufacturing, a reflection in part of the problem of the US domestic automobile industry. Since the late 1970s the rate of return on domestic investments in the United States declined in absolute terms as well as in relation to foreign direct investment (Dumenil and Levy 2011). The decline was especially dramatic for the 1997–2007 period.

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The US response to these combined crises was twofold: on the one hand, by closing the gold window, US demand was limited only by the amount of dollars the rest of the world was willing to hold. At the same time, the United States sought to counter the declining rate of profit through the neoliberal offensive: by reorganizing work and breaking worker resistance to capital, ultimately severing the link between productivity and wages that served as the linchpin of the postwar settlement (Harvey 2007). These policies, which originated with the Carter administration but became fully realized in the Reagan years, were sustained through high interest rates, deregulation, tax cuts, new legal restrictions on trade unions, increasing rates of immigration, and subjecting labor to increased global competition through trade liberalization and outsourcing. By failing to address any of the systemic problems that intensified in the post–Bretton Woods era—stagnation, growing US deficits, and corresponding current account imbalances—they set the stage for the present crisis. Hence, the Volcker shocks of 1979, under which high interest rates imposed harsh monetary discipline on the rest of the world, laid the basis for the emergence of the dollar–Wall Street regime with the dollar as linchpin (Gowan 1999; Sarai 2008), a prolongation of US hegemony based on debt. As a result of global capital market liberalization, US financial institutions could attract massive inflows of capital, greatly enhancing their capacity to restructure US society along neoliberal lines. Financialization gathered steam throughout the 1980s and 1990s as the regulatory framework that had been established during the New Deal was reconfigured by the Clinton and George W. Bush administrations under the close supervision of money-center banks and the US Treasury. The United States’ structural power enabled it to transform indebtedness into a strength by its ability to shape the preferences not only of debtors but also of creditors. So-called financial innovation enabled the United States essentially to tax the resources of the major holders of US debt in Asia and Europe. The United States “sought to avoid undertaking adjustment measures by encouraging foreign governments and private investors to finance these deficits” (Seabrooke 2001, 10; see also Gowan 1999). By 2006 the US current account deficit had reached $811.5 billion (Bureau of Economic Analysis 2011). These large dollar inflows enabled the United States to finance trade and budget deficits while dramatically increasing military expenditures. They also contributed to the steep decline in the overall share of manufacturing in US GDP. Much of this capital was used for overseas investment. Most other countries became dependent to varying degrees on the US market while US consumers increasingly became dependent on finance and debt. All of these structural problems were exacerbated by the Asian financial crisis as capital flowed in ever-greater quantities to the United States as a safe haven, fueling the stock market and housing bubbles. Capital inflows

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thus served to maintain demand, which was under pressure from stagnant real wages even as the rising dollar further devastated the manufacturing sector. The following data provide the context for understanding the explosive growth and structural power of the financial services industry, including not only the expansion of existing banks and financial institutions but also the growing involvement of industrial corporations in finance and investment. Between 1990 and 2006 the financial services industry doubled in size, from 4 percent to 8 percent of GDP. In 2006 it produced no less than 41 percent of the profits of the US domestic economy. In the third quarter of 2010 the six largest US banks (J. P. Morgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley) had assets worth 65 percent of US GDP, up from 55 percent in 2006. By contrast, in 1995 the assets held by these six banks were 17 percent of GDP. The contemporary crisis and the terms of its resolution suggest that a further “quiet coup” (Johnson 2009) has taken place whereby the structural power of finance capital in the United States has become instrumentalized among a small oligarchy of leading money-center banks that are “too big to fail” and whose interests and outlook now entirely transcend party politics and electoral cycles. A similar picture can be painted with regards to the British financial sector. At the onset of the crisis in 2007, the financial and professional services sector of the City of London accounted for around 11 percent of GDP, and the United Kingdom enjoyed large surpluses in trade in financial surpluses. The United Kingdom was the world’s largest source of international bank lending and accounted for the world’s biggest share of cross-border lending in September 2008 (Talani 2011). In 2007 London hosted almost double the number of foreign banks as New York. It was the fastest-growing market for asset management and was also the world’s leading market for international insurance. The UK capital markets were thriving as well, and London accounted for over 30 percent of world foreign exchange business. The city has successfully defended its autonomy vis-à-vis national and EUlevel regulations; there is little evidence that the financial crisis has put an end to the hegemonic position of the City of London, either in relation to Europe or within the structure of British capitalism (Talani 2011). The stagnation of real incomes in the United States as a result of the neoliberal offensive reinforced the tendency toward financialization as an expanding pool of investment resources outpaced opportunities available in the real economy (International Monetary Fund 2011a). In the three decades after 1979, real income for the top 1 percent of households rose by 256 percent compared to 21 percent for the middle fifth, and 11 percent for the bottom fifth. Alongside the hyperconcentration of wealth, trade union membership declined from 31 percent of the workforce in 1960 to 11 percent in 2010, and is destined to decrease further as public-sector unions bear the brunt of state and metropolitan fiscal crises. At the same time, as working- and

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The Crisis in the Global Economy

middle-class households sought to maintain levels of consumption by working longer hours and accumulating rising debt on credit cards, education, automobiles, and mortgages, they were encouraged by a burgeoning shadow banking system seeking to expand credit to progressively less-qualified buyers. The ability of the Federal Reserve to keep credit flowing was facilitated by the willingness of Europe and Asia to finance the trade deficit and maintain demand for their exports. Continuing high levels of consumption depended on a succession of bubbles, each larger and with more systemic consequences than the previous one, and ultimately unsustainable levels of household debt. As US Treasuries delivered decreasing returns to foreign investors, they sought higher-yielding investments in presumably safe mortgage securities. The big banks obliged by lowering lending standards and devising complex financial instruments to spread risk more widely. In fact, the resultant explosion of debt magnified the risk and ultimately brought the global financial system to its knees as the full-fledged subprime crisis erupted in August 2007, followed by the crash of Lehman one year later.

Eurozone in Crisis The collapse of the Bretton Woods system constituted a fundamental challenge to the Fordist mode of regulation in Western Europe. The stability of the dollar-gold standard was essential to Fordism. US trade surpluses could be recycled, and capital outflows would return as demand for US goods and services. Two European countries in particular, Germany and Italy, achieved large export surpluses with the United States. As US industry lost its competitive edge and military and social spending increased, the purchasing power of the dollar fell. Western European countries experienced growing instability in the form of inflation and, especially after 1971, currency fluctuations. While the catalyst for regional monetary cooperation was the danger that France’s post-1968 inflationary policies posed to the Common Agricultural Policy (CAP), the broader objective of these cooperative attempts throughout the 1970s was to preserve the terms of the Fordist settlement at both the national and intraregional levels by insulating Europe— Germany in particular—from the disruptive effects of dollar instability (Parboni 1982; Carchedi 2001). These embryonic but ultimately unsuccessful attempts at monetary cooperation in the form of the “snake in the tunnel” and EMS, which attempted to limit currency fluctuations, of course, predated the single market. But the failure to construct a zone of regional monetary stability on an intergovernmental basis demonstrated the difficulties of maintaining fixed exchange rates within the relatively more consensual framework of the postwar social settlement, when the costs of adjustment arising from uneven development could not readily be passed on to strongly entrenched working classes.

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The Maastricht treaty was signed in a very different sociopolitical climate. After the failure of France’s nationalist strategy from 1980 to 1982, European capital as a whole sought a decisive departure from the postwar settlement. By this time, working-class power had steadily eroded as a result of growing unemployment, globalization, and the nascent incorporation of the former Soviet bloc economies into transnational capitalism. Already in 1985 the highly influential European Round Table (ERT), representing the interests of big European capital, had called for a single currency. Its proposal, Reshaping Europe (1991), bore remarkable similarities to the Maastricht timetable for the EMU (Van Apeldoorn 2002; Carchedi 2001). If the decision to adopt the EMU as enshrined in the Maastricht treaty was a result of a multiplicity of factors operating in both the geopolitical and economic spheres, the project ultimately expressed the strong turn toward finance-led growth and neoliberalism, not the least in Germany. In contrast to the Werner Report as well as the McDougall Report of 1977, both of which bore the imprint of the postwar settlement and envisioned a monetary union buttressed by a substantial community budget and macroeconomic policies designed to promote full employment, the Maastricht criteria and successive fiscal pacts firmly subordinated macroeconomic policy to the performance of short-term global financial markets. The “straitjacket” served as the handmaiden to the full range of neoliberal policies; it was, for instance, attractive to Italian capital as “Europe” became a rallying point for fiscal austerity (Talani 2003). Given the monetarist design of the ECB, flexible labor markets and other structural reforms— now identified as “internal devaluation”—were offered as the cure for “eurosclerosis” and the only means of averting the breakup of the eurozone. Spurred on by a Commission-led project of competitiveness, the European Union increasingly sought to emulate the Anglo-US model of labor flexibility and capital market liberalization, even as it rejected its emphasis on macroeconomic promotion of growth. Yet flexible labor markets and capital mobility exacerbate low growth and high unemployment through “competitive austerity” (Albo 1994; Bellofiore et al. 2010) among the constituent units; each unit reduces domestic demand as part of its export-oriented production strategy wherein wage increases and benefits are kept below productivity growth. The uneven nature of this dynamic is important. Some countries and regions, for some of the time, have been able to experience considerable economic growth. This includes small, export-oriented economies, based on high value-added niche products and services, such as the Netherlands in the latter part of the 1990s and Sweden and Finland in the late 2000s, although it should be said that periods of crises have also punctuated their success. Other countries, most notably some of the now infamous PIIGs (Portugal, Ireland, Italy, and Greece), who were (with the partial exception

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The Crisis in the Global Economy

of Ireland) unable to exploit any competitive advantages to overcome the negative effects of renouncing exchange rate and monetary autonomy, followed the logic of finance-led growth par excellence. They could only utilize the reduced exchange rate risk the euro membership entailed, to attract speculative foreign investment into the housing sector on the basis of high rates of growth in asset values. In the wake of a financial crisis, no wonder these countries found themselves in the eye of the storm. The contrasting trajectories of Germany and Italy over the last decade illustrate with great clarity the chronic problems and imbalances that emerged in post–Bretton Woods Europe and which the EMU has exacerbated. Germany has pursued a strategy of relentless cost-cutting, and its modest record of growth since the late 1990s has been achieved largely on the basis of exports. A succession of reform programs and “employers’ offensives” (Kinderman 2005), undertaken by both Christian and SocialDemocratic governments, dramatically decreased unit labor costs, especially after 2002 in conjunction with excessive budgetary rigor and ensuing Hartz IV labor reforms, which greatly reduced trade union power. Agenda 2010 resulted in sweeping changes in unemployment protection and social assistance. Alongside these initiatives, German corporations have pursued extensive outsourcing strategies, resulting in increased levels of poverty, inequality, and part-time and precarious work (OECD 2010; Weinkopf 2009). As a consequence, the link between export-led growth, wages, and the expansion of the internal market that characterized Germany’s postwar phase has been severed (Hugh 2007; International Monetary Fund 2007; see also Bibow 2009; Dumas 2010). By 2009, Germany’s current account surplus with the rest of the world reached $235 billion, representing 6.4 percent of GDP, of which 85 percent was with the rest of the European Union. In contrast, Spain’s current account deficit was $154 billion, equal to 10 percent of GDP. Greece and Portugal had even larger current account deficits in relation to GDP (Lund and Roxburgh 2009). In the second half of 2011, Italy experienced an increasing pressure on its sovereign debt from financial markets. From July to November 2011, the spread between the Italian BTPs (Italian 10-year treasury bills) and the German Bund, a common measure of such pressure, surpassed 400 basis points on many occasions. In the same period, the interest rates of Italian government long-term debt bonds increased steadily to reach quota 6.99 percent in November 2011. Overall, the EMU has aggravated Italy’s already serious economic problems, and it greatly impedes Italy’s future growth prospects. Italy’s relative labor cost competitiveness has seriously deteriorated since an essentially political decision was made to join the EMU. Italy’s effective overvaluation, at approximately 35 percent, and trade deficit are the mirror opposite of Germany’s effective devaluation and trade surplus. Since 1991 the Italian economy has essentially remained stagnant,

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registering a zero increase in productivity gains and real GDP growth. During the first three months of 2011, Italian output was 17.8 percent below precrisis levels (La Republicca 2011). Such a result could hardly have been surprising to German proponents of monetary union. Yet, given the depth of its competitiveness crisis, even a steep euro devaluation would have little impact on Italy. Rather, recovery of export competitiveness would require a substantial internal devaluation coupled with the harsh austerity program inaugurated by the new administration of Mario Monti in the immediate aftermath of the markets’ attack on Italian debt. Indeed, Charles Dumas (2010, 144) concludes that a return to competitiveness is “irretrievable. . . . In any normal view of the euro’s future exchange rate, the unemployment needed to get labor costs competitive will be pure sadism and ensure nil growth for a full decade.” Yet if Italy’s future in the eurozone can be described as sadistic, it is also the case that Germany has experienced neither significant growth nor productivity gains in terms of output per worker over the last decade. Germany’s modest economic recovery in 2010, based largely on exports, came on the heels of a massive downturn in 2009 as world trade declined. Moreover, between 2001 (the end of Europe’s previous recession) and 2009, Germany registered 3.5 percent cumulative growth (less than 0.5 percent per year) in comparison with 11 percent in the United Kingdom and 10 percent in France. Real consumption growth was 0.5 percent in Germany compared to 3.5 percent in Italy (Dumas 2010). Germany must compensate its eurozone partners for its massive trade surplus by either lending or granting transfers to deficit countries, neither of which appears to be a sustainable policy. But Germany’s relative export competitiveness is declining, and its export-based strategy thus faces significant limits. Neither China nor the United States can reliably serve as a destination for Germany’s exports. At the same time, China is rapidly becoming a competitor in high-value areas of manufacturing that Germany has long dominated (Bellofiore et al. 2010; Schafer 2011). Therefore, as they have generated growing imbalances within the eurozone, the mercantilist strategies of the large European states, and most decisively, Germany, have also reproduced Europe’s dependence on the United States, especially within the context of the slow-growth eurozone regime. As Bellofiore et al. wrote, Crucially, the United States functions as the market where the net neomercantilist position of Europe is consolidated. . . . For the European countries, the deficits with Germany weigh heavily on their overall external account balance. Thus, attaining a surplus with the United States has become a necessity, to compensate for those persistent deficits as well as for the deficits with dollar-based raw materials and energy-exporting countries. The United States has remained the largest, richest, and most durable market for the realization of net surpluses for the EU, and for the eurozone in particular. (2010, 121)

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Neomercantilism is thus both a cause and effect of stagnation, as deficit countries are compelled to adjust through recession or (following the EMU) internal devaluation. Wage stagnation and growing inequality along with the more regressive tax policies that have gradually been introduced throughout much of the eurozone (see, e.g., European Commission 2010; OECD 2010; Stancil 2010) depress demand and consequently draw European capital into the US financial sector in the search for profits. Europe’s integration into Atlantic circuits of capital was facilitated by the European Commission’s Financial Services Action Plan of 1999, which established a unified market for financial services. It reflected an active process of emulation of, and linkage to, the US model, which was at the time generating higher growth and productivity rates (Grahl 2011). Emulation played out most strikingly in Germany, where capital markets have become increasingly important for German firms as the shift toward investment banking has weakened traditional ties between banks and industry. Hedge funds, insurance companies, and foreign investors have gained influence as Anglo-Saxon shareholder value increasingly challenges the Rhineland model. Moreover, rather than relying on their traditional house-bank linkages at home, German and European corporations increasingly turned to the US stock market to raise capital (Sablowksi 2008). As European capital poured into the US economy in the decade preceding the crisis, the volume of financial transactions between the United States and Europe increased exponentially. At the end of 2007 the share of EU securities in foreign holdings by US individuals amounted to 42 percent for equities and 53 percent for asset-backed securities, totaling, by the end of 2006, $1.8 trillion of equity holdings and 87 percent of debt holdings. Similarly, the share of EU investments in US equities amounted to 39 percent of total foreign investments, while that of asset-backed securities was 32 percent. By 2007 the United States accounted for 40 percent of global stock market capitalization; 26 percent of European asset price variation was due to developments in the United States (Deutsche Bank Research 2008; International Monetary Fund 2007). European banks were hit hard by the collapse of the US subprime market and the ensuing crisis. Not only British, Swiss, and French but also German banks were heavily exposed. At the start of the crisis, German banks had the largest leverage rates among OECD countries. Many German banks, including not only Deutsche Bank, which listed fifty private Goldman Sachs deals for subprime bonds mostly issued through the Cayman Islands, but also the Landesbanks suffered substantial losses (Gordon 2009). At the end of 2009, European banks were estimated to hold more than $1 trillion in toxic assets, more than two-thirds of which were held by German banks (Carrington 2009), and a large proportion of these in the PIIG states (Bank for International Settlements 2010b). In July 2010 the EU conducted stress tests that served to conceal the precarious condition of

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the European banking system, as exemplified by the fact that the tests gave Anglo-Irish and Allied banks a clean bill of health.2

EU Response to the Crisis Thus, the global financial crisis erupted in the United States, but it immediately crossed the Atlantic and, in important respects, was transformed into a crisis of the transatlantic order. Linkage to the precarious but still growing US economy had made it easier to ignore the underlying problems and contradictions in Europe’s second project of neoliberal integration. Given the vulnerabilities of the United States—most notably an unfolding fiscal crisis linked to the international role of the dollar that in the aggregate surpasses that of the eurozone as a whole—it is very doubtful that the European economy can continue to rely on the US growth-and-profits locomotive. Focused primarily on inflation-targeting and competitiveness reforms, both the ECB and the European Commission were caught unaware by the depth and breadth of the crisis. In marked contrast to the US Federal Reserve Bank and the Treasury, they were very slow to recognize the threat posed to the eurozone, and subsequent policies have been largely reactive and incremental. Following the US-linked modest recovery of 2003–2005, the ECB had embarked on a program of interest rate increases that served to reinforce the German employers’ offensive. Indeed, as late as July 2008, long after the crisis had erupted, interest rates were raised from 3.75 percent to 4.25 percent, and under the terms of the Stability and Growth Pact (SGP) public deficit reductions were enforced. After the crash of Lehman Brothers Bank in August 2008 the ECB moved to provide massive liquidity to troubled banks, which, as noted above, were highly exposed to the US market and offered guarantees for interbank lending. Governments became major shareholders of large banks while others were nationalized. The government of Ireland, which (along with Spain) was running a budget surplus before the crisis erupted in 2008, moved to guarantee the liabilities of its banks. European states thus effectively socialized bank losses, converting them into public debt. The immediate manifestation of Europe’s crisis was bank debt resulting from deregulation; this was converted into a succession of sovereign debt crises. The lead role in crisis management initially fell to the US Federal Reserve and Treasury. They recoiled at the specter of global depression and, despite the massive US current account and budget deficit, made the United States serve as lender of last resort. In the six weeks following Lehman’s collapse, the Fed injected $3.3 trillion in reserves; a $787 billion stimulus package equal to 3 percent of US GDP in 2009 and 2010; and unprecedented, massive amounts of liquidity to commercial banks. European banks were among the largest recipients of the Federal Reserve Bank injections

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(Tett 2010b; Chan and McGinty 2010). In addition, the Fed carried out swaps to the ECB, Japan, and emerging markets totaling $585 billion. It was possible to argue that the United States had become effectively the “central bank of the world” (Bloomberg 2010) and that “in a sense the Fed became the market in 2008 and 2009, not just in the United States but in parts of Europe too” (Tett 2010b). Following the outbreak of the Greek crisis in May 2010, it was US pressure—reputedly in the form of Obama’s personal intervention with Angela Merkel (Willis 2010)—that finally persuaded European capitals to establish a €440 billion European Financial Stability Fund (EFSF) alongside $250 billion from the IMF, further indication of the limits of European policy autonomy. Greece was provided with €110 billion of emergency support, at 5 percent interest, with a further IMF contribution of €30 billion. The onset of the banking crisis, in the context of asymmetries that have haunted Europe since the last days of the Bretton Woods system and greatly increased following the adoption of the single currency, thus posed an enormous challenge to European crisis management capacities. Membership in the EMU had insulated debtor countries from currency crises even while keeping their borrowing costs artificially low. At the same time, of course, it precluded devaluation as a means of regaining competitiveness. As a result of a one-size-fits-all interest rate structure, household debt in Greece, Spain, and Portugal skyrocketed to offset the structural current account deficit arising from German export success, while German and other core-nation banks became massively overexposed. At the end of 2009, French and German bank exposure to Greece, Ireland, Portugal, and Spain was 16 percent and 15 percent of their GDP, respectively. French bank exposure to Greece totaled $138 billion (of a total of $392 billion) while German exposure was $84 billion (Bank for International Settlements 2010). Former Bundesbank head Karl Otto Pohl characterized the rescue package for Greece in the following terms: “It was about protecting German banks, but especially the French banks, from debt writeoffs. On the day that the rescue package was agreed on, shares of French banks rose by up to 24 percent. . . . You can see what this was really about—namely, rescuing the banks and the rich Greeks” (Spiegel 2010a). Swedish and Austrian banks also experienced similar levels of exposure in the Baltic states and eastern Europe, as member states remaining outside the eurozone faced their own problems with debt and deflation. The collapse of the housing and construction markets in Ireland, Spain, and Portugal, where construction accounted for more than 10 percent of all employment, threatened core state banks but also provided new opportunities for profit seeking through government bailouts.3 As the recession deepened throughout late 2008 and early 2009, Europe’s ailing banks and hedge funds realized that peripheral eurozone states were in danger of default and, taking advantage of the ECB’s effective zero-interest-rate policies, began to attack the weakest links in the chain. These attacks could not, of course,

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trigger currency crises—as with the European Monetary System and Exchange Rate Mechanism—but rather provoked massive speculation on sovereign debt.4 As the spread between German and peripheral bonds rose, savage austerity plans—effectively channeling public funds to the banks—were introduced as the price of emergency injections of capital to be repaid at punitive rates. As the threat to the eurozone resumed with the Irish crisis in November 2010, emergency lending was once again provided alongside similar austerity measures and repayment terms, including EFSF loans at 6 percent interest, and the ECB stepped up its bond market purchases. In 2011 and 2012, Greece was the recipient of two bailouts, the second of which involved significant debt writedowns and “haircuts,” imposing losses on bondholders. However, the common denominator of these rescue operations—and similar ones held in reserve for Spain and Portugal—was internal devaluation. The long-term prognosis must inevitably be debt deflation and instability amid persistent demands for debt restructuring. The specter of default in the context of popular resistance to crippling austerity threatens to destabilize Europe’s already precarious and overextended banks, although the Greek bailouts have succeeded in transferring two-thirds of Greek debt to the IMF and EU. Amid predictions of eurozone collapse at the end of 2010, the European Council formally began discussions on the institutionalization of a permanent rescue vehicle, the European Stability Mechanism, to succeed the EFSF, which was set to expire in 2013. Given the likelihood of further crises and efforts to restructure existing agreements, discussions were held on longer-term solutions, which included expansion of funds for the EFSF, and broadening its powers to include creation of European bonds (E-bonds); recapitalization of banks; setting interest rates for borrowers; and establishing short-term lines of credit. In March 2011 the European Council signed the Euro-Plus Pact, giving the European Commission greater control over member-state economic policies. As bond yields in Spain, Portugal, Italy, and Greece soared in the fall of 2011, the European Union implemented novel monetary and fiscal policies. Central bank policies are usually characterized in terms of conventional measures, such as interest rate cuts and, in the case of a liquidity trap (when interest rates are effectively zero), quantitative easing or nonstandard measures, including enhanced credit support and securities markets programs. By effectively implementing quantitative easing, the Long Term Refinancing Operation (LTRO) enabled the ECB to act as a hidden lender of last resort. Through the LTRO, a three-year lending program, the ECB provided virtually cost-free liquidity to banks, thereby allowing them to acquire the sovereign debt of countries under attack. Finally, on March 2, 2012, the European Council approved the so-called fiscal compact (officially the Treaty on Stability, Coordination and Governance [TSCG]).5

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However, the fiscal compact and the LTRO have not resolved the underlying structural crisis. The fiscal compact falls short of being a real fiscal constitution for the European Union, not only because the decision by the United Kingdom not to sign it made it impossible to incorporate it into the EU treaties. In essence, the fiscal compact is an intergovernmental agreement. Indeed, compared to the declaration made in December 2011, two things stand out in the latest treaty draft: First, there are no provisions for automatic sanctions. Second, the pact allows countries to temporarily deviate from the requirements of having their budgets in balance or in surplus in case of an unusual event outside the control of the government concerned or in periods of severe economic downturn. Notwithstanding the rhetoric, the fiscal pact represents little more than a replay of the Growth and Stability Pact. The LTRO allowed the ECB to flood the banking system with cheap money, thereby allowing Spanish and Italian banks to engage in the highly profitable carry trade. Between December 2011 and February 2012, Spanish banks bought €67 billion of sovereign debt while Italian banks acquired an additional €54 billion. However, if the LTRO temporarily prevented a wholesale meltdown, it not only failed to resolve the underlying problems but arguably exacerbated them. By April 2012 austerity generated new crises of confidence, and bond yields began to increase into the danger zone. As a result, the underlying insolvency problems of banks reappeared, and indeed became more acute, as did the exposure of the ECB itself. The German government has continued to prevent the ECB from transferring risk to its own balance sheet, as the Federal Reserve Bank has done. Moreover, whereas at Copenhagen in March 2012 the ESM was increased to €500 billion, with significant new commitments from the IMF, these sums would still not be sufficient to resolve a full-blown crisis arising in either the Spanish or Italian bond markets. These crisis resolution plans have been presented in terms of “economic governance” that would “take European cooperation to a whole new level” (Spiegel 2011). Yet, these plans reflect bilateral Franco-German negotiations, the results of which are essentially dictated to the Commission and the rest of the member states. They offer the prospects of limited fiscal transfers but stop well short of a genuine fiscal union or European Treasury with a common budget and powers of taxation and redistribution. The common denominator is austerity: Within the new framework of the European semester, the European Council endorsed the priorities for fiscal consolidation and structural reform. It underscored the need to give priority to restoring sound budgets and fiscal sustainability, reducing unemployment through labour market reforms, and making new efforts to enhance growth.

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Outside the eurozone the crisis has been no less severe. On the eve of the crisis the new member states already were struggling with a model of development based on foreign direct investment in search of cheap labor and trade dependence on Western Europe, especially Germany (Bohle 2006; Ivanova 2007). Central and Eastern European countries, for example, depended on Western Europe for 80 percent of exports. Strategic sectors of the Central and Eastern European economies, including banking, telecommunications, and utilities, had been privatized and sold to Western firms. Many Central and Eastern European economies were heavily exposed to borrowing in foreign currencies and struggling with large current account deficits. By 2004, for example, debt service payments accounted for 25 percent of Hungary’s, 27 percent of Croatia’s, and 35 percent of Poland’s exports. Western and European banks, especially Austrian, German, Italian, and Swedish, were heavily exposed by virtue of their participation in property bubbles (Raviv 2007). With the exception of Poland, Eastern and Central European member states suffered massive decreases in GDP and large spikes in unemployment after 2007. The European Union deployed the IMF as the key arbiter of emergency funding (Verhofstadt 2009), eventually concluding agreements with eleven countries in the region, starting with Latvia, Hungary, and Ukraine. Yet these agreements were essentially procyclical structural adjustment programs. As with the situation in Greece and Ireland, they were designed primarily to bail out heavily exposed Western European banks (Weisbrot 2011). Most CEE countries returned to growth in 2010, but they continue to face massive problems of slow growth, large current account deficits, and high unemployment.

Europe of Capital While a regime of ad hoc emergency loans, bond purchases, and austerity programs has thus far averted collapse, it has not addressed the eurozone’s pressing problems resulting from structural imbalances and the slowing US growth locomotive. At the same time, this approach has plunged much of Europe’s periphery into near-depression, almost certainly condemning it to years of harsh austerity and political instability. Notwithstanding Germany’s own export-led recovery, at the beginning of 2012 the EU27 had 24.5 million people unemployed, with millions more who do not qualify for benefits and 84 million living at the risk of poverty. In Ireland, output per person declined by more than 20 percent since 2007, and unemployment rose from 4.3 percent in 2006 to 14.7 percent in 2012. Greece’s unemployment rate jumped from 7.5 percent in 2007 to more than 21 percent in December 2011 (Eurostat 2012). By the beginning of 2012 youth unemployment in Greece, Spain, and Portugal exceeded 50 percent.

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As noted above, Italy has endured years of stagnation and diminishing export competitiveness. Not surprisingly, the crisis has greatly damaged the already tarnished legitimacy of the European Union, not only in the periphery but in Germany itself where resistance to bailing out southern “profligacy” is strong.6 French and German leaders have expressed unequivocal support for the EMU, rejecting calls for alternatives that include managed default or radical restructuring of debt, the transition to two or more currencies, or as discussed below, more progressive solutions that are not austerity based. Yet any form of transfer union would provoke conflict in the context of a German political culture that, like an amputee, still senses the lost limb of the deutsche mark and has undertaken to balance its own budget by the end of 2016. Is there no alternative, then, to the construction of a fiscal union that would finally fulfill the neofunctionalist prediction, the Federalist dream, and the German nightmare? In 1997 Hans Tietmeyer, then-president of the Bundesbank and no friend of political union, asserted, “Any split in real economic trends would, naturally, exert pressure in the direction of a transfer and social union, or even of a European ‘superstate’” (quoted in Phillips 2010, 2). Abstract statements in support of a putative but undefined fiscal union have come from French finance minister Christine Lagarde, ECB president Jean-Claude Trichet, former IMF managing director Dominique Strauss-Kahn, and even German finance minister Wolfgang Schauble, while correspondingly, Bank of England governor Mervyn King has expressed alarm over such a development (Willis 2010). The fiscal compact, however, is certainly not based on an expansionary and Keynesian logic. Nor does it represent an improvement on the present system of crisis management, with all of its limitations and dangers. Nor, in the final analysis, does it take Europe in the direction of an ever closer union based on democratic legitimacy and genuine supranational governance. Rather, it institutionalizes a highly coercive and undemocratic regime under which limited transfers are conditioned on fiscal orthodoxy and internal devaluation—in brief, a European structural adjustment program supervised by Berlin. The fiscal pact, moreover, was advanced within the more general framework of the neoliberal competitiveness agenda with all of its attendant problems and limitations. Europe 2020, the European Commission’s strategic growth plan for the coming decade, contains no reflections on how or why the growth and employment targets of the Lisbon Strategy were never reached, even as its proposals replicate the Lisbon Agenda’s emphasis on labor flexibility while ignoring the problem of imbalances. Nor has the European Commission addressed key problems of financial regulation. The transformation of the existing European supervisory committees on January 1, 2011, into the European Banking Authority (EBA) based in London, and the establishment of the European Securities and Markets Authority

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(ESMA) in Paris and of the European Insurance and Occupational Pensions Authority (EIOPA) in Frankfurt to create the new European Supervisory Authorities (ESAs), to be inserted in the European System of Financial Supervisors (ESFS), does not address the issue substantially. National authorities remain responsible for the day-to-day supervision of individual firms, with the new European architecture only providing an overarching framework for financial supervision. The new agencies employ around sixty people each (as compared to the 3,000 of the UK Financial Services Authority) and need the help of national supervisors. Moreover, the ESAs themselves comprise high-level representatives of all of the member states’ supervisory authorities under permanent chairmanships. They will have the power to temporarily ban certain high-risk financial products and activities, such as naked short selling, as well as instructing banks and other financial actors in crisis situations, drawing up standards for national regulators, and settling disagreements between them. However, this authority will be possible only in situations of emergency to be defined by the council, and it is limited by a safeguard clause attributing to the member states the power not to abide by the decisions of the ESAs. The ESA is complemented by a group connected to the Frankfurt-based European Central Bank called the European Systemic Risk Board (ESRB), which monitors the risk of major threats to the economy, such as problems at major banks or asset bubbles. Although connected to the ECB, the ESRB seems to be mainly a consultative body, which does not appear to activate the idle clause in the Maastricht treaty that gives the ECB a formal role in banking supervisory policy (Art. 105[6]). In sum, while the European banking system has become even more concentrated and in some respects renationalized as a result of the crisis, EU banking and financial supervision remains largely in the hands of national authorities.

Geopolitical Dimensions What, then, remains of the broader European political project? Europe’s relaunching inspired conceptions of an emergent post-Westphalian Europe that greatly influenced EU studies on both sides of the Atlantic. Mainstream theorists advanced concepts such as a “European polity” (Hix 1999) and “multilevel governance” (Marks 1993). One strand of critical theory proposed the emergence of a nascent “transnational capitalist class” (Van Apeldoorn 2002). This latter formulation presupposes not simply a common agreement among national capitalist classes over a given regulatory mode or “comprehensive concept of control” (van der Pijl 1984) but rather the transcendence of national capitalist class power and interest on the basis of European-level corporate linkages (see also Holman and van der Pijl 2003). At the same time, EU institutions are assumed to displace national sover-

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eignty by articulating and in some respects at least implementing a project of an embryonic European capitalist class. Yet while EU crisis management has consolidated neoliberalism in the form of austerity, it has also thrown into sharper relief the further development of interstate and intercapitalist class rivalry. This has been evident not only in the more or less covert mercantilism that has characterized Germany’s policy throughout the crisis, but also in the abandonment of Franco-German industrial projects in the nuclear and military industrial arenas; the growing subordination of the European military-industrial complex to US corporations (Cafruny 2008); and the complete surrender of European energy policy to national energy champions (Abdelal 2010). The FrancoGerman directorate that has dictated crisis resolution policies to the Commission and the rest of the member states is dominated by Germany. France fared relatively well in the crisis thanks to the specificities of its labor market and a social protection net that allowed its shock absorbers to contain the recession. At the same time, national industrial policy served to boost demand and maintain employment. In the longer term, however, France faces many of the same issues of productivity and competitiveness as Europe’s southern flank. The crisis has raised more fundamental questions in Berlin about the basic European and Euro-Atlantic political structures. In this context, does Germany’s economic weight and virtually unchallenged political primacy within the eurozone lay the basis for a second Rapallo, implying the potential transformation of the European geopolitical order (see, e.g., Wallerstein 2009)? To be sure, Germany faces novel challenges not only because of its export-oriented profile but also because of its energy dependence on Russia. In 2009 Germany imported 32 percent of natural gas and 35 percent of crude oil from Russia (Abdelal 2010). At the same time, Russia has become an increasingly important market for German exports and foreign direct investment (FDI), especially in the energy sector. Prior to the crisis Russia was the fastest-growing market for German exports. In 2009 Germany was Russia’s second-largest source of FDI, after the United Kingdom (Eurostat 2010). Deutsche Bank is the leading foreign bank operating in Russia, with extensive participation in equity, capital, and bond issuance (Deutsche Bank 2009). These dependencies have served to deepen Germany’s diplomatic and commercial links to Moscow and its more or less consistent policy of equivocation between Washington and Moscow. Within the energy sector, German E.ON and BASF along with French EDF and GDF Suez A.A. have invested heavily in Gazprom but also in pipelines, especially Nordstream, that compete directly with Washington- and Brussels-sponsored initiatives, including the proposed Nabucco pipeline, to reduce EU and eastern European dependency on Russian energy. Together with Italian ENI, the key investor in South Stream, they have effectively “dis-intermediated” Ukraine while bypassing the Baltic states and Poland (Abdelal 2011, 35).

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These economic developments have geopolitical implications. Since 2008 Germany has undertaken several diplomatic initiatives with regard to Russia on a unilateral basis. Most important in this respect has been the joint proposal for cooperation in security arising from bilateral discussions between Merkel and Dmitry Medvedev, arising out of the 2008 war in Georgia—when Germany (and the Russian army) compelled the United States to abandon plans to bring Ukraine and Georgia into NATO. Within the G-20, Germany has aligned with China, its leading market for exports and an increasingly important investor in European peripheral bond markets, over the issue of global current account imbalances. In March 2011 Germany joined Russia and China in the UN Security Council in abstaining from the Anglo-French proposal to establish a no-fly zone in Libya. These initiatives in themselves could probably not persuade Germany now to abandon its commitment to the economic and political-military structures of Atlanticism and, ultimately, continuing subordination to the United States. While Russian and Chinese capital and export markets are important to Germany, they are far less significant than the European Union and United States both in terms of export markets and destination for FDI. A breakup of the eurozone would be catastrophic for Germany, not only because wholesale debt default would entail massive losses for its stillfragile banks, but also because it would greatly impinge on Germany’s basic mercantilist strategy. Moreover, by removing Germany’s anchor to Western Europe, a breakup would have unpredictable consequences for Franco-German relations and so for the European Union as a whole. Germany and France have ultimately treated the defense of the euro— alongside the rescue of their banks—as a core national interest. The Lisbon Summit of December 2010 confirmed the centrality of the alliance to the European Union, including the establishment of a pan-European antiballistic missile (ABM) system, the expansion of the North Atlantic Treaty Organization (NATO) to embrace “a wide network of partner relationships with countries and organizations around the globe” (NATO 2010), and the call by Herman Van Rompuy to “break down the remaining walls” between NATO and the European Union (European Council 2010).

Conclusion It has long been axiomatic in the study of EU foreign policy that the analysis of crises provides the only reliable standpoint for assessing genuine European political cooperation (Hill 1983). The global financial crisis has certainly been no exception to this rule. What is true of the economic sphere also applies to the geopolitical: Set against this rather obvious benchmark, it is apparent that the high point of European influence and autonomy from Atlantic structures has not been the post-Maastricht era, but rather the

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1960s. Indeed, the European powers arguably achieved their greatest— albeit still very limited—degree of autonomy long before Europe’s relaunching. Coming on the heels of France’s recognition of the PRC in 1964, President Charles DeGaulle’s assertion of state supremacy—and not supranational integration—paved the way for the expulsion of US forces from France and withdrawal from the military wing of NATO in 1966, challenges to the dollar-gold standard, and the attempt to forge an independent policy in the Middle East. Germany’s ostpolitik followed a similar logic of relative autonomy from the United States. At the present time, by contrast, the Franco-German project has withered under the pressure of competitive austerity. And as Europe’s military-industrial complex has merged into Atlanticism, ironically it was left to the Gaullist Nicolas Sarkozy to ratify the hub-and-spoke relationship with a beleaguered US superpower that was consummated through France’s reentry into NATO military structures on US terms, and its increasing participation with the United States in the Middle East, Africa, and Asia under the NATO flag. Europe is arguably more divided and subordinated than at any time since 1991 and perhaps even the 1960s. Attempts to resolve the present crisis on the basis of neoliberalism foreclose closer integration and reinforce a dynamic whereby austerity is limited only by political mobilization from below and pressure on Germany from other member states, hardly a recipe for closer unity or regional autonomy. To be sure, there is no shortage of alternatives. Given the relatively small amount of Irish and Greek debt in relation to the size of the European economy as a whole, European authorities might, for example, have guaranteed medium-term borrowing needs—allowing for temporary fiscal stimulus while Germany and other northern surplus countries could expand consumption—and avoided imposing punitive interest rates on ESFS loans (Weisbrot 2011). The European Trades Union Confederation (2011) has proposed a program whereby the ECB would hold euro bonds of member states while attracting purchases of these bonds by the central banks of surplus economies, coupled with a dramatic expansion of the lending capacities and remit of the European Investment Bank, funded in part by a financial transactions tax. Notably, most of these policies would require neither fiscal federalism nor treaty changes. They would, however, need to be combined with genuinely pan-European banking regulations designed to restrict the size and power of banks, the restoration of progressive tax rates, greatly expanded public investment, and the reduction of imbalances by increasing consumption in Germany and other surplus member states rather than austerity in debtor states. That these alternatives to neoliberal crisis management have gained so little traction in the face of massive economic instability points rather to the underlying power realities of the contemporary European project and the corresponding crisis of social democracy.

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Notes 1. A comprehensive list of these academic works can be found in Cafruny and Ryner 2007 (1–2). For a broader critique of the underlying assumptions informing these optimistic accounts, see Cafruny and Ryner 2011. 2. Wolfgang Munchau (2011a, 8) called these tests “a deliberate attempt by Europe’s regulatory authorities to misrepresent facts and mislead the public.” 3. Pohl’s comments concerning Greece applied with equal force to Ireland, whose banks were not systematically involved in the Irish economy. The decision to guarantee their liabilities reflected the interests of German, French, and UK banks. As Michael Lewis (2011) observes, “In retrospect, now that the Irish bank losses are known to be historically huge, the decision to cover them appears not merely odd but suicidal. A handful of Irish bankers incurred debts they could never repay, of something like 100 billion euros. . . . Their debts were private—owed by them to investors around the world—and still the Irish people have undertaken to repay them as if they were obligations to the state.” 4. For an early analysis of how uneven development led to the abandonment of the original terms of the Stability and Growth Pact (SGP), and that the next stage of crisis would reveal itself in the increased spread of bond yields, see Cafruny and Ryner 2007 (35). 5. For the full text, see http://www.europeancouncil.europa.eu/media /639235/st00tscg26_en12.pdf. 6. The percentage of Germans who respond that they have no confidence in the European Union has increased from 51 percent before the crisis to 63 percent in January 2011, according to a poll by the Allensbach Institute (Frankfurter Allgemeine 2011).

3 The Dollar and East Asia— the Endgame? R. Taggart Murphy

Americans have long been warned that running large, continuous deficits courts disaster. “We are living on borrowed money and borrowed time” was the way Walter Mondale put it to the 1984 Democratic convention, when the US government’s cumulative deficit was some $12 trillion less than it is today. Three years later, a spate of cartoons and op-eds would depict the 1987 stock-market crash as a vicious hangover—the just deserts of a wastrel nation. The ever-accumulating deficits so frightened President George H. W. Bush that he famously reneged on his “Read my lips” promise not to raise taxes. In 1992 Ross Perot launched the most successful third-party presidential candidacy since Eugene Debs by making the rivers of red ink his central campaign issue. Bill Clinton’s great boast was that he managed temporarily to close the federal government deficit, although the trade deficit continued to grow during his administration. It was not supposed to work that way; the government deficit had long been understood as a prime cause of the trade deficit. But before the puzzle resolved itself, George W. Bush arrived in Washington and, with his tax cuts, wars, and lavish spending directed at his electoral base, ripped open the sutures that the Clinton administration had stitched between US government spending and tax revenues. The size of both the government and the trade deficits soon reached levels that would have been regarded as inconceivable by many economists a few years before. Doomsayers extended far beyond the ranks of Democrats and old-school fiscal conservatives; at the beginning of 2005 Warren Buffett announced that he was so scared by the deficit trends that he was largely going to quit buying stocks or bonds denominated in dollars (Forbes 2005). At the Davos Forum that year, C. Fred Bergsten of the Institute for International Economics warned of a dollar crisis “within weeks” (Smith 2005). In a widely reported speech at Stanford a month later, Paul Volcker, former chairman of the Federal Reserve, spoke of an economy “skating on thin ice” (Volcker 2005). These men saw no plausible scenario other than a dollar crash for any reversal in

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the ever-growing deficit trends. At some point, the foreigners who help finance the two deficits would surely refuse to throw more good money after bad. They would dump their dollar holdings, leading to a crash in the dollar that would finally force Americans to live within their means. But none of this happened. It wasn’t a dollar crash that blew up the US economy in the fall of 2008, it was a burst housing bubble and a Wall Street that had been allowed to run amok. Indeed, the strength of the dollar—in other words, the continued willingness of investors to accept US government paper—permitted incoming president Barack Obama to respond to the economic implosion in classic Keynesian fashion: a stimulus package that promptly added another $800 billion to the US national debt. Liberal economists such as Paul Krugman and James K. Galbraith complained that the package was far too small to do the job; Galbraith wrote in March 2009 that “the deficit and the public debt of the US government can, should, must, and will increase in this crisis,” and that the increase would be easily financed. “There is no risk of even a massive program generating inflation or higher long-term interest rates,” he went on to point out (Galbraith 2009). As of the time of this writing, he was absolutely right. The accumulated deficits shot up in the subsequent two years by over $3 trillion, but at this point, the market for US government securities shows no sign of indigestion. The politics, however, have been another story. The Keynesian logic supporting a bigger stimulus package may have been unassailable, but too many politicians were either genuinely scared of the deficit numbers or could not avoid the temptation of seizing on them as a weapon with which to score partisan political points. Larger deficits—deficits that could have pushed the unemployment rate below 8 percent—became politically impossible. Indeed, as the accumulated deficits approached a number equal to the entire US GDP, the Republicans played on the resultant fears to recapture the House of Representatives in the 2010 midterm elections. Meanwhile, the Federal Reserve injected an additional $600 billion in liquidity into the economy in a process labeled by some as QE2 (quantitative easing, round two), by others as “monetary heroin,” while leaving the door open to a possible QE3 and beyond. The result has been a veritable outbreak of hysteria about the coming end of the dollar’s reign over global finance. Hence the conundrum: We have been hearing for a generation now that the deficits cannot be sustained, yet they continue to climb while a dollar crash stubbornly refuses to occur. Keynes once compared the stock market to a beauty contest in which the winnings went to whoever could pick the contestant thought by the other judges to be the most beautiful. If this is true of stocks, it is emphatically the case for currency markets. The day is long gone when the ebb and flow of international trade determined the value of currencies. Daily volume on the world’s foreign-exchange markets runs in the trillions of dollars, with the US dollar bought or sold in roughly

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85 percent of all currency trades—most of them speculative. If enough people believe that enough others will hang on to the dollar come what may, then the dollar will not fall, whatever happens to the US deficits. There is no secret about the identity of the biggest dollar holders. They are the central banks and other financial institutions of Japan, China, South Korea, Taiwan, Hong Kong, Saudi Arabia, and the Gulf emirates. If the dollar is going to crash, one or more of these places is going to have to change its stance toward the US currency. These nations, however, display such a seemingly reflexive commitment to accumulating and retaining dollars that some commentators have described the current global financial order as “Bretton Woods II”—a continuation by other means of the institutionalized, dollar-centered international order that prevailed in the immediate postwar decades. The label does not itself explain why these states behave as they do, but it suggests that, for whatever reason, these countries have motives other than maximizing returns on their foreign-currency holdings; that those motives include a vested interest in the continuation of a US-led financial system.

A Voluntary Order The Bretton Woods system conceived by Keynes and Harry Dexter White in 1944 was more than a simple recognition of the reality that the United States would emerge from World War II in a position of overwhelming economic strength and that any workable global financial regime had to start from that premise. It mandated specific institutional action and IMF approval to reset the exchange value of any currency in the system vis-à-vis the dollar. Most importantly, it required that the United States maintain both the will and the ability to sell gold at thirty-five dollars an ounce to foreign central banks on request, which implied that Washington would take action whenever trade deficits threatened a precipitous loss of gold. When in 1971 the Nixon administration suspended the gold sales, refused to consider economic tightening to reverse the onset of structural US trade deficits, and could neither persuade nor browbeat its trading partners—notably Japan— to undertake compensating adjustments, the system collapsed. But despite a decade that saw the exchange value of the dollar plummet, the financial world continued to revolve around the dollar and does so to this day. The United States has every reason to be happy with Bretton Woods II; the United States reaps obvious benefits from the arrangement, most importantly in the ability to run government deficits without any discernible impact on interest rates by borrowing money from foreigners. The United States can also finance trade deficits with impunity—what French economist Jacques Rueff famously labeled “deficits without tears” in his 1972 book, The Monetary Sin of the West. Among other effects, Washington can

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project military power around the world at little real financial cost, since the necessary money is first created by the Federal Reserve, then exchanged for goods and services from foreigners, and borrowed back by the US Treasury.1 (Technically, it does not matter in what form foreigners hold dollars, whether US government debt, corporate debt, equities, or anything else with a US dollar sign. As long as the securities are denominated in dollars, they remain within the US banking system, where they serve to create credit in the United States.) But if the benefits to the United States in Bretton Woods II may seem obvious, the benefits to those who prop it up are much less so. Indeed, the system is curious in at least two ways: unlike Bretton Woods I, there is no formal institutional requirement on anyone to support it. In addition, adjustment burdens have generally been shouldered not by the system’s primary beneficiary—the United States—but by its creditors. Japan’s support for the dollar was a major cause of fifteen years of deflation and low growth that nation endured after 1990, while lower-income China has used savings extracted from its citizens—hundreds of millions of whom still live in poverty—to finance US consumption rather than increase domestic purchasing power. Initially the Organization of Petroleum Exporting Countries (OPEC) nations, led by Saudi Arabia, did the most to prop up a dollar-centered international order after the collapse of Bretton Woods I. OPEC’s swollen revenues were deposited in London, where they were recycled by leading commercial banks in the form of loans to non-petroleum-developing countries, financing the latter’s petroleum import bills. True, several OPEC nations briefly flirted with the idea of charging their customers in a currency other than dollars, but for a mixture of practical and geopolitical reasons (at the time, no other currency circulated in sufficient quantities, and the Saudi regime depended on US military protection), they stuck with dollars. But beginning in 1977, when Japan became the first developed nation to recover from the worldwide mid-1970s recession, to the last few years when it was overtaken by China, Japan played the starring role in dollar support operations. Japan unleashed the floodgates of its burgeoning financial wealth in the early 1980s to finance the so-called Reagan revolution— the first US experiment in steep tax cuts without concomitant spending reductions. Japan was the nation that pumped credit into the international system in the weeks after Black Monday—October 19, 1987—when the US stock market lost one quarter of its value in a few hours. Japan also largely financed the first Gulf War, sold billions of yen for dollars in the wake of the Mexican peso crisis of 1995, and kept buying dollar securities right through the Asian financial crisis; September 11, 2001; and the invasions of Afghanistan and Iraq. In the last ten years China has joined Japan as a primary supporter of Bretton Woods II; China’s official international reserves now exceed $3 tril-

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lion, as opposed to Japan’s $1.3 billion. Neither country reports precisely which percentage is denominated in US dollars as opposed to other currencies, but if either one were to switch large portions out of dollars into other currencies, the markets would instantly register such activity. Since no such event has occurred, even a conservative estimate would be Chinese dollar holdings of some $2 trillion–plus and Japanese holdings of some $650 billion. Many—even the majority—of Japan’s dollar holdings are, unlike China’s, not counted as official reserves since they sit on the books of private financial institutions. Japan’s comparative role in supporting the dollar is thus larger than these numbers at face value would suggest; holdings of US government securities by both public- and private-sector Japanese institutions exceed $1 trillion, according to the US Treasury.

Weight of the Past So, what’s in it for these countries? In strictly economic terms, they would seem to have only one compelling reason for their dollar support operations: as the world’s largest holders of dollars, they stand to lose the most (other than perhaps the United States itself) in any general dollar crash. Japan and China find themselves in the position of market players that have cornered so much of what is being traded that they cannot liquidate their positions without destroying their value—and in the meantime, have to pony up more and more to support them. But narrow economic calculations illuminate only part of the picture. In Japan’s case—and let’s start with Japan, for the Japanese have been at it for far longer—that picture includes fifteen years during which the Japanese financial system seemed to outsiders on the verge of a collapse that stubbornly refused to happen. It includes a political elite groping with realities they had never anticipated and for which neither their own history nor examples from abroad offer much guidance. The situation also features a nominally capitalist economic system that flouted almost every neoliberal precept, a political system that suffers from an institutional flaw rooted deep in its past, and a series of elaborate disguises that the elite used to conceal the sources of its power. Finally, Japan has a long history of active support for the dominant foreign country of the day, one aim of which is to forestall threats to its own domestic power alignments. The 1868 seizure of power by the modern Japanese elite came dressed up as a restoration, rather than a revolution, and took place in accordance with existing indigenous legal procedures, such as they were. In contrast to what happened after the Chinese revolution eighty-one years later, the last shogun did not flee to a remote island and seek to perpetuate a rival regime to that of Tokyo; instead, he formally returned power to the emperor. Yet despite the trappings, the Meiji Restoration was in fact a coup d’état

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launched by disgruntled elements on the fringes of the existing elite. They seized on the ancient institution of the Throne, previously a virtually powerless token of legitimacy, and used it as a cloak under whose cover they smashed a feudal system of fiefdoms and quasi-independent power centers while centralizing political and economic institutions of control in their own hands with a ruthlessness that would have drawn Napoleon’s admiration. The samurai from the hinterlands of Japan’s southwest who converged on Edo in the 1860s, renamed it Tokyo (literally, “eastern capital”), forced the abdication of the shogun, and brought the emperor and his court in from Kyoto were not inclined to share power with Osaka’s merchants or await the organic development of capitalist institutions. They sought to forestall the fate of the rest of the non-Western world—colonization at the hands of the imperialist powers—while suppressing at home an increasingly restive and impoverished peasantry. The merchants were generally ruined or expropriated, and the countryside squeezed even more mercilessly than it had been under the shoguns to extract every spare yen to finance Japan’s race for industrialization. Controlling stakes in the fledgling banks and industries were concentrated in the hands of former samurai, backed by a new bureaucratic mandarinate organized along Prussian lines. Meanwhile, imported institutions of social control were grafted onto an existing feudal order to deter domestic unrest. These institutions included universal male conscription; a militarized public education system; a deliberate reworking of folk religious practices into a politicized, centrally administered state Shinto; and the inculcation of a hypernationalist ideology of emperor worship. Throughout their half a century of rule—roughly 1868 to the early 1920s—the leaders of Meiji Japan also played a deft, high-stakes game in positioning themselves in a global financial-cum-military order revolving around the City of London. That order saw the machinery of a supposedly neutral universal gold standard working in tandem with the law of comparative advantage to bring about what was touted as a best-of-all-possibleworlds outcome. In fact, the order was managed by the Bank of England and policed by the British Navy. Countries such as Turkey and Egypt that ran out of gold or silver and defaulted on their debts found themselves facing loss of territory and even independence at the hands of the Western powers. Japan’s leaders were acutely sensitive to the power dynamics that underlay the global financial regime of the time.2 The rapid draining of gold from the country in the wake of Commodore Perry’s 1854 opening had been a proximate cause of the collapse of the shogunate; the domestic gold/silver exchange ratio was 1:5, so out of line with the prevailing international ratio of 1:15 that savvy traders quickly bought up much of the country’s circulating gold coin using its overvalued silver. The entire financial thrust of the subsequent industrialization had as its primary motive the accumulation of gold—or more precisely, the accumulation of claims on gold. When Japan

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actually succeeded in acquiring ownership of sufficient gold—extracted as reparations from a prostrate Qing dynasty after the 1895 Sino-Japanese War—to render its credit acceptable abroad, the country’s leaders chose to buy the goodwill of Britain by leaving the gold in the vaults of the Bank of England, rather than bring it back to Japan. The policy was known as zaigai seika—literally, “specie kept outside.” It relied on the ability of high-powered money—money used to create other money, such as gold, bank reserves, and international reserves—to play simultaneous roles: backing for Japan’s own credit creation and as part of Britain’s money supply. Keynes would describe the mechanism in his first major published work, Indian Currency and Finance, when he noted how earnings from India’s surplus trade with Britain that were left in London became part of the domestic money supply there and did not lead to a loss in British purchasing power. A Bank of Japan governor would later cite Keynes to justify zaigai seika. The policy would form the financial backdrop for the signing of the Anglo-Japanese Alliance in 1902, which sealed Japan’s admission into the club of nations supporting the existing global order. In thirty-four years, the country had moved from a poor backwater, whose very future as an independent nation was in doubt, to an important pillar of British hegemony in East Asia and an imperialist power in its own right. The resultant freedom of action, among other things, gave Japan the wherewithal to raise on global markets the funds necessary to wage and win the 1904–1905 Russo-Japanese War, which in turn helped lay the groundwork for the Russian Revolution.

Changing Hegemons But for all their success, the Meiji architects of Japan’s rise to global respectability had not solved core political problems, including the construction of institutions with the full legitimacy to determine succession and bestow the right to rule.3 Power was theoretically exercised in the name of an emperor who did not in fact rule. Behind the façade of the imported institutions of parliamentary government and the elaborate fiction of imperial blessing, the men who had seized power in 1868 continued to run the country themselves as a kind of collective oligarchy, controlling the great bureaucracies they had built. They failed, however, to leave their successors any sort of mechanism that could adjudicate among competing claims to power. The passing from the scene of the Meiji oligarchs coincided with the collapse of the British-centered world order in the fields of Flanders. A power vacuum in East Asia was among the many consequences of the inability of Great Britain and the unwillingness of the United States to assume systemsustaining functions in the wake of World War I. Mid-ranking officers in the Japanese Army grabbed the levers of control at home and filled that vacu-

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um, raining destruction down on their neighbors and ultimately their compatriots. Yet Japan’s devastating military defeat at the end of World War II did not lead to the replacement of one government with another. Washington’s endless self-congratulation notwithstanding, the US occupation did not engineer any fundamental break in the nature of Japanese rule. The constitution written by the occupiers no more settled the question of who had the ultimate right to determine the country’s agenda than had the leaders of the Meiji era. True, the writers of the constitution aspired to reposition sovereignty with the Japanese citizenry, supposedly acting through its legislature, rather than the emperor. But a semirigged electoral system that saw rural votes worth some three to five times their urban counterparts allowed the real policymakers in Japan to buy political stability with pork-barrel spending in the countryside. Those policymakers in the great bureaucracies that determined what actually went on in Japan were still unaccountable to any outside source, be it emperor or diet. The judiciary was still independent in name only. There was no oversight—from elected legislature, court of law, or monarch—over what any of the great bureaucracies were doing, and no accountability. But two things had changed. First, the prewar and wartime bureaucracies with the means of physical coercion at their disposal—the military and the Naimusho, or Interior Ministry—were either fragmented into less powerful shards or emasculated altogether and brought under the thumb of the Budget Bureau of the Ministry of Finance. Meanwhile, the great economic ministries—Finance and Munitions, now renamed as International Trade and Industry—were left largely untouched. Second, the United States assumed for Japan those functions by which a state is most commonly identified: providing for national security and conducting foreign relations. In most nations, questions of security, foreign policy, and the allocation of public funds to competing domestic interests form the stuff of politics. But with foreign and security policy taken out of Japan’s hands, and reconstruction the obvious priority in the immediate postwar decade, political discussion of substance (as opposed to theater) largely vanished; with its disappearance, a necessary infrastructure—most importantly, a vigorous, independent, quality press and a cadre of public intellectuals—atrophied. With the 1955 merger of the two major conservative parties to form the Liberal Democratic Party, the postwar configuration of Japanese political life was complete. The merger was taken to forestall any possibility of leftists coming to power, something that the United States had effectively insisted on as a condition for ending the occupation. But the 1955 system also included the sublimation of all other national goals into single-minded devotion to economic growth and acquiescence in the US-Japan alliance.4 The aim was to build an industrial superpower under US military protec-

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tion and within a stable, dollar-centered global financial framework; the Japanese elite did not concern themselves with the long-term sustainability of either. As Japan emerged from postwar devastation and launched a renewed drive for industrial growth so dazzling that it acquired the label “miracle,” it seemed as if the tale of the Meiji years was being retold. Again, Japan moved in the space of a couple of decades from a poor backwater to a major player, snuggling up to the superpower of the day. Again, it would serve as a crucial military asset for that superpower vis-à-vis the great Eurasian continental—and now Communist—empires. Again, Japan would leave the proceeds of its export earnings within the superpower’s banking system, providing indirect financial support for the superpower’s ability to project military force. And again, its subordination to a financial-cum-political global order managed and policed by the superpower would permit it to sidestep fundamental political questions. The Japanese political setup thus came to resemble a flourishing vine that had grown to great heights around the pole of a US financial-military world order. But the image requires qualification, for not only did the pole support the vine, but the vine became an increasingly important prop for the pole. The United States needs Japan today to a far greater degree than Britain ever did. Japan’s companies manufacture a range of both highvalue-added components and finished products on which US technological and military supremacy totally depend—something that became quickly evident in the wake of the 2011 East Japan earthquake, which damaged enough of Japan’s industrial base that supply constraints appeared almost instantly, constraints that threatened to halt the manufacture of scores of products worldwide—from commercial-grade videotape to smart meters, circuit boards, automobiles, aircraft, and pharmaceuticals (International Herald Tribune 2011). Meanwhile, Japan’s continued central role in financing US trade and government deficits and propping up a dollar-centered international order had become the key explanation for Washington’s ability to project and sustain a vast global military establishment without crushing domestic tax burdens. Since the mid-1970s, at every crisis point when it looked as if upheavals in the foreign-exchange market might force the United States to live within its means, it was the Japanese elite that acted to support the dollar, the Bretton Woods II regime, and by extension the continuation of US hegemony.

Fleeting Fantasies For a brief period—from the late 1980s until the early 1990s—the Japanese elite did appear to give serious thought to a fundamental restructuring of the relationship with Washington along more independent lines. From the 1979

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publication of Ezra Vogel’s Japan as Number One, the Japanese had been told by both their own homegrown cheerleaders and a diverse group of seemingly clued-in foreigners (I was part of the chorus, although like most non-Japanese I expressed some reservations) that they were on the verge of global economic preeminence, if they hadn’t already achieved it. Japan appeared to have surpassed the United States by every significant measure of economic strength save sheer size, and that was only a matter of a few more years. Particularly after the 1987 stock market crash, interpreted in Tokyo as a damning verdict on US profligacy and economic weakness, the Japanese elite seemed convinced they were living in the last days of US economic hegemony. To be sure, the United States still provided useful military protection against what was seen as Japan’s major external security threat and close neighbor, the Soviet Union. And the residual buying power of the US market was thought to form a necessary bridge to Japan’s historic assumption of the role of the world “headquarters economy,” to quote a National Interest article forecasting precisely this (Hollerman 1991). But Japan had already taken the lead in containing the damage from the 1987 stock market crash. Its companies dominated every important new technology, and its banks dwarfed their foreign rivals. The seemingly bottomless money pump of the domestic real-estate market made it possible for the Japanese to buy any asset, anywhere, for what seemed, from their perspective, chump change. The Ministry of Finance withdrew its historic opposition to the globalization of the yen and launched study programs on the conversion of East Asia into a yen bloc. All that seemed to be required was formal acknowledgment of the underlying reality: the passage of hegemony over the global economy from the United States to Japan. The Japanese money pump of the late 1980s, however, had been built on the quicksand of ever-rising land prices. When the authorities intervened to slow the rate of increase, they discovered that they had thrown the entire mechanism into reverse—and then could not stop it. Before land prices finally bottomed out, a Japanese financial system that had appeared on the verge of global dominance would have to retreat from international markets into a forced overhaul at home, while some of its proudest names disappeared in a series of shotgun mergers. A Japanese electronics industry that had trumpeted its supposed supremacy in semiconductors in the pages of Scientific American watched in stunned disbelief as US companies it had never heard of—Apple, Microsoft, Intel, Sun Microsystems, Cisco—walked away with leadership in all the important emerging information technologies of the 1990s, mobile phones the one notable exception. Against all expectations, the United States managed to reduce and finally eliminate its national government deficit between 1990 and 1995 and was rewarded with robust growth and a strong currency. Meanwhile, Japan seemed to lurch from one incoherent policy response to another,

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while its government debt accumulated at a pace even the United States had been unable to match. During the 1990s a sense of realism gradually settled in again after the puffery of the bubble economy. Japan’s elite came to see that it was facing the first fundamental challenge to its control since 1945. The rest of the world interpreted the problem as primarily an economic one, and indeed it manifested itself in such phenomena as stagnant GDP, rising unemployment, bankruptcies, tottering financial institutions, and deflation. But it was at heart a political challenge: how and whether the Japanese system should reconfigure itself to cope with unanticipated new realities in a world where the old methods no longer seemed to work. To mainstream economists in much of the world, the solution to Japan’s troubles seemed obvious: the full-fledged adoption of the institutions of liberal capitalism—corporate governance by outsiders; free trade; a purge of large, unprofitable banks and manufacturers and a sell-off of their assets to those who could manage them for higher returns; transparent markets for labor and corporate control; the busting up of cartels; price setting (for interest rates, the yen, labor, land, food, and housing) by markets rather than bureaucrats. The loudest exhortations along these lines emanated from Washington—ironically, since had Japan actually implemented these policies, the result would probably have been an economy-wide shakeout that would have forced large-scale liquidation of Japan’s dollar holdings and sharply curtailed its ability to prop up a US-centered global financial order. After all, companies and banks left to fend for themselves without the accustomed protection of an all-enveloping bureaucratic system would have come under strong pressure to do everything they could—including selling dollar assets—in order to survive the free-for-all of a market economy. Japan might have emerged on the other side of that shakeout with a stronger economy, as conventionally defined, but in the process its practical support for Bretton Woods II would have come to an end. There was, in fact, never any real possibility that Japan’s power holders would commit political suicide by abandoning control over the economy to markets that they did not trust. But the circumstances of the 1990s nonetheless posed formidable challenges: how to guide a financial system back from the precipice without provoking a crash, how to manage an economy where increases in nominal GDP (real GDP plus the rate of inflation) could no longer be taken for granted, how to lower the expectations of a sullen and disenchanted citizenry without provoking real civil unrest. On top of Japan’s unprecedented domestic challenges, the nation’s elite had to cope with a new global economic order in which the direction and pace of economic growth seemed to have passed from straightforward manufacturers to those who had mastered the art of delivering complex bundles of services— uncomfortable for a country whose greatest economic strength lay in making things.

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A Neoliberal Turn? In responding to these challenges Tokyo followed what—except for the 1931–1945 period—had been the guiding principle of its foreign policy since the late nineteenth century: subordination to the global interests of the superpower of the day, in return for a degree of protection and indulgence. Much mainstream Western opinion, however, would misinterpret this reaffirmation of Japan’s place in the US-centered order as the decisive turn to neoliberalism so many had been predicting for a generation or more. The misunderstanding is due in part to a mixture of amnesia and wishful thinking. For a decade or more, the financial press, neoclassical economists, and Wall Street analysts alike had been warning of the direst of consequences unless Tokyo got religion and adopted all the correct neoliberal reforms. Since the disaster had not happened—Japan’s financial system had not collapsed, and its manufacturers continued to dominate several key sectors— perhaps the reforms had been instituted on the sly. In addition, Japan’s elite deliberately fostered the notion that the country had made a turn toward neoliberalism. The language and some actual practices imported from what the Japanese like to call “Anglo-Saxon capitalism” proved useful both in lowering middle-class expectations and in promoting efficiency.5 The widespread talk of resutora, coined from that Wall Street favorite “restructuring,” plus a few visible foreign takeovers of ailing companies—Nissan Motors, the Long-Term Credit Bank—served to concentrate the minds of Japan’s salaried workers and managers, faced with the undreamt-of horror of reporting to foreigners younger than themselves or even losing their jobs. And the neoliberal talk was, of course, music to the ears of a superpower whose attention had been forcibly distracted by events elsewhere. Indeed, until January 2006 one could get the impression that Japan had become another devotee of Wall Street sermons. Management-fad jargon flowed glibly from the mouths of Japan’s young bankers and businesspeople, CEOs talked the talk of shareholder value, MBA programs sprouted in Japan’s universities (I teach in one of them), and “M&A” was no longer a dirty term. In the wake of a dizzying succession of faceless, in-and-out prime ministers, Koizumi Junichiro emerged in 2001 and put on a convincing act as a reformer determined to drag his country into the twenty-first century. The George W. Bush White House lapped it up, while the left muttered darkly of Koizumi’s subservience to the US globalist, neoliberal hegemony. Subservient to Washington Japan may be, but the notion of a wholesale conversion to neoliberalism should be taken with a heap of salt. If some in Japan’s business and financial circles had convinced themselves that a new era of dealmakers and value had thrown the old bureaucrat-run economy into permanent eclipse, behind the scenes Japan’s Ministry of Finance

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(MOF) —and its offshoot, the Financial Services Agency—was still calling the most important shots. The continued power of these two great bureaucracies was evident in the bill to privatize the postal savings system, upon which Koizumi hung his spectacularly successful September 2005 call for elections to choose a new diet. On the surface, this seemed the perfect contest between the dinosaurs of old, bureaucratic Japan and the new order. Postal savings had been the central financial pillar of the 1955 system. Collected through a dense network of post offices that blankets the country, they formed the world’s largest pool of discretionary cash. This money was traditionally turned over to the MOF, which used it to sop up Japanese government bonds, finance projects in the districts of politicians of the ruling Liberal Democratic Party (LDP), and support the dollar. Post offices offered slightly higher interest rates, more branches, and friendlier service than the traditionally haughty banks. Postmasters, particularly in rural areas, were important local figures, often with LDP connections; it was not unusual for the position to be passed from father to son. Koizumi ostentatiously burnished his reform credentials by picking a fight with LDP backbenchers who opposed the Japan Post privatization bill. These unreconstructed old-style pols understood that privatization represented a first step in draining the source of their power—the networks of rural LDP supporters whose jobs were financed, directly or indirectly, by postal savings. But the notion that the bill heralded the emergence of a shareholder-driven economy overlooked the fact that the bill had been written by the Ministry of Finance (Koizumi admitted that he had not even read it). To be sure, Koizumi pulled off an impressive political sleight-of-hand. His opponents in the LDP, closely linked to the rural-based construction industry and the post office bureaucracy, fell for his ploy of announcing he would call an election if the bill were defeated. They voted it down, allowing him to define the election as a choice between reform—himself and his handpicked candidates—and those “against change”: anyone who opposed him. The maneuver sucked out of the system the oxygen that might otherwise have permitted genuine champions of reform to start a small fire.

Horiemon Conventional wisdom abroad nonetheless held that Koizumi’s reelection represented the dawn of a turbocharged free-market system. Many Japanese themselves were also seduced by this talk. The leading symbol of the supposed new economy was a young entrepreneur by the name of Horie Takafumi. Horie had been slated for a position in the elite when he secured passage through its most important gate—matriculation at the University of Tokyo. But instead of doing what was expected of him—graduate and join the ranks of the governing bureaucracy or a major company—he left the

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university without a diploma. Modeling himself on the likes of Bill Gates and Steve Jobs, who had also dropped out of elite schools, he set up a company to pursue opportunities offered by the coming of the Internet. His firm, Livedoor, grew rapidly; soon, in classic Wall Street style, Horie began to launch takeover bids, using his mastery of the new media to appeal over the heads of entrenched managers to the shareholders who theoretically owned the firms. In the process, he became an icon for younger Japanese, defensive about their country’s supposed eclipse by the likes of Apple and Goldman Sachs. Schoolchildren nicknamed him “Horiemon”—the suffix derived from the English “monster,” having morphed into the designation for a boyish action hero (Pokemon, Doraemon). Clad in T-shirts and jeans, Horie became a familiar figure on Japanese television, upbraiding stuffy, besuited executives for their stick-in-the-mud ways. Horie was very much of a piece with Koizumi’s talk of reform, and he ran on the Koizumi list against a traditional LDP heavyweight, Kamei Shizuka, in the 2005 elections. Kamei ended up leaving the LDP, but remained a proudly unreconstructed champion of the traditional buy-ruralvotes-with-big-infrastructure-projects system and won easy reelection in a district that had done very well with the old ways. But Horie’s run boosted Koizumi’s reform image while enhancing his own celebrity. That celebrity was probably his downfall. On January 16, 2006, every TV station, radio broadcast, and newspaper featured wall-to-wall coverage of hordes of prosecutors descending on Livedoor’s offices; a week later, Horie was arrested. Several of his associates were thrown in jail, and another was said to have committed suicide; the more scurrilous journals hinted at murder. What ensued was a classic all-enveloping scandal of the type that has punctuated Japan’s political life since 1945. As if on signal, the entire media establishment went into overdrive, pouring vituperation on a figure who just a few weeks earlier had been celebrated as an avatar of the new prosperity. Karel van Wolferen has argued that scandals represent a central structural feature of a Japanese political order that is not ultimately grounded in law. Scandals correct excess and resolve power struggles that, in other countries, would be settled by courts or elections (Chuo Koron 1991). The prosecutors who threw Horie in jail were in no hurry to bring any indictment. After a month of rifling through his company’s papers—giving time for the quality press and the networks to whip up the equivalent of a national lynch mob—they finally settled on violations of the securities and exchange code, and later with accountancy fraud. In Japan, prosecutors do not initiate proceedings on their own initiative against figures suspected of financial crimes. Nor do they act on behalf of disgruntled investors. They move only at a sign from inside the Ministry of Finance and other bureaucracies charged with overseeing the country’s economy. The media coverage of Horie’s downfall invited comparison with

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the Enron affair, and it appeared that he was engaged in dubious financial gamesmanship (his favorite tactic involved repeated stock splits, which provided a window of opportunity—while the new shares were being issued and the old shares could not be sold—in which to ramp up the price). But vilifying him for manipulating his company’s accounts recalls Casablanca’s Captain Renault finding himself “Shocked, shocked!” at the gambling in Rick’s Café Americain, while pocketing his winnings. Many Japanese companies have long used lax accounting practices to hide the true financial condition of their businesses. The latest such incident involves the optical equipment maker Olympus. The company had doctored its books for some two decades in order to hide bad investments, but then made the mistake of hiring foreigner Michael Woodford as president. Woodford refused to shut up about what had been going on; he lost his job as a result, but not before he made the shenanigans impossible to ignore. The difference between the treatment of Olympus and Horie’s Livedoor is revealing. The Japanese establishment closed ranks to keep Olympus from falling under the control of foreign interests. (Woodford had urged that the board of directors be replaced with a new board partly selected by foreign investors.) Olympus executives have received what amounts to prosecutorial slaps on the wrist while Horie went to prison and his company was delisted. Horie’s real crime lay less in his accounting gimmickry than in his failure to see that many of the neoliberal trappings with which Japan’s spokesmen had bedecked their economy were just another imported suit of clothes, to be discarded as last year’s fashion the moment they had outlived their usefulness to the real power holders. This kind of borrowing and discarding had been going on since the 1860s: take in something from the West, keep what is useful, and throw out the rest, particularly when it challenges the fundamental distribution of power. Many of the reforms of the last decade may indeed prove to have been real and lasting—particularly those that privileged manufacturers with a strong comparative advantage in key upstream industrial components and materials and encouraged labor mobility (Schaede 2011). But when it came to allowing companies to be bought and sold in open markets, the Horie case served as an object warning. Prosecutors gave the game away when one of them announced that Horie’s arrest would remind people that “wealth comes from hard work.” Horie’s celebrity made him the perfect target for a message that only the dimmest could fail to get: Neoliberal talk is fine for Washington; it can usefully serve as a cloak for welshing on unwritten employment norms, such as job security and steady increases in income. But anyone who tried to use it as a means of disrupting existing power alignments would find himself an example of that favorite Japanese proverb: The nail that sticks out will be hammered down.

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A New Third Player As Koizumi left office in September 2006, a convincing economic recovery finally seemed to be taking hold after several false starts. But it turned out to be yet another instance of the traditional Japanese economic model at work: an export-led recovery. For all the talk of revived domestic demand, exports remained central to Japanese corporate profits and the ability to service debt. Since the early 1950s, exports have been the lodestone of Japan’s growth. But one thing had changed. While the United States had long been the primary market for Japan’s exports, it was surpassed early in the 2000s by China. China’s hunger for Japanese capital goods and upstream components—used largely to produce the exports to feed a US market—permitted Japan’s capital goods and materials manufacturers to boost capacity utilization rates to the point where they were making money again. The positive cash flow meant that balance sheets could be strengthened and debt paid down, allowing the banking system to put the worst of the so-called bad loan crisis behind it. China thus helped alleviate what had come to seem an insoluble problem: the overwhelming pressure on the cost structure of Japanese industry once it joined the ranks of the developed nations. Japan had long sought to preserve what is essentially a late-developer model: export-led growth, systemic protectionism, severe restrictions on foreign equity, and cartels that funneled cash into industrial coffers in order to offset the price cutting necessary to win export markets. But during the 1990s the yawning gap between domestic Japanese prices and those overseas finally sucked in and chewed up cartel after cartel (“price destruction” was the term coined by distraught Japanese businessmen). Meanwhile, the collapse of real estate prices crippled the financial mechanism that had seen cheap financing channeled from household savings to industry. And no matter what was done to shackle market forces, there was no escaping the economic reality of welltrained Chinese willing to work twice as hard as their Japanese counterparts for one-tenth of the wage. But Japanese industrial leaders found the means of coping with this threat to their way of doing business by undertaking what amounted to a division of labor with China. Both countries engaged in tacit cooperation to support the dollar, permitting Americans to purchase Japan’s high-valueadded products—automobiles, machine tools, aerospace components—and China’s lower-end products, manufactured largely on imported Japanese equipment and containing many high-end Japanese-made components and materials. Japanese companies, for example, captured 34 percent of the value-added in the hot new iPhone 3G assembled in China (Wall Street Journal 2010).

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Meanwhile, for many Japanese working-class households, the end of job security was partly alleviated by waves of cheap Chinese imports of food and clothing. Japan’s informal economic mechanisms—lifetime employment, a reluctance of banks to foreclose, mutual assistance between companies in the major business groupings (keiretsu or guruppu gaisha)— came under strain but continued to function well enough to forestall the final shakeout that so many foreign observers had predicted. But while much of the essence of the Japanese economic system may have survived, this survival necessitated the acceptance of a third player whose arrival introduced a whole new set of problems and uncertainties. Since the mid1950s, there had been only one really important external task for Japan’s administrators: managing the United States. The US security framework and unrestricted access to the US market had to be protected at all costs; that essentially constituted Japan’s foreign policy. But by the middle of the last decade, an unpredictable China had once again become part of the picture.

Storm Clouds over the East China Sea From the collapse of the Tokugawa shogunate down to the present day, China has been a central Japanese obsession. Japan’s forced industrialization in the late nineteenth century was a direct response to the sight of a weak and prostrate China carved up by the Western powers. For fifty years after the 1895 Sino-Japanese War, much of what Japan did abroad was premised on attempts to forestall the rise of an independent Chinese power, while buttressing its own. Japan’s long postwar acquiescence to the status of a US protectorate is in part, as we have seen, a matter of following the path of least resistance. But it is also due to the belief, held by much of Tokyo’s political elite, that the alternative to US protection is incorporation into a new Chinese empire as a tributary state. As Japan’s economic dependence on China deepens, the rationale for a US counterweight becomes all the more obvious—to Beijing, of course, as well as to Tokyo. These conditions may explain some of the theatrics of Sino-Japanese relations over the past few years. To outsiders, the spectacle of antiJapanese demonstrations in China, of visits by prime ministers to shrines celebrating Japan’s war efforts, and of brouhahas over the wording of a few passages in school history texts can seem bizarre. But in a region where politics has long been practiced as theater, the striking of these poses suggests underlying messages. First, “Do not confuse our investments with tribute; we will not fall into your orbit”; second, “We are prepared to make things difficult for you—very difficult—if you continue to acquiesce in the hegemonic ambitions of an external power in blocking our return to our histori-

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cal preeminence in Asia.” Increasing world political tensions under the George W. Bush administration only accentuated these stances. The Chinese knew that the radical foreign policy intellectuals who assumed positions of influence in the Bush White House had identified China as the new US enemy and were spoiling for a fight, until Osama bin Laden diverted their attention. While Japan hastened to prove itself the perfect ally in the Bush war on terror, an increasingly assertive China fretted over Japan’s de facto role in what seemed Washington’s blatant return to containment as its strategic aim vis-à-vis Beijing. The Chinese government can give the impression of proud self-confidence; this is, after all, a regime that has presided over the most rapid improvement in living standards in human history—a government that took a shambles of a country and turned it into a major power that commands respect and even apprehension around the world. But it is nonetheless haunted by fear of disorder and of challenges to its fundamental legitimacy. Consider the hysteria with which the Beijing government reacted to the appearance of a cultlike new religion in the form of the Falun Gong, or to the awarding of the 2010 Nobel Peace Prize to the dissident intellectual Liu Xiaobo. A secure, self-confident government would not elevate the suppression of a cult or the denigration of a literary critic to leading policy objectives, nor would it devote immense efforts to policing the Internet for unfavorable posts about itself. But for the members of a political elite that saw lives and careers in their parents’ generation destroyed by the chaos of the Cultural Revolution, no threat to social peace and stability can be safely ignored. The Chinese Communist Party derives its legitimacy from its position as the successor to the mandarinate that ruled China for thousands of years. Its credibility derives less from Marxist postulates than from age-old notions of Chinese political philosophy, among them the automatic right to rule by an educated class and the Mandate of Heaven, which stipulates that prosperity and order demonstrate in and of themselves the legitimacy of rulers, while poverty and disorder are proof of the reverse.

China’s Dollars How does China’s dogged persistence in holding so much of its national wealth in dollars fit this picture? China needs to create millions of new jobs a year to forestall politically dangerous unemployment; Chinese leaders are acutely aware that large numbers of idle young men form a most reliable recipe for political disorder. The strategy for creating those jobs grew out of the turbulence that marked the final years of Mao Zedong. During the brief reign of the Gang of Four, as the first claimants to Mao’s mantle came to be known, Beijing

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had flirted with a return to Stalinist autarky. But Deng Xiaoping, who would emerge in 1978 as China’s so-called Paramount Leader out of the struggle following the downfall of the Gang of Four, would announce a new economic direction with his famous words, “It doesn’t matter whether a cat is white or black as long as it catches mice.” The preeminent mouse catcher of the time was Japan. Following widely publicized visits by Deng to Japan and Singapore in 1978, China set about systematically copying key aspects of the Japanese economic model, particularly the privileging of export-related industries capable of earning international reserves, principally dollars.6 But while Japan had financed its buildup of production capacity largely through domestic savings, China supplemented these with direct foreign investment. The reason probably lay in the sense of urgency that the Chinese leadership felt after the political upheavals associated with the Cultural Revolution and the Gang of Four. With the abandonment of orthodox Marxist-Leninist doctrine on economic development, China’s leadership had no choice but to deliver rapidly improving living standards both as a concrete demonstration of its competence and legitimacy, and to forestall domestic political challenges—an obsession with the Chinese leadership, as the violent suppression of the 1989 Tiananmen Square protests would demonstrate. The result was the pell-mell rush to build production capacity financed with whatever it took. For anyone with an eye for numbers, the evidence of this strategy blazes out of China’s balance of payments statistics like flashing lights on a police car. Most countries, such as Japan, that regularly run surpluses on current account (trade plus transfers and dividend and interest payments) see the money recycled abroad through overseas lending plus acquisitions and portfolio investments in foreign countries. As its spate of high-profile acquisitions around the world demonstrates, China is certainly recycling some of what it earns from trade to buy mines, companies, and oil wells overseas. But more investment flows come into China than leave it; they help finance the factories that dot the Chinese landscape and the skyscrapers sprouting everywhere in its cities. The laws of balance of payments accounting produce the result: an explosive buildup of international reserves, primarily dollars. Whatever else China’s leaders may think about the United States, they can have no illusions that the dollars they have accumulated can ever be redeemed for anything close to their current nominal values. Any attempt to shift large parts of its reserves out of the market for US government debt risks precipitating a US bond-market crash that would carry other markets with it and thereby defeat the purpose. Instead, by the early years of the new millennium, China found itself in the same place Japan did in the late 1970s; it had accumulated such a large position in dollars that it could no longer afford to walk away from that position without doing incalculable damage both to itself and to the global

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financial regime. Whether intentional or not, Beijing had ended up as a de facto pillar of the dollar-centered world order. But the burgeoning dollar reserves fueled a rapid buildup of credit that in turn led to ever more worrisome climbs in asset prices; real estate prices in Beijing and Shanghai would soar by over 40 percent in 2010 alone.

The Endgame? The events running from the financial implosion of September 2008 to the catastrophic earthquake-tsunami that struck Japan’s northeast coast on March 11, 2011, fanned fears that the global financial order could not survive much longer, even though the currency and bond markets underscored the lack of a credible alternative to existing arrangements. China would recover quickly from the so-called great recession brought on by the financial collapse, but it did so through renewed investment spending on production capacity that far exceeded the country’s domestic needs and via exports that were themselves the only conceivable result of that wave of investment (Pettis 2009). Given that the rest of the world grew hardly at all during the months right after the implosion, China’s exports had to come directly—and inevitably—at the expense of export market share from other countries, leading to howls of pain worldwide. China’s performance stood in sharp contrast to that of the United States first sinking into recession and then limping into a jobless recovery, leading to widespread speculation that China’s currency was poised to take over key settlement and reserve functions from the dollar, at least in Asia. University of California–Berkeley economist Barry Eichengreen would, for example, write in the Wall Street Journal: China . . . is moving rapidly to internationalize the yuan, also known as the renminbi. The last year has seen a quadrupling of the share of bank deposits in Hong Kong denominated in yuan. Seventy thousand Chinese companies are now doing their cross-border settlements in yuan. Dozens of foreign companies have issued yuan-denominated “dim sum” bonds in Hong Kong. In January the Bank of China began offering yuan-deposit accounts in New York insured by the Federal Deposit Insurance Corp. (2011)

Michael Pettis, a professor of finance at Beijing’s Guanghua School of Management, responded to Eichengreen with a closely argued piece that took issue with Eichengreen’s claim about the imminent preeminence of the Chinese currency in Asia: The RMB (renminbi) is unlikely to become a serious reserve currency in the foreseeable future. There are a number of reasons for this. First and

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most obviously, there are few realistic mechanisms by which the world can acquire RMB. Either China needs to run large current account deficits, or it needs totally open domestic financial markets in which foreigners can easily acquire domestic RMB-denominated bonds to the tune of several percentage points of China’s GDP annually. . . . We are unlikely to see either for many, many decades. Although China will struggle to bring its current account surplus down, there are only two ways it can do so. . . . One way is for a further surge in investment. At current levels, however, investment is already so value-destroyingly high (to coin a new adverb), and it is pretty clear that Beijing is desperate to reduce the economy’s dependence on further investment growth, so we can pretty much dismiss investment acceleration as something that is likely to be maintained over the next decade. The other way is to reduce savings by raising the consumption share of GDP. . . . This is going to be excruciatingly difficult, and will likely come about only with a sharp reduction in Chinese GDP growth (in which case one of the main reasons for predicting the rise of the RMB will be undermined). (2011)

This is the heart of the matter. China seems to have landed in the same trap that enmeshed Japan: once you put investments and exports rather than domestic demand in the driver’s seat of your economy, the financial fuel of your economy becomes a constant inflow of international reserves—that is, dollars. But unless you are prepared to risk significant economic disruption, you can switch neither driver nor fuel. And economic disruption brings political upheaval. Events in Japan made this connection explicit. Koizumi had been followed as prime minister in quick succession by three LDP hacks, none of whom could manage to last more than a year in office. Then came the financial implosion of September 2008. In contrast to what happened in China, the implosion sent the Japanese economy into a tailspin. The shrinking of the US market for its exports and the concomitant collapse of demand for Japanese-made goods made it clear to the Japanese voter—if it hadn’t been clear already—that existing power holders had no idea how to respond to the sudden and drastic deterioration in economic fundamentals. Further, the practices that had heretofore provided for economic security for ordinary households—lifetime employment, the willingness of banks and large manufacturers to throw credit lifelines to borrowers and suppliers that would have gone bankrupt in an “Anglo-Saxon” economy—were obviously crumbling beyond hope of repair. For the first time (with one brief exception) since 1955, the voters turned over the reins of Japan’s formal governing institutions to a party other than the LDP. The newly elected Democratic Party of Japan (DPJ) announced that it actually intended to govern—to remove ultimate economic and political decisionmaking from the ministries and lodge it with elected politicians. Even before the August 2009 elections that swept the DPJ into power, however, the party’s entrenched opponents in the bureaucracy, the judiciary,

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and the media had come together to make real governing by the DPJ as difficult as possible. Using the tested recipe of hyping minor financial irregularities as major scandals, orchestrating campaigns of vilification in the press, and threatening an investigative circus from the public prosecutor, they forced the party to remove Ozawa Ichiro as its leader. Arguably the most formidable politician to emerge in Japan in a generation, Ozawa had been the architect of the DPJ’s rise. But his very success at shaking up the old order meant that he was widely hated and feared by those who had the most to lose from its demise—and they had sufficient clout to block him from assuming the prime ministership. In his place, the DPJ settled on the diffident Hatoyama Yukio. Hatoyama soon found himself undermined by the same elements that had engineered Ozawa’s removal. They played on US fears that, under the DPJ, Tokyo might not continue to be the malleable vassal to which Washington had grown accustomed, and that the US Marines might not get a new base on Okinawa, which they had been promised. Hatoyama was treated with calculated rudeness by President Barack Obama and his top aides, allowing the DPJ’s domestic political opponents to portray Hatoyama as an “amateur” who threatened Japan’s supposedly most important security relationship. Increased tensions with China and North Korea in the spring of 2010 made this a plausible enough contention for many that Hatoyama was forced to step down in June (Murphy 2010). In his place, the party elevated Kan Naoto to the prime ministership. With sagging poll numbers and the media playing up factional disputes in the DPJ, it soon looked as if he was headed for the same fate as Hatoyama and his three immediate LDP predecessors—forced to resign after less than a year in office. But then Japan was struck by the great East Japan earthquake of March 2011. The catastrophe temporarily strengthened Kan’s and the DPJ’s hold on the leadership, partly because of the natural tendency of any country in such circumstances to rally around its leaders. But two other factors were at work. First, despite the overwhelming nature of the disaster—tens of thousands dead or missing, hundreds of thousands made homeless, and disruptions up and down economic supply chains—the elected government gave every indication that it accepted ultimate responsibility both for delivering emergency aid and for orchestrating reconstruction. The attitude conveyed by Kan and his top aides contrasted markedly with that displayed by their predecessors sixteen years earlier after the great Hanshin earthquake that leveled much of Kobe. At that time, Japan’s political leadership gave many the impression that it believed it was up to corporations, religious groups, and other organizations to rescue their own from the destruction—that those with no affiliation with such organizations were seemingly to be left to fend for themselves. Indeed, outrage over the government’s abdication of responsibility was one stated reason Kan and Hatoyama had left the LDP in the first place.

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The crisis at the Fukushima Daiichi nuclear plant also played into the hands of the DPJ. In the days after the tsunami destroyed the plant’s backup cooling systems, its owner and operator, Tokyo Electric Power (TEPCO), stood revealed as an object example of a bureaucracy that had been allowed to function without check or external accountability. As Andrew DeWit (2011) writes, “The reactors at the core of the crisis are the legacy of vested interests’ dominance of Japan’s energy policy. Key actors in this ‘power elite,’ if you will, are Japan’s 10 monopolized utilities that have the country divided into their respective fiefs. They are backed by bureaucrats in the Ministry of Economy, Trade, and Industry (METI), as well as a broad swath of the political class. Their priorities have led to a focus on, indeed an obsession with, nuclear power.” Writ large, this is precisely the problem that the DPJ had been elected to fix: bureaucracies operating without accountability inside self-constructed echo chambers. While illuminating what was wrong with Japan’s traditional governing setup, the catastrophe also revealed what an overwhelming task lay ahead. The DPJ had not begun to have the time or resources to construct the political network necessary to replace what it had inherited, as was evident in the response to the financial turmoil that the catastrophe provoked. In the days right after the earthquake, the yen soared to a postwar high against the dollar. Currency traders worldwide assumed that Japan would be drawing down some of its accumulated dollar horde in order to pay for reconstruction, leading to an inevitable weakening of the dollar, at least in yen terms, and concomitant strengthening of the yen. Such a scenario fit earlier trial balloons that DPJ insiders had floated about the possible benefits to Japan of a strong yen. But it was not to be—at least not quite yet. US Treasury secretary Timothy Geithner felt compelled in March 16, 2011, testimony to the Senate Banking Committee to discount fears that Japan might sell US Treasuries to raise cash—that is, finally begin to use its accumulated dollar horde for its own needs. Whatever Geithner might have said, however, these fears were sufficient to provoke coordinated action two days later by the world’s leading central banks, including the Bank of Japan, to drive down the yen—the first such action since 2000. The joint intervention succeeded, and the yen drifted down against the dollar in the weeks that followed. While this may have provided breathing room for the dollar, it was not at all clear how the joint intervention had benefited Japan. The country needs to spend the yen equivalent of hundreds of billions of dollars to rebuild its ravaged northeast, and cheapening the currency seems only to add to this burden. And while a strong yen hurts traditional large exporters, these companies are no longer the most profitable in Japan. Ulrike Schaede (2011) points out that they have been replaced by companies such as Keyence, Pacific Metals, Ono Pharmaceuticals, Nippon Electric Glass, Hirose Electronic, and Union Tools—firms that often enjoy

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such a dominant position in their respective markets that they can survive and even thrive in a strong currency environment. In an issue devoted to canvassing Japan’s leading experts for recommendations on how to recover from the March 2011 earthquake and tsunami, the prominent Japanese opinion journal AERA ran an article by the economist and analyst Akio Mikuni (2011). The article, whose English title was “Using the High Yen to Restructure the Economy Towards Domestic Demand,” noted that despite the horrendous damage, the disaster provided Japan with an opportunity once and for all to place domestic demand rather than exports in the driver’s seat of the Japanese economy. Specifically contradicting Geithner, Mikuni advocated repatriation of the export earnings that had been placed in the US banking system. He maintained that rather than funding asset bubbles in the United States, this credit should be used to help finance reconstruction in Japan. Mikuni could be seen on Japanese television advocating similar measures. Mikuni’s recommendations—if followed—would spell the end of Japan’s support for the dollar-centered international order. Whether the Bank of Japan finally allows the yen to seek its own level rather than joining its counterparts overseas to intervene whenever the currency tests new limits, the March 2011 catastrophe has certainly added yet one more burden to a global financial order already buckling under the demands placed on it by the financial implosion of 2008 and a series of subsequent debt crises around the world. Increasingly the term “endgame” can be found in discussions of that order. For forty years now, the dollar standard supported by an East Asia running ever larger surpluses that would not be spent at home has allowed—even required—the United States to run ever larger counterpart external and government deficits. But the imbalances the system spawned are becoming increasingly incredible, to choose a word deliberately. A financial system based on fiat money lives on its credibility, and when credibility disappears, the system collapses. Reforming the system is not, however, simply a matter of finding another currency or currencies to replace the dollar. There are serious— even fatal—problems with all alternatives. For reasons discussed above, the renminbi is unlikely to take over the dollar’s role even in Asia, not to mention worldwide—and even if Beijing is prepared to take the policy steps to see it happen, which it manifestly is not. With Japan reeling from the March 2011 earthquake—as well as suffering two decades of subpar growth—no one speaks any longer of the yen replacing or serving together with the dollar as the world’s principal standard of value. Meanwhile, the countries in the euro bloc have, since the financial implosion of 2008, been going through the worst series of political and economic crises since the adoption of their common currency. While it is much too early to foresee how Europe’s experiment with a single monetary regime will ultimately pan out, the notion that the euro can or will replace the dollar as the world’s money

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is a nonstarter. Among other things, there is no combination of China and Japan to support it. Endgame assertions have thus begun to seem all too plausible even when the markets themselves betray (as of this writing) no direct sign of impending collapse. Today’s global financial order grew out of the early 1970s wreckage of the postwar Bretton Woods system and the lack of political will at the time to design an explicit global monetary architecture to replace Bretton Woods. It was an experiment without blueprint or intention, an experiment in drafting the fiat money of a single country to serve as the world’s standard of economic measurement, the world’s leading mechanism for settling accounts, and the world’s primary store of value. The experiment has continued as long as it has because it has served the political interests of powerful players in Washington, Tokyo, and Beijing—as well as in Seoul, Riyadh, Frankfurt, London, and Basel—who had the will and the ability to cope with its ever-more-manifest contradictions. These contradictions took visible shape in the exploding imbalances of the leading players—in the rivers of red ink that threaten to sink the US government, in the external deficits of the United States, in Japan’s ever-rising national debt, in the vast buildup of restless monetary reserves in China, in that country’s system-threatening external surpluses. But with weak governments across the world unable to square the demands on public treasuries with revenues, and with so much of the world’s financial regulatory apparatus captured by those who seek only to line their own pockets, it seems that neither the will nor the ability to sustain the system can last much longer. But when and how it will collapse, what will replace it—and the cost of getting there—is anyone’s guess.

Notes This is an updated and expanded version of an article that first appeared in the New Left Review 40 (Second Series), July–August 2006, pp. 39–66, under the title “East Asia’s Dollars.” 1. The additional costs incurred by the Pentagon during the first year of the occupation of Iraq were thus roughly equal to the incremental purchases of US Treasury securities by the central banks of Japan, China, South Korea, Hong Kong, and Taiwan. As long as those central banks do not sell these securities (or fail to roll them over when they mature), Washington bears no additional financial burden in mounting a vast military operation, beyond the (relatively) modest interest payments. Taxes need not increase; Americans need not work harder to produce more goods for export or reduce their consumption in order to pay foreigners back the money they have borrowed from them. 2. The effect of contemporary events in Egypt and Turkey on the thinking of the Meiji leaders is described in Norman 1975. 3. See Karel van Wolferen’s discussion of how the question of the right to rule—“the most fundamental problem of Japanese political life”—has plagued the country’s modern history (1989, ch. 12).

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4. The “alliance” is, in fact, a protectorate since it imposes no formal obligations on Japan other than to host US military facilities, whereas the United States is legally obligated to come to Japan’s defense in the event of an attack. See the discussion in Murphy 2009. 5. The most persuasive advocate for the lasting effects of the reforms of the late 1990s and early 2000s on Japan’s economic structure is Schaede, who argues that the “main facets of Japan’s industrial architecture have been irreversibly altered” (2008, 257). 6. See the discussion of Deng’s trip to Japan in Vogel 2011 (294–310). The trip to Singapore is discussed on 287–291.

4 The Missing Crisis in Latin America Peter Kingstone

The 2008 financial crisis that began in the United States with the collapse of Lehman Brothers and then swept through the global economy has shaken the pillars of the international economic and political order. As of 2011, the United States, Europe, and Japan remain mired in crisis and seemingly incapable of articulating a coherent policy response. Yet Latin America, along with much of the developing world, returned quickly to robust growth. The mismatch in performance has led some to talk of challenges to Western capitalism from new, state-led economic models and to the rise of alternative centers of economic might (especially the so-called BRIC countries: Brazil, Russia, India, and China) (Bremmer 2010). For observers of Latin American political economy, one of the biggest surprises is how insulated the region appeared to external financial shocks—something arguably unprecedented in its history. The unexpected resilience of the region led Arturo Porzecanski (2009) to refer to it as the case of the “missing financial crisis.” An additional measure of the region’s success is Brazil’s emergence as a global player, which includes the discovery of substantial offshore oil deposits and the state-owned Petrobrás’s global leadership in deep-sea oil extraction. The Pre-Salt discoveries are estimated at over 40 billion barrels and could place Brazil among the largest producers in the world. The shift in power also includes successful challenges by Brazil and Chile to international financial institutions, most notably successfully overcoming developed countries’ opposition to the introduction of capital controls. Finally, and perhaps most tellingly, Brazil’s development model has become an example to emulate among the region’s governments, competing both with Hugo Chávez’s more aggressively anti-US statist model as well as the United States’ preferred market model (frequently referred to as neoliberalism or the Washington Consensus). Brazil’s surging growth, declining poverty and inequality, and low inflation stand in stark contrast to policy gridlock and confusion in the United States, coupled with ballooning debt

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and deficits and the prospect of long-term unemployment and underemployment. The enthusiasm that this current period has engendered begs a crucial question: Is the success for real? There is no disputing the robustness of the region in the face of a substantial financial shock. The crisis reached all of Latin America by early 2009 with significant declines in GDP growth, steep falls in exports, and diminishing capital inflows. But by late 2009 and into 2010, much of the region had recovered. The missing financial crisis is all the more telling, given the series of exogenous financial shocks that roiled the region as recently as the 1990s. The success turns on external and internal factors. On the external side, beginning in roughly 2003, high commodity prices and demand, especially from fast-growing countries like China, have had an array of positive effects, including solid GDP growth rates, rising wages in the agricultural sector, declining debt and debt servicing burdens, and strong foreign reserve accumulation. Commodity booms, however, are neither new nor permanent. The need to develop a sustainable model of growth that does not rely solely on commodity exports and unusually positive terms of trade has not receded. On this front, a small number of changes have taken place, but overall there is little evidence that the region has made substantial inroads, even in the leading economies of the region such as Brazil’s. The boom contributed to the stronger financial position on average, which in turn shielded the region from the worst of the crisis. Nevertheless, very few countries were in a strong enough position financially to turn to strong countercyclical fiscal policies or to deepen significantly investments in infrastructure or human capital. Ultimately, strengthening the productive base of the region’s economy and raising the welfare of the population—that is, promoting meaningful economic development—will depend on the ability to do so. Latin America continues to face important challenges to fostering economic development. On the domestic side, the sources of success rest on sturdier foundations and greater promise for the future. Most Latin American nations implemented a series of market-enhancing reforms through the 1980s and 1990s (the Washington Consensus) that were frequently unpopular and did not always produce immediate and obvious benefits. The political struggles over these reforms challenged democracy’s durability and deepening in the region, and in some cases contributed to the radicalization of politics (for example, in Bolivia and Venezuela). These reforms included budget cuts, tax increases, trade liberalization, privatization of state-owned enterprises, as well as a number of measures to strengthen the banking system and improve prudential regulation. The overall net effect of these neoliberal policies is subject to intense debate, but even many critics agree that they played an important role in improving the macroeconomic environment.1 As a result, Latin America was particularly well prepared for the financial

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shock and indeed is an important element in the resilience of the region to the deeper threat of a financial crisis. Note, however, that the discussion of the average performance of the region conceals considerable variation. In particular, those countries more closely tied to US manufacturing (essentially Mexico and most of Central America) benefited less over the 2000s and have suffered greater adverse effects from the crisis. In short, the surprisingly strong rebound of the region from the global shock rests on the ephemeral benefits of unusually positive terms of trade as well as the deeper reforms that represent real changes to the Latin American development model. Those real changes, assisted by the good fortune of the global economic context, offer a base for promoting a better path for economic development under democratic auspices. The robustness of the region in the face of the 2008–2009 crisis was a welcome surprise, but the problem of strengthening the productive base of the region’s economy has not been resolved. This chapter makes this argument in six sections. The first section reviews the development path leading up to the crisis, focused particularly on the region’s history of vulnerability to international shocks. The second section examines the region’s economy since the crisis and demonstrates the surprising robustness in the face of the global shock. The third section examines the external sources of the region’s success, while the fourth section considers the set of policy reforms implemented throughout the region since the 1980s and its contribution to the economy’s resilience. The fifth section explores the limits to this success, particularly the threat of Chinese manufacturing and the weaknesses of the development model. The chapter concludes by examining the contending models of development in the region in the wake of the discrediting of the US-sponsored neoliberal program: Brazil and Venezuela.

A History of Hard Times: Commodity Booms, Busts, and Adjustments That Latin America has shown so much resilience to the global crisis is a bit of a surprise given that vulnerability to financial shocks has been something of a permanent feature of the region. As Arturo Porzecanski has noted, the “financial vulnerability of Latin America to the vagaries of international capitalism has been on all too frequent and public display” since at least 1825 (2009, 2). In fact, as recently as the 1990s, the region suffered from repeated currency crises, some originating in Latin America itself, such as the Mexican peso crisis of 1994, and others originating outside of the region but with contagion effects for Latin America, such as the 1997 Asian flu. Thus, it is not surprising that astute observers expected Latin America to suffer much more than it did from the current crisis (Ocampo 2009).

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The reasons for pessimism are rooted in the long history of relying on development models that heightened Latin America’s exposure to financial crises. Latin American economies have followed a range of models, beginning as primary commodity exporters, shifting in the early- to mid-twentieth century to inward-oriented industrialization, and finally returning to more market-led models of growth in the 1980s and 1990s. Each model of development generated benefits, but with flaws that left the region vulnerable to crisis. In each instance, the prevailing model was largely abandoned in the face of a severe shock. The wars of independence left Latin America in profound disarray, but by the late nineteenth century most countries of the region consolidated politically and reintegrated with the global economy as commodity exporters. Foreign investment poured in to develop infrastructure and in some countries assumed control of key export sectors. This reintegration of the region with the global economy led to rapid growth, large increases in immigration to the region, increased urbanization, the emergence of sizable middle and working classes, and vast expansions of infrastructure. The elite oligarchy had little incentive to invest in manufacturing or support state promotion of industrialization. As a result, the urban middle and working classes that began to emerge with economic development presented difficult challenges, as they demanded both political inclusion and better economic opportunities than those afforded by heavy reliance on commodity exports. The increasingly violent conflicts that plagued the region in the early twentieth century threatened the long-term viability of what was an inegalitarian and undemocratic development model (Collier and Collier 1991). But the final blow came as a result of the Great Depression. By the onset of the Great Depression, the region’s dependence on commodity exports had already led to relative decline vis-à-vis the United States and Europe due to declining terms of trade. The collapse of global demand for commodities plunged Latin America into a severe economic and political crisis. In fact, virtually every regime in the region broke down. Incipient democratic experiments in a number of Latin American countries came to an abrupt end. With the collapse of global trade, many Latin American countries, notably the largest in the region, began to experiment with a new model of development eventually dubbed “import-substitution-industrialization” (ISI). ISI policies promoted industrialization through state support for manufacturing. Policymakers selected sectors for support by identifying existing manufactured imports and promoting domestic substitution through protection and a range of financial instruments, such as subsidies. In most Latin American countries, policymakers also manipulated exchange rates to make necessary imported goods (such as capital equipment and machinery) artificially cheap and to indirectly tax commodity exports. Thus, exchange rates were used as a mechanism for transferring resources from the politically

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powerful oligarchs to the rising industrial class. The urban sector benefited further from artificially high wages (supported by ample tariff and nontariff barriers on manufacturing) and generous welfare state benefits for the middle class and the formal labor class (Cardoso and Faletto 1979; Thorp 1998; Franko 2003; Bulmer-Thomas 2003). ISI provoked a profound transformation in the economy and society of Latin America—as Hirschmann (1986) noted, the region’s equivalent of France’s “les trentes glorieuses.” Yet ISI had important limitations as well, including the fact that it did little to alter the profound inequality of Latin American societies or to diminish the tremendous vulnerability to external shocks. Indeed, exchange rate overvaluation, highly protected domestic manufacturing, and financially unsustainable wages and benefits for the organized urban classes pushed Latin American economies toward crisis through inflation and recurring balance-of-payment struggles. As with the decay of the earlier commodity export model, the economic challenges of ISI’s decline presented enormous political difficulties that in many instances led to violence and even regime breakdown. The final straw for ISI as a model came as a result of the devastation flowing out of the 1973 OPEC oil shock. The recycling of oil revenues following the shock led to a period of enthusiastic borrowing (and lending). For Latin American states wrestling with the declining success of ISI and the effects of sharply increased oil prices, easy loans appeared as a simple solution to their political and economic challenges. By 1980, the six largest Latin American nations had accumulated over $350 billion in loans, denominated primarily in dollars at floating interest rates. The second oil shock of 1979 crippled the region. The Federal Reserve Board’s decision to counter US inflation by sharply raising interest rates drove rates up on Latin America’s dollar-denominated debt. In addition, the recession that followed the oil shock depressed global demand and prices for Latin America’s commodity exports—its only source of US dollars. As a result, the region was crushed in a vise of declining export revenues on one side and rapidly increasing debt obligations on the other. By the early 1980s, Latin America had entered into a lost decade of low growth, spiraling inflation, rising poverty and inequality, severe fiscal imbalances, and crippling debtservicing costs (Kuczynski 1988). The policy response throughout the region was a package of marketenhancing reforms frequently labeled “neoliberalism” or the “Washington Consensus” (Williamson 1990). The overarching purpose of the reform program was to eliminate the distortions and disequilibria due to excessive state involvement and to promote growth essentially through getting prices right. As with the earlier models, neoliberalism produced a series of positive benefits, most notably containing inflation. Over the late 1980s and into the 1990s, budget deficits came under control, debt-export ratios improved considerably, and foreign investment began to flow into the region, partly

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through the privatization of state-owned enterprises, partly through increases in portfolio investment, and partly through new foreign direct investment. Other economic aspects performed less well or were more ambiguous in their results. Poverty probably did not worsen under neoliberal reforms, but in all likelihood it did not improve much either. Unemployment remained a persistent problem, especially for unskilled male workers who were displaced out of the formal sector into the informal sector on a large scale (Saavedra 2003). Perhaps the most serious problem, however, was the tremendous exposure of the region to financial shocks. The original proponents of the Washington Consensus insisted that they had not supported liberalization of financial accounts. Indeed, John Williamson (1990) warned that premature liberalization of the capital account exposed the region to considerable risk. But foreign-capital-hungry Latin American governments widely pursued similar policies that greatly facilitated capital flows in and out of their respective countries. Those included fixed exchange rates (as in Argentina or Mexico) or managed floats (such as in Brazil), relaxed rules on capital flows, and strong commitments to macroeconomic stability to reassure foreign investors through procyclical fiscal policy. The consequences were brutal for the region. The Mexican peso crisis of 1994 and the subsequent “tequila effect” through 1995, the 1997 Asian flu followed by the 1998 Russian ruble crisis, the 1999 run on the Brazilian real, and the 2001 collapse of the Argentine peso all followed similar patterns. Macroeconomic imbalances—even modest ones—led investors to conclude that the government could not maintain the value of the currency, triggering a run. Runs on the currency quickly turned into stampedes as foreign and domestic investors fled. In most cases, a contagion effect occurred as investors retreated from emerging markets in general. The ensuing social consequences, such as profound deepening of poverty, were devastating (Manzetti 2003). Not surprisingly, the political trends in the region followed economic performance. The 1980s were characterized by generally poor growth rates, high rates of inflation, high unemployment, and cumbersome debt servicing obligations. The lost decade led voters, often in relatively new democracies, to support neoliberal reformers and their promises of improvement. Through the early 1990s, neoliberal reforms’ success in lowering inflation and restoring foreign investment flows to the region led to the election and reelection of a number of reformist presidents, including several surprise reformers who had originally campaigned against neoliberalism, then switched in office. But the renewed period of financial volatility beginning with the 1994 peso crisis and subsequent tequila effect undermined the tentative sense of optimism in the region. Procyclical fiscal policy meant that budget deficits generally remained low and inflation continued at modest

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levels in most countries of the region. But growth and unemployment in particular performed poorly, especially after global growth turned down after 1998. Perhaps not surprisingly, voters rejected neoliberal candidates across the region, leading to a sweeping resurgence of leftist political parties and candidates, beginning with Hugo Chávez’s 1998 presidential victory. For the most part, voters had not shifted wildly to the left and in most Latin American countries were not looking for radical policy reversals (Baker and Greene 2011; Morales 2008). Yet disappointment in the neoliberal regime made voters open to critical messages and promises to at least modify the program to increase the focus on concerns such as unemployment, poverty, and inequality. Given the region’s historic volatility and fragility under both market-led and state-led growth, especially the very recent roller-coaster performance, one would not predict the apparent robustness of the economy in the past decade and particularly in the wake of the 2008 crisis.

The Surprise of Good Times in the 2000s The global crisis hit Latin America by 2009, and early indications suggested that it would follow the traditional pattern of economic shocks. Latin America’s dependence on commodity exports and promotion of weak, uncompetitive industry, coupled with its financial exposure, left it open to multiple mechanisms of transmission of global shocks. Thus, by early 2009, Latin American experienced a profound trade shock as prices and volumes of main exports fell. In the first half of 2009, global declines in trade hit the region hard as exports fell by 30.9 percent in value and 15.3 percent in volume over the same period in 2008. In addition, the region suffered roughly a 10 percent decline in the value of remittances as a percent of GDP (Ocampo 2009). The loss of remittances was particularly important for the smaller Central American countries, given the greater relative weight in their domestic economies. Finally, the global financial crisis hit the region in financial markets and through exchange rates. Perhaps most importantly, the time from late 2008 into 2009 witnessed a virtual halt to domestic bond issuances (and sharp increases in the spreads and yield on sovereign and corporate bonds), declines in stock market prices, loss of access to international credit, and sizable capital outflows in general. In turn, capital outflows led to currency depreciation in all major Latin American countries, reinforcing the negative effects of the initial crisis. Thus, it is no surprise that many observers expected Latin America to suffer substantially. José Ocampo summed up a range of international financial institutions’ projections: “According to current projections, Latin America will be the region hardest hit in the developing

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world, with the exception of Central and Eastern Europe, both in terms of reductions in per capita GDP and slower growth vis-à-vis the boom years” (2009, 705). Yet by early 2010 the region had rebounded, and projections for the future remain optimistic. For example, most of the major economies of the region reported robust returns to economic growth, particularly Brazil, Peru, and Chile. Even Mexico, which had suffered the strongest decline in the region in 2009, reported an estimated GDP growth of more than 5 percent for 2010 and projections of more than 4.5 percent average growth through 2012. In fact, among the major economies in the region, only Venezuela continued to record negative growth rates for 2010 and 2011. The contrast with the projected growth rates for the United States in 2010 (1.5 percent) and the European Union (0.5 percent) could hardly appear sharper (International Monetary Fund 2011a). Commodity prices recovered by late 2009, and although lower than their peak in 2008, they remain high by historic standards. Export volumes and values also recovered and by 2010 were back in the vicinity of 2008’s extraordinary levels. Remittances remained weaker as they derive primarily from migrant workers in developed economies, but they largely work in sectors hit hard by the crisis, such as construction. Nevertheless, Latin America performed well on other financial measures. Spreads and yields on bonds began falling by late 2009, while bond issuance rose again after virtually no issuances in the fourth quarter of 2008. Perhaps most importantly, foreign reserves barely fell from late 2008 to early 2009. 2 As of February 2009, the foreign reserves of the seven largest economies stood at $411 billion—only 5 percent below the September 2008 mark. Similarly, stock market prices stabilized quickly and began to rise anew by early 2009. In short, in general terms, the crisis was intense but fairly short-lived, and it remained almost entirely a trade shock and not a financial one. Thus, the recovery of trade in late 2009 and the financial robustness of the region when the shock hit spared the region from the worst of the global crisis (Ocampo 2009). Latin America’s resilience was something of a surprise, but to some extent it is an extension of the very strong performance in the years immediately preceding the global shock. The period from 2003 to 2008 witnessed some of the best economic results in the region’s history. While average growth rates were slightly higher in the years 1968–1974—the last period of robust growth in Latin America—the good performance in the recent period was more generalized, and the impact on poverty and inequality was unusually strong. Virtually every country in Latin America experienced strong growth with low to modest inflation, considerable improvement in the external accounts, and poverty and inequality on the decline everywhere.3

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Understanding the Sources of Success 1: Chinese Growth and the Commodity Boom The causes of Latin America’s good performance in the 2000s and particularly since the 2008 crisis are subject to some debate. One central element in the region’s success has certainly been the commodity boom driven by voracious Chinese demand. Since the early 2000s, rapid Chinese growth has had both direct and indirect effects on commodity prices. Kevin Gallagher and Roberto Porzecanski’s (2010) analysis of Latin American exports illustrates that Chinese consumption directly affects only a select set of commodities from a small subset of countries. In particular, ten sectors contribute roughly 74 percent of the value of all Latin American and Caribbean exports to China: crude petroleum, ores and concentrates of base metals, soybeans, iron ore, copper alloys, soybean oils, nonferrous base metal waste and scraps, pulp and wastepaper, feedstuff, and meat. The large majority of these exports originate from Argentina, Brazil, Chile, and Peru, and to a lesser extent Colombia and Mexico. In some cases, the dependence on China as a market is stark. Argentina’s exports of soybeans and other seeds to China account for over 73 percent of the country’s total exports in the sector. For Brazil, exports to China of soybeans and other seeds account for over 42 percent of total exports, while iron exports to China account for over 37 percent of total exports. In the same vein, pulp and paper exports to China represent roughly 25 percent of Chile’s total exports in the sector. For Peru, feedstuff exports to China represent over 36 percent of total exports in the sector. In short, for a small number of countries in a select set of sectors, Chinese import growth has been a major source of export growth and revenue. But China’s impact extends beyond the direct effects. In fact, over the 2003–2008 period, the global economy grew on average more than 5 percent per year, with rising middle-class consumption in an array of emerging markets, such as India and Turkey, in addition to China. Global exports grew more than 60 percent between 2000 and 2006. China’s contribution to this global expansion was important, as exports to China grew tenfold in real terms between 1985 and 2006 (Gallagher and Porzecanski 2010). The boom of Chinese demand helped fuel global growth rates, tightened commodity supplies, contributed to rising wages in emerging markets (and therefore increased middle-class consumption), and fostered the larger process of export growth and price increases. For Latin America, the direct and indirect effects combined to produce tremendous benefits. Between 2000 and 2006, exports of the top seventeen sectors increased by 110 percent (Gallagher and Porzecanski 2010). Chinese import growth accounted for only some of this. For example, Chinese import growth accounted for more than half of the total export growth of

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soybeans and iron ore. But in other sectors important to Latin America— such as meat, crude petroleum and refined oil, or fruits and nuts—China contributed little. For example, Chinese demand for meat actually decreased as a percent of the total export growth over the 2000–2006 period even as Latin American exports grew by over 210 percent (Gallagher and Porzecanski 2010). Thus, even in sectors in which China played little role, its indirect contributions to total global demand increased prices. This period of rapid commodity export growth benefited as well from a reversal in the long-run trend of declining terms of trade. Raúl Prebisch, the first director of the UN Economic Commission on Latin America and the intellectual force behind the ISI model, first identified the long-run unfavorable trend for terms of trade, warning that commodity export dependence was a long-run trap for the region. The data bear out his concerns. The terms of trade for Latin American commodities fell steadily throughout the twentieth century, particularly from the 1970s into the 1980s, contributing to the brutality of the lost decade. Prices fell sharply again in the recession of 1998–2003, but began to rise sharply thereafter. By 2008, real commodity prices were at historic highs, with all non-oil prices roughly 15 percent higher in real terms than in the 1945–1970 period and metal prices nearly double (Ocampo 2009). Booming commodity exports and high prices greatly strengthened the region’s financial position. Perhaps most importantly, the period saw a dramatic decline in foreign currency–denominated debt and an extraordinary accumulation of foreign reserves. Net external debt fell from 30 percent of GDP in 1999 to roughly 5 percent of GDP by 2008 (Ocampo 2011). Among the seven largest economies (Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela), total foreign reserves increased from roughly $185 billion to over $430 billion by the end of 2008. Adding to the region’s financial resilience was the decision by public and private actors to decrease their exposure to exchange rate risk by paying down foreign currency liabilities and relying on domestic currencies instead. As of 2000, roughly 40 percent of liabilities, public and private, were in foreign currencies. By 2008, that had fallen to roughly 20 percent of outstanding debt (Porzecanski 2009).4 Arturo Porzecanski (2009) contends that currency mismatches—when assets and liabilities are denominated in different currencies—are a major source of vulnerability to financial crisis. Porzecanski has tried to capture the full extent of currency mismatch by looking at foreign-denominated debt, net foreign assets, an estimate of the capacity to generate export earnings, and the extent to which the domestic banking system issues foreign currency–denominated loans and bonds. As of 2003, among the major economies, only Peru and Venezuela did not have significant currency mismatches, and Argentina was in an extremely vulnerable position. By 2008, all seven major economies had solid positive positions and therefore greatly reduced vulnerability. In addition, the period beginning roughly in 2002–

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2003 was unusually propitious in terms of international liquidity. Both portfolio investment and foreign direct investment increased during the boom period. In fact, domestic bonds increased 15 percent from 2001 to 2007; a review of the external balance sheets of the seven largest economies shows that portfolio liabilities increased from 16.8 percent of GDP in 2001 to 28 percent in 2007, while stocks rose from 5.5 percent of GDP to 16.9 percent in the same period (Ocampo 2009). Latin American history has been defined by its weak and vulnerable position on debt, debt servicing, and external accounts. The 2000s, by contrast, left the region in an unusually strong position financially when the global crisis hit. The healthy macroeconomic position protected Latin America from the worst financial effects of the crisis, despite considerable temporary declines in access to external sources of finance, rapidly falling export revenues, and a virtual shutdown of domestic bond markets. In effect, this strong macroeconomic position is a central cause of the missing financial crisis.

Understanding the Sources of Success 2: Internal Adjustments Although there is broad consensus on the contributions of the external environment to Latin American prosperity, fewer analysts agree on the impact of domestic policy reforms. Latin American nations responded to the lost decade with a series of reforms intended to restore macroeconomic equilibrium and launch a new model of economic development based on stronger markets and more limited government intervention. These neoliberal reforms were often controversial and politically difficult. They included budget cuts and realignment of spending obligations, removal of trade protections and scaling down of regulations, and large-scale privatizations of state-owned assets. In addition, they also included substantial improvements to domestic financial systems, including sale or liquidation of stateowned banks, strengthening of central banks, and greatly improved prudential regulation of the banking system. The reform process was highly contentious politically. Leftist critics charged that the reforms were socially destructive and unjust, primarily serving domestic and international holders of capital (Petras 2005). More moderate critics argued that the reforms had done little to promote economic growth and were harmful both to democratic governance and social justice (Huber and Solt 2004). Even proponents of the reform program conceded that market-oriented reforms performed well below expectations and that advocates had oversold the benefits (Williamson and Kuczynski 2003). Nevertheless, macroeconomic stability, low budget deficits (or surpluses), and strong domestic banking helped Latin American countries take full

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advantage of the dramatically improved global context after 2002 and shielded the region from a deeper financial crisis after 2008. Two elements stand out in particular. First, the region has demonstrated a strong commitment to macroeconomic stability, as indicated by efforts to keep public sector debt and deficits manageable. Spending did increase during the boom years, but below the rate of revenue and GDP growth. The result has been declining debt-to-GDP ratios (as well as conversion to denomination in local currency). Public sector debt fell from roughly 60 percent of GDP in 2002 to roughly 30 percent of GDP by 2008 (Porzecanski 2009). Furthermore, budget deficits remained modest at worst, and budgets were in surplus in many cases. As of 2007, only seven countries reported fiscal deficits, with Colombia recording the largest one at 3 percent of GDP. At the other end, Chile’s budget surplus was 8.8 percent of GDP (Ocampo 2009). On average, the region had a budget surplus of 0.5 percent of GDP. The second element was the strength of the banking system after a decade of neoliberal reforms that cleaned up or privatized state banks and greatly improved prudential regulation. One important consequence was that Latin American governments did not have to abandon their commitment to fiscal conservatism in order to support failing banks. Most Latin American countries have implemented banking reforms intended to strengthen domestic lending and diminish the risks of speculative or reckless behavior. Reforms have included increasing reserve requirements, introducing deposit insurance, tightening control over offshore activities, opening the banking sector to foreign firms, significantly improving accounting requirements, and greatly improving monitoring of banks. The entrance of foreign banks has been an especially important part of the deepening of domestic financial markets. Foreign banks have entered into Latin America in large numbers, accounting for 40 percent of banking assets by 2008. But they operate primarily like local banks, issuing most loans in local currency, backed by local currency assets. This deeper banking system was also much more prudent than in the United States or the European Union. On average, Latin American banks maintained very high liquidity standards, with liquid assets averaging 35 percent of total assets. One indicator of the strength of Latin American banking is that Fitch did not downgrade a single Latin American bank in the second quarter of 2009 as the crisis was at its peak in the region (Porzencanski 2009). The strength of local capital markets meant that local corporations and governments were able to turn to domestic markets for financing through the 2008–2009 crisis.

The Limits to Success The performance of the region has generated a reasonable sense of optimism, but there are important limitations to the success. For one, consider-

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able variation exists across the region. Brazil and Chile are poised to continue growing rapidly with at most modest inflation (and serious commitments to keeping it under control). By contrast, Argentina and Venezuela are enduring high and rising inflation, made worse by the absence of any effort or even admission of the scale of the problem.5 In between, the performance discrepancies are considerable. Thus, not all Latin American nations are sharing equally in the good times of the 2000s. Moreover, virtually all Latin Americans confront at least two very significant limits that have important medium- to long-term implications. First, almost no Latin American states are in a strong enough position financially to offer meaningful countercyclical policies not financed by debt or to invest in vital areas such as infrastructure, education, and health. Second, reliance on commodity exports is not a viable long-term development program. Few Latin American nations are making significant progress in promoting a higher-value-added development model. Brazil is arguably the regional leader in this regard, but even there serious challenges need to be confronted, not the least of which is growing manufacturing export competition from China. The Continuing Weakness of State Finances The region’s solid macroeconomic position shielded it from the ravages of a financial shock, but was not strong enough to support strong countercyclical policies or longer-term investments in human capital and infrastructure. Several countries have improved their positions through the creation of stabilization funds—in effect, reserve funds built from high export revenues. Bolivia and Peru, for example, channeled limited export revenues into these reserve funds. But stabilization funds have for the most part been sufficient only to stabilize, not truly stimulate, the economy. Most Latin American nations implemented at least moderate stimulus efforts (ECLAC 2009). Those included housing and infrastructure expenditures, transfers to the poor, and tax and loan incentives. In addition, several Latin American nations eased monetary policy in an effort to provide stimulus, but those stimulus efforts were limited by the need to manage debt and deficits and as result were frequently offset by budget adjustments. Even neoliberal advocates, such as the World Bank, have expressed concern about the reliance on procyclical policies and the growth-hampering effects of austerity measures in recessionary contexts (Gutiérrez and Revilla 2010). As Liliana RojasSuarez (2011) observed, unfunded stimulus financing that subsequently must be supported by a fiscal adjustment is, in effect, a procyclical policy. Chile is the most important exception to this trend. Chile’s Economic and Social Stabilization Fund (FEES), financed principally by copper-exported revenues, permitted the Chilean government to increase expenditures without additional borrowing. Brazil also introduced an aggressive stimulus package, principally the roughly $500 billion Program for the Acceleration

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of Growth (PAC), a public-private partnership for infrastructure investment. Brazilian stimulus efforts were financed by debt, and policymakers were concerned about the inflationary impact and the need to eventually rein in spending. The 2008 budget picture across Latin America reveals the limits of real stimulus efforts. The average budget surplus for 2007 was 0.5 percent of GDP. By 2008, it had fallen to a small average deficit of –0.1 percent of GDP—only a modest shift in the fiscally conservative position of the region (Ocampo 2009). Unfortunately, national savings have barely changed from the 1970s until the present. Latin American countries, then, effectively remain dependent on external accounts for their finances and the possibilities for countercyclical policy and long-term human capital and infrastructure investment. The absence of meaningful investment shows particularly in social policy and the effort to construct human capital. As noted earlier, poverty and inequality have been on the decline in the region over the 2000s, and both rapid export growth and innovative social policy have played a role. Among the innovative social policies, the most distinctive include Mexico’s internationally praised the Oportunidades (Opportunities) program and Brazil’s international award-winning Bolsa Família (Family Stipend). Both programs are conditional cash transfers—direct transfers of cash to poor households, contingent on meeting certain conditions, including income thresholds and a set of requirements such as keeping children in school or regular health checkups. Conditional cash transfers (CCTs) have disseminated across the region with varying levels of success (McGuire 2012). In general, they have raised household incomes and protected large segments of the poor from the worst scourges of poverty, notably hunger. Without minimizing the successes of these programs, their contributions to building human capital are more uncertain. As María Noel Pi Alperin (2009) has observed regarding Argentina’s Jefes y Jefas de Hogar Desempleados (Unemployed Heads of Household program), CCTs appear to have little long-term impact on structural poverty. For governments that implement them, they have two significant benefits: they are politically popular, and they cost little. But meaningful improvements in areas such as education require considerably more than cash payments to induce poor kids to stay in school. Improved education needs investments in physical facilities, teaching materials, teacher salaries and training, effective educational bureaucracies to monitor and support schools, and social and psychological monitoring and counseling. Low-cost, hugely popular CCTs are a good start, but educational systems in Latin America are sorely deficient. The weaknesses of Latin American social policy contribute to what the OECD has described as the “vulnerability” of Latin America’s middle classes. The “middle sectors” are defined as households with income between 50 and 150 percent of the national median (OECD 2011). Unfortunately, these

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households tend to be at much greater risk in Latin America than in the developed West, due to high levels of employment in the informal sector, low levels of education, and inadequate health care and pensions. In short, poor investment and low levels of access to and quality of basic social policies condemn even the middle sectors in Latin America to the risk of sudden impoverishment (OECD 2011). Social policy in Latin America has largely focused on the poor. But the high level of informality even in middle sectors, with its attendant risks of poor educational mobility, low pension coverage, and poor access to health care, affect economic growth and general welfare. Solving it requires an investment in universal, noncontributory social policies (OECD 2011; Rojas-Suarez 2011). Some countries have begun to some make advances in this area, particularly Chile’s noncontributory health plan, Plan Auge. But efforts generally have fallen far short of what the region needs. A Weak Development Paradigm The issues discussed above point to the overarching challenge of finding a new development model for the region that increases good employment opportunities in the formal sector. Commodity export growth has brought gains for Latin American nations, but its dependence on unusually high prices means it is not a promising long-term model (Ocampo 2009). Furthermore, the region’s exports are neither well diversified nor highvalue-added. Thus, even the existing commodity boom is limited in important ways. In addition, Kevin Gallagher and Roberto Porzecanski’s (2010) analysis of China’s economic relations with the region demonstrates powerfully that the benefits of Chinese consumption are offset by rapidly growing competition from China in third-party markets. In effect, Latin America’s manufacturing exports are being squeezed out by China’s growth as an industrial producer. The threat from China is particularly strong because Latin America historically has lagged, and continues to lag, badly on public support for education, innovation, and technological enhancement. Export diversification is a problem for the region, in terms of partners and products. In particular, exports from Mexico and Central America are highly dependent on the United States and thus singularly sensitive to the US economy. Mexico sends more than 80 percent of its exports to the United States, which accounts for the fact that Mexico endured the sharpest contraction in the region in 2009. Perhaps not surprisingly, some of the strongest economies in the region have diversified their trade partners the most—notably Brazil, Chile, and Peru. But export partner diversification is not sufficient. At the same time, the region’s exports are also heavily concentrated in primary goods, and for most countries only a very small number of them. Measures of export concentration indicate that Latin America’s

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is much higher than either East Asia’s or Eastern Europe’s, with Venezuela an extreme, depending almost exclusively on oil (Gallagher and Porzecanski 2010; Ocampo 2010). Overall, the region’s exports are heavily concentrated in a limited basket of goods, including oil, soybeans, base metals, and copper, few of which have benefited from introduction of higher technology (Rojas-Suarez 2011). A significant part of the problem is simply the lack of investment in technological development and the weakness of Latin America’s position in higher technology in the global economy. Latin America has lagged even compared to other developing regions, particularly in Asia. For example, research and development expenditure averaged 0.57 percent of GDP between 1980 and 2005, with no change in the last five years. By contrast, in East Asia and the Pacific, research and development expenditure averaged 0.89 percent of GDP (0.98 percent of GDP in China) and rose to 1.09 percent of GDP in the last five years (1.21 percent of GDP in China). Similarly, patent applications averaged over 100,000 over the 2000–2005 period in East Asia and the Pacific, with 69 percent filed by residents as opposed to nonresidents (73 percent in China). In the same period, over 33,000 patent applications were filed in Latin America, but only 13.5 percent of them by residents—a percentage that has barely changed since 1990 (Gallagher and Porzecanski 2010). Not surprisingly, Latin American countries’ share of high-tech exports is very low and has changed little since 1985. While China’s participation in global high-tech markets has risen from 0.1 percent in 1985 to 13.4 percent in 2005, only two Latin American countries have even a measurable presence: Brazil and Mexico. Brazil’s has remained relatively steady at 0.4 percent of the global market. Mexico’s rose from 0.2 percent in 1995 to 3.4 percent in 2000, but then fell again in 2005 to only 2.7 percent (Gallagher and Porzecanski 2010). Mexico’s decline in global high-tech markets is part of a larger risk of Chinese displacement of uncompetitive Latin American manufacturing. Kevin Gallagher and Roberto Porzecanski’s study of China’s relation with Latin America examines the degree of threat facing the region’s manufacturing exports. They measure the level of threat by examining those markets where Chinese exports are growing at the same time as Latin American exports are declining (direct threat) and where both are growing, but Chinese exports are growing faster (partial threat). For Latin America as a whole, 94 percent of all manufacturing exports to the world were under direct or partial threat—40 percent of all exports. The problem was particularly acute for Argentina, Brazil, Chile, Costa Rica, and Mexico (Gallagher and Porzecanski 2010). In sum, Latin American growth has been too heavily dependent on a select set of commodities enjoying unusually favorable terms of trade. Meaningful development, however, depends on better formal-sector jobs in

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higher-value-added activities. Protecting both the poor and the large, vulnerable middle sectors depends on the expansion of higher-quality labor and the extension of formal-sector benefits such as pensions and quality health care. Latin American governments have enjoyed strong macroeconomic positions that shielded them from the worst effects of the global crisis, but did not give them the strength to move beyond limited countercyclical efforts and to turn to longer-term investment in critical areas of need. Over the past decade, three models have contended for influence over how to promote development: a largely discredited Washington Consensus, the Venezuelan “Bolivarian” model, and Brazilian pragmatic neoliberalism. The Venezuelan and Brazilian alternatives are contrasted below.

Two Contrasting Examples: Brazil and Venezuela Two Latin American countries offer vivid examples of the contrasting paths followed in the region, contending alternatives to the US-preferred Washington Consensus. In political terms, the two are often placed at two poles of the partisan/ideological divide in the region: moderate left and radical left.6 Brazil is the prototypical example of the moderate or pragmatic left—a group that includes Chile and Uruguay, for example, and which El Salvador and more recently Peru have openly embraced. Pragmatic leftist governments have accepted the value of the market as a mechanism of development, but temper it with strong social policies and selective state intervention intended to support the market. The radical left—led by Venezuela, and including countries such as Bolivia, Ecuador, and increasingly Argentina—offers a much stronger critique and suspicion of the market, and US influence more broadly. The radical left cases have asserted much stronger roles for the state, actively intervening in the market, including reversals of many privatizations that took place in the 1990s. In the radical left cases, governing parties have also expressed greater hostility to procedural notions of democracy and have been willing to openly attack the ability of opposition parties to contest elections and policy deliberation. Although most of the radical group have done well in the 2000s on the back of high energy prices, they have also been less careful about macroeconomic stability and therefore more vulnerable to inflation. Furthermore, although poverty and inequality in the region have declined over the 2000s, the declines in the pragmatic left group have been stronger, and according to Birdsall, Lustig, and McLeod (2012), they appear more sustainable. Thus, to the extent that a real alternative development model may be emerging in the region in the wake of the crisis, it is located in the moderate, market-favoring cases rather than the more radical alternatives.7

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Brazil Brazil has probably made the greatest turnaround in the past twenty years of any country in the developing world. As late as the end of the 1990s, Brazil was decried as an ungovernable country with a chaotic economy managed by unserious people—“drunk” as the Economist magazine described it (1991, s1). Others were equally unflattering: “hyperactive paralysis” (Lamounier 1996) and “feckless” (Mainwaring 1995). In fact, aside from a small handful of Brazilian political scientists who defended the country’s politics, the large majority of observers were critical of the country’s governing institutions (Figueiredo and Limongi 2000). The economic data seemed to support a skeptical view. Brazil wrestled with high and even hyperinflation from the early 1980s to 1994—longer and tamed later than any other Latin American country. GDP growth was highly volatile over the 1980s and 1990s, while open unemployment—notoriously underestimated in Brazil—remained high persistently. External and domestic debt both remained high also, and efforts to rein in budget deficits and address long-term structural fiscal problems frequently floundered despite almost continuous political struggles to advance reforms: “hyperactive paralysis.” The problem lay in a highly fragmented party system with very strong incentives for politicians to cultivate personal votes. As a consequence, each successive president found himself negotiating with large numbers of individual legislators who were fairly independent of their party leaders and highly dependent on resources that could be used in visible ways to support patronage, clientelist, or interest-group purposes. Legislative coalitions had to be negotiated anew for each individual piece of legislation, and the fiscal costs could be high. Needless to say, macroeconomic stability proved difficult in this context (Mainwaring 1998; Ames 2001). Nevertheless, change in Brazil progressed slowly through successive administrations as each small set of gains created a base for the next president to secure another round of incremental victories (Kingstone 2000). Ultimately, President Fernando Henrique Cardoso’s innovative stabilization program—the Real Plan, first initiated while he was finance minister in 1993–1994—shifted the economic trajectory of the country and altered the political incentives for parties and individual legislators. The Real Plan had several key elements. First and perhaps most important, it was a transparent, gradual program debated openly in the legislature. Second, it introduced a managed float that gave the government some flexibility on the exchange rate while also enhancing the credibility of the new currency, the real. Third, the plan’s introduction was accompanied by a critical fiscal adjustment negotiated with the Congress that strengthened the state’s macroeconomic position and thereby the credibility of the government’s commitment to the program. Fourth, the gradual, incremental introduction of the new

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currency tied to the value of the dollar gave actors time to adjust their contracts in an orderly way that was not perceived as abusive, arbitrary, or a shock. As a result, the final step in the program on July 1, 1994, six months after its introduction in Congress, brought about a dramatic decline in inflation from 25 percent per month to 2 percent per month by October 1994. Finally, low inflation permitted the federal government to open the books of federal, state, and private banks and for the first time effectively determine the health of the financial system. Effective supervision of banks and state governments ushered in broad reform of the financial system: eliminating or privatizing unhealthy banks and strengthening prudential regulation of the healthy ones, as well as providing honest accounting of the federal and state governments’ actual debts. The result of the last element was that the reported level of debt rose substantially, but so did the government’s credibility (Fishlow 1997; Oliviera 1995). The global recession that hit in 1998 kept Brazilian growth relatively low and unemployment high. But when global growth picked up by 2002– 2003, Brazil was well placed to benefit. From 2003 to 2008, the economy grew steadily faster, with inflation contained and wages rising for most Brazilians. The period saw one of the largest levels of upward social mobility in the country’s history (Kingstone and Ponce 2010). When the global crisis hit in 2008–2009, Brazilian finances, both domestic and external accounts, were also healthier than perhaps at any time in the country’s history. Brazilian banks were solvent and governed by sound prudential regulation. Domestic debt was manageable, while the country was sitting on reserves in excess of $200 billion after paying off all its external, dollardenominated debt. The budget was in primary surplus, thanks partly to several years of moderate growth as well as high tax collections, particularly courtesy of the Tax on Financial Flows (IOF), a tax on all financial transactions. There were no hidden surprises of insolvent state banks or state governments with concealed debts—as there had been in the past and is apparently increasingly the case in China. Lower inflation also altered the political calculus for Brazil’s party leaders. After 1994, low inflation increasingly became a requirement for electoral victory. Between 1994 and now, Brazil has increasingly moved from a disorganized, fragmented political system to one in which two major blocs contend for power and congressional alliances are more coherent and consistent. Policy reform has not been easy, but voters are offered relatively clear choices for president between a moderate center-right bloc led by the PSDB (Brazilian Social Democratic Party) and a moderate center-left bloc led by the PT (Workers’ Party) (Santos and Vilarouca 2008). Policy reform in Brazil has also meant that all major contenders share a relatively broad consensus on an economic approach that could be called “pragmatic neoliberalism.” This approach consists of three elements. First, since 1994 all governments have openly and firmly committed to low infla-

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tion. The primary policy mechanism has been inflation targeting, with primary budget surplus targets ranging as high as 4 percent of GDP. The exchange rate has floated freely since the 1999 real crisis, but fiscal policy flexibility has been sacrificed for macroeconomic stability. Some have criticized this approach for its lack of regard for the microeconomic goals of competitiveness and innovation. Even so, low inflation has resulted. Inflation has averaged 6.5 percent since 2000, and policymakers have reacted firmly and consistently in response to inflationary pressure. Indeed, since 2009, Brazil’s economy has faced considerable inflation risk as capital has flowed into the country seeking a good return in a widely praised market. Brazilian policymakers have expressed concern about the weakness of the dollar and China’s undervalued and nontradable yuan, but in the short term have had little recourse but to impose capital controls and raise interest rates to among the highest in the world (Goforth 2011). The second element of pragmatic neoliberalism is a willingness to use state power to promote critical areas of the economy. The Brazilian government has introduced a number of measures since the mid-1990s, including selective use of industrial policy (including protectionism), most notably for the auto industry; support for technological development and innovation; and public-private partnerships for infrastructure investment, most importantly the Program for the Acceleration of Growth financed by the BNDES (Brazilian National Bank for Economic and Social Development). Furthermore, in the wake of the crisis, the healthy macroeconomic position allowed the Brazilian government to resort to several countercyclical measures, including monetary policy initiatives such as a reduction in the legal reserve requirements, permission to authorize loans in foreign currencies, broader powers of intervention for the central bank, and the creation of an investment bank to purchase shares of firms in troubled sectors such as real estate. On the fiscal side, among a number of initiatives, the Lula government reduced its inflation-targeting goal from 4.3 percent of GDP budget surplus to 3.8 percent of GDP, expanded consumer credit by over $40 billion, granted tax incentives for troubled sectors, brought forward government spending plans, and increased infrastructure spending resources through the PAC (ECLAC 2009). The use of state power to help promote technological innovation and infrastructure development is critical, because Brazil does not perform particularly well on either (Amman 2009). Furthermore, domestic industry is not highly competitive in global markets and suffers from a host of challenges, including high capital costs, inefficient and cumbersome taxes, an uncompetitive exchange rate in recent years, and growing threatening competition from China. Brazilian industrialists have called for greater attention to these issues, citing dramatically falling industrial exports since 2008 and describing the situation as “de-industrialization.” Brazilian policymakers and economists are divided on the meaning of the fall in exports, but the

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appreciation of the real and Chinese competition represent considerable policy problems (Getulio Vargas Foundation 2010). Thus, state efforts to support technological innovation, infrastructure development, and competitive domestic industry are all important elements of the model. What stands out in particular with these efforts is that they are market supporting—that is, they are tools for strengthening the performance of the market. This policy change is a significant break from the previous seventy years in Brazil. The final piece of this model is a commitment to social policy to address poverty and inequality. Since the 1990s, Brazil has been a laboratory for social policy innovation. In health care, Brazil had been a notorious underperformer, with extremes of inequality reflected in dismal rates of infant and child mortality and inadequate health care for the poor generally. Yet through a variety of reforms, such as the introduction of low-cost health clinics in poor communities, Brazil experienced the fastest rate of improvement in infant mortality rates in the world (McGuire 2010). The Bolsa Família program, referenced above, brought school enrollments up to the eighth grade to 100 percent. In addition, the conditions of the CCT virtually doubled household income in the eleven million households that received it, effectively eliminating hunger among recipients and increasing consumption of goods such as clothing that children need (McGuire 2012; Hall 2008). Pragmatic neoliberalism has been successful for Brazil, and one can understand why it has become the consensus approach in the political system and the preferred model for other moderate leftist governments in Latin America. But excitement about Brazil has tended to obscure the very real challenges continuing to face the country. Inadequate infrastructure, woeful education (despite high enrollments), and ongoing fiscal challenges (especially inefficient taxation and the onerous costs of the country’s regressive pension system) threaten the economy’s long-term performance. Most important, however, Brazilian growth in recent years has depended too much on the commodity boom and has not made enough progress to strengthen other parts of the economy. Eventually, perhaps sooner rather than later, commodity prices will fall. At that point, the Brazilian economy will need a stronger base to continue raising living standards for what remains a deeply unequal society. In sum, something real and important has changed for the better in Brazil, but it is too soon to conclude that Brazil has closed or is closing the development gap with the West (Anderson 2011). Venezuela While the verdict is not yet in on Brazil’s formula for development success, Venezuela’s situation is more clear-cut. Despite Hugo Chávez’s rhetoric, his Bolivarian revolution seems to have had little success in promoting a new model of economic development. Instead, it appears to be simply a retreat

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to a statist past that has already proven deficient (Corrales 2010). Perhaps it is not surprising, then, that while Brazil is among the region’s economic performance leaders, Venezuela is among its worst performers, particularly with regard to inflation and unemployment. The Venezuelan political economy has benefited from high oil prices, but generates almost no other export revenues. Oil revenues permitted Chávez to spend freely, both on domestic policy initiatives and in promoting his international agenda, such as the creation of the anti-US, anti-neoliberal Alianza Bolivariana para las Américas (ALBA, Bolivarian Alliance for the Americas) bloc or his fuel-assistance program in the United States. Volatile oil revenues in recent years have left the country with a host of economic problems, including rising inflation and budget deficits, and diminished capacity for Chávez to spend his way out of the problem. In effect, while Brazil has traversed the path from most chaotic country to surprising success, Venezuela has marched the reverse path from a widely perceived regional success as a democracy to one of the more chaotic and authoritarian countries in the region. Venezuela’s downward trajectory began in the late 1980s as its longestablished “pacted” democracy—the Punto Fijo regime—began to implode in the context of drastically declining economic performance. The Punto Fijo pact was a power-sharing agreement between the two major contending political parties, the Acción Democrática (AD) and the Christian Democratic Party (COPEI) (Collier and Collier 1991). The agreement emerged in 1958 after decades of authoritarianism interspersed with turmoil. The decision to rotate the presidency and ensure formal inclusion of both parties in everything from the cabinet down to union representation stabilized the political system and created the impression of a well-functioning moderate democracy. The nationalization of the oil industry in 1974 granted the regime a revenue boon that financed infrastructure construction as well as social benefits. However, the system became increasingly corrupt as access to resources was contingent on party membership. Venezuelan democracy essentially converted into a partidocracia (partyarchy). The system continued to work as long as there were sufficient funds to go around, but the decline in oil prices at the beginning of the 1980s set in motion a steady decline of the country’s finances and growing anger at the corruption and exclusionary practices of the partidocracia (Crisp 1997). The implosion began with the election of Carlos Andrés Pérez (AD) in 1989 and his turn to neoliberal reforms. Pérez was the hero of the 1974 nationalization and a symbol of the statism and the oil-financed social benefits (widely understood as “rights”) of the old regime. His turn to neoliberal reforms (el gran viraje) betrayed public expectations as well as his own party’s strongly held preferences. The policy shift sparked riots that were violently suppressed (the “Caracazo”) and two failed coup attempts, one headed by Colonel Hugo Chávez. Eventually the Congress, led by the AD, impeached Pérez on corruption charges and set in motion the dissolution of

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the long-standing Punto Fijo system. Pérez’s successor was another hero of the statist regime: Rafael Caldera, originally of the COPEI but running as an independent on a platform promising a return to statist policies. A severe banking crisis, however, left Caldera no choice but to turn to the IMF and a resumption of neoliberal policies. By the end of his term, both the AD and the COPEI were badly discredited, while the Venezuelan economy was in shambles. The 1998 presidential elections brought Hugo Chávez to power on personal charisma, sharp criticism of neoliberal reforms, and a strong critique of Punto Fijo institutions. For a population suffering economically and alienated politically, Chávez offered an attractive alternative. He won the election with 56 percent of the vote, and his new party, the Movimiento Quita República (MVR), along with some smaller allies won control of the legislature. He then embarked on a still-ongoing process of dismantling the remnants of the Punto Fijo system, politicizing all of the main institutions of accountability, such as the judiciary and electoral oversight institutions, and concentrating power in the hands of the executive. The 1999 Bolivarian Constitution, approved in a national referendum, created a host of discretionary powers for Chávez, including the establishment of a stabilization fund financed off of “excess” revenues, which the executive could use virtually without oversight.8 In addition, Chávez blurred the boundaries between the executive and the military, appointing military officials to state positions. He has continuously weakened opposition forces through attacks on free speech and manipulation of electoral institutions and rules. Finally, he turned Petróleos de Venezuela S.A. (PDVSA), the state oil company, into an arm of the executive and therefore a source of substantial revenues for his discretionary use (Corrales 2010). In economic terms, Chávez began his tenure rather moderately, but as oil revenues began to rise in the 2000s, he became increasingly radicalized. For example he renationalized a large number of previously privatized firms, including in telecommunications and electricity, or gained control of them through administrative expropriation, notably in the oil industry. The Chávez administration has had to confront rising inflation over the 2000s, especially as oil revenues declined. Unfortunately, the regime has resorted to tried and profoundly unsuccessful measures, including wage and price controls, underreporting the real rate of inflation, and increasingly threatening criminal charges for store owners who raise prices. These methods have been as unsuccessful as in the past, and Venezuelan inflation in 2011 stood at roughly 30 percent and rising. The growing evidence of economic failure has contributed to a decline in Chávez’s popularity, although he successfully won reelection in the 2012 presidential elections. Chávez’s administration has spoken of a new model of development that they call “endogenous development,” but the meaning of that term is not clear. Javier Corrales has described the economic pattern emerging

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under Chávez as another iteration of what he calls the “ax–relax–collapse” pattern. Debt, deficit, and current account difficulties (stemming primarily from low oil prices) lead to sharp budget cuts and austerity measures as the administration tries to restore macroeconomic stability. With a return to booming oil prices, the government relaxes, spending lavishly and inefficiently. Falling oil prices lead to a new collapse and a new round of austerity measures. In this view, Chávez does not represent a new endogenous model of development, but one more iteration of a pattern that has repeated itself regularly in Venezuela. One area in which the Chávez administration has innovated is social policy; his various misiones (missions) have been sold as new mechanisms of addressing poverty and unequal access to services like education and health care. But despite his claims, analyses of his social policies suggest that they have performed poorly at best and at worst have functioned largely as mechanisms for distributing largesse for political purposes (Ortega, Rodriguéz, and Miguel 2006; Rodriguéz 2008). In short, the Venezuelan alternative is almost certainly an illusion created by high oil prices, particularly from 2003 to roughly 2008. Venezuela’s fortunes shift with oil prices. Low prices from the 1980s through to the early 2000s corresponded with low growth rates, current account difficulties, and highly contentious budget austerity. Rising oil prices in the 2000s left Venezuela’s current accounts strong, and government spending rose dramatically in line with high export revenues. In short, the dangers of procyclical policy, highlighted by José Ocampo of ECLAC among others, are exaggerated in Venezuela. Vast oil revenues allowed the Chávez administration to ignore macroeconomic considerations, permitted him to focus on short-term political gain over investment in long-term development, and gave him the resources to finance allies in countries such as Argentina, Bolivia, Ecuador, and Honduras. But falling oil revenues, as predicted by Corrales, have exposed the weakness of the regime’s economic program, as rising inflation and falling growth rates left Venezuela among the worst performers in the region in the wake of the 2008–2009 crisis. While Brazil’s growth rate rose to 7.5 percent in 2010 and is projected to be even higher in 2011, Venezuela’s GDP contracted 3.3 percent in 2010 and is projected to shrink an additional 2 percent in 2011, with sharply rising rates of unemployment and budget deficits. The crisis has merely intensified the growing economic problems while prompting an intensification of the regime’s obscuring the real data and intimidating critics. The response of the Chávez administration to the downturn essentially consisted of a promise to continue its existing policies, even though the evidence is increasingly clear that they have not been successful at promoting an equitable and sustainable model of development. Brazil’s model faces important challenges, but the long-term path has promise. Venezuela’s dismal record, politically and economically, clearly does not.

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Conclusion Latin America withstood the global crisis surprisingly well. Booming commodities and difficult domestic reforms strengthened the region’s macroeconomic position, deepened domestic financial markets, and thereby prevented the shock from becoming a financial crisis. This represents an important and historic shift for the region. Renewed demand for commodities in the global market restored the region to growth quickly, but the longterm prospects for development require more than commodity exports. On this score, the region continues to face serious challenges. Domestic savings and capital markets are not yet strong enough to support countercyclical spending and long-term investments in infrastructure, technology, or human capital. The region’s continued dependence on external sources of financing means that policy continues to be largely procyclical. Unfortunately, the welfare of the poor and the middle sectors depends on deeper investments that can foster the emergence of a more sustainable, broader model of development. The Washington Consensus no longer appears credible in the region. Disappointment with neoliberal reforms coupled with the United States’ economic weakness have discredited the “orthodox” market approach. Two alternatives are contending in the region today. Venezuela’s radical version offered a powerful challenge to the United States, but is in decline in the wake of the crisis. The Brazilian model by contrast appears on the rise in the region. Brazil’s combination of macroeconomic caution, coupled with the use of state power to promote industrial policy and innovative social policy offers greater promise for the future. Brazil faces considerable challenges, but its successful weathering of the 2008–2009 crisis suggests greater hope for a region that has consistently failed to find a sustainable development path.

Notes 1. The debate about neoliberalism has often been acrimonious with highly charged accusations on both sides. A thoughtful exchange can be found in Latin American Research Review between Evelyne Huber and Fred Solt on one side (Huber and Solt 2004), and Michael Walton on the other. For more on the debate, see Kingstone (2010). 2. Stiglitz and Charlton (2005) argue that Latin America’s large foreign reserves actually slowed economic growth, and there is no doubt that holding export earnings in reserve diverted them from potential productive investments. Nevertheless, the region’s experience with debilitating consequences of inadequate foreign reserves to cushion against shocks and to protect countries from having to resort to procyclical policies suggests that the trade-off is worthwhile. 3. On this last issue, recent data analysis by Birdsall, Lustig, and McLeod

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(2012) points to some of the most robust declines in poverty and inequality in the region’s history, partly due to rising wages in primary commodity sectors and partly due to a wide array of innovative social policies explicitly targeting the poor. 4. Porzecanski warns, however, that the full extent of the vulnerability in the region is hard to measure, as some large corporations continue to conceal their total liabilities due to speculative trading in currency options. In fact, several major corporations, such as Brazilian giants Aracruz Celulose and Sadia, were caught by the rapid currency depreciation of late 2008; in that instance the Central Bank was forced to come to their assistance. Nevertheless, these appear to be exceptions as opposed to what had been much more common in the past (Porzecanski 2009). 5. In fact, in Argentina, both husband-and-wife presidents, Nestor Kirchner and Cristina Fernandez, have aggressively attacked official and nongovernmental sources of reports of high inflation. In particular, INDEC (National Institute for Statistics and Censuses), the state agency responsible for monitoring and reporting inflation, has been the target of overt, heavy-handed manipulation. As of 2011, the Fernandez government claimed that inflation was running at 9.5 percent, while private, unofficial estimates claim at least twice that and perhaps as high as 25 percent. 6. The rise of the left in Latin America has been the subject of intense scrutiny and a good deal of debate on how best to characterize and classify the various cases. There is no consensus, but most discussions tend to identify two versions, one more moderate and one more radical, although there are differences on which cases to include in each category and even which cases should be considered leftist governments. For a more extended discussion of the political bases of the left, see Levitsky and Roberts (2010), or Corrales (2008). Weyland, Hunter, and Madrid (2010) examine the policy and policymaking differences among leftist governments. Extended discussion of political and policy outcomes can also be found in Castañeda and Morales (2008). 7. Both Castañeda and Morales (2008) and Weyland, Hunter, and Madrid (2010) reach the same conclusion, comparing the performance of the moderate left and the radical or “contestatory” left across an array of economic and social policies. 8. The fund works by establishing estimated export revenues and then allocating any “excess” earnings to the stabilization fund for Chávez’s discretionary use. Oil prices typically have been dramatically underestimated, leading to very large diversions into the fund.

5 Migration and Remittances Ariane Chebel d’Appollonia

In the context of two decades of increasing migration and corresponding increases in the flow of remittances to home countries, the global financial and economic crisis that started in 2008 has brought with it significant new challenges for both industrialized and developing countries. These challenges relate to the worldwide weakening of economic activity, the decrease in world trade, and a dramatic increase in global unemployment. In the case of developing countries, the crisis has severely affected the extent to which migration can support development goals. Indeed, migrant workers tend to be disproportionately affected by job losses in destination countries, and the flow of remittances has suffered a major decline as a result; yet the impact of the crisis in itself is more limited than might have been anticipated. Migration flows from developing countries to advanced economies have slowed down but have not turned negative. Overall remittance flows to developing countries remained resilient. In 2010, remittances recovered to the 2008 level of $325 billion after having dropped to $307 billion in 2009 as a result of the global financial crisis. Flows are projected to rise to $351 billion in 2011 and $374 billion by 2012 (World Bank 2011). A closer examination reveals some important variations related to remittance flows and migration patterns. This diversity among the states and regions that have experienced significant growth and decline in remittances is particularly striking. These varied developments highlight the need to better understand how the issues of migration, labor markets, financial trends, and development are interconnected. Analyzing the trends before the crisis sheds light on the current complex relationship between migration, remittances, and economic cycles in both Organization for Economic Cooperation and Development (OECD) and developing countries. Such analysis also illuminates the extreme diversity of migration patterns (in the case of both immigration and emigration), the different forms of migration (such as permanent, temporary, illegal, and humanitarian), and the evolving nature of the relationship between immigration and financial flows.

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To date, the economic downturn has confirmed two major trends. First, global migration patterns are affected by business-cycle fluctuations, but other factors—such as policy changes in both sending and receiving countries—still play a major role. Second, although remittance flows are deeply connected to these global migration trends, other factors also explain the current fluctuations of remittances. Some of these variables, such as currency changes, are linked to the economic situation in both industrialized and developing countries. Others, such as the impact of new regulations and the use of new technologies, are less correlated with shifts in global economy.

Evolution of Migration and Remittance Flows Before the Crisis The economic boom years of the last decade were characterized by a steady increase in migration flows and the levels of remittances. From 2001 to 2007, remittance receipts reported in the IMF’s Balance of Payments Statistics Yearbook more than doubled, to $336 billion (IMF 2009a, 1). According to the World Bank, formal remittance inflows increased from $132 billion in 2000 to $443 billion in 2008, with almost two-thirds of this total going to developing countries. The average annual growth rate was 18 percent between 1999 and 2007; over the period, year-on-year growth ranged from 9 percent in 1999–2000 to 25 percent in both 2002–2003 and 2006–2007. Between 2007 and 2008, remittances to developing countries rose 15 percent, a sharp increase linked to rising migration and labor mobility, more liberal and competitive financial intermediaries, and improved data recording.1 According to UN estimates, the number of global migrants was 195 million in 2005—which was 2.5 times greater than the 75 million recorded in 1960—and their number grew by 9.6 percent to nearly 215 million by 2011. 2 The overwhelming majority of international migrants move— whether permanently or temporarily—in search of better economic opportunities. According to both the International Organization for Migration (IOM) (2008) and International Labor Organization (ILO), there were about 100 million global migrant workers in 2008, accounting for roughly 3 percent of the global workforce of more than 3 billion people. These estimates do not include illegal migrants; therefore, the true scale of migration is believed to be even larger. The United Nations estimates that there are roughly 20 to 30 million unauthorized migrants worldwide, composing 10 to 15 percent of the world’s immigration stock. An estimated 11 million unauthorized immigrants live in the United States, according to US government estimates. About 618,000 unauthorized migrants resided in the United Kingdom, and nearly 210,000 live in Japan.

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While South-North migration has caught most of the attention, SouthSouth migration dramatically increased, up to 47 percent of the total emigration from developing countries. In 2005, 74 million of the migrants from developing countries resided in other developing countries, and almost 80 percent of South-South migration took place between countries with contiguous borders. The increasingly diverse destinations of migration have changed the origin countries of remittance flows. In 2000, five traditional countries of immigration—the United States, Saudi Arabia, Germany, Switzerland, and France—accounted for about half of all remittances sent worldwide. By 2008, the number of countries that accounted for half of all remittances sent worldwide had grown to eighteen. 3 Although South-South migration approximates South-North migration, South-South remittances amounted to $55.4 billion, less than 20 percent of the North-South flows. According to the latest available data, this amount represented 29.5 percent of recorded remittances received by developing countries in 2005 (Ratha and Shaw 2007). Thus, while rich countries remained the main remittances source, the general impression that remittances originate mainly from developed countries is only partly true. In 2006, the United States was the largest source, with $42 billion in recorded outward flows, followed by Saudi Arabia ($15.6 billion), Switzerland ($13.8 billion), Germany ($12.3 billion), and the Russian Federation ($11.4 billion).4 Considering remittances relative to the percentage of GDP results in a different list than one based on global flows. The top 10 remittance senders in 2006 were Luxembourg (18.2 percent), Lebanon (18.2 percent), Tajikistan (14.0 percent), Bahrain (11.9 percent), Maldives (9.1 percent), Tonga (5.4 percent), Kyrgyz Republic (5.4 percent), Guyana (5.4 percent), Saudi Arabia (5.0 percent), and Vanuatu (4.6 percent). Similarly, the belief that remittances flow mainly to poor countries is only partially true. In 2003, for example, of the $173 billion in total remittances, about two-thirds accrued to developing countries. The top ten remittance recipients in 2006 were India ($27.0 billion), China ($25.7 billion), Mexico ($25.0 billion), Philippines ($17.0 billion), France ($12.5 billion), Spain ($8.9 billion), Belgium ($7.2 billion), the United Kingdom ($7.0 billion), Germany ($7.0 billion), and Romania ($6.8 billion).5 In 2008, India ($52 billion), China ($49 billion), Mexico ($26 billion), and the Philippines ($19 billion) remained the top remittance-receiving developing countries.6 If developed countries were included, France, Spain, Germany, Belgium, and the United Kingdom would be on this list. Indeed, France, Spain, and Germany combined received more remittances than China in 2008. Growing global migration has thus resulted in rapid growth in global remittances. There were, however, other factors that have driven the growth in remittances. The first one relates to expanding networks in the money

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transfer industry. The remittance business was formerly dominated by money-transfer companies like Western Union, which processed almost $700 billion in transfers and payments worldwide in 2002 alone. In recent years, however, major commercial banks have begun to compete for remittance business, increasing opportunities for migrants when sending money overseas. In the aftermath of the tequila crisis of the mid-1990s, for example, Spanish and US banks bought Mexican banks and formed alliances with other banks in order to leverage the remittance business, with the intent of turning remitters into full banking customers. Second, the emergence of new financial infrastructure for money transfers has reduced the cost of remitting—although huge variations can still be found, depending on the amount transferred, the transfer agent, and the geographical area. In the US-Mexico corridor, for example, the cost of sending $300 fell by 54 percent between 1999 and 2004, from more than $26 to $12 (Ratha 2007).7 Third, the recent doubling of recorded remittances was also the result of a better measurement of flows, especially in the aftermath of the events of September 11, 2001. In their fight against terrorism, many governments and the international Financial Action Task Force (FATF) have taken steps to address informal value transfer systems in order to counter money laundering and the financing of terrorist activities. This was illustrated, for example, by the USA Patriot Act (Title III), and a series of EU Money Laundering Directives. These measures aimed at encouraging a shift from informal to formal channels for sending remittances.8 Fourth, part of the increase in officially recorded remittances only reflects the variation in currency convertibility, notably the effect of the depreciation of the US dollar that raised the dollar value of remittances in other currencies. For example, remittance flows to some South Asian and East Asian countries increased partly because depreciating currencies against the US dollar made assets in the home country more attractive, resulting in a shift from remittances being sent for consumption to remittances for investment. For all these reasons, remittances have become a major source of external development finance. Remittances have become more important than foreign direct investment (FDI) as a source of capital inflows for poor countries, exceeding them for the first time in 2006—when remittances topped $300 billion and FDI totaled $167 billion. In addition, remittances greatly exceed official development aid (ODA), which in 2006, for example, equaled just $107 billion (Goldberg and Levi 2008). Remittances have benefited some regions more than others, notably Latin America, South Asia, Europe, and the Middle East. Nearly half of all remittances received by developing countries flowed to middle-income countries. For example, about half of East Asia’s total went to China, and about three-quarters of South Asia’s total went to India. Growth to low-income countries has not

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been very strong. Sub-Saharan Africa received the least amount of reported remittances between 2000 and 2006. At the country level, however, the importance of remittances depends on how large the remittances are relative to the receiving economy, as a share of its GDP. In 2008, for example, remittances accounted for 49.7 percent of GDP in Tajikistan, 37.7 percent in Tonga, and 31.4 percent in Moldova (World Bank 2010). Furthermore, remittances have proved to be more stable than other external sources of financial flows, such as private capital flows. They have appeared to be countercyclical relative to the recipient economy. According to Dilip Ratha, “They tend to rise when the recipient economy suffers a downturn in activity, an economic crisis, natural disaster, or political conflict, as migrants may send more funds during hard times to help their families and friends” (2007, 3). This tendency was illustrated during the financial crises in Mexico (1995) and Indonesia and Thailand (1998), as well as in Central America in the aftermath of Hurricane Mitch (1998), and in Haiti—a country afflicted by both economic and political crises (such as in 2004) and natural disasters (floods in 2004, earthquake in 2010).

Effects of the Crisis on Remittances and Migration The global financial crisis has had a major impact on migration patterns and levels of remittances around the world. The World Bank reported a decrease of recorded global remittance flows, from $443 billion in 2008 to $413 billion in 2009. Remittances amounted to about 1.8 percent of GDP for developing countries in 2009, a slight drop from 1.9 percent of GDP in 2008. The World Bank also reported important regional variations. Flows to Latin America and the Caribbean region fell by 12 percent in 2009, to Eastern Europe and Central Asia by 23 percent, and to the Middle East and North Africa region by 8 percent. In South Asia, there was a significant slowdown in the growth of remittance flows (5 percent in 2009, compared to 26.7 percent in 2008) while flows to East Asia, the Pacific region, and sub-Saharan Africa remained flat (Ratha, Mohapatra, and Silwal 2010a). The decline in some countries was especially dramatic. In Latin America and the Caribbean region, the greatest declines were reported in Ecuador (27 percent), Jamaica (15 percent), and Mexico (13.4 percent) (Orozco and Ferro 2009). In Africa, remittances to Somalia decreased by 25 percent in 2009, and Uganda’s dropped by 56 percent. South-South remittances from Russia, South Africa, Malaysia, and India have been affected by both the evolving crisis and exchange rate movements. While the US dollar has strengthened against the currencies of many major destination countries, the value of remittances from these countries has declined in US dollar terms. Remittances from Russia to Tajikistan, for example, have declined because the ruble depreciated by over 25 per-

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cent against the US dollar in 2009 (Ratha and Mohapatra 2009). According to the World Bank, remittances to India declined by 7 percent in the first quarter of 2009. Rupee appreciation and declining interest rates contributed to this decline, which growth in the remaining quarters overcame.9 The general countercyclical nature of remittances was illustrated by some national trends in South and Southeast Asia, as well as in the Middle East and North Africa. The Sri Lankan Foreign Employment Bureau stated that remittance flows increased from $2.5 billion to $2.6 billion between November 2008 and November 2009. The State Bank of Pakistan figures showed that Pakistanis working overseas sent $5.7 billion home between June 2008 and March 2009, which was 20 percent up on the same period of the previous year. Remittances from Egyptian workers, the majority of whom work in the Gulf Cooperation Council (GCC) countries, increased by 7.5 percent during the fiscal year 2008–2009 (Awad 2009). However, evidence also suggested that reverse remittances took place in some of the major migration corridors. Migrant workers from the Dominican Republic and Mexico, for example, who chose to remain in the United States although they were unemployed, were forced to spend savings previously sent home. In Chiapas, a southern state of Mexico, officials used to seeing money flowing in from the United States reported in 2009 that more money was going out than coming in (New York Times 2009). Judging the extent of such reverse remittances is extremely difficult. Data on outward remittance flows are of questionable quality in most of these countries. According to some experts, inferences about reverse remittances can be drawn from a decline in foreign currency deposits—which are most probably held by migrants or their relatives. In 2008, for example, these deposits declined by 7 percent in the Dominican Republic, 12 percent in India, and 6 percent in Mexico (Ratha, Mohapatra, and Silwal 2009a). A reduction in migration flows has been reported in some countries. For example, the estimated annual inflow of immigrants from Mexico to the United States—about 175,000 between March 2008 and March 2009—was lower than at any point during the decade and only about half of the average for the previous two years.10 Similarly, after a near sevenfold increase in the share of immigrants among the total population over the past decade, Spain’s immigrant population has suffered massive labor-force dislocations. The result has been a 25 percent decline in total immigrant inflows from Eastern Europe, with Romanian and Bulgarian migrant levels declining by more than 60 percent (Fix et al. 2009). Evidence also suggests that return migration is occurring in some countries. The United Kingdom and Ireland, for example, have witnessed a rapid turnover of workers from the eight Eastern European countries (referred to as the EU-8) that joined the European Union in 2004—particularly those from Poland. Of the 1.4 million EU-8 workers who had come to the United

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Kingdom between May 2004 and March 2008, almost half had returned by the end of 2008. The National Statistics Institute estimates that the number of migrants leaving Spain nearly doubled, from 120,000 in 2006 to 232,000 in 2008. Eastern Europeans with the right of return, as well as some Moroccans who have legal permanent residence, appear to be leaving Spain and returning to their home countries.11 The recession has slowed new employment of temporary foreign workers, both because employers have requested fewer workers and because some governments have halted the recruitment of new foreign workers. As a result, evidence suggests a slowdown in emigration flows. According to the Migration Policy Institute, recent data show that while the number of overseas Filipino migrant workers increased overall between 2007 and 2008, slightly fewer Filipinos left the country for overseas employment in December 2008 (89,800) than in either November 2008 (106,600) or December 2007 (95,300). The outflow of Nepali migrant workers decreased by 13 percent during the same period due to the economic crisis (Fix et al. 2009). Declines in irregular migration flows have been notable in some countries. For example, the number of illegal immigrants in the United States, after peaking at 12 million in 2007, fell to about 11.1 in 2009 and 11.2 in 2010. The number of illegal immigrants in the labor force (8 million in 2009) had decreased from its peak of 8.4 million in 2007. According to the Pew Hispanic Center, this reduction came primarily from decreases among illegal immigrants from Latin American countries other than Mexico (Passel and Cohn 2011). Similarly, according to a Frontex analysis, a decline occurred in illegal border crossings in the European Union: the number of illegal border crossings in the first quarter of 2009 was 50 percent less than in the fourth quarter of 2008 and 16 percent less than in the first quarter of 2008. In its report, the agency noted that as economic opportunities deteriorated in EU countries, fewer unauthorized migrants were arriving in Europe (Frontex 2009). The combined effect of decreasing immigration (both legal and illegal) and return migration flows has reduced migrant stocks. Data from official population surveys suggest that the historic growth in the stock of immigrants in the United States is slowing. The slowdown first appeared in the US Census Bureau American Community Survey data for 2007. The ACS registered a net increase of just over 500,000 immigrants between 2006 and 2007 (compared to 1 million between 2005 and 2006). Mexicans in the United States are the country’s largest immigrant group, but their numbers have remained constant rather than growing by an expected 1 million (Fix et al. 2009). These trends tend to confirm the most common assumptions about the impact of the financial crisis on migration and remittances. First, a crisis

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usually limits job opportunities for immigrants, and therefore results in a slowdown of emigration.12 In the United States, for example, immigrant economic outcomes began deteriorating in 2006, as a result of the housing crisis. Residential construction employment declined, and immigrant employment rates fell accordingly. The employment rate for immigrants dropped by 4.6 percent between 2006 and 2009, while their unemployment rate rose from 3.4 percent to 9.2 percent (Orrenius and Zavodny 2009).13 In the European Union, the general unemployment rate dramatically increased between 2008 and 2010. As in the United States, migrant workers were more affected than native-born workers. In Spain, the impact of job losses has been disproportionately borne by migrant workers. In particular, employment in 2008 fell by over 20 percent and 23 percent among male migrant workers from Morocco and the rest of Africa, respectively, compared to only 6.9 percent for Spanish-born workers. In Ireland, unemployment grew in 2009 by 2.7 percent among native workers but by 7.1 percent for migrant workers.14 In the United Kingdom, the unemployment rate was also higher for foreign workers (7.3 percent) than for nationals (6.5 percent). In Central and Eastern Europe (non-EU) and the Commonwealth of Independent States (CIS), massive layoffs have affected all workers, including migrants from Kyrgyzstan, Moldova, Tajikistan, Ukraine, and Uzbekistan. Many returnees, resulting from job losses in the Russian Federation (where unemployment reached 8.5 percent in 2009 compared to 6.1 percent in 2007), have been reported (Awad 2009). Second, for countries of emigration, the crisis disrupts the export of workers. This point was illustrated during the Asian financial crisis by a reduction of job opportunities for Filipinos by about 94,000 between 1997 and 1999, and significant returns of Asian workers in their country, including about 300,000 from Burma to Thailand, and 200,000 from Indonesia to Malaysia (Koser 2009). Similarly, fewer Filipinos left the country for overseas employment in December 2008 (89,800) than in December 2007 (95,300). Over 6,000 Filipino migrants, mostly women working in electronics factories in Taiwan and men working on Middle Eastern construction projects, returned home before the end of their contracts in 2009 (Fix et al. 2009). New migration flows from many other countries appear to have been impacted by the financial crisis and weak job markets in the destination countries. A large fall in new deployments has occurred in many sending countries. In Bangladesh, for example, migration fell by nearly half in the first nine months of 2009. Third, in times of crisis, slack demand for labor increases the likelihood of precarious and irregular employment. While little evidence exists, migrant workers are typically forced to take on jobs offering poor working conditions or in the informal economy. As reduced overall demand for labor affects employment and migration opportunities, as well as terms and con-

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ditions of work, migrants send fewer remittances home. A general context of contraction, in turn, affects countries of origin—especially those that rely heavily on remittances. For example, a third of the labor force in Tajikistan is employed abroad, and the remittances they send back constitute 35 percent of GDP (Awad 2009).

Puzzling Variations in Remittances and Migration Trends A closer examination, however, reveals some puzzling variations related to remittance flows and migration patterns. The diversity among the states that have experienced significant growth and significant decline in remittances is particularly striking. While most countries experienced declines (although with important variations) in remittance flows, there were some notable exceptions. Overall, remittance flows to the Philippines, for example, increased by almost 3 percent in 2009 and by 6.6 percent in 2010. Bangladesh received a record $9.68 billion during the 2008–2009 fiscal year, an increase of 22 percent from the previous year. Flows further increased by 8.6 percent in 2010 and by 12.2 percent in 2011, despite a slower growth in flows from the Gulf Cooperation Council (GCC) countries (Orozco and Ferro 2009). Recent estimates provide a contrasting picture. At the global level, remittance flows to developing countries increased by 6.2 percent in 2010, and by 7.1 percent in 2011—and are expected to increase by 8.1 percent in 2012. In Latin America and the Caribbean region, the decline in remittance flows appears to have bottomed out since the last quarter of 2009. Flows to Jamaica have been positive since November 2009, and are expected to increase by 6.3 percent in 2011 (RemittancesGateway.org 2010). Flows to El Salvador, Honduras, and Guatemala became positive again in March 2010, and are expected to increase by 6 to 9 percent in 2011. In contrast, remittances to Venezuela continued to decline by an estimated 2 percent in 2011 (RemittancesGateway.org 2010). A high unemployment rate in Spain (up to 20 percent in 2010) affected remittance flows to Ecuador, Colombia, and Bolivia. In Europe and Central Asia, global remittance flows increased from $28.4 billion in 2006 to $45.8 billion in 2008, yet flows started to decline in 2009 by 23 percent, reaching a total of only $36.7 billion in 2010. This trend unevenly affected developing countries in the region. Flows to Kyrgyzstan increased by 33 percent in 2011, and by 21 percent in Georgia. In contrast, remittances to Albania decreased by 8.2 percent. Intra-EU remittances fell by 13 percent in 2008–2009. Romania was the most affected country, with a decline of more than 50 percent because of the crisis in Spain and Italy, the two major destinations of Romanian workers, yet remit-

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tance flows to Europe and Central Asia increased by 6.5 percent in 2011 and are expected to increase by 10.4 percent in 2012 (Ratha, Mohapatra, and Silwal 2010a). Furthermore, despite a slight decline in remittance inflows in some regions and countries, global remittance flows have remained more resilient than other types of resource flows, such as equity flows and foreign direct investment. Portfolio flows, for example, became negative in 2009 as foreign investors pulled out of emerging markets (Ratha, Mohapatra, and Silwal 2010b). The decline in overall remittances during the financial crisis (5.5 percent in 2009) was modest compared to a 40 percent decline in foreign direct investment in 2008–2009 (Mohapatra, Ratha, and Silwal 2010b). The global financial crisis has therefore emphasized the importance of remittances for meeting a country’s external financing gap. They have contributed to the reduction of current account deficits in many developing countries. According to the World Bank, in low-income countries (such as Bangladesh and Nepal), the current account deficit as a percentage of GDP would have been more than double in the absence of remittances. Remittances have also largely offset trade deficits in many middle- and lowincome countries. The effects of the global crisis on migration flows were also nuanced. The financial crisis and weak job markets in destination countries appear to have affected new migration flows from many countries. Potential migrants, considering the high costs of migration and reduced employment opportunities, have chosen not to migrate. Overall migration flows remained positive, however, although they have slowed down. Furthermore, and contrary to expectations, little evidence exists of significant return migration as a result of the financial crisis in the United States and Europe.15 The Pew Hispanic Center, for example, found no evidence of an increase in the number of Mexican-born migrants returning home from the United States, despite rising unemployment and slowing inflows.16 Voluntary return programs implemented by destination countries have fallen far short of the targeted numbers. Spain introduced financial incentives in November 2008 to encourage voluntary returns. This program, however, had received only 5,088 applications as of June 2009. In April 2009 Japan introduced a program that pays $3,000 to unemployed immigrants of Japanese descent from Latin America to return to their countries of origin until the economic conditions have improved in Japan, but this offer has not led to large-scale returns. The Czech Republic also introduced a program in February 2009 for unemployed migrants from non–European Union countries to return home but had received only 1,345 applications by April 2010. Migrant workers often choose to remain despite deteriorating labormarket conditions in order to preserve social security benefits. The adverse economic and employment situation in the country of origin also discourages them from returning home. This situation partially explains the persist-

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ent income gap between sending and receiving countries. In Spain, for example, migrant workers from Morocco earn between 4.5 and 10.5 times the average earnings of all men and women, respectively, in Morocco.17 Migrants are also unwilling to return to their countries of origin, because they fear they may not be able to reenter their nonnative nation once they leave because of tighter immigration controls. Finally, the slight decrease in illegal flows noticeable in some countries is balanced by an increase in illegal migrant stocks, as migrant workers who are unemployed choose to remain in their host country without authorization. Insufficient data are available, however, to assess its overall effect.

The Complex Relationship Between Immigration Flows, Remittances, and Business-Cycle Fluctuations Some of these variations in migration and remittance flows can be explained by the specifics of the current crisis. Yet historical and current evidence raise further questions about any direct relationship between economic-cycle fluctuations, migration patterns, and global remittance flows. First, the crisis that originated in developed countries spread to developing countries. In his study of prior crises (notably the Asian crisis of 1997–1999, the financial crisis in Russia in 1998, and the Latin America crisis of 1998–2002), Koser notes that “while all of those earlier crises had global ramifications, their impact was most keenly observed at the regional level. During earlier recessions, one region tended to benefit economically at the expense of another” (2009, 9). In contrast, the current crisis is global, with global effects on rich and poor countries, as well as on sending and receiving countries of migrants and remittances. Yet in this context of global contraction, regional and national economies have not slowed down to the same extent, and a few economies have not slowed down at all. The degree of slowdown has also varied among economic sectors, with some registering growth despite the general contraction. According to the International Labor Organization, “Construction, manufacturing, and hotels and restaurants, have particularly suffered, both in terms of growth and employment. In contrast, a number of sectors, in some countries, have witnessed growth in employment. In the same country, an overall reduction can coexist with preservation or even increases, of employment and migration opportunities available for migrant workers” (Awad 2009, 5). In the United States, for example, by the beginning of 2009, 1.1 million jobs were lost in the construction sector since employment in this sector had peaked in January 2007. In contrast, health and social work, a sector with a high concentration of immigrant employees, registered a gain in employment (an average of 17,000 per month in 2009). In the United Kingdom, some 102,000 new jobs were created in

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2009 in education, health, and public administration, while manufacturing employment fell. Considering that the situation in the destination country and the sector of employment are essential factors, the impact on migrant workers has varied significantly. Some migrants switched across sectors and countries. In the Gulf, for example, many migrants moved from Dubai to other emirates and neighboring countries, where massive construction projects are still ongoing. According to United Arab Emirates (UAE) estimates, the recruitment of South Asian workers even increased in 2009, securing employment for large numbers of migrants from Bangladesh and India.18 Second, no single, global trend characterizes the ways the recession has affected migration flows; the effects depend greatly on the character of flows (permanent, temporary, illegal, and humanitarian). Papdemetriou and Terrazas note that “as a general rule, lawful permanent resident (LPR) immigration flows are less responsive to the economic cycle than those for unauthorized immigrants and temporary workers” (cited in Koser 2009, 6). Humanitarian immigration flows are largely independent from the economic climate in the destination countries. Furthermore, although temporary worker flows gradually adjust to labor market conditions, return migration is more closely related to the economic situation in countries of origin than with economic conditions in receiving countries. Another general rule relates to the impact of tougher border controls that do little to curb the number of illegal immigrants. Rather, they increase the stock of illegal immigrants by limiting circular migration, as well as boosting migrant smuggling and human trafficking. This trend was illustrated in Western Europe during the oil crisis of the 1970s, with increasing restrictions on migration flows generating a new market for illegal immigration. A similar effect was noticeable during the Asian financial crisis—notably in Malaysia, where restrictive policies fueled the informal sector rather than fighting illegal immigration. Both the US and European governments today face the counterproductive effects of their restrictive border policies. Third, the relationship between the economic cycle and immigration is weaker than commonly expected. Migrants decide to move for various reasons—economic, political, and social ones. Furthermore, in destination countries, factors other than the economic situation, such as immigration policy changes, play a key role in the volume of immigration flows. For example, the decline in legal immigration observed in the United States during the Great Depression actually began in 1928, before the crash of 1929, as a result of the Immigration Act of 1924 that was implemented in 1928. Conversely, policy changes in countries of origin affect emigration flows. During the Asian crisis, migrant-sending countries such as Thailand and the Philippines adopted specific programs designed to support their overseas workers and to explore new labor markets for avoiding repatriation of workers who lost their jobs. A similar policy of labor export is currently imple-

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mented by many countries of origin in order to compensate for any reduction in new migration flows. In 2008, for example, the Philippines concluded an agreement providing for Japanese recruitment of Filipino caregivers. In 2009 India negotiated mobility partnerships with some European countries. Sri Lanka and Bangladesh have asked their ambassadors to seek alternative employment for their unemployed overseas workers. In Uzbekistan, authorities are actively seeking new migration destinations for their migrant workers (International Labor Organization 2009). Fourth, contrary to popular perception, remittance flows in a given year are not directly related to migration flows during the same year; instead, remittances are sent by almost the entire existing stock of migrants—that is, cumulated flows of migrants over the years. The relative stability of the migrant stock, therefore, contributes to the resilience of remittance flows despite a crisis. If migrants do indeed return, they are likely to take their savings back with them, as illustrated by the case of Indian workers who had to leave the Gulf during the 1990–1991 war (Ratha and Mohapatra 2009). Furthermore, factors other than migration patterns play a significant role in the evolution of remittance flows. The exchange rates between local currencies and the US dollar affect the US dollar valuation of remittances. In 2009, for example, remittance flows to several Central Asian countries declined precipitously in US dollar terms, but the fall was smaller in ruble terms. For example, remittance flows to the Kyrgyz Republic declined by 15 percent in US dollar terms in the first half of 2009, but actually increased by 17 percent if measured in rubles (Ratha, Mohapatra, and Silwal 2010a). Exchange rate changes also affect the consumption/investment motivation for remittances. Migrants’ remitting behavior is shaped by macroeconomic variables, such as the economic situation in their host country and exchange rate fluctuations, yet remittances are mainly seen as a family obligation. Robert Meins, expert at the Inter-American Development Bank, notes, “Unlike speculative flows or foreign investment, profit motives do not drive remittance levels” (Orozco and Ferro 2008, 8). Migrants are therefore more likely to cut back on their own consumption than to reduce the amount of money they send to their families. In this context, three recent trends are of note. First, many countries— including El Salvador, Nepal, the Philippines, and Rwanda—have become more aware than ever of the importance of remittances as a stable source of foreign currency earnings. They have issued diaspora bonds in order to raise financing from overseas workers. Second, the global financial crisis has intensified efforts to reduce remittance costs and leverage remittances. The diffusion of new technologies, such as mobile money transfer technologies, has facilitated this trend. In 2010 MasterCard’s cellular telephone–based payment platform opened its infrastructure to other banks. Twitter launched Twitpay, in which customers can send money with a cell phone using a linked PayPal account (Orozco and Ferro 2010). A third trend, however,

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relates to the increased taxation of remittances—which operates against the reduction of remittance costs. The state of Oklahoma, for example, introduced a new tax in 2009 on wire transfer (1 percent for transactions of more than $500), in order to fund the fight against money laundering and drug trafficking. A similar tax was introduced in Kansas in 2010, and other US states are considering the idea of taxing remittances.19

Conclusion The length and the depth of the current crisis is not yet clear, but that the crisis will in some manner influence migration and remittance flows is certain. It is, therefore, premature to evaluate the effects of restrictive immigration policies that have been introduced in receiving countries, especially in the United States and European nations. It is also premature to evaluate the impact of the new labor-export strategy that some sending countries have implemented. However, as illustrated by previous crises, migration trends appear to be resilient in the face of economic cycles. As Robert Meins argues, “Only an unprecedented decrease in the stock of migrants sending remittances, a significant drop in wages across a large segment of immigrant cohort, or an equally large rise in immigrant unemployment will have a major impact on remittance flows” (cited in Orozco and Ferro 2008, 9). To date, we have not reached that stage. We can assume, however, that the combined effect of restrictive immigration policies and the upsurge of antimigrant feelings in most of the host countries will have adverse consequences for migrant workers. Furthermore, other factors than migration legislation have to be taken into account, such as currency exchange rates, commodity prices, and political events. The Arab Spring, for example, has brought a great deal of uncertainty to the issues of migration and remittance flows. Remittance flows to the region registered a quick recovery in 2010 after the financial crisis, and were expected to grow by 4.5 percent in 2011. The resettlement of more than 700,000 migrants that have fled from Libya, as well as the economic problems raised by political instability in the region, will certainly have some effect on remittance flows in the near term. The global financial and economic crisis has also had some positive effects. One of them is the impact on recipients in purchasing power terms, as the dollar has appreciated against major Latin American currencies— resulting in falling commodity prices. Another effect relates to the multiplication of recent initiatives, such as the European Union’s Payment Services Directive, which is intended to simplify money transfer by standardizing payments processing throughout Europe after November 2009. The heads of state and government of the major industrialized democracies (G8) announced in February 2009 the formation of a Global Remittances

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Working Group (G8 GRWG) with the purpose of facilitating the flow of remittances worldwide. One of its main objectives is the reduction of the average cost of sending remittances by 5 percent over five years (the “5x5” target) by fostering market transparency, enhancing market structure and competition, and adopting best practices in the area of risk management. The Obama administration backed and Congress enacted in July 2010 the Wall Street Reform and Consumer Protection Act, aiming at improving transparency in the pricing of remittance services. These structural changes to the global remittance market are expected to generate positive outcomes for sending and receiving countries.

Notes 1. According to the World Bank, the true size of remittance flows, through both formal and informal channels, is believed to be 50 percent larger on average than the figures provided by official data. See World Bank 2005. 2. International migrants are defined as persons who left their country of birth or citizenship for at least a year. The United States was the top immigration country in 2005 (with 38.4 million immigrants), followed by the Russian Federation (12.1 million) and Germany (10.1 million). The top immigration countries relative to population were Qatar (78 percent), the United Arab Emirates (71 percent), Kuwait (62 percent), Singapore (43 percent), Israel (40 percent), and Jordan (39 percent). In high-income OECD countries, the average share of immigrants was under 10 percent. The top sending countries were Mexico, Russia, India, China, Ukraine, Bangladesh, Turkey, United Kingdom, Germany, and Kazakhstan. See United Nations Department of Economic and Social Affairs 2009. 3. In 2000, the United States was the source of nearly one-quarter of all remittances, but its share had fallen dramatically, to about 10 percent in 2008. In contrast, the Russian Federation was the origin of less than 1 percent of remittances sent in 2000, compared to 6 percent of remittances sent in 2008. While improvements in accounting and tracking remittance flows may explain some of these changing trends, they certainly reflect real phenomena related to the diversification of migration flows (Fix et al. 2009). 4. The other major sources were Spain ($11 billion), Italy ($8.2 billion), Luxembourg ($7.5 billion), the Netherlands ($6.7 billion), and Malaysia ($5.6 billion). 5. The top ten remittance recipients in 2006 (percentage of GDP) were Tajikistan (36.2 percent), Moldova (36.2 percent), Tonga (32.3 percent), Kyrgyz Republic (27.4 percent), Honduras (25.6 percent), Lesotho (24.5 percent), Guyana (24.3 percent), Lebanon (22.8 percent), Haiti (21.6 percent), and Jordan (20.3 percent). 6. They were followed by Poland ($11 billion), Nigeria ($10 billion), Romania ($9 billion), Bangladesh ($9 billion), Egypt ($9 billion), and Vietnam ($7 billion). 7. A study of remitters in Bogotá and Mexico City found that the cost of sending $100 was $19 when using a bank for an unbanked person. For the same transaction made by a bank account holder, the transfer cost drops to a standard ATM charge (see Solo 2005). 8. Formal remittance channels are those officially authorized to operate in the

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money transfer business, such as banks, money transfer operators, or other officially registered institutions. Semiformal remittance channels include formal institutions providing money transfer services outside the regulatory mechanisms of the country authorities. Informal remittance channels are outside of financial regulation and supervision but often legal. Informal systems (informal value transfer systems [IVTSs]) include the hawala system found in South Asia (also called hundi in Pakistan and India) and in immigrant communities in the United States, the feich’ien system in China, the hui kuan in Hong Kong, the phei kwan in Thailand, the chop and chit systems found in East Asia, the padala in the Philippines, and the casa de cambio in South America. The least official and formal channels for transfer of funds may involve intermediaries who do not operate as formal businesses. These transfer funds derive from both legitimate and illegitimate activities, ranging from funds deployed by intelligence agencies to those related to corruption, tax evasion, drugs, and terrorism. 9. Currency effects are also noticeable in Europe. A significant part of the decline in remittance flows to Poland are traceable to the weakening of the British pound against the US dollar. The British pound depreciated by over 25 percent between the third quarter of 2008 and first quarter of 2009, reducing outflows in US dollar terms (Ratha, Mohapatra, and Silwal 2009a). 10. See http://www.un.org/esa/population/publications/2009Migration_Chart/ ittmig_wallchart09.pdf. See also http://www.pewhispanic.org/2009/07/22/iii-fewermexican-immigrants-are-arriving/. 11. However, the bulk of unauthorized sub-Saharan African and Latin American migrants are staying put, in large measure because of poor economies in their home countries. 12. According to the International Labour Organization’s (ILO) (2009) Global Employment Trends report (GET), there could be a dramatic increase in the number of people unemployed worldwide. Depending on the timeliness and effectiveness of recovery efforts, the GET envisages an increase in global unemployment in 2009 compared to 2007 by a range of 18 million to 30 million workers, and more than 50 million if the situation continues to deteriorate. Migrant workers are especially vulnerable to these economic and labor market turbulences. 13. The unemployment rate among the native-born rose from 4.9 percent in 2007 to 8.6 percent in 2009 (SOPEMI 2009). This rate reached 9 percent in 2009 (compared with 9.9 percent for immigrants). 14. In the eurozone, the employment rate declined by 0.2 percent in the fourth quarter of 2011. The largest fall in employment was recorded in construction (1.5 percent), a sector employing a large proportion of immigrants. 15. I refer here to voluntary return migration, as opposed to involuntary return migration such as removals and other forms of deportation. 16. Additional data from the Mexican government’s “Survey of Migration on the Northern Border of Mexico” show that return migration from the United States appears to have declined in recent years (the first quarter of each year). About 210,000 migrants returned in the first quarter (Q1) 2007, compared to about 199,000 in Q1 2008, and 166,000 in Q1 2009. 17. International Labour Organization; see http://www.ilo.org/ global/About_the_ILO/Media_and_public_information/Feature_stories/langen/WCMS_126487/index. htm. 18. This uneven impact across national economic sectors was noticeable during previous crises. For example, during the Asian crisis of 1997–1999, in Thailand, the construction and manufacturing sectors (in which migrants were overrepresented), were deeply affected. In contrast, agriculture (also an important employer for

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migrant workers) was largely unaffected. With regard to regional mobility, the oil crisis resulted in significant declines in job opportunities in Western Europe (especially in the manufacturing and construction sectors), but it also resulted in new employment opportunities in oil-rich states in the Middle East (Koser 2009). 19. The Kansas bill requires money transmitters to collect $5 on each transaction and 2 percent of a transaction that exceeds $500. The Mexican government declared that this was “an insulting measure linking immigration with drug trafficking” and passed a resolution denouncing US states imposing remittance taxes. The Mexican House of Representatives in April 2010 called upon the Mexican government to establish trade measures against these states. (Mexico is the number-one international trade partner of both Oklahoma and Kansas.) See RemittancesGateway.org 2010.

PART 2

The Crisis and US Hegemony

6 China and the United States in the Battle for Jobs and Growth Herman M. Schwartz

Once you start issuing $1–$2 trillion [of US government bonds] . . . we know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do. —Chinese Finance Ministry official, 20091

Mao Zedong famously said that political power grew out of the barrel of a gun. But how to pay for that gun? The financial crisis of 2007–2009 and the subsequent great recession drove the official US unemployment rate to levels that had not been seen since the early 1980s. Meanwhile, China’s economy, courtesy of a massive Keynesian stimulus, powered on with doubledigit growth. These diverging trends have raised the same kinds of fears of terminal US decline that surfaced in the 1970s and 1980s when Europe and Japan were growing much more rapidly than the United States. Are the United States and China locked into a zero-sum battle for employment and growth in the aftermath of the great recession? Does this battle inevitably end with a margin call from Chinese bankers to an indebted United States? This chapter argues that up until about 2005, the United States and China had a symbiotic—indeed, codependent in the pop psychological sense—relationship with respect to growth and employment. China exported exceedingly cheap, labor-intensive goods to the United States and the world, and recycled its trade surpluses as credit to the US consumers buying those goods. Cheap Chinese goods and lending helped paper over an increasingly unequal income distribution in the United States by enabling a job-creating housing boom. But from 2005 onward, China’s growth became more capital-intensive, and US homebuyers faced a market whose prices were completely out of touch with any plausible economic future in which housing debt could be repaid. Relatively more capital-intensive Chinese exports also eroded medium-technology manufacturing in the US industrial heartland, rather than just labor-intensive manufacturing in the rural US

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South. At this point the relationship became destructive. Finally, after 2009, manufacturing began shifting back to the United States as firms recognized that energy (and thus transportation) costs would remain relatively high, and Chinese wages were rising. The chapter thus has four parts. The first part discusses the incomplete and misleading conventional wisdom on the US-China relationship, which focuses on the unbalanced bilateral US-Chinese balance sheet. The chapter’s next section addresses the codependent growth dynamic prevailing from the mid-1990s until 2005, presenting a stylized model of growth for each country. The third section shows how codependent growth created internal contradictions that shifted the models after 2007 into something closer to a zero-sum relationship. In other words, a contradiction emerged from the dialectical relationship between the United States and China. The final part of the chapter looks at the current state of play, focusing on the issue of which country has a more decisive final move. This section is necessarily speculative, but it suggests that the United States, as a debtor and deficit country in relation to China, not only has exercised but still retains a decisive power to make the last move in any economic conflict. For this reason, the chapter’s first section finds the conventional wisdom wanting.

Chinese Bankers, US Debtors On October 10, 2010, the conservative pressure group Citizens Against Government Waste released a video ad titled “Chinese Professor” that instantly went viral on YouTube.2 The ad showed a Chinese professor in 2030 explaining the decline and fall of a series of empires. The United States, he said, had crippled itself by trying to tax and spend itself out of a great recession. The video ends, “Of course we owned all their debt, so now they work for us.” Putting aside its partisan animus, the video captures the essence of the conventional wisdom on the US-China relationship circa 2010. This wisdom rested on the following claims: China’s massive holdings of US Treasury, agency, and private debt put China’s hand around the US throat. Having underwritten US fiscal and trade deficits for years, China now had a geopolitical lever to move the heretofore immovable US earth. Indeed, a forensic analysis of the cumulative US trade deficit from 1999 to 2009 shows that roughly 39 percent—or nearly $2 trillion—of the cumulative $5.1 trillion US trade deficit accrued to China (Bureau of Economic Analysis database). Furthermore, China accounted for 18 percent of all current account outflows attributable to income payments on government debt, although only 5 percent of all income outflows. This bilateral trade deficit is the origin of the roughly $2 trillion of various US debt instruments the Chinese state held in 2011. Even without adding in Hong Kong’s holdings—and they should be added in—China’s holdings are

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grossly out of proportion to the size of its economy relative to the world or the United States, or indeed a wide range of developed economies. On a net basis this would be even more evident. Figure 6.1 shows gross holdings of US foreign debt by country as of 2010. But do these holdings convey power? Are US citizens, as US Senator Jim Demint (R-SC) charmingly put it, “on our knees in front of China for credit”? A similar debate erupted over what were perceived at the time as outsized Japanese holdings of US Treasury and other debt in the late 1980s and 1990s. Then, as now, two distinct lines of argument emerged, one based on stocks and one based on flows. First, critics argued that Japan or China might make a concerted effort to reduce their stock of Treasury bonds by selling a significant portion of those holdings. This action would drive down the dollar’s value to the extent that either seller swapped proceeds into other currencies. It would also drive down the value of US Treasuries and related securities. This sort of sale, however, is what former Treasury secretary Larry Summers was referring to when he talked about a financial balance of terror between China and the United States. Much like a nuclear exchange, these sales would inflict damage on both sides. While massive sales would damage the creditworthiness of the US government, they would also destroy the balance sheet of the People’s Bank of China (PBoC), China’s central bank. US Treasury and other US government bonds are the assets on the PBoC’s balance sheet that match its equally large liabilities denominated in renminbi. Panic selling of Treasuries that drove down both

Figure 6.1 Gross Holdings of US Public and Private Debt, June 2010, US$ billions

2000 1600 1200 800

Ch in

a

&

H on g

0

Ko ng Ja pa n Br ita in Ca na da Be lg iu Sw m itz er la nd Ire la nd M id ea st N O et il he rla nd s Ta iw an G er m an y Fr an ce Si ng ap or e

400

Source: Author’s construction from US Treasury International Capital System data, http://www.treasury.gov/tic.

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the dollar relative to the renminbi, as well as the market price for those Treasuries, would leave the PBoC with a huge uncompensated liability. Indeed, it would require a recapitalization of the central bank roughly equivalent to half of China’s current GDP. Second, in a much more likely scenario, critics alleged that the scale of Japanese or Chinese Treasury bond purchases made them the marginal buyer of Treasuries. On a flow basis, then, these purchases might give China the ability to influence the interest rate on new issues of government debt. Chinese abstention from bond auctions would reduce demand relative to the supply of new debt, pushing up interest rates. The interest rate on US Treasuries sets the reference rate—the benchmark—for interest rates on virtually all other debt instruments in the United States. Rising interest rates on Treasuries thus would not only make it harder to fund the federal deficit but would also hurt everyone else attempting to fund consumption or investment by borrowing. Presumably, a sustained absence from bond auctions could bring about a recession. Is this argument plausible? Econometric analyses suggest that recycling of Japanese and then Chinese trade surpluses as purchases of Treasury debt during the late 1990s and early 2000s depressed yields on 10-year US Treasury debt by about 90 basis points, or almost 1 percentage point, and as much as 150 basis points in 2005 (Warnock and Warnock 2006). This effect is significant, albeit in the opposite direction. But it is not entirely clear that withdrawing demand rather than providing it would have the same effects. Higher Treasury bond rates might well attract inflows of money from elsewhere, driving rates back down again. Moreover, if China or Japan continued to run trade surpluses, sales of their excess dollars might well have flowed back to the United States as other countries’ purchases of Treasuries or goods and services, either of which would mitigate the effects of a Chinese or Japanese buyers’ strike at bond auctions. Nevertheless, the threat of an auction disruption—and a 200-basispoint rise in interest rates—is perhaps serious enough to concentrate minds in Washington. China’s refusal to buy more of Fannie Mae and Freddie Mac’s debt issues in 2008 was followed by nationalization of the two US mortgage giants. Did China force this nationalization? Certainly it helped force the Treasury and Fed’s hand in this matter, but as everyone was avoiding debt issued by the twin agencies, the blame cannot be laid solely at China’s feet. Moreover, had Fannie and Freddie been solvent, a Chinese buyers’ strike would have had effects much like those listed above. If the conventional wisdom about what is central to the US-China relationship is wrong, what then is central? The answer is that the United States and China had a codependent relationship that promoted growth in both countries until 2005, but then became fratricidal.

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Codependent Growth From the mid-1990s until the mid-2000s, the United States and China each had growth models promoting mutual growth, often to the detriment of third parties. This mutually beneficial interlock helps explain why China and the United States together accounted for 45 percent of total world growth on a purchasing power parity basis, and their combined share of global GDP increased from 32 percent to 36 percent during the 1995–2006 period (Maddison database). How did each growth model work? The US growth model The US growth model had two interlocked virtuous cycles that ran through its housing finance system. (See Figure 6.2.) The peculiarities of the US housing finance system translated falling nominal interest rates in the 1990s into additional consumption and growth much more effectively than the housing finance systems of continental Europe and Japan. The 1990s were a period of profound disinflation everywhere in the OECD. Unlike the 1970s and 1980s, long-term nominal interest rates fell. Euro-area long-term interest rates fell from 11.2 percent in 1990 to 3.5 percent by 2005. US longterm rates similarly fell from 8.7 percent to 4.0 percent during the 1990– 2003 period (OECD 2005). While real interest rates did not fall, studies

Figure 6.2 The US Growth Cycle, 1991–2005

FED ↓ Interest Rates

Disinflation

Housing Finance System

Asia Recycles US Dollars as New Mortgage Debt

↑ Tax Revenue

More Consumption

Faster US Economic Growth US Trade Deficits

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show that housing prices are much more sensitive to nominal rates than real rates (Green and Wachter 2007). Disinflation potentially could have released new purchasing power into the hands of consumers and companies. Why didn’t the global disinflation aided by the Clinton administration’s conservative fiscal policy benefit all OECD economies equally? While debtors everywhere could see falling nominal interest rates, not every debtor could take advantage of the situation to reduce their interest payments and free up cash for other consumption. Corporate debtors with easy access to bond markets could refinance, but not all indebted consumers were able to reduce their interest rates and thus refresh their purchasing power. Moreover, consumers in different countries had different levels of debt. In the ideal case, the biggest Keynesian aggregate demand stimulus would occur where there were relatively high levels of private, individual homeownership financed through mortgages, and the financial system permitted cheap and easy refinance of those mortgages. All three conditions are true in the United States, which has high levels of private homeownership, high levels of mortgage debt in relation to GDP, and a very liquid housing finance market. By replacing high-interest-rate mortgages with lower-interest-rate ones, people in the United States freed up considerable purchasing power. Moreover, US homeowners have the ability to easily cash out and spend their home equity—the positive difference between the home’s market value and the mortgage debt. Finally, mortgage debt interest payments are deductible from income at tax time. In the 1990s, refinancing and home equity extraction contributed a large portion of new GDP; from 2000 through 2007 they accounted for almost all US growth (calculated from Greenspan and Kennedy 2007). We have already hinted at one connection with Asia in general and China in particular in this disinflation-driven growth. The 10-year Treasury bond rate sets the reference rate for mortgages, so recycling of Japanese and Chinese trade surpluses helped push down mortgage rates and enable the refinancing-into-growth feedback loop to operate. But a second feedback loop also connected disinflation to US growth. China’s and Hong Kong’s share of US imports rose from 5.7 percent to 15 percent of total US imports, 1991 to 2005. China’s low-wage labor provided an increasingly larger volume of low-cost, imported, consumer nondurable consumption in the United States, which magnified disinflationary pressures. In contrast, the share of US imports from high-wage Japan shrank by almost the same 10 percentage points in the same period (Bureau of Economic Analysis database). Much the same was true for the European economies (Eurostat 2008). In the United States, imported disinflation reinforced the refinancing loop, unlike in Europe, where less liquid housing finance markets are the norm. Finally, the Federal Reserve Bank (the Fed) reinforced both trends by

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steadily lowering short-term interest rates after 1995 as growth narrowed and then eliminated the fiscal deficit. Politically, strong US growth and falling interest rates helped paper over the worsening distribution of income in the United States during this period (Rajan 2010). Roughly speaking, to the extent that personal income increased, only the top 20 percent of the income distribution saw significant income gains; within that group, the top 1 percent captured over half the increase. Ever-cheaper financing costs allowed homeownership rates among the middle 30 percent of the income distribution to rise despite stagnant income, while cheaper consumer nondurables eased the burden for the bottom 30 percent of the income distribution. Debt-fueled prosperity proved unsustainable, but in the medium run it prevented a loss of legitimacy in the face of absolute income declines for the average male in the bottom quarter of the labor force.

China’s Growth Cycle What about China? It had two strong feedback loops driving growth that intersected with those promoting US growth. (See Figure 6.3.) China’s fundamental geopolitical and domestic political problems intersect on the matter of GDP growth. Absent robust GDP growth, China will be unable to transform roughly a billion poor peasants into moderate-income citydwellers. The Communist Party’s legitimacy became particularly dependent on delivering growth after the 1989 Tiananmen crackdown. Equally so,

Figure 6.3. China’s Growth Cycle, 1995–2007

↓ Domestic Consumption Low Interest Rates No Welfare State

Central Bank Sterilizes $$ Issuing RMB

State Banks & Party Elites

More Investment for Exports

Trade Surplus Central Bank Buys $$

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China’s external security (and any hope of recovering Taiwan Province) rests on transforming a backward economy into an industrial powerhouse. Yet efforts to privatize the many small, state-owned enterprises in pursuit of greater efficiency also put roughly 50 million additional workers back into the labor market from 1995 to 2004 (Yao 2010). Finally, accumulating large foreign currency reserves would limit potential vulnerabilities to dependence on external raw materials. Moving up the value chain would allow it to produce its own weapons. Chinese growth began and remains largely domestically driven. The smashing of the iron rice bowl—the rudimentary welfare state that provided China’s citizens with pensions, health care, education, and housing—created a huge surge in personal saving. Individuals and families had to rely on their own savings rather than their enterprise or municipality. Because China has a tightly controlled, state-owned financial system, politically unconnected households had only one option for those savings—bank accounts yielding low real and nominal interest rates. Low rates induced extremely high rates of saving to compensate for the slow accumulation of savings via compounding. Politically connected elites and state firms could tap into the state-owned banking system to finance massive investments in export capacity. Chinese economic growth relied heavily on exports to provide more than a margin of error in employment generation and to drive industrial upgrading. China needed to generate about 20 to 24 million jobs per year after 1995 to keep employment steady—requiring GDP growth higher than 7 to 8 percent per year. While China’s internal economy was quite dynamic, only a robust export economy could guarantee rates this high, which meant exporting to the United States. By the 2000s, the United States was absorbing between 30 and 40 percent of China’s exports, and a 1 percent increase in US GDP predictably created a 1 percent increase in Chinese GDP. The People’s Bank of China, the nation’s central bank, played a critical role in assuring that exports continued to drive growth up to politically necessary levels. China’s initial advantage in world markets was simply extremely low wages. For example, consider clothing, where China’s share of world exports doubled from roughly 15 percent in 1992 to 27 percent in 2005 (Athukalora 2009). In garment assembly, there was simply no way that a US worker earning the minimum wage (in 1999, roughly $9 per hour including the employer’s nonwage costs) could compete with a Chinese worker earning roughly $0.50 per hour. US productivity was at best two times the Chinese level in this sector, not the twenty times needed (China Textile University and Harvard Center of Textile and Apparel Research 1999). The shift of assembly of commoditized garments out of the United States (and Europe) became a certainty—but it was not a certainty that Chinese work-

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ers, rather than Bengali, Indonesian, or Vietnamese workers, would be the primary beneficiaries of this disparity. Moreover, going forward, the Chinese government wanted to use export surpluses to upgrade from lowskill products like garments to medium-technology products like machinery. Success in garments, though, might generate outcomes that would make both continued success and upgrading more difficult. Put simply, in the absence of intervention in currency markets, a durable export surplus would exert upward pressure on the renminbi’s exchange rate relative to the dollar and the currencies of rival Asian exporters. If the renminbi rose relative to the dollar while competitor countries’ currencies did not, then the giant retail firms organizing garment commodity chains would shift production elsewhere. If the renminbi rose relative to the dollar, then the much larger productivity differential with the United States in medium-technology goods would make it pointless to extend a production chain across the Pacific and would thus truncate China’s development at the level of labor-intensive assembly. China thus made a political decision to hold its exchange rate steady against the dollar to assure continued surpluses and easier upgrading. Figure 6.4 shows the renminbi and yen exchange rates against the dollar, on an inverted scale. Note the relative stability of the renminbi from 1995 to 2005. This stability was accomplished by having the PBoC buy dollars from exporters with renminbi, and then mopping up the new liquidity by issuing RMB-denominated bonds (MacKinnon 2006). (In this manner, the PBoC ends up with a balance sheet comprising renminbi bond liabilities and US Treasury assets.) China’s highly regulated financial system made steriliza-

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tion of this increase in the money supply easier—banks could be forced to buy PBoC bonds. But even with efforts at sterilization, the decision to keep the renminbi fixed against the dollar reinforced the feedback loop favoring continued investment—indeed, overinvestment—in exports. First, even with sterilization, the liquidity from continued export surpluses pushed down nominal and real interest rates in China. Low nominal and real interest rates enabled higher rates of investment, which the Chinese state desired as part of its industrialization push. The subsequent investment also had a political basis as well, because only state-owned firms or those connected to party elites had access to formal credit, and thus low, subsidized interest rates (Tsai 2004). Indeed, one consequence of Tiananmen was a policy shift favoring urban areas and large firms at the expense of small and particularly rural enterprise (Huang 2008). The larger, favored firms dominate the export economy or supply many of its nontraded inputs (energy, transport). Cheap capital thus enabled excessive investment in export production capacity, which was then validated by sales to the United States; a fixed exchange rate made those sales possible, closing the loop by forcing the PBoC to continue to accumulate dollar-denominated assets on its balance sheet to prevent a rise in the renminbi. This strategy was successful in terms of export promotion. From 1995 to 2005 China’s share of global exports went from 2.9 to 7.3 percent (WTO database). Keeping the renminbi fixed against the dollar also kept Chinese household income from rising, also reinforcing the feedback loop favoring investment in exports. While Chinese household income rose absolutely, consumption fell continuously as a share of income because household income growth lagged production growth by a consistent two to three percentage points each year (Pettis 2009). Faced with low interest rates, Chinese households continued to save. Meanwhile, state firms channeled their increasing income into continued investment rather than distributing profits as dividends. Household consumption declined from a more or less normal 50-plus percent in the 1980s to an already low 46 percent of Chinese GDP in 2000, and then to 35 percent in 2009. The macroeconomic counterparts to declining consumption were burgeoning investment and the export of capital (deferred consumption manifested as trade surpluses) as purchases of US securities. The US and Chinese feedback loops intersect in this exchange of Chinese goods for US debt; Chinese workers’ extra savings are matched by Americans’ extra consumption.

The Unraveling Chinese and US growth were thus codependent until around 2005. After that, the linked growth dynamics in each country became increasingly dysfunctional, for three main reasons. First, China grew to the point to which

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its calls on world raw materials began to reignite inflation in the United States rather than promoting disinflation. Second, the PBoC’s continued sterilization of trade surpluses started to cause Chinese firms to substitute relatively cheap capital for labor. Rather than being labor-absorbing, Chinese growth became labor-shedding. Third, the increasing capital intensity of Chinese production meant that it began to compete with onshore US production of medium-technology goods, hindering rather than helping US employment. The counterparts to these Chinese trends were increased pressure on middle-class expenditures in the United States, erosion of middleclass incomes, and the $8 trillion housing bubble. All this contributed to the 2008 financial crisis. By accelerating each trend, the crisis simply brought US-China economic conflict to the fore. Successful Chinese industrialization reversed part of the growthpromoting disinflation dynamic in the United States after 2005. Given its initial low level of development, Chinese economic growth necessarily involved greater and greater calls on global raw material supplies, including, most importantly, oil. Development meant creating an entirely new infrastructure—roads, buildings, power generation, telecommunications— and thus huge inputs of cement, steel, copper, and energy. For example, China’s iron ore imports, which in aggregate equaled half of Brazil’s total iron ore exports in 1996, rose to three times the much larger level of Brazilian exports in 2006. All told, Chinese imports of oil, soybeans, and copper were about thirty times higher in 2008 than they were in 1995 (Jen and Bindelli 2007). Inflationary pressure from raw materials forced the Fed to increase rather than decrease interest rates. Rising prices and rising interest rates both put pressure on household budgets. The bottom half of the US income distribution receives only about 18 to 20 percent of the nation’s total income; it is income-constrained, already facing sharp trade-offs in its consumption. Prices rose most strongly for goods with low elasticity—fuels and foods, in particular. While fuels account for about 11 percent of the average US household budget, in the bottom half of the income distribution they amount to over 15 percent. Many of these households also had purchased housing using adjustable-rate mortgages, which exposed them to rising interest rates. Rising prices and rates thus forced these vulnerable households to choose among getting to work, buying food, or making their mortgage payments. Second, Chinese production became increasingly capital intensive from 2004 onward, partly in response to rising wages (see below). But it also reflected a natural response to the subsidization of export production and capital investment that the PBoC’s fixed exchange rate with the US dollar created. By keeping the renminbi artificially cheap, the PBoC essentially subsidized exports, encouraging a continued export orientation. The ratio of exports to GDP rose continuously through 2007. By keeping domestic interest rates low—which it had to, in order to avoid losing money on the ren-

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minbi bonds balancing its US Treasury holdings—the PBoC encouraged a shift toward capital-intensive production methods. China’s enterprises can borrow at essentially zero cost. Indeed, some argue that China’s stateowned enterprises generate zero or even large negative profits after interestrate subsidies equaling roughly 3.8 percentage points (380 basis points) are stripped out (Ferri and Liu 2009; Jing 2011). The rising capital intensity of Chinese production created problems in China, because the rate of labor absorption slowed. But the increased focus on capital also put pressure on US incomes by directly lowering them, rather than by simply increasing prices. More capital-intensive Chinese production led to a substitution of local Chinese-made components for imports, and to displacement of US production of higher-end consumer nondurables and electrical goods production. From 1994–1995 to 2005–2006, China’s world market share of electrical goods exports went from 3.1 percent to 20.6 percent (Athukalora and Kohaiboon 2010). This export surge led to declining nominal income in the bottom half of the US income distribution, as even more industrial jobs disappeared. Falling prices for imports had helped drive a disinflationary increase in real consumption in the 1990s. But falling prices now eroded incomes, making the price of imports moot to more and more families. Put differently, China nearly doubled its share of the rising US non-oil trade deficit to 46 percent between 2000 and 2006. Third, successful Chinese industrialization also led to rising wages in China, and a shift toward more capital-intensive modes of production. Though some debate exists around the level of processing in Chinese exports and the degree to which Chinese wages are rising, these disagreements are about rates, not trends. From 2004 onward, wages and benefits in Guangdong Province began rising above the level of productivity growth— as much as 20 to 40 percent in 2004 alone—prompting an exodus of laborintensive firms into China’s interior and to neighboring Vietnam (Garnaut 2010). While textiles and garments constituted 28 percent of Chinese exports in 1997, electronics, at 35 percent, replaced them as China’s largest export by 2005 (Cui and Syed 2007; Athukalora 2009). Components and parts still composed a growing share of China’s machinery imports, but imports fell in relation to total exports, indicating a rising local composition for exports. A telling indicator is that per capita steel consumption in China barely doubled from 1990 to 2000, but then quadrupled from 2000 to 2010 (McKay, Sheng, and Song 2010). These trends meant that China was no longer competing simply with garment assemblers in the United States, but now was competing with or displacing medium-technology production in cheap refrigerators, electric tools, and housewares. Continued—indeed, increasing—Chinese trade surpluses after 2005 thus helped create the conditions underlying the massive financial crisis of 2007–2009. China was not responsible for the specific form or depth of the crisis, which were purely a function of deregulation and nonregulation

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inside the United States that permitted financial firms to link different parts of the financial system together in a carry trade around housing. In a carry trade, investors deliberately borrow money on a short-term basis and then invest it on a long-term basis; this maturity mismatch is extremely risky. US and European financial firms deliberately created a maturity mismatch, hoping to profit from differences in interest rates for short-term liabilities to the commercial finance part of capital markets and those for long-term assets in the subprime mortgage market. They compounded this approach by using credit default swaps to ensure against mortgage defaults, thus also putting the insurance sector at risk. But what China was responsible for was a continued flow of recycled trade surpluses as mortgage money—Chinese purchases of debt issued by Fannie Mae and Freddie Mac—that made it possible to extend credit to the subprime part of the mortgage market without facing a trade-off with other forms of investment. Thus, what had been a symbiotic set of relationships promoting growth turned fratricidal. US exports of capital to China had enabled a vast reverse flow of cheap goods that helped power nominal interest rates ever lower. Falling nominal interest rates enabled US consumers to refinance their mortgages, cash out home equity, and continue to import goods from China as well as drive up local housing-related employment. China meanwhile received millions of higher-quality industrial jobs and enough extra internal aggregate demand to transfer millions of people from rural to urban employment. But by 2005 China had entered a capital-intensive growth path that destroyed too much employment in the United States and undermined Chinese efforts to complete its transition to an urban economy. Deliberate manipulation of the dollar-renminbi exchange rate was producing inflation in China and depression in the United States.

After You, Please The shift to a more fratricidal relationship between China and the United States creates considerable potential for conflict. The first section of this discussion dismissed the fear that China’s hoard of Treasury bonds gave it some form of leverage against the United States. But other forms of power are still at each party’s disposal. Who has the upper hand in the current relationship? And what about third parties? Two things matter: The structural situation in each country and the issue of who has the last move. Structurally, both countries have extremely weak financial systems. In the United States, the core issue is the speed at which housing prices recover and—almost the same thing—how fast banks rebuild their capital. Recapitalized banks and stable housing prices would allow the Fed to reel in the liquidity it created to bail the banks out of bad mortgages. Put simply, Fed intervention during the crisis meant printing money to

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buy Treasury bonds, which could then be exchanged for banks’ holdings of bad mortgage-backed securities (MBS). By March 2010 the Fed was holding approximately $1.25 trillion in MBS. In principle it could hold these MBS to maturity, hoping that a steady revival of the economy and thus nominal house prices would allow redemption at par. In practice, given that 25 percent of all mortgaged homes were worth less than their mortgage in 2011, an orderly resolution might leave the counterpart $1.25 trillion in excess liquidity hanging around in financial markets for years. This $1.25 trillion was the source of much misplaced anxiety about inflation in 2010– 2011. Nevertheless, even if those anxieties were misplaced in 2010, rising food and fuel prices in 2011 threatened recovery for precisely the same reasons they were problematic before the crisis. On the other side, by 2011, unemployment had been at historically high levels for longer than any prior post-1950 recession, and labor force participation had fallen back to 65 percent, a level not seen since 1982. The longer people stay unemployed, the less likely that they will ever find employment again. A permanent drop in labor force participation would slow future growth and wreck household balance sheets. The Fed thus found itself trapped between too fast a recovery, which might trigger an inflation-scare interest-rate spike, and too slow a recovery, which might lock millions of people into permanent unemployment. Meanwhile, market forces were pushing manufacturing back to the United States (Sirkin, Zinser, and Hohner 2011). In China the core issue is the degree to which any effort to control inflation will reveal the degree to which banks hold nonperforming loans. As Michael Pettis, a Beijing-based economist, bluntly said in early 2011, “The Chinese banking system is one of the least efficient major systems in the world when it comes to assessing risk and allocating capital, and would be massively bankrupt without repressed interest rates and the implicit (and sometimes explicit) socialization of credit risk” (2011). Although some analysts credit China’s fiscal federalism as a force promoting growth, it can lead to too much of a good thing (Montinola, Qian, and Weingast 1995). The central state finds it hard to control provincial-level lending, particularly after years of promoting officials based on their local economic growth performance. Tight clusters of local bankers, builders, and party officials have huge incentives to develop real estate, infrastructure, and industry as fast as possible. Lending has an economic basis; land sales are a major source of provincial revenue. But the choice of what to lend to whom and for what occurs on a largely political rather than strictly economic basis. Overbuilding and overcapacity thus emerge from interprovincial competition. By 2010 China’s provinces were building 66 subway systems (more than Western Europe possesses) and another 45 airports (on top of its exist-

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ing 175) at a time when worries about peak oil had already surfaced and when 130 of those airports were already operating at a loss (Dyer 2011). Subsidized credit also led to considerable excess industrial capacity. China’s excess capacity in cement production exceeded the combined consumption of the United States, Japan, and India in 2008; China’s excess capacity in steel exceeded the combined output of the Korean and Japanese industries, and was almost double European output. In this context the temptation to engage in the kind of massive stimulus—four times that in the United States, relative to the size of the economy—that China undertook in 2009 is obvious. Yet this stimulus flowed into the usual channels, aggravating existing problems with overinvestment. Local governments exacerbated this overlending using local government investment trusts. By 2010, then, China faced its own version of the typical trade-offs in the Mundell-Fleming trilemma. The Mundell-Fleming trilemma says that countries can attain only two of the following three policy options: fixed exchange rates, free capital mobility, and monetary policy autonomy. China opts against free capital mobility, which means that in principle it remains possible to use monetary policy to control inflation. As noted above, though, keeping the renminbi fixed against the dollar at a point below the real rate of exchange creates inflation via a rising trade surplus. Monetary policy is thus also pinned, as inflation is built into the macroeconomy via the choice of the exchange rate. Each of China’s policy choices thus involves a politically painful decision. Much as in Southeast Asia in 1997, this anticipated pain delays any decision, causing the potential costs to mount. The central bank could raise interest rates sharply, slowing investment growth. But boosting interest rates will put many firms into a negative cash-flow situation unless purchasing power can be shifted toward personal consumption that absorbs their excess capacity. In addition, as noted above, higher interest rates would also invert flows on the PBoC’s balance sheet, causing it to lose money. China could free the capital account, but this would undoubtedly lead to a stampede of private capital outward in search of higher returns and more secure property rights. Finally, China could break the exchange rate and revalue. This step would allow Chinese consumers readier access to imports, but would drive down the export sector’s profits. The natural reaction by that sector would be to flee into even more capital-intensive production and more production for the domestic market. The result would likely be China freezing at its current level of productivity and per capita income. Although the rest of this section mostly considers potential conflicts, various avenues to an amicable resolution do exist. For one thing, China need not use its foreign currency reserves to purchase manufactured imports from the United States. Gang Xiao has run a thought experiment on the implications of Chinese parents’ desires for an overseas education for their

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children. Put simply, if the number of students studying abroad continues to grow at its current 8 percent per year, this would absorb 30 percent of China’s current reserve holdings (Xiao 2010). This would simultaneously remove exchange rate risk from the PBoC balance sheet, upgrade Chinese human capital, and maintain employment in one of the most important sectors in the US economy as the college-age population goes through one of its periodic declines. Nevertheless, this optimistic scenario probably requires both sides to be more rational and more willing to confront their own local elites than they have been in the past. A steady revaluation of the renminbi against the dollar is probably the safest way for both countries to achieve balance. A substantial revaluation seems unlikely given the distribution of political power in China and the potential instability arising from China’s overexposed local governments. However, China’s overall trade surplus has been falling in relative terms, from about 10 percent of GDP in 2007 to 3 percent in 2011, although China’s economy has grown so fast that this change represents an actual decline of only $50 billion, to $305 billion. Moreover, China’s bilateral surplus with the United States accounts for almost all of China’s global current account surplus. While China’s trade with Europe is also substantial, the bilateral US-China relationship remains central. Moreover, the central fact about the current situation is that the United States essentially has the last move for two related reasons, and the last move involves forcing China to revalue. First, the United States possesses not just a reserve currency, but the reserve currency. Second, in the bilateral US-China relationship, the United States is the deficit and debtor country. While this is problematic, in an economic conflict it means that the United States has less to lose in employment and growth terms from escalating trade tensions. If trade tensions result in fewer US imports from China, the United States would most likely experience a revival of local production. While many Chinese imports would not be replaced with local US production, the countries that would replace China as the source of US consumer nondurables all have more modest ambitions regarding their industrial future. These countries are less likely to sterilize trade surpluses in order to maintain global market share once China is taken out of the trade equation. Instead, their surpluses would return to the United States as purchases of US-made capital goods and infrastructure equipment. Increased imports from Mexico, for example, generate more US exports to Mexico than do increased imports from China. In September 2010, the US Congress passed a bill calling for a 10 percent tariff surcharge on Chinese exports to the United States. As in prior trade disputes with Japan, this bad-cop message from Congress was matched immediately by a good-cop message from the executive branch. In

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October 2010 Treasury secretary Timothy Geithner noted, “Our initial achievements [attaining global rebalancing] are at risk of being undermined by the limited extent of progress toward more domestic demand-led growth in countries running external surpluses and by the extent of foreignexchange intervention as countries with undervalued currencies lean against appreciation” (Geithner 2010). The Chinese response was an oddly posed threat that reflected their weaker hand. Prime Minister Wen Jiabao noted that a stronger renminbi might create social unrest in China: “Do not work to pressurise us on the renminbi rate. . . . Many of our exporting companies would have to close down, migrant workers would have to return to their villages. If China saw social and economic turbulence, then it would be a disaster for the world” (Beattie 2010). The positions here are asymmetrical. The United States stands to gain employment and growth from a decline in Chinese exports, while China cannot gain from refusing to sell to the United States, or, as noted above, doing what amounts to the same thing by declining to buy Treasury bonds. Meanwhile, third parties like Brazil, Japan, India, Thailand, and Korea were becoming increasingly irritated with China’s exchange rate policies. In this context, the Federal Reserve Bank’s decision in fall 2010 to proceed with QE2—quantitative easing of the monetary supply by buying $600 billion in assets using newly created cash—was a signal that the United States would attempt to change the exchange rate on its own if China did not cooperate. Much as the quote at the beginning of the chapter suggests, China could do little by way of retaliation. Instead, QE2 simply magnified China’s internal problems with inflation. The PBoC has attempted to damp down this inflation by raising reserve requirements and the interest rate at which it lends to banks. But the renminbi’s undervaluation is now creating inexorable pressure for revaluation, either as a matter of policy or through the inflation-driven repricing of Chinese production costs. Whether the change in the exchange rate will be gradual or abrupt remains to be seen. China and the United States are currently locked into a zero-sum battle over jobs and economic growth. Chinese exports are largely predicated on the current low value of the renminbi. To the extent that past Chinese investment requires massive volumes of exports to validate the debt incurred to make that investment, and to the extent that Chinese growth requires exports in order to be able to absorb its labor overhang, Chinese growth is displacing jobs in the rest of the world, particularly in the United States. On the other hand, efforts by the United States to reemploy its nearly 7 million long-term unemployed necessarily involve a reduction in the US trade deficit to more sustainable levels. That reduction can occur either through substitution of imports by local production or a shift away from imported consumption. As of 2011, then, the central dilemma in the global economy was a choice between Chinese inflation and US stagnation. No

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one knows who will bear the greater share of adjustment pain. Nevertheless, China’s holdings of dollar assets are not a source of power in this conflict, although they might be part of the solution if they are spent wisely.

Notes 1. Luo Ping, director-general at the China Banking Regulatory Commission, quoted in Henny Sender, “China to Stick with US Bonds,” Financial Times, October 12, 2009, http://www.ft.com/cms/s/0/a403d716-f8a6-11dd-aae8000077b07658.html. 2. The original video can be found at http://www.youtube.com/ watch?v=OTSQozWP-rM; an amusing parody can be found at http:// www.youtube.com/watch?v=LCD5gzG511c; pushback attacking the original rightwing video can be found at http://www.youtube.com/watch?v=ycdiCL5ZOP8 and http://www.youtube.com/watch?v=Vo6vWyxsSRM&NR=1.

7 Oil and the Sino-American Rivalry Timothy Lehmann

The point that I am trying to suggest to you, Congressman, is that the gross domestic product in this country is becoming increasingly more conceptual. The process of creative destruction has been accompanied by an evergrowing conceptualization of economic output. Ideas rather than materials or physical brawn have been by far the greatest contributors during the past half-century to our average annual increase of 3-1/4 percent in real gross domestic product. —Alan Greenspan (2004)

The global financial crisis has clarified at least one thing: We still live in an industrial era. While in much of the United States and Western Europe, financial services have increased their share of gross domestic product and certainly trafficked in highly conceptual products, they have not supplanted the strategic significance of the material-based physical economy. Energyintensive industrial production is the primary driver of economic and military capabilities, and the importance of natural resources in these processes and to great power diplomacy has once again been starkly revealed. The Japanese government capitulated to resource-based Chinese economic coercion in September 2010, releasing a Chinese fishing trawler’s captain who had engaged a Japanese naval vessel in the disputed Senkakus/Diaoyu islands area (Bradsher 2010a; Yu et al. 2010). The Japanese did so not because the Chinese rare-earth-elements embargo against them hurt their “conceptual” value-added in the form of patented ideas on hybrid drivetrains for cars, for example. Instead, it was Japan’s actual ability to produce hybrid cars and sell them to customers in need of transport that China’s actions directly and physically jeopardized. In using their rareearth-elements’ leverage so boldly, the Chinese underscored a growing confidence about their current economic power despite their increasing overall vulnerability with respect to the most strategic natural resource: oil.

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Petroleum is the lifeblood of economic and military power, and has been ever since the British Navy began converting its fleet to oil prior to World War I. In 1999, then CEO of Halliburton, Dick Cheney, captured oil’s centrality well: Oil is unique in that it is so strategic in nature. We are not talking about soapflakes or leisurewear here. Energy is truly fundamental to the world’s economy. The Gulf War was a reflection of that reality. The degree of government involvement also makes oil a unique commodity. . . . It is the basic, fundamental building block of the world’s economy. It is unlike any other commodity. (1999)

Among other reasons, oil is fundamental to this industrial and mechanized era because there is little transport and projection of economic or military influence without it (e.g., fuel for commercial container vessels carrying petroleum-based plastic product exports or for armored personnel carriers). Oil is still the largest energy source in use in the world today, although its end use has grown even more concentrated into the transportation sector. Globally, in 2007, 61 percent of oil’s use went toward transportation fuels and related end uses, up from 45 percent in 1973 (International Energy Agency 2009). The motive power for all transportation crafts relies upon the marriage of fuels and machined engines, and any great power must attain competency in this core capability (Jensen 1968). Scholars across the various international relations traditions generally accept this proposition, yet the relationship is less well documented between national position in the global political economy on the one hand and oil-based fuels and the industrial production of engines and transportation machinery on the other (Keohane1984; Strange 1987; Morgenthau 1963; Gilpin 1981; Nowell 1994). For example, the technological and industrial capacity to manufacture jet engines for commercial and military avionics applications is directly related to petroleum refining that allows the expensive transportation crafts to perform best. These goods are crucial to both wealth and military power projection, as the contest between Airbus and Boeing readily demonstrates. All of these oil-related transportation goods are substantial portions of the world economy, whether in terms of the value of domestic production or international trade.1 By focusing on the energy and industrial rivalry that is endemic to world politics, this chapter evaluates whether China’s rise is upsetting America’s preponderant influence over the oil core of the world economy, a position made even more uncertain by the financial crisis. The leading position of the United States in the world since World War II has been based upon military and economic dominance of the petrochemical core of economic and military capabilities. This position was first established from the United States’ own reserves of petroleum and the industrial production of the engines and vessels that led it to victory in World War II (e.g., 100-

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octane gasoline and related aircraft engines). As its domestic oil advantage dissipated from the 1950s onward, US maintenance of its global position has required ever more coercive military influence over the Middle Eastern center of the world’s oil supplies (Painter 1986, 1993; Yergin 1991; Goralski and Freeburg 1987; Shwadran 1974). Whether China is challenging this oil-based US order such that it will not endure is one of the most vital questions in international political economy and security. In this chapter I lay out a longer view of international order and great power rivalry, drawing relevant lessons from the US eclipse of Britain and the other great power aspirants in the oil world during WWII. I argue that by helping China develop its economy along an oil-dependent path, the United States has successfully incorporated a rising China into the US-led petroleum order. Nonetheless, US capacity to maintain its influence is not limitless and the costs to domestic autonomy are excessive and debilitating, while China is gaining greater capacity either to usurp the US role in the Middle East or to change the oil game entirely (e.g., with a fully electric transportation vehicle revolution). Given US dependency on oil and Houston’s apparent dominance over US policy on alternative energies, the initiative lies with the Chinese challenger.

Oil and the Post-WWII US Predicament The post-WWII US hegemonic system was formalized by the late 1950s, and much of it is still operative today. The economic foundation of this system was the provision of oil for industrialization and export-led development among the key states outside of the former Soviet bloc (West Germany, Japan, etc.). Allied development entailed significant exports of manufactured goods to the United States for dollar earnings that then paid for dollar-priced oil imports; as a result, allied industrial and export-led growth continued. The United States intentionally ran trade deficits with its increasingly oil-dependent allies so that they might develop more quickly and along similar petrochemical lines (e.g., oil’s share in Japan’s total energy use was 71 percent in 1970). This “oil triangle” with the US dollar and domestic consumer as both pillar and hub of the system worked until the 1970s (Sugihara 1993; Fukami 1989; Painter 1984; Hein 1990; Stokes 1994; Little 2008). Thereafter, US military weakness due to the Vietnam War and the consequent oil nationalizations, coupled with increased dollar surpluses among allies, helped crash the dollar-gold Bretton Woods fixed exchange rate system, setting off the dynamic of large US trade imbalances, increased inflation, and debt. In fact, most of the growth in US gross domestic product (GDP) since then has been due to unprecedented levels of indebtedness (e.g., since 1980 the overall US debt-to-GDP ratio has grown from 142 percent to well over 300 percent today).2 Adding this much debt

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relative to GDP since 1980 does not comport with Alan Greenspan’s irrational exuberance about a 3.25 percent “real” GDP growth rate, because most of the growth is simply expenditure of borrowed monies. With the seismic shifts of the 1970s, the United States adapted by adding more players to the system (e.g., China) and allowing the interrelated processes of domestic deindustrialization and increased consumerism to marry up with vastly increased inflation and debt. These trends have permanently altered prior US dominance in lending, industrial production, and exports. What has not changed is US economic reliance on oil and its inability or unwillingness to substitute for it.3 While the United States has certainly deindustrialized in great measure since the 1970s, it is by no means true that the world as a whole has, or that those states that have continued to embrace industrial production have fared as badly as the United States. In fact, it is precisely the greater emphasis on energy-intensive industry, transportation goods, and exports that has propelled both China and Germany ahead of the United States with their recent higher economic growth rates and exports compared to the United States (e.g., Germany now has its lowest unemployment level since reunification). In 2009 the United States was only the third-largest exporter in the world behind China and Germany. China assumed the top position for the first time and has retained it through to the present while German economic performance has never been better (Bradsher 2011; Thesing 2012). Not coincidentally, neither Germany nor China has reduced the share of industry and manufacturing in their economies to the degree the United States has. Manufacturing was only 13.2 percent of US gross domestic product in 2008, down from 18.3 percent in 1990, and the 1953 peak of 28.3 percent. In China, manufacturing was 43 percent of GDP in 2008, up from 35.5 percent in 1990, while in Germany manufacturing was 24 percent of GDP in 2008, down only slightly from 28 percent in 1990.4 Unlike in the United States, the financial crunch of the great recession did not cause an economic slowdown or energy-use drop-off in China. Energy use continued to grow at very high rates as the Chinese car and light truck market surpassed the US market in absolute size in 2009, and major domestic infrastructure stimulus drove even more energy-intensive industrial output. For example, China’s high-speed rail system and plastics production expansion have both expanded Chinese energy use. Chinese economic growth merely slowed down a bit from its torrential pace, and only for a short time. It does not matter whether one looks at polymers, pesticides, or plastics, much manufactured output is oil-based, even beyond the usual focus upon refined fuels, chemicals, and transportation equipment. Could it be only a spurious correlation among China’s expanding industrial output, leading exporter status, and its vast pool of accumulated investment capital from the largest foreign exchange reserves in the world?

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The global test of the proposition that energy-laden industrial prowess does not matter as much anymore is surely coming. China has already demonstrated, however, that wealth and political influence move toward those who build and deploy large-scale industrial and transportation systems.

The Challenge of China’s Petrochemical-Dependent Rise What often is lost in marveling at recent Chinese relative strength in industry and trade is the fact that much of this growth is dependent on increased oil use, imported oil comprising the majority of Chinese oil consumption. The plastics-based products that China exports and China’s rapidly growing car and light truck market require oil in ever-larger amounts. Even the advanced-technology products in the telecom and computer products area, such as telephone equipment or laptop shells, require oil-based petrochemicals to produce (Morrison 2011; Gallagher 2006). While China’s growth is impressive and contributes to the unease about the fate of the United States, the occasional public rhetoric of Sino-American leaders is largely hyperbole and misses the underlying driver of the relationship: oil. For example, China’s export dynamism has bred some overconfidence that the yuan should become a major reserve and vehicle currency in world finance. Recently, President Hu Jintao declared that the “current international currency system is the product of the past,” implying rather directly that the US dollar’s role in the world economy would of necessity give way to China’s yuan.5 This argument overlooks that 10 to 15 percent of China’s recent import bills comprise dollar-priced oil imports, wherein the Chinese currency has no role save that of acquiring dollars to finance the oil deficit.6 A broad rivalry exists between the United States and China (Sutter 2010; Jacques 2009; Mahbubani 2008; Ross and Feng 2008; Shambaugh 2006). Its principal contours and tendencies, however, are not necessarily most visible in the currency question, the narrowly viewed bilateral trade and debt imbalances, or even in the fledgling Chinese “blue water” navy and stealth fighters. Rather, the essential fault line lies in the competition for natural resources, particularly energy resources. Since World War I, the contest for superior energy resources has determined relative economic and military power as well as the alliance dynamics that affect outcomes in great power contests (Stokes and Raphael 2010; Lai 2009; Moran and Russell 2009). Since its reengagement with the West in the 1970s, and with the assistance of the United States and Japan, China has chosen a developmental path that effectively mirrored that of the United States with petrochemical-intensive growth in agriculture, industry, and transportation

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(Harrison 1977; Lee 1984; IEA 2001; Wan 2006). As a result, China’s oil use has grown markedly, from 3.16 million barrels per day (mbd) in 1994 (one-fifth of US consumption) to just over 9mbd in 2010 (one-half of US consumption). Mirroring its economic growth rate, China’s oil reliance is growing rapidly, nearing the 35 percent share that oil has in worldwide energy use (e.g., compared with coal, natural gas, nuclear, and wind). Today, China’s oil share in total domestic energy use is 20 percent, while the United States is still closer to 40 percent (British Petroleum 2010). China’s heavy reliance on coal for personal consumption related to food and shelter as well as coal’s 80 percent share of China’s ceaseless electrical generation needs marginalize oil a bit statistically, but not in terms of strategic import, as China imports more than 50 percent of its oil consumption. China’s oil diplomacy has sought to carve out a diverse and politically dependent set of oil providers to fulfill this domestic need. Since the mid-1990s, China has been quite skillful in picking off oil partners from the soft underbelly of the USled system (e.g., Sudan, Congo, Libya, Angola, Yemen, and Venezuela). These partners have quantitative and public relations limitations, however, and China has had to come to the Middle Eastern core of the oil world in search of long-term ties with Saudi Arabia, Iraq, Kuwait, and Iran. As a result, China must deal with US dominance over the region and often accept a junior-partner position. For example, China National Oil Corporation has an enticingly sized minority stake of 49.33 percent to British Petroleum’s 50.67 percent in Iraq’s largest oil field at Rumaila (“Baghdad Awards 4.8Mn B/D Second Tranche of Upstream Oil Projects” 2009). China has oil deals with Iran, Iraq, and Saudi Arabia, which do yield it a unique position among these top three oil reserves states. But China’s capacity to act autonomously and apart from US preferences with any one of them is questionable. For example, in the most important case of SinoSaudi relations, China has largely accepted the recent chastisement from the Saudis about Chinese-Iranian ties. The large increased amounts of Saudi oil to China are meant to compensate for decreased Chinese relations with Iran and support for US sanctions efforts isolating Iran (Sanger 2010). More narrowly, looking at increased Sino-Saudi economic ties and concluding that the United States has lost position might cause an observer to miss a key role that US actors play within this particular relationship. For example, the significant and growing Fujian refinery in China has been built to process imported Saudi crude from Aramco, which is a 25 percent owner in the project along with China’s Sinopec and the Fujian provincial government. To some, this type of Sino-Saudi bilateralism might appear troubling, but Exxon-Mobil holds an equal 25 percent stake in the project with Aramco and is the lead technology provider and foreign marketer for the refinery’s output. To see only decoupling and lost position is to miss the structural

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position of US oil firms and their utility in potentially binding important states together under US influence. Similar US-led efforts with Iraq’s oil for Chinese energy security and subsequent Chinese compliance with at least the trappings of international community isolation of Iran only indicate Beijing’s subordinated status. As a result, I contend that China is unlikely to overturn the US-dominated system any time soon. The United States could be toppled if, and only if, it loses its military preponderance over the Middle East, or the rest of the world somehow moves off of oil as the primary energy source. Barring these two eventualities, the United States is likely to remain the lead state ordering economic relations among the great powers because of its influence upon the politics of the Middle Eastern oil core of the world economy. It remains an open question whether China will challenge the US position as directly as the United States did Britain’s after World War I. If China did so, would the United States respond as Britain did—with reluctant co-optation and peaceful compromise—ceding the Middle East to US leadership while accepting a permanently subordinate position?

The Importance of Oil to the Contemporary US-Led Order The long-term risk to the US position lies with the regimes of the Middle East and their growing ties to China (Davidson 2010; Niazi 2009; Calabrese 2009; Alterman and Garver 2008). If the United States were to lose position within these states and their relations with China, then the long-standing Middle East–Asia ties might lead to a strategic decoupling from the United States.7 While the domestic US economic position is attenuated and the financial crisis exacerbates the trend of Near East and Far East economic integration, the geostrategic position of the US military and US transnational oil companies militates against any simple conclusion of an inevitable—let alone a quick or peaceful—hegemonic transition to China. The Iraq War (2003) and the US drive to isolate Iran belie any such likelihood for the foreseeable future. To help them pursue their own interests, the individual regimes of the Middle East region have not trusted one another or China more than they have the United States. At least until US support for the ouster of Egyptian president Hosni Mubarak, these states remained divided among themselves, much to the benefit of the United States in maintaining influence over all of them as against any extraregional interlopers. For example, it has been easier to keep China off balance in its regional aspirations and Saudi Arabia in the US camp when Iran challenges the Saudis in the region and China is forced to choose between them by a more assertive Saudi state. This beneficial strategic position may not endure,

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however, if the conservative Gulf monarchies continue to view the United States as a revolutionary state, undermining their domestic legitimacy and stability through democracy promotion (Carey 2011; Bakr 2011). China presents an alternative and attractive soft power model, much as the United States did after World War I when it compared favorably to British and French imperialism in the calculations of the Saudis (Brown 1999; Oren 2007; Gracia Group 2002; Prados 2003; Kurlantzick 2007). Like Britain before it, the United States operates a delegated dominion through private oil companies, coupled with the use of military power to police the system. In public, US officials justify US management of this system by declaring the objective to be the disinterested provision of an international public good of open access to the Middle East region’s oil for the development of the world economy. Exhortation of this provision of security for oil market access is as ubiquitous among US oil elites and lay scholars as it is incomplete and disingenuous.8 During 1999–2000, Saudi Arabia—out of a base economic interest but also from a political desire to punish the Clinton administration’s outreach to Iran, punitive Iraqi sanctions, and unilateral measures at a Palestinian-Israeli peace agreement—led the Middle Eastern OPEC states in restricting output and raising world oil prices (Bronson 2006; Alkadiri and Mohamedi 2003; Marquis 2000). Conforming to the post–World War II lexicon, in early 2001, the US oil elite congregated under the auspices of the Council on Foreign Relations and the Baker Institute and reported that “recently things have changed. These Gulf allies are finding their domestic and foreign policy interests increasingly at odds with US strategic considerations. . . . They have become less inclined to lower prices in exchange for security of markets, and evidence suggests that investment is not being made in a timely enough manner to increase production capacity in line with growing global needs” (Morse and Jaffe 2001, 13). US concern that the Gulf states were not living up to their end of the relationship, underserving the global good of adequate oil production, coincided nicely with the George W. Bush administration’s early deliberations for the Iraq War and public declarations that China was a “strategic competitor.” In February 2001 President Bush explained why US and British warplanes had recently attacked targets in and around Baghdad, well outside of the no-fly zones. President Bush said his administration was “spending a lot of time on the Persian Gulf and the Middle East,” and identified China’s presence in Iraq as “troubling.” This was followed by several news accounts of Chinese assistance to Iraq’s air defense network in violation of UN sanctions (Bush 2001; Calder 2003; Prados and Katzman 2002; Gershman 2001). The Bush administration’s early focus on rivalry with China (e.g., the EP-3 incident) coupled with its officials’ open interest in changing the trend lines in the Middle East were all indicative of their

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desire to reassert US primacy (Suskind 2004). The attacks on 9/11 simply abetted this broader strategic vision, and the Iraq War was advocated from this first day of national tragedy and mobilization (Clarke 2004; Gordon and Trainer 2006). The purpose of the Iraq War was simple: reassert US dominance over the region vis-à-vis the regional oil-producing states and inveigling great powers, particularly a rising China (Cramer and Duggan 2011; Cafruny and Lehmann 2012; Gilpin 2005; Klare 2004). This did not mean, however, that China was to be cut out of future Iraqi oil dealings; China was simply to be rendered supplicant to the United States in them, as Britain had tried to do with the United States in the 1920s. Zbigniew Brzezinksi captured the enduring rationale for the United States’ oil-based hegemonic position when he held, America has major strategic and economic interests in the Middle East that are dictated by the region’s vast energy supplies. Not only does America benefit economically from the relatively low costs of Middle Eastern oil, but America’s security role in the region gives it indirect but politically critical leverage on the European and Asian economies that are also dependent on energy exports from the region. Hence good relations with Saudi Arabia and the United Arab Emirates—and their continued security reliance on America—is in the US national interest. (2004, 8)

Brzezinski concluded this revealing piece by noting, “Strategic domination over the area, even if cloaked by cooperative arrangements, would be a globally decisive hegemonic asset” (2004, 13). Adding Iraq back to the US-led system has indeed increased the US hegemonic asset base and yielded even more platforms to bind others into the US system. But we are still left somewhat in the dark as to how this US system operates and just how the oil firms within it hold influence positions over others, cloaking dominance in cooperative arrangements. US oil firms are formidable actors affecting energy autonomy around the world. Their importance has not been significantly reduced despite the 1970s nationalizations and the shift away from direct control of every aspect of oil’s development from the wellheads to the final point of sales (Kaufman 1978; Rodman 1988; Parra 2004). They have retained their significance in upstream exploration and production activities as well as the downstream refinery and distribution operations in customer locales. The largest exploration and production firms are headquartered in Houston, and they comprise the dominant share of global upstream activity (Tudor 2011; IHS Herold Review 2010; Berkman and Stokes 2010; “World’s Ten Largest Oilfield Service Companies” 2009). Befitting its status as the largest global corporation, Exxon-Mobil alone accounts for nearly one-tenth of all oil products sales globally each year, and in the Asia-Pacific region, it is second or third in oil reserves under management, refining, and final product

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sales (Energy Intelligence 2010; British Petroleum 2010; Petroleum Intelligence Weekly 2009). Despite the greater size of national oil companies in terms of reserves and production, US oil firms have maintained their significance within the oil world’s value chain (e.g., in drilling technology and refining operations, and final point of sale facilities). Oil is approximately 15 percent of world trade by value, and just over one-third by physical volume of total seaborne exports. Oil’s share of total weight in world trade is down from 56 percent in 1970, but it is still the biggest item in world trade by value and volume, as it has been nearly every year throughout the post–World War II period (United Nations Commission on Trade and Development 2009). Brzezinski’s logic noted above is timeless, as the political leverage that comes with influence over distribution of this largest and most valued strategic resource has preoccupied every US administration since President Woodrow Wilson’s.

Oil, Great Powers, and Building the US System Overseeing global oil production and trade for grand strategic purposes has been a core US state function since World War I, but it no longer occurs based upon North American supplies. The Middle East is now strategically vital because the center of gravity in the oil world shifted away from the United States during World War II; the United States has transitioned from producing 71 percent of the world’s oil in 1918 to only 9 percent today, while the Middle East’s share has risen from 7 percent in 1945 to the 30 to 40 percent range it has held since the early 1970s. The United States peaked in oil production in 1970 because its reserves were tapped excessively from the pre–World War I era through the 1960s’ height of the Cold War. The United States dissipated its oil reserves to fulfill the necessities of alliance building with the British, winning World War II and then setting the post– World War II system on a US-compatible petrochemical basis (Hikino 2007; Chapman 1991; Painter 1993). This process was exceedingly contentious, not just with the Japanese and German enemies during World War II, but also with the British, the leading oil power after World War I. Despite vast US domestic production, after World War I, Britain controlled the dominant share of foreign oil reserves outside of the United States and the Soviet Union (Fanning 1947). These were jealously guarded by Britain and only doled out to allies like the French and Dutch when strategically necessary. Other than the great powers themselves, the lead producing territories of that era were the Dutch East Indies (DEI), Mexico, Venezuela, Iran, and Iraq. The continued denial of US oil firms’ expansion into the DEI, Iran, and Iraq in the early 1920s caused US officials to accept at face value the public utterances from some British officials that their strategy was to burn out US oil reserves prematurely and force the United States to come to

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British terms for access to sterling-priced oil outside of the Western hemisphere (DeNovo 1956; Davenport and Cooke 1924). Anglo-American rivalry continued well past the Anglo-American-Dutch settlement in 1928 establishing the Achnacarry cartel among their oil corporations (Hogan 1977; Randall 2007; Yergin 1991). In fact, in this accord the United States gained only the same Deutsche Bank share percentage of the Turkish Petroleum Company concession covering Iraq that Britain had used in 1914 to entice Germany into a cooperative yet fully subordinate position. The deal to jointly develop the DEI and collude against Japan’s search for energy security in 1927–1928 carried far more strategic import (the DEI was the fourth-largest global producer and major source in Asia for the top three navies competing there). As a result of this arrangement, the United States came to hold Japan’s vital oil lifeline with Californian oil products instead of Japan getting its oil from the much closer territory of the DEI. President Franklin D. Roosevelt declared this leverage a “noose” around Japan’s neck, and used it in July 1941 to “goad” Japan into attacking south against AngloAmerican-Dutch possessions at the end of 1941 (Lehmann 2009; Murray and Grimsley 1994). Prior to using this coercive oil power, President Roosevelt had to ensure that Britain did not appease the Japanese using DEI oil as it had done during the old days of the Anglo-Japanese alliance. The Mexican oil nationalization of March 1938 provided Roosevelt with a perfect opportunity to achieve this, while also improving the US image as good neighbor to the developing world. By 1938, Mexican oil was largely in British hands, with 63 percent of the oil under British firms’ control. President Roosevelt and his trusted ambassador to Mexico, Joseph Daniels, fully understood that this squeeze against Britain would force Britain into the US camp in a subservient position. Therefore, Roosevelt and Daniels fully supported the rights and prerogatives of the Mexican government to nationalize their oil reserves and the foreign producer assets atop them (Jayne 2002; McBeth 1985; Gardner 1964). The Mexican nationalization threatened British interests far more than US interests and confirmed Britain’s reluctant analysis that they would have to accept a US lead in the coming strategic partnership (Leutze 1977; Reynolds 1981). Britain resented its wartime oil dependency on the United States, and toward the end of World War II, rivalry over the future of the Middle East came to the fore again. After the war, Britain exacted some measure of retribution when it obtained the Eisenhower administration’s full backing for the coup against Iran’s democracy after it also nationalized British oil interests in 1951. Even when President Eisenhower reined in an exuberant British desire to control the chief Middle Eastern oil transit point to Europe during the Suez crisis in 1956, he used US oil power to curb Britain’s overt and rather unwelcome imperialism. President Eisenhower refused to release oil to Britain from the Western Hemisphere after the Saudi embargo in support of Egypt began, noting, “Those that began this

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operation should be left to work out their own oil problems—to boil in their own oil, so to speak” (Bronson 2006, 72; Citino 2002; Kunz 1991). Fully reversing the late 1920s’ cartel arrangements, which saw the United States as the junior partner to Britain in the Middle East, Britain capitulated rather quickly in 1956, thus sealing its fate as a subordinate partner to the United States through to the contemporary era. The problem, however, of managing all Middle Eastern oil now fell squarely upon the United States. In 1955 Senator Lyndon Johnson implored Secretary of State John Foster Dulles to ensure that Iranian oil returning to world markets not “result in further increases in already heavy imports of oil into the United States . . . that care was to be taken to see that this oil did not serve to jeopardize the position of American independents in supplying domestic requirements” (US Senate Subcommittee on Multinational Corporations 1975, Part 8, 560). The State Department assured Senator Johnson that, beyond European requirements, Middle Eastern oil’s natural market outlet was in the Eastern Hemisphere, in markets “east of the Suez” (e.g., India, Japan, Taiwan, and South Korea). The Eisenhower administration then chose to shield the US domestic market from “cheap Middle Eastern oil” by instead having this oil flow to subordinated US allies in Europe and Asia (Bohi and Russell 1978). As a result of these policies, the post–World War II Middle Eastern share of total US oil imports peaked at 34.5 percent in 1955. Thereafter, the United States depleted its own oil reserves more quickly while Middle Eastern exports went increasingly to Asia, albeit intermediated by US-based international oil companies (United Nations 1960; Harrison 1977; Hein 1990). These actions codified the oil basis of the Bretton Woods system of industrial growth and trade under US dominance. Oil coming out of the Middle East would be priced in dollars and flow to subordinated US allies in Europe and Asia, while US oil demand would be met by the inordinate production of domestic oil reserves in deference to independent oil producers and their allies in Congress and the executive branch. The United States and Britain forged a partnership from their rivalry across the decades after World War I, and despite being tightly bound allies in World War II, oil rivalry inhibited their fullest collaboration until after the Suez crisis in 1956. While the United States and China have some basis as tacit allies from the 1970s Cold War era, there is little reason to view with much confidence the likelihood of continued Chinese co-optation under US dominance.

Adding China to the US System In 1958, former secretary of state Dean Acheson declared that China could not be considered a great power because it lacked the requisite oil resources necessary to industrialize and project power abroad. In 1959, Chinese crude

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oil production started to grow dramatically, and Chinese oil power based on exports of crude became a possibility by the late 1960s (Park and Cohen 1975; Kambara 1974). China emerged as a great power at this time with its nuclear developments and border war with the Soviet Union, and it rose even higher within the US-led order by the late 1970s, opening up its economy to the outside world. The chief indicator of its openness in those days was its energy exports, particularly crude oil to Japan and the United States. Given the attention Chinese oil imports and related diplomacy receive today, it is well worth remembering that China was first a major oil exporter to the partners of the US-Japan security treaty. After normalization of relations with the United States and Japan began in 1972, China exported oil to Japan for many basic economic reasons; in part, Japan sought Chinese crude as a way to diversify away from US oil company dominance of its needs via Middle Eastern suppliers (Harrison 1977; Lee 1984). More important than each party’s economic interests, however, China sought to use the oil exports to keep Japan from forging any closer ties to the Soviet Union based on Sakhalin Island or Siberian oil alternatives. These developments worked well for all parties as the United States and Japan pulled China into the anti-Soviet camp and helped it develop the modern agriculture, industry, and transportation systems that the United States had helped Japan develop after World War II (Lee 1984; Park and Cohen 1975). In exchange for the oil, Japan and the United States helped China develop these more modern practices that were, of course, also more petroleum-reliant in their operations (Wan 2006). Apparently unaware of the importance of husbanding one’s own oil reserves against the privations of would-be partners, China embarked on this oil export program in the early 1970s with gusto. During the 1970s and 1980s, China developed its oil reserves extensively and exported substantial proportions of its oil, depleting its own reserves prematurely in the process. For example, even in China’s first year as a net importer of oil, 1994, the United States took 17 percent of Chinese oil exports, accelerating the exhaustion of Chinese oil reserves as the United States and Japan had been doing since the mid-1970s (China National Chemical Information Center 1997). Japan took 64 percent of Chinese oil exports in 1994 as well, and together, the United States and Japan absorbed a little over 10 percent of total Chinese oil production. During the heyday of China’s oil reserves’ exhaustion in the 1980s, China exported substantially more of its overall domestic production. In 1985 China exported 29 percent of its total domestic oil production (Weil 1988; Kong 2010). As importantly, the US oil firms’ share of the burgeoning exploration and development market inside China proceeded apace with this oil production and trade growth. By the mid1990s, the United States was the “largest foreign player in China’s oil and gas sectors,” holding 65 percent of the market for sales of technology and equipment related to exploration and development of China’s oil resources

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(International Energy Agency 2001; Richelson 1999a; 1999b, documents 01044 and 01730). US oil technology exports to China went in tandem with a China-US partnership on oil-based transportation that paralleled US policy from the late 1940s forward with respect to European and Asian Cold War allies. A good example of this and its contemporary pitfall is visible in US automobile ties to China. US automobile export promotion and direct investment in co-production in China have been consistent US policy objectives since the early 1980s (Richelson 1999c, document 01756). While any strategic purpose in US policy on Chinese oil and autos has been unstated, the role of the United States in establishing these exchanges is clear. In 1983 Secretary of Commerce Malcolm Baldridge described well the driving force of the overall relationship: “US-China trade development has not happened on its own, overnight. The tremendous growth we have already seen in our bilateral trade took much planning. It required government guidance” (Richelson 1999d, document 00646). In the oil and automobile nexus, the United States only has itself to fault for China’s increasing growth and displacement of the once-dominant US position. China passed the United States in 2009 as the largest car and light truck sales market in the world with 13.5 million units sold, and China is poised to consistently outpace the United States in this bellwether industrial category, which is, of course, incapable of growth without oil (Wang 2011; Kennedy 2011). The paradoxical fact that General Motors became a bankrupt ward of the US state in 2008 while its largest and most profitable market was in China comes as no surprise, given China’s largely successful efforts at energy-intensive industrialization and transportation manufacturing. The US capacity to continue to incorporate China into the postwar US system is not unlimited. China’s growth has been exceptional, as its industrial and transportation sectors typify (e.g., autos and high-speed trains), while its position in the petrochemical sector has led it to a point at which “China looks set to overtake the United States as the world’s most important chemicals producer from 2015” (Deutsche Bank 2008). To be sure, US businesses have facilitated this transition, as General Electric, for example, shed its plastics division to Saudi Arabia’s Basic Industries Corporation in 2007, which in turn invested in several petrochemical development projects with Chinese refinery companies. Oil-based plasticized products still dominate consumer goods, and China will soon be the core producing site for these as well. It is no longer possible to dismiss China as merely an assembler of manufactured goods, “a place where the rest of the world essentially rents workers and workspace at deflated prices and distorted exchange rates” (Joffe 2009, 28; Lardy 2005). The quality of Chinese industry appears to improve at a far greater rate than in the United States, and China has moved into more advanced industrial and manufactured goods, particularly in energy for transportation systems. The fact that China has deployed an opera-

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tional high-speed rail system which, like hybrid car drivetrains, relies upon Chinese world dominance in rare earth elements is testament to Chinese industriousness and leading-edge research and development (Humphries 2010; Hurst 2010; US Government Accountability Office 2010; Osnos 2010; Simon and Cao 2009; Lohr 2011). In contrast, the United States has continued its decades-long process of investing small sums in pilot projects for electric cars or upgraded rail that is only potentially high speed on certain limited track segments. Furthermore, in 2009, China invested twice the amount of the United States in renewable energy technologies at $34.5 billion, including for electric batteries in autos and light trucks, where the Chinese are leading and expected to continue to do so (World Bank and PRTM 2011). Duke Energy’s Jim Rogers correctly observed, “The Chinese are important to work with because they are going to deploy faster, scale faster than we are in the United States” (Chipman 2010).

Stakeholder in or Challenger to the US System? The speed and scale of China’s ascent are challenging a United States accustomed to gradual inclusion of smaller and largely dependent great power subordinates (e.g., Britain, Japan). The key question of the twentyfirst century is whether the United States will peacefully accommodate a rising China and incorporate its legitimate resource needs and desire for prestige in the international system. If US officials adequately reflect on Britain’s reticence in accommodating the United States after World War I, they might avert the worst outcomes of great power rivalry by being even more accommodative of Chinese natural resource gains. Given oil’s centrality to material capabilities since World War I, the diplomacy surrounding oil resources and trade naturally emerges as the most salient arena for observing tendencies in US-China relations. China abandoned its export of crude oil in the 1970s and 1980s to become the second-largest oil importer since the mid-1990s, and now it is the Asian region’s largest oil products exporter because of its extensive construction of refining capacity (Petroleum Intelligence Weekly 2010). Despite China staying within the existing petrochemical order (e.g., little electric car development as yet), US policymakers have warily observed China’s decision to satisfy its growing oil needs through deals with regimes on the periphery of the US system. US officials seem genuinely unsure of how best to co-opt a rising China while also trying to get it to stay within the boundaries of the US-led hierarchy over the Middle East. In the most recent Bush administration, the tension in trying to achieve both of these objectives was too much, and Michael Green and Robert Zoellick, among others, asserted that China was practicing a modern form of “mercantilism,” choosing oil partners that “hurt China’s reputation and

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lead others to question its intentions” (Zoellick 2005, 10; Abdelal and Segal 2007; Sanger 2006). Amid all of China’s diverse and growing oil partners around the world, to US officials, the most troubling Chinese ties have been with Saudi Arabia and Iran. 9 In the aftermath of 9/11, the US Defense Department commissioned a report on growing Sino-Saudi ties amid the strained US-Saudi public relations of that moment. This report concluded ominously that “Saudi Arabia and China share common geopolitical and cultural interests, which should deepen along with economic ties. These include a desire to liberalize their economies without losing governmental control, support for a counterbalance to US dominance in global affairs, resistance to perceived US and UN ‘meddling’ in internal affairs and human rights criticisms” (Gracia Group 2002, 28). Fear of Sino-Saudi decoupling from US influence should have increased since this time as their partnership has only deepened. For example, Saudi oil exports to China grew from 229,000 barrels per day in 2002 to just over 1 million barrels per day in 2011 (Petroleum Intelligence Weekly 2012; Petroleum Intelligence Weekly 2007; Mouawad 2010). Instead, US officials now appear content to see Saudi Arabia’s ties to China as a surrogate source of leverage for the United States. This faith may be misplaced, as the strategic gains that are accruing to China are showing up in relations with Saudi Arabia that transcend the oil trade. For example, Saudi Arabia recently awarded the China Railway Construction Corporation the contract to build a high-speed rail line between Mecca and Medina (Meyer 2010; Petroleum Intelligence Weekly 2010). US firms can sell weapons to the Saudis but not high-speed rail systems because US firms do not yet have the natural resources, technology, and industrial capacity to develop and deploy such systems. The Chinese do, and they are using their commercial and soft-power leverage with Saudi Arabia to increase their gains with the Saudis and minimize Saudi capacity to coerce them successfully over Iran or any other issue area (e.g., Aramco as an investor in Chinese-based petrochemical refineries maintains longterm ties and possible Saudi subservience in the future). When the United States began to pressure Sino-Saudi ties in service of an effort to isolate and sanction Iran, the Saudis demurred from publicly chastising the Chinese into complying (International Oil Daily 2010). Instead, with Dennis Ross’s gentle encouragements, the Saudis have sought to appease China with more oil to draw better Chinese behavior against Iran. But the leverage lies with China in complying or frustrating US and Saudi interests (as it does with China over North Korea). The Saudis have increased their efforts at commercial integration and strategic appeasement of China, but only marginal reductions in Sino-Iranian ties have resulted. In fact, China’s crude oil imports from Iran in 2011 were 557,000bpd, up from the previous all-time peak in 2009 of 465,000bpd, and still twice the amount of 2002. More importantly, the Chinese have violated the spirit of the latest UN Security Council sanctions on Iran from July 2010, as they

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have shipped gasoline to Iran in many instances and are still in long-term energy development deals with Iran (Merolli 2011; Sampson 2010; Cala 2010; Energy Intelligence Finance 2010). The US response to this and impressive Chinese gains in other regions seems to border on peevish and only marginally self-aware weakness. For example, Secretary of State Hillary Clinton’s oft-cited musing, “How do you deal toughly with your banker?” seems mild in comparison to Assistant Secretary of State for African Affairs Johnnie Carson’s alleged comments. He recently observed: The United States does not consider China a military, security or intelligence threat. China is a very aggressive and pernicious economic competitor with no morals. China is not in Africa for altruistic reasons. China is in Africa for China primarily. . . . The United States will continue to push democracy and capitalism while Chinese authoritarian capitalism is politically challenging. The Chinese are dealing with the Mugabes and Bashirs of the world, which is a contrarian political model. (Blair 2010)

Conclusion: The Financial Crisis Clarifies and Reduces the Sino-US Rivalry There is assuredly an ongoing global contest of models at play between the United States and China. Believing that a US-led democratic-capitalist model will remain atop the world is, however, questionable at best (Deudney and Ikenberry 2009). As the United States haltingly supports deposing autocratic allies for democratic revolutions in North Africa and the Middle East, the soft-power attractiveness of China has grown in Kuwait and Saudi Arabia, among other energy-rich states. In the more material world, Chinese capabilities and energy security have increased since the financial crisis of 2008. In simple trade and finance areas, China is demonstrating the benefits of its constantly evolving export-led industrialization model and has managed to reduce its trade-partner reliance on the US market. As a result, the United States is even more limited going forward in potentially exercising trade leverage against China, as exports to the United States were only 25 percent of total Chinese exports in 2009, comprising about 6 percent of Chinese GDP. In 2003, Chinese exports to the United States were 11 percent of GDP, while in 2000, 35 percent of total Chinese exports came to the United States (China 2001; China Foreign Economic Statistical Yearbook 2001). Over the last year, Chinese holdings of US debt have decreased while China has also become the largest lender to the developing world, outpacing the World Bank itself in the last two years (Eddings 2011; Dyer 2011; Norris 2011). China’s sovereign wealth and accumulated capital have allowed it to take full advantage of the financial crisis by picking up distressed energy assets all around the world. In every region of the

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world, China has gained control of valuable oil assets during this Western economic downturn, finally convincing moderate analysts like Erica Downs that “there’s been a big change this year. . . . Clearly there has been a big push [to] continue investing” (Andrews-Speed 2011, 80; Nicholson 2011; Dent 2011; Cala 2010). Sinopec’s purchase of Brazilian and Gulf of Mexico assets from financially distressed Spanish energy company Repsol is a good example of intelligent opportunism. In the last two years, Chinese oil companies have acquired assets as diverse as shares in Canadian tar sands to significant rights to Angolan deep-sea exploration to the outright takeover of Addax Petroleum. The financial crisis has simply allowed those already gaining to gain even more. Chinese acquisitions in these traditional petrochemical businesses and the continued development of domestic refining capacity in deals with the major Middle Eastern national oil companies reinforce the precrisis conclusion of Exxon-Mobil CEO Rex Tillerson. In 2008, he noted, “For the foreseeable future—and in my horizon that is to the middle of the century—the world will continue to rely dominantly on hydrocarbons to fuel its economy.” Globally, investment in alternative energies has declined due to the financial crisis, while in the United States private investment in some alternatives has been fully abandoned in a few key potential rivals to oil, like biofuels (International Energy Agency 2010; Morales 2010; Herndon 2010; Odell 2004). Much heralded in the US press and occasionally from the bully pulpit, the only remaining player in biofuels is the US Navy, whose production demands are a pittance compared with traditional US military fuels purchases. For example, the US Navy has contracted for 8,000 barrels per year of biofuels capacity by 2012, but it currently uses 29 million barrels of oil per year (Jet Fuel Intelligence 2010a, 2010b). US military investments may provide a lifeline to this industry. Absent a large-scale federal government commitment, however, it appears doubtful that a thriving biofuels sector will displace Houston instead of being coopted by it. Prior US efforts at alternative fuels have come and gone, and there is little reason to expect different outcomes at this moment (e.g., President Carter’s Synthetic Fuels Corporation, President George W. Bush’s “freedom fuel” hydrogen vision, and the several cycles of electric car rollouts). In fact, higher oil prices have led to greater investment in Canadian tar sands than in fourth-generation biofuels (Statistics Canada 2011). The US oil majors have not lost wealth in the downturn and are recording their highest profits in years with scheduled investments that dwarf the outlays in alternative energies (Gold 2010). Any green transition away from petrochemical dominance is unlikely to come from within the United States. While it is true that the center of gravity for the world’s energy and economic system is shifting east, it is far too early to venture that China will lead a revolution against the US petrochemical-based system with its Middle Eastern oil core (Friedberg 2011; Beckley 2011/12). Instead, it is far

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more likely that the United States and China will continue to jockey for position, with the United States seeking to co-opt China as subordinate partner in the Middle East while China looks for opportunities to peel away oilrich lands from the US sphere, cooperating only when it must. US exhortation for responsible stakeholding by China will fall on deaf ears absent real incentives or coercion, which but for its omnipresent military the United States lacks. China must bide its time because it is militarily weaker than the United States, and it still relies on seaborne trade for 80 percent of its oil imports, just over 40 percent of its total consumption (Erickson and Collins 2010). Exxon-Mobil and the US military are only deepening their positions in Iraq and the Gulf states. They are not going to leave the Middle East anytime soon. As Gregory Gause noted, the retrenchment out of Iraq militarily was to Qatar, Kuwait, and Bahrain, not North America (Gause 2010, 249). The United States is actively seeking to increase the role of Exxon and others inside China’s petrochemical growth, and is using Iraq and Saudi Arabia to help bind China into supporting the US position. How long China will accept a junior role in a US-led Middle East is an open question, as is whether the United States will be invited to remain indefinitely astride the Persian Gulf with its military. One thing is certain: more open Chinese positions of defiance against plaintive US appeals are likely (e.g., Iranian sanctions), as are verbal rebuttals in defense of US prestige. Then secretary of defense Robert Gates foreshadowed this growing trend in early January 2011, when he stated, “I’ve watched this sort of cyclical view of American decline come around two or three times, perhaps most dramatically in the latter half of the 1970s. And my general line for those both at home and around the world who think the US is in decline—that history’s dustbin is filled with countries that underestimated the resilience of the United States” (Gates 2011). Despite former secretary Gates’s bravado, the United States is in relative industrial decline, and absent a will to alter this, China is well positioned to challenge the United States for dominance over the energy and industrial order (Uchitelle 2011; Gertner 2011). This process would accelerate if the United States loses ground in the Middle East or the world transitions off of oil without the United States. If oil remains the dominant energy source, and there are few indications that it will be displaced any time soon, then the United States is likely to retain its primacy in the world precisely because the oil world was built by US hegemonists after World War II and has been maintained by them ever since. Trying to hold this position has required ever more use of direct military force in the Middle East, with costs both to the environment and US autonomy. The US state has not adapted to these costs in any meaningful manner. The essential, and always quickly abandoned, question is: Could the United States lead an evolution off of oil? If the United States chose to revitalize the industrial base of transportation in an innovative way, it might stem the stagnation and rela-

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tive decline from excessive US debt and paper entrepreneurialism that subtracts from real growth. The United States, in fact, could prove it is the highly innovative and transformative country that its Alan Greenspan–type defenders say it is by actually developing oil-free conceptual ideas into industrial transportation products. This need has been self-evident since the early 1970s. The United States is actually less well positioned for any transformation than Japan, Germany, or China precisely because of its oil-based, path-dependent development. In refuting Adam Smith’s exhortation that the United States ought to remain a primary product and agricultural producer, Alexander Hamilton noted that “not only the wealth, but the independence and security of a Country, appear to be materially connected with the prosperity of manufactures” (Hamilton 1966, 291). The United States might challenge a rising China and a debilitated domestic frontier by manufacturing an autonomous energy and transportation infrastructure instead of warring over the world’s remaining oil reserves for positional maintenance in a bygone era. This possibility seems remote, as US manufacturing continues to decline, ending 2010 at a mere 11.7 percent of the US economy. In transportation, a great deal of public excitement surrounds the return of GM to profitability, the possibility of electric cars, and the end of the oil era. Only 1.2 percent of global sales in 2010 were hybrid or fully electric vehicles, however, and GM’s Volt production line stands idle at present due to insufficient demand and safety and quality concerns, while Chevron owns significant patents on electric battery alternatives to the oil-fired internal combustion engine (Harrop and Das 2011; Harrop 2011; Ramsey 2008). It is as plausible that China will use its dominance in rare earths, disregard for patents, and weaker military presence in the Middle East to build on its growing industrial and technological capabilities by developing a large-scale, fully electric transportation sector. Whatever paths the United States and China choose, the struggle over energy and industrial transportation among the oligarchic oil actors and leading industrial states will define order and rank in the twenty-first century.

Notes 1. For example, oil, autos, and other transportation machinery items are at least half of the value of world trade. See United Nations, International Merchandise Trade Statistics, Special Table F, Structure of World Exports by Commodity Classes and by Region for 2007, available at http://comtrade.un.org/pb/SpecialTables. aspx?y=2007. 2. See the Federal Reserve Z table US debt aggregates, which leave out the internal federal government debts (e.g., $5 trillion in Social Security and Medicare trust fund IOUs), while also underestimating private and household debt that goes unaccounted (data available at http://www.federalreserve.gov/releases

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/z1/Current/z1r-2.pdf). Hence, outside consultancies often come up with larger figures. Even before the large debt run-up since 2009, McKinsey Global Institute (McKinsey Consulting Group 2010) calculated the US debt-to-GDP ratio for 2008 at 290 percent. 3. In contrast, Daniel Yergin argues that the United States is “twice as energy efficient as it was in the 1970s” (2009, 94). Per capita oil use in the United States is basically unchanged since the early 1980s. Yergin runs this data point against debtinflated GDP merely to obfuscate an essential truth (DeGolyer 2006). 4. See US Department of Commerce, Bureau of Economic Analysis, Industry Economic Accounts, available at http://www.bea.gov/industry/ gpotables/gpo_action.cfm; United Nations Conference on Trade and Development 2010. 5. See Hu Jintao’s written comments in “China’s Hu Jintao Answers Questions with Washington Post” (Washington Post 2011). President Hu’s sentiment is in the popular zeitgeist, particularly among economists. Simon Johnson of MIT recently opined, “The age of American predominance is over. The yuan will be the world’s reserve currency within two decades” (Felsenthal 2011). For the opposite view, noting continued dollar dominance, see Eichengreen 2011. 6. See People’s Republic of China, General Administration of Customs, China’s Customs Statistics (various years), summaries available at http://www.uschina.org /statistics/tradetable.html. Oil is the largest Chinese import, and these oil shares as a percentage of total Chinese imports are up dramatically from the mid-1990s. For example, Chinese oil imports were only 4.3 percent of total imports in 1996 (Wang 1999). For the United States, oil imports are by far the largest traded item (at least 20 percent of annual imports) and comprise anywhere from 50 to 67 percent of the total annual trade deficits in recent years. US data available at http://www.census.gov/foreign-trade/statistics/graphs/PetroleumImports.html. 7. It is vital to recall that Middle Eastern oil was set up in the mid-1950s to flow to Western Europe and Asia, not the United States. For example, Saudi Arabia, Iran, and Iraq exported as much or more oil to Japan than to the United States in the peak era of the Middle Eastern import share into the United States, from 1955 to 1958. This was the case even before formal US import quotas in 1959, which drastically limited US oil imports from the region (United Nations 1960). 8. Many political scientists accept the public rationale for US military presence in the Middle East in terms of open access to the region’s oil and merely lament the irrational nature of this rationale because “markets” would adjust if the US military simply withdrew (Gholz and Press 2010; Preble 2009; Layne 2006). 9. For generally benign views of Chinese oil diplomacy gains, see Downs 2009; Houser 2008; and Lai 2007. Michael Klare (2004), Aaron Friedberg (2011), and Gal Luft (2009) view Sino-American oil-based conflict as more likely.

8 Can the Euro Rival the US Dollar? Hubert Zimmermann

Since at least the end of World War II, the US dollar has been the world’s leading international currency. This role encompasses, among others, its use as a reserve instrument in almost all other countries, an anchor for a substantial number of other currencies, or a medium in which the major commodities of world trade are priced. Controversy has existed for decades as to how much the United States benefits from this status of its currency. Some US commentators even argue that such a distinction is actually a burden.1 Despite this ambiguity, few would doubt that the international role of the dollar is closely connected to the status of the United States as the preeminent superpower. Dollar dominance remains one of the fundamental facts of the global political economy. Yet in the past decade, many experts have observed that since the introduction of the euro, the monetary world is moving toward a more bipolar system (Cohen 2009; Eichengreen and Flandreau 2008; Goldberg 2010; Norllof 2009). A continuously expanding body of work tries to quantify the reach of global currencies and to assess how far the euro has come in terms of replacing the dollar.2 Predictions diverge, though most agree that the euro is still a distant second.3 Even if the euro never rivals the greenback, it has led to a novel situation: for the first time in half a century, a credible alternative exists to the US currency. This fact alone dramatically alters the options and incentives available to official and private financial actors. International political economy (IPE) scholars are only beginning to understand the political and economic consequences of such an emerging currency duopoly. The financial crisis allows a first tentative assessment. To this end, I first summarize the ups and downs of the dollar and the euro during the crisis, noting that not much has changed with respect to the overall balance of power in the international monetary system. However, the crisis has underlined the advantages of owning international currencies. I identify three recent research strands that help to specify these advantages. Based on these advances, I assess how the internationalization of the euro

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influenced the reaction of the eurozone to the crisis. I argue that, in contrast to the United States, which heavily profits from cheap credit, the most important effect of the international role of the euro continues to be the autonomy to pursue stability-oriented policies. However, as a result of the sovereign debt crisis, the eurozone also begins to capitalize on easier access to cheaper credit facilitated by the international role of its currency.

Has the Crisis Undermined the Dollar’s and the Euro’s Role as International Currencies? To many observers, the subprime mortgage crisis initially appeared to herald the end of the dollar as the undisputed global currency leader (Munchau 2008; Eichengreen 2009b). The enormous accumulation of dollars in the international system since the late 1990s was seen as one of the core drivers of the global capital glut that fed the speculative excesses of the precrisis decade. Was now the time when the chickens finally came home to roost and US profligacy would result in a collapse of the dollar’s value? Such speculation was compounded by the huge expansionary program of the US government, which was deemed necessary to counter the effects of the meltdown. Many believed that in conjunction with inflation or a long-lasting recession—or both—this scenario would undermine confidence in the dollar. In addition, Wall Street’s role as the center of global finance, which had made investments in dollars so easy and attractive, seemed to have taken a massive hit. Dollar pessimists, however, were soon silenced by the greenback’s continuing role as safe-haven currency while the crisis kept rolling along. Even more importantly, the euro, as the only credible contender to the dollar, soon descended into spectacular troubles when the Greek predicament alerted markets to the serious sovereign debt problems of many eurozone economies. Suddenly it seemed that rather than any advancement toward global preeminence, the European currency’s survival was at stake (Garnham 2010). Rumors spread on how official and private investors were unloading their holdings of euros. Despite all this, the financial crisis has not fundamentally reshaped the monetary system. There is still no serious contender for the dollar and the euro. The ECB’s recent report, “The International Role of the Euro” (2010) confirms that on all indicators the dominant positions of the dollar and the euro have not been affected substantially. The ECB concluded that shifts in global currency use obviously happen only at an extremely slow pace and that the inertia in the system is strong enough to mitigate the effects of the crisis (ECB 2010). Asymmetric monetary bipolarity therefore continues to be the fundamental structure of the international monetary system, which raises the interesting question: What are the advantages and disadvantages of having a

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global currency, and how has the crisis underlined these effects? Obviously, a crisis of this magnitude provides an ideal real-time experiment in this respect. Such macroeconomic shocks can lead to enormous losses of wealth, and the question of distributing these losses across countries is among the core issues of the global political economy. Recent research can help us clarify where to look when one tries to identify the not easily observable benefits and drawbacks of international currencies.

Recent Research on the Distributive and Political Benefits of Global Currencies The fluctuations in the presumed global importance of the dollar and the euro are among the most closely watched phenomena in the global economy, including not only the world’s most important exchange rate, but also the ups and downs in the various functions and uses of global currencies. In most op-ed articles, blogs, and many more general texts touching upon the issue of the euro’s future as global currency, it is simply assumed that a national currency that takes on an international role enhances the power of the issuing country. Many political scientists, following the footsteps of Susan Strange, assume that the dollar has been and still is an indispensable bedrock of US global influence by giving it enormous structural power—in particular, the power to create credit (Strange 1988). A large number of critical analyses argue that a dollar–Wall Street regime dominates the global economy, perpetuating US hegemony (Gowan 1999). The same assumption is made with respect to the rise of the euro: “The euro gives European policy makers both global influence and responsibilities which, prior to its introduction, were the preserve of the United States” (Thom 2000, 179). However, substantiating in what sense the possession of a global currency actually bestows power on the issuing country is not so easy. Many voices indicate that the supposed exorbitant privilege might actually be a “burden” in some respects (Bergsten 2008). Countries including Germany and Japan have successfully tried to stop an expansion of the role of their currencies, and the ECB in its public statements has made clear that the internationalization of the euro is a process that is not necessarily as desirable, although the ECB would not actively resist it. The advantages of international currencies are not as straightforward as the phrase “dollar hegemony” suggests. In recent years, however, a lot of new research has moved beyond rather unspecified assertions of monetary power. This work allows a much better appreciation of the political and economic consequences of shifts in global currency patterns. Three different strands of this research can be identified. A first group of analyses, often pursued by economists and frequently sponsored by official financial institutions, looks at the different functions of global currencies; assesses quantitative changes, using

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them as indicators for global currency usage; and sometimes tries to calculate the consequences of these changes in terms of financial gains or losses. A second research focus, pioneered by US and European IPE scholars, concentrates on the political consequences of monetary power and stresses above all the political leverage gained by possessing a global currency. A third and still very recent research area involves the attempt to disaggregate the political and economic consequences and to look at how different groups within currency areas that owe a global currency or that are affected by global currencies profit or lose from the effects of monetary power. The argument here is that an international currency conveys advantages to specific groups, and these groups are not the same in every country or currency area. Instead they reflect the respective varieties of capitalism. This chapter briefly summarizes these three research strands, laying out in what sense they identify the advantages of global currencies and assess how the financial crisis has substantiated or disproved these claims.

What Are the Economic Gains from Having an International Currency? Conventional analyses of global currencies distinguish among several functions that the currencies fulfill. Figure 8.1 provides a standard classification of these functions, which basically identify the purposes for which actors use these currencies. Only a currency that market participants use to a significant extent for one of these functions can be called truly international. The dollar and the euro are the only currencies of major importance in each of these areas. The factor quoted most often in serious assessments of shifts in global currency usage is share of currencies in total official reserves.4 According to the IMF, the dollar share shrank from 71.5 percent in 2001 to 64 percent in 2008. The share of the euro meanwhile rose from 19.2 percent to 26.5 percent, though in the past few years this trend has slowed down almost to zero, despite a gigantic growth of global reserves (IMF 2009b).5 The most recent preliminary data from the IMF COFER database suggest that in the first quarter of 2012 the dollar’s share has declined to 60.7 percent, whereas the euro share has stagnated at 26.3 percent.6 This confirms that the crisis has not led to large-scale shifts. What are the associated advantages of this function? On a purely economic level, the importance of the indicator of reserve composition lies in the notion of seigniorage. As other nations and their citizens hold the global currency at no or low interest, they effectively extend a loan to the issuing country. However, in terms of global financial power this effect is generally assumed to be relatively small (Kenen 2003); estimated figures are on the

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order of 0.05 percent GDP (Bini-Smaghi 2009). A more important facet of the seigniorage effect is that the country issuing the dominant currency also benefits from a liquidity premium (Portes and Rey 1998). High demand for the bonds of this country due to accumulation by foreign entities reduces the real yield that has to be paid to investors. The country thus benefits from cheaper borrowing costs. Estimating the corresponding gain is hard. Under a scenario in which most investments switch from dollar to euro, the premium might amount to 0.5 percent of GDP for the eurozone (Papaioannou and Portes 2008, 23). Breuss, Roeger, and in ‘t Veld (2008), who model a shift in global reserve composition toward equality between dollars and euros, arrive at similar figures, derived from a lowering of real interest rates as a consequence of higher demand. But these figures are highly speculative and depend on the substitutability of assets. Overall, the direct wealth effect of seigniorage is limited. The high symbolic value of the indicator of reserve composition also has political effects since changes might send a powerful signal to the markets. States that reduce the share of certain currencies in the composition of their reserves signal mistrust and thus may drive up the interest that the states issuing these currencies will have to pay on their bonds. This issue became important during the second stage of the financial crisis, the sovereign debt crisis, as we shall see later. The use of the euro as vehicle currency is concentrated in the regional proximity of the Economic and Monetary Union (EMU) (Papaioannou and Portes 2008). This condition did not change during the crisis (ECB 2010). The dollar thus remains the world’s leading vehicle currency, being part of 85 percent (out of 200 percent because two currencies are involved) of

Figure 8.1. Functions of International Currencies

Function of Money

Official Use

Private Use

Store of Value

Official currency reserves (reserve currency role)

Deposits, loans, and bonds denominated in international currency

Medium of Exchange

Vehicle currency for foreign exchange intervention

Vehicle currency in foreign exchange markets

Unit of Account

Anchor currency

Invoicing or quotation currency for trade and financial transactions

Source: Adapted from Cohen 1971; Kenen 1983; Galati and Wooldridge 2006.

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global foreign exchange transactions in 2007, whereas the euro share is 39 percent (BIS 2010). These most recent figures of the BIS suggest a small decline for the dollar and an equally small rise for the euro over the past three years. The principal advantage accruing to global vehicle currencies is the lower exchange rate risk for companies located in the core country. Though hard to quantify, this benefit can be considerable, particularly at times of volatile exchange rates. Export-dependent countries, such as most members of the eurozone, are particularly interested in a stable trading environment. Through currency hedging and outsourcing, however, firms can limit these risks, and they do so to an ever-growing extent. Additionally, countries with global currencies tend to generate most of their wealth in their huge domestic markets. Related to this role is the so-called exorbitant privilege of financing deficits with liabilities denominated in the home currency (De Beaufort Wijnholds and McKay 2007). This phrase has been employed to mean quite a lot of different things. French politicians in the 1960s claimed that an overvalued dollar helped US businesses to buy European industries at a discount. Critics of US global policy use it to claim that the United States is able to finance its global strategies with cheap credit without ever having to fear bankruptcy. The impression is that international investors just throw valuable money at the United States, which the US then uses for consumption or global expansion. Of course, though, this money is invested in Treasury bonds that mature and pay interest. A more precise and nuanced meaning of the exorbitant privilege is that the United States all through the postwar period was able to borrow short and lend long, continuously earning a higher income on its liabilities abroad than foreigners earned on their generally low-yielding dollar assets. Gourinchas and Rey (2005) demonstrated in a well-known paper how, even when US liabilities exceeded its assets by a considerable margin, the US recorded a substantial net income. Basically, the United States is at the center of a system of global arbitrage: it issues safe, low-yield liabilities, mainly Treasury bonds, to risk-averse investors across the globe and invests these funds in riskier assets abroad that provide a higher return (Schwartz 2009). Habib (2010) shows that one-third of this higher return is due to the yield differential7 and two-thirds to capital gains.8 The eurozone does not benefit from such an exorbitant privilege, reflecting the high risk premium some eurozone countries have to pay. However, the negative yield differential that existed prior to the EMU has vanished (Habib 2009). Whether the higher return is due to the dollar’s international role is not entirely clear. Perhaps the US variety of capitalism privileges high-risk short-term strategies, whereas savers in most foreign societies prefer safe long-term assets. A December 2009 study by the McKinsey Global Institute (McKinsey Consulting Group 2009) found that the net benefit of the exorbitant privilege to the United States in 2007–2008 might have been 0.3 to 0.5

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percent of US GDP (between about $40 billion and $70 billion)—not enough to make preserving this privilege a policy-relevant consideration of US decisionmakers. However, the capacity of international currencies to attract investors who are risk-averse and therefore willing to receive a low interest rate on their investments is undeniably a major advantage. Bonds issued in truly international currencies rarely face a buyer’s strike. Most of the figures reported above boil down to one observation: Issuers of international currencies have easier access to credit, and all other things equal, they get it cheaper than others. In a recent paper, Papaioannou and Portes (2007) argued that the anchor currency role (unit of account) in the end determines the other indicators. Currency pegs are a potent incentive for a country to hold reserves in the currency to which it is pegged. Available data suggest that the role of the euro as anchor is growing, though it is still mostly confined to areas in geographic proximity (Galati and Wooldridge 2006). The policies of anchor currencies obviously have a huge impact on countries that peg their own currencies to them. The financial crisis has underlined this relationship. A vivid example is the Danish experience after Lehman. When the ECB loosened monetary policy and flooded the markets with liquidity, the Danes had to raise interest rates to defend their currency (Eichengreen 2009b). They also had to approach the ECB for a currency swap. Another example occurred in Switzerland. The Swiss franc became a safe-haven currency during the Greek crisis. Its rise threatened Swiss exporters, who are overwhelmingly dependent on European markets. The effort to limit the appreciation of the franc cost the Swiss national bank enormous sums (Ewing 2010). Switzerland had to adjust to the crisis of the euro and lost part of the autonomy to tailor its monetary policy to domestic objectives.

What Are the Political Gains? The Notion of Autonomy A pathbreaking recent volume on monetary power edited by David Andrews (2006a) introduced exactly this notion of policy autonomy as the fundamental base of monetary power. On a systemic level this entails autonomy in policy choices—the pursuit of fundamental preferences of states, their leaders, and their societies without constraints deriving from exchange rate considerations, currency crises, imported inflation, and so on. On a subsystemic level, autonomy entails the avoidance of costs for domestic groups and the autonomy to choose economic strategies for state actors. In the same volume, B. Cohen defined the essence of monetary power as “the relative capacity to avoid the burden of payments adjustment, making others pay instead” (2006, 50). The ultimate measure of monetary power is therefore to be able to pursue one’s goals without regard to the effects on others (influence, Cohen’s second dimension of power, ultimately derives from autono-

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my). Potential adjustment costs fall on other participants, since opting out of the monetary system is impossible for practically all market participants. The one red thread running through any analysis of US monetary policy since the ascendancy of the dollar is US unwillingness to subject domestic economic strategies to movements on global currency markets, and more importantly, its capacity to do so. There have been exceptions, notably during the 1960s when, for reasons related to the cohesion of Cold War alliances, the United States implemented various restrictions on its international monetary transactions, negotiated deals with allies, and participated in a series of international mechanisms, all designed to bolster the dollar (Zimmermann 2002). The United States was also somewhat constrained by the existence of gold as an alternative reserve asset, at least until 1973. Essentially, however, the United States didn’t have to adjust—most notably, of course—to the massive current account deficits of the past decades. Nixon’s secretary of the Treasury, John Connelly, was certainly not a great economic thinker, but he captured this fundamental truth very well in his famous quip to a group of Europeans: “The dollar is our currency, but your problem.” In words that created a huge buzz in the blogosphere, a high Chinese official pronounced the same thought some years ago: “Once you start issuing $1–$2 trillion [of US government bonds] . . . we know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do” (Sender 2009). The capacity of the United States to spend its way out of the crisis by creating massive amounts of additional debt at low yields is part of this autonomy (Vermeiren 2010). With its integrating markets, which necessitate a high level of exchange-rate stability, Europe suffered particularly from the autonomous choices of US monetary policymakers. Frequently, the very survival of European cooperation seemed at stake when supposedly strong currencies appreciated against the dollar and weak currencies came under pressure. Attempts by the Europeans to coordinate their currencies through schemes such as the snake of the early 1970s or the EMS, created in 1978, regularly led to currency crises and wild recriminations among those European countries that felt they had to bear the cost of adjustment. Geopolitical events, such as the fall of the Berlin wall, had similar repercussions. The 1992 crisis of the European Exchange Rate Mechanism that had followed the EMS is a vivid illustration (Marsh 2009). Acrimonious struggles erupted between the countries of the Common Market about the distribution of adjustment costs and the consequences of current alignments for European producers (Zimmermann 2008). Isolation from the effects of dollar fluctuations was a major reason for creating the EMU. Doubtlessly, the introduction of the euro has made the eurozone much more autonomous in this sense. Exchange rate fluctuations such as the fall of the dollar since early 2002 would have led to incessant asymmetric

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adjustment pressure on European currencies in earlier times, whereas in the current situation Europe has suffered remarkably little impact, apart from some losses on exports to the dollar area. The eurozone was also able to set its interest rates independently even when the Federal Reserve slashed its rates massively and embarked on quantitative easing as a response to the subprime disaster. Just as the United States was able to pursue a major objective—that is, to ascertain a continuous inflow of capital without inflation or other adjustment pressures—the eurozone has been able to pursue its preferences: most importantly, price stability and reduced exchange-rate volatility. The concept of preferences introduces a new layer and leads us to the third strand of research, which asks, Who sets these preferences? Talking about US or eurozone preferences aggregates a huge diversity of policy objectives and obscures important internal differences of opinion.

Differential Accumulation as a Consequence of International Currencies: Who Gains? Herman Schwartz’s 2009 volume Subprime Nation on the origins of the financial crisis offers an alternative account of the advantages of having a reserve currency. He focuses on the wealth effect and claims that the global role of the dollar permitted differential accumulation, allowing the United States to grow quicker than its competitors (Schwartz 2009). He shows how foreign lending to the United States kept interest rates in the US economy low, feeding a housing boom in a market that permitted easy refinancing. Expanding homeownership was one of the core domestic economic goals of the Clinton and G. W. Bush administrations, substituting for the lack of an effective welfare state (Kapner 2010). This policy led to a prolonged Keynesian stimulus, pushing US growth rates above those of most OECD countries, and consequentially bolstering the global role of the dollar. This global role in turn gave the United States access to abundant and cheap capital, permitting a system of global arbitrage that benefited internationally mobile US investors. According to Schwartz, most eurozone countries do not have the flexible market structures allowing them to profit from cheap credit as a result of having a global currency. However, the eurozone is likely not so keen on this attribute. More demand for a global currency can drive up the exchange rate, threatening exporters. In addition, it is very likely that the ECB would probably regard an abundance of cheap credit as an eminent inflationary threat. Uncontrollable currency holdings by foreigners can make the control of the money supply difficult, especially in the case of sudden swings in market sentiment. Some telling episodes show that eurozone authorities are very alert to this danger. In 2006 the government of Montenegro decided to unilaterally

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adapt the euro without worrying about whether its economy actually fulfilled the EMU convergence criteria. EU representatives, while not actively trying to discourage Montenegro, clearly expressed their disapproval (International Herald Tribune 2007). When the Icelandic krona collapsed in the wake of the global financial crisis in 2007–2008, Iceland began to contemplate the idea of a euro-ization of its economy. Both the ECB and EU institutions reacted very negatively, to the point of threatening sanctions (SZ 2008). In fact, if the ECB had to tighten its policy in response to external influences, this might create enormous strains in some eurozone countries (Tilford 2006). Given the economic weight of these potential “euroizers,” their potential to disrupt the eurozone is limited, similar to the minuscule impact of dollarizing countries on US monetary policy (Cohen 2002). It is interesting, therefore, that the United States has reacted neutrally to dollarization (Helleiner 2003), while the eurozone has been quite explicit in its resistance. The autonomy to control the money supply clearly emerges as the key preference of the eurozone, at least as long as the ECB dominates external decisionmaking. A look at the sources of monetary preferences shows that different groups in different countries might have contrasting ideas about the advantages and disadvantages of global currencies. The well-known Bretton Woods II argument also stresses the influence of export industries in emerging economies, leading these countries to prefer undervalued currencies and to neutralize trade surpluses by accumulating foreign exchange reserves (Dooley, Folkerts-Gerber, and Landau 2003). How a global monetary power perceives or uses the advantages (and disadvantages) conveyed by its currency depends on whether the dominant societal preference is served. The United States uses its structural power to get cheap credit, the eurozone to preserve monetary stability—at least officially. Why this difference? This question obviously requires an extended analysis of the social purpose of market structuring in various countries. A look at the respective savings rates offers one good indicator of where to look (see Figure 8.2). Figure 8.2 suggests that the preferences of savers in aging and riskaverse European societies play a much bigger role than in the United States or the United Kingdom. Effects of international currencies that threaten these preferences will meet the resistance of eurozone authorities. The dynamics of savers and investors is a core determinant of the future of international currencies. Policies regarding the internationalization of the euro and the dollar reflect this. But preferences are not fixed forever: particularly during major upheavals, they might shift. In addition, the eurozone is a rather internally divided actor. Countries with excess savings and structural current account surpluses such as Germany coexist with deficit countries with low savings rates. The financial crisis shows that the eurozone—reluctantly—had to dilute its dominant social purpose: monetary stability. The

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Figure 8.2. Gross Household Saving Rates in the Four Largest EU Economies, the European Union, and the United States, 1995–2007 25

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sovereign bond crisis resuscitated the other great privilege of reserve currencies: borrowing more cheaply than others.

How Has the Euro as International Currency Helped Europe During the Financial Crisis? As stated at the outset, the financial crisis has not led to significant shifts in the relative importance of global currencies. Little research has yet taken place into how the fact that they were located in currency areas with internationalized currencies helped or damaged financial institutions in the United States and Europe. For sure, institutions outside the dollar area and the eurozone were faced with serious exchange-rate risk as these currencies became safe havens (as the Eastern European example showed). But the eurozone emerged not unscathed. A recent BIS study seems to point to privileges of US banks vis-à-vis their European counterparts. McGuire and von Peter (2009) show how large net US dollar positions by European banks prior to the crisis exposed these banks to serious funding risks once liquidity dried up after Lehman. European banks built up these positions to finance the expansion of their investment bank activities (McGuire and von Peter 2009). Only rapid agreements on unlimited swap lines between the Fed and the ECB helped to overcome the dollar shortage. This episode indicates the dollar’s continued dominance as a safe asset and the additional risk that foreign institutions face during situations of stress (Kaminski 2009). The dollar shortage was overcome quite quickly by the unprecedented expansion of liquidity in the system. More serious was the ensuing sovereign debt crisis, which demonstrated that the capacity to raise funds and

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sustain debts is a core component of currency power (Helleiner 2006). The major US weapon against the crisis was sharply increased government spending, raising public debt levels to enormous heights. Despite that, riskaverse markets continued to accumulate US bonds. The experience of the past years suggests that the eurozone is starting to benefit from a similar privilege. Bolstered by the credibility of the euro, many members of the eurozone embarked on a credit-fueled expansion, which came to a screeching halt when liquidity dried up in Western economies and massive bailouts inflated the debt of most OECD countries. The euro had permitted the weaker members to ride on the coattails of stronger nations, as it compressed yield differentials between weaker and stronger countries. The risk premium that certain countries had to offer to the markets to sell their debt decreased rapidly once these countries were about to or had become eurozone members. Figure 8.3 shows the yield of Greek government bonds since 1998. The country entered the euro in January 2001. With the increasing likelihood of its eventual entry, Greek yields declined significantly prior to that date and continued to do so until the end of 2005. Afterward they rose slowly, but not dramatically until the eruption of the Greek sovereign debt crisis in 2010. The trajectory was basically stable. Between 2000 and June 2008, when the financial crisis began, inflation-adjusted annual GDP growth was about 1 percent, which was hardly enough to inspire confidence. Nonetheless, Greece enjoyed a long period of cheap credit. A similar logic is at work in the case of Italy. In May 1998, the decision was made on which eleven nations would be the original members of the

Figure 8.3. Yield Curve, 10-Year Greek Government Bonds

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eurozone, after a long period of uncertainty about whether Italy would make it. Borrowing costs briefly rose after the decision to admit Italy, but thereafter they remained at a fairly low and stable level, even during the crisis. GDP growth between 1998 and mid-2008 was a paltry 0.33 percent per year. Participation in the euro significantly depresses the yield that has to be paid on sovereign debt (Hallerberg and Wolff 2008). Compare this with the data for Hungary, which is not a member of the eurozone. The Hungarian graph (see Figure 8.4) shows a significantly higher volatility, despite an average annual GDP growth from January 1999 to June 2008 of almost 4 percent. That is, the Hungarian economy performed much better than the Greek or Italian economy. Nonetheless, it had to offer a significantly higher risk premium. Once the crisis struck, Hungary experienced the massive drawbacks of not being part of an international currency. The attractive rates offered by the euro had led many Hungarians to borrow in euros. The depreciation of the Hungarian forint against the euro during the crisis proved disastrous for many borrowers (Bohle 2010). As painful as the debt crisis was for Greece, at least it did not suffer from the crippling effects of currency volatility with its major markets. Greece and other countries would probably have had even more difficulties with borrowing if they were confronted with the crisis on their own (Oakley 2010). Greece had to pay more than 20 percent on its bonds in the early 1990s. What has widened during the crisis is the spread to Germany, which benefits from record lows in the yields on its bonds—a typical effect of the safe-haven status of an international currency. Due to the existence of the European Financial Stability Facility, however, Greece does not have to tap

Figure 8.4. Yield Curve, 10-Year Hungarian Government Bonds

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the markets for the duration of the program (Cottarelli et al. 2010). For sure, Greece has lost the option of devaluation to restore its competitiveness, yet this option has its drawbacks, since it delays necessary adjustment measures and perpetuates grave inefficiencies. Furthermore, devaluation is fundamentally incompatible with adherence to the Common Market. It is debatable whether devaluation would indeed have made life easier for Greece. Adherence to the eurozone and to an international currency carries further advantages. Even in a situation of extreme market distrust, Greece was able to tap more resources than other countries in less serious situations. During a July 2010 state visit of German Chancellor Angela Merkel to China, the Chinese premier confirmed that Europe would remain one of the main investment markets for China’s huge surplus. Just prior to the visit, the Chinese had bought several million euros of Spanish bonds (Dyer 2010). China had also invested in Greece at moments of direst need. Such moves were essential to restore faith in Europe’s public debt, and they considerably reduced the yield that European governments had to pay. Many have interpreted China’s surprising interventions as a political ploy, for example, to get access to Greek ports. In a column in the Financial Times, Gillian Tett maintained that the European U-turn on the issue of stress tests for their banks was due to pressure from official and private Asian investors who threatened to stop their accumulation of European bonds (Tett 2010a). Despite US pressure, the eurozone had refused to submit their banks to the rigorous stress tests, which had been employed so successfully by the US in 2009. After a G-20 meeting in Busan, South Korea, in June 2010, they had a change of heart, supposedly because of Asian interventions. But the Chinese also have few alternatives, given the dollar’s longstanding problems. In fact, most surplus nations had continued to invest in the bonds of eurozone countries (Shellock 2010). One Japanese government official was quoted by Reuters as saying: “Even if the dollar or the euro is in trouble, is there anywhere else to invest? Not really. There needs to be a certain degree of liquidity. Currencies of countries with capital controls won’t work, too. That leaves us with very few options” (Kihara and da Costa 2010). The continued accumulation of euro bonds throughout the crisis shows that the currency had maintained its safe-haven status. The crisis thus demonstrates that the eurozone can already capitalize on one of the major advantages of international currencies: access to credit despite unfavorable economic circumstances. The eurozone faces one essential weakness, however. There is no euro bond. Investors can choose among the bonds of different governments— some of them risky, some considered ultra-safe, some of them offering a high return, some a very low one. Excellent opportunities for speculation are available. The currency crises of former decades have now morphed into sovereign bond crises, and the absence of a euro bond has long been considered an essential weakness: “Only when a homogeneous debt instrument

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with a euro-wide market comes into existence, when it is backed by the full faith and credit of euro area governments as a group, and only when it is backstopped by the ECB will the euro be in a position to seriously rival the dollar as a reserve currency” (Eichengreen 2009a). A euro bond would signal to markets that there is a near-zero default risk. As does the United States, eurozone members could profit systematically from cheaper credit. The creators of the eurozone have shunned this essential attribute of global currencies because of its inflationary implications. Yet confronted with the Greek disaster, the eurozone seems to face a choice between creating a euro bond (or its functional equivalent) and breaking up. When the ECB announced its decision to buy up the debt of member countries, it effectively gave a guarantee (albeit silent) on the bonds of weaker eurozone members. The €750 billion EU/IMF financial aid package of May 2010 had a similar effect. Significantly, auction of Spanish and Greek government bonds met with success in the months after this pledge. The Greek crisis thus may introduce a euro bond through the back door. The debates in 2011 about a second and third Greek rescue package increasingly moved toward the realization that only a common debt instrument can stop the markets from repeatedly testing the resolve of European decisionmakers 9 —despite the resistance of stability-oriented eurozone members, especially Germany. Does this mean that Germany and other stability-oriented economies are now the losers in the eurozone? Not necessarily. Inside the eurozone, Germany has benefited from the stabilization of its trade environment and a prolonged boost to its manufacturing sector. In addition, Germany gained investment opportunities for its surplus savings. While it may have to compromise its traditional inflationary stance, Germany currently benefits from a similar privilege as the United States: the yield it has to pay on its bonds has never been as low. A euro bond would probably lead to a higher interest rate for German debt. However, should the euro then solidify its potential as international currency, rates should go down again.

Conclusion The financial crisis demonstrated the many faces of monetary power. It has been argued that the question of monetary power resides in its link with societal preferences, in particular the dominant preference. Certain groups, such as savers, are advantaged under the current philosophy and institutional biases of the eurozone. Those who designed the eurozone and are influential enough to resist changes also profit from the international role of the euro, as it lends them the means to push through their preferences without interference from abroad. The financial crisis made clear, however, that when push comes to shove, even the ECB feels compelled to abuse the

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hegemonic privilege of cheap credit creation—a privilege of international currencies that French proponents of a common currency had craved for a long time. The global role of the euro has helped the eurozone to weather the financial crisis.

Notes 1. Kirshner (2008) briefly reviews the debate; see also Bergsten (1996). 2. For recent assessments, see European Central Bank 2010; Goldberg 2010. 3. Helleiner and Kirshner (2009) offer a range of opinions. 4. Countries hold foreign exchange reserve to finance international transactions, to insure against currency crises, or simply to neutralize trade surpluses. Currently, China holds the largest reserves, a whopping $2.5 trillion, followed by Japan with $1 trillion (July 2010). 5. One might argue that much of the rise of the euro in official reserves is due to the effects of the dollar’s fall over the past few years and thus is purely temporary, but that presupposes some hypothetical fixed value for a currency—which makes little sense. A major problem of this indicator is, however, that the IMF data on which it is based are very incomplete since many official reserve holders treat the composition of their reserves as confidential. About 63 percent of all official reserves are reported. 6. See http://www.imf.org/external/np/sta/cofer/eng/cofer.pdf. 7. The yield differential benefiting the United States results from other countries having to pay a higher risk premium on their bonds. 8. Capital gains abroad are increases in the value of a capital asset, such as investment in foreign bonds, equity, or real estate. The gain is not realized until the asset is sold. 9. Pros and cons of euro bonds as well as a summary of different proposals can be found in Guillermo 2011 at www.europarl.europa.eu/activities/committees /studies.do?language=EN.

PART 3

Critical Views of the Crisis

9 The Crisis of Home-Centered Consumer Capitalism in the United States Maria N. Ivanova Since the summer of 2007, US capitalism has grappled with a subprime mortgage crisis, a credit crunch, a financial crisis, a housing crisis, and ultimately a generalized economic crisis—a great recession according to some, a very great depression according to others. This spectacular avalanche of crises was triggered by the burst of two formidable, mutually reinforcing bubbles—the biggest housing bubble in US history and the Great Consumption bubble whose underlying asset—the home-centered American Dream—inflated out of proportion relative to both the historical trend and the so-called economic fundamentals. The great recession was officially declared over as of June 2009. Paradoxically, the end of the housing crisis is not yet in sight, while unemployment seems to have reached a permanently high plateau. In light of these dire realities, one might reasonably ask: Are we truly seeing a recovery or merely a crisis of a different kind? Starting with an inquiry into the socio-material foundations of homecentered consumer capitalism as it emerged under Fordism and evolved under neoliberalism, this chapter examines the deepening crisis of this model and highlights the unfavorable odds for its survival.

Toward a Home-Centered Consumer Capitalism At the turn of the twentieth century, emerging monopoly capitalism struggled to cope with a serious profitability crisis as a range of capital-intensive industries—from steel to synthetic chemistry—were confronted with capitalism’s enduring nemesis: the rising organic composition of capital and the resultant decline in the rate of profit. The problem announced itself as a rise in the overhead costs; the growing share of fixed costs in the total cost structure meant that any reduction in output would lead to a dramatic increase in unit costs. Consequently, maintaining high production and sales volumes became an imperative that encouraged a massive effort by the biggest industrial players to obtain control of market movements. In the case of the United States— 165

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still a debtor country, but already an emerging industrial giant with the world’s highest wage level—coping with the profitability crisis at that juncture necessitated “a substantial increase in the rate of exploitation of the labour employed in the industries at home” (Sohn-Rethel 1978, 146). Thus, monopoly capitalism seemed to be faced with the difficult dilemma of how to have its cake and eat it, too: How to extract more surplus values and simultaneously raise wages in order to maintain demand? The combined efforts of two of the great organic intellectuals of monopoly capitalism—Fredrick Winslow Taylor and Henry Ford—represented the first step toward resolving this problem. The Fordist-Taylorist methods tremendously increased production volumes and potentially sped up the turnover of capital. But what was needed for this potentiality to be realized was a system of mass consumption that could proceed on par with mass production. American hegemony, as Gramsci (1971, 285) remarked, was “born in the factory” but did not remain confined to it; it penetrated every corner and aspect of society. For one, a worker spent only about half of his waking time in the factory. Thus, the rest of the time needed to be engaged in ways that rationally furthered the reproduction of capital. The surge in productivity made possible by the intensification of work under the Fordist-Taylorist division of labor necessitated the intensification of consumption by the working classes. The emergence of the workers-as-consumers worldview was brought about by the recognition that exercising direct control over labor power was not a sufficient condition for the successful reproduction of mass-production monopoly capitalism (Ivanova 2011b). The potential of homeownership to become the cornerstone of a bourgeois consumer hegemony was comprehensively articulated in the 1920s by Edward Filene—another leading organic intellectual of monopoly capitalism. Filene was a department store owner from Boston who, similarly to Ford, pioneered progressive employment practices, such as high wages, a profit-sharing plan, a forty-hour week, and medical benefits. Filene (1925) recognized that old industrial capitalism—characterized by undisguised worker exploitation, growing disparity between rich and poor, and class conflict—had run its course. It had become not only inconsistent with, but outright disruptive to monopoly capitalism, whose tremendous productivity and massive production volumes could only remain profitable with the support of an ever-increasing army of consumers. Filene took inspiration from Ford’s successful application of Taylorist methods, enabling the simultaneous increase of profits and wages, to advocate a democratic version of consumer capitalism. He was convinced that the average worker had little interest in politics and could only be lured into subversive activities when subjected to extreme exploitation and economic hardship. In contrast, the consumer society would be a peaceful one because “men who can take care of the whole material side of life by working, say six hours a day, simply won’t be interested in socialism or communism” (Filene 1925, 204). Filene

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redefined democracy as people’s freedom to consume and the marketplace as the proper terrain where this freedom could be exercised. He argued that workers could be integrated into consumer capitalism through more economic freedom—that is, higher wages, shorter work hours, and access to mass education and consumer goods, including new housing. Filene’s slogan, “Make houses like Fords,” expressed his key insight of housing as the primer for mass consumption that would lay the foundation for a thriving consumer democracy. But in 1925, when Filene’s book was published, and eleven years after Ford had introduced the “five-dollar day,” the idea that high wages had become a necessity for the system of mass production was anything but universally accepted by the overwhelming majority of traditionally minded capitalists. This situation was not quick to change, for, as Marx (1993 [1939], 419) observed, while capitalists tend to see the total mass of workers as consumers and “possessors of exchange value (wages),” this point of view usually does not extend to their own workers. Despite Filene’s efforts to convince the business community of the merits of a high-wage industrial democracy, by 1934 capitalists’ support for New Deal programs had largely evaporated (McQuaid 1976). Ultimately, it took not only the Great Depression, but also a protracted period of struggle by “citizen consumers” and labor unions “obsessed with expanding workers’ purchasing power” (Cohen 2003, 153), and most importantly, a massive, decades-long effort on the part of the state for the housing- and automobile-centered, workers-asconsumers paradigm to gain ground. This paradigm was grafted onto consumerism—an ideology of collective participation into the benefits of capitalist development that materially and symbolically co-opted workers to the existing order. Consumerism became the glue that held together the components of the Fordist model, which “became known throughout the world after the war as ‘the American way of life’—a productivist model which was ‘hedonistic’ in that it was based on the pursuit of happiness through the mass availability of a greater number of goods” (Lipietz 1992, 6). Mass consumption in the United States became organized through the radical spatial restructuring of work and life as epitomized in suburbanization. Demand in the suburbs was structured around the consumption of two key commodities: the home and the automobile, symbolically representative of the dichotomy of work and life, which, in turn, spurred the demand for a host of other housing-related goods and services.

The Crisis of Fordism and Post-Fordist Restructuring The Fordist period of capitalism—roughly from the end of World War II to the late 1960s—has often been romanticized by scholars impressed with its high rates of productivity growth, economic growth, and most importantly,

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the fact that the working classes shared in the overall prosperity. Since social demand was institutionally regulated through the capital-labor compromise and the institutions of the Keynesian welfare state, rising productivity translated into incremental increases in workers’ wages, which were a key source of demand. A significant body of literature debates the causes of this model’s demise, and revisiting these debates or trying to contribute to them is beyond the scope of this chapter. The Fordist model, however, relied on one key assumption that turned out to be demonstrably false—the belief that the crisis-prone nature of capitalism can be reformed by institutionally regulating demand. This assumption rested on the observation made by both Marx and Keynes of the tendency to uneven development between Department I (producing investment goods) and Department II (producing consumption goods). While in Marx’s theory of crisis, this was just one of several disproportionalities that characterized the capitalist mode of production, and not even the key one, the entire Keynesian edifice of theory and policy rested on the importance of institutionally supporting demand. The crisis of Fordism was not a crisis of insufficient demand. Domestic demand in the 1970s was quite healthy; thus, it was not the regulation of effective demand that malfunctioned. The crisis of Fordism was a supply-side crisis caused by the rising cost of mechanization of production (i.e., rising organic composition of capital) with corresponding decline in profitability, which was further aggravated by chronic overcapacity and overproduction (Brenner 2006), and as Lipietz noted, a crisis of the labor process, “which, because it dehumanizes the worker, ends up by not being efficient, even from the employer’s point of view” (1992, 17). The deep structural crisis that engulfed the United States and the world economy in the 1970s unleashed a profound restructuring of production and social relations. Capital sought to resolve the crisis in two ways: reorganization of the labor process along with spatial restructuring of production and exchange. The 1980s witnessed the proliferation of workplace flexibility, which intensified work while strengthening control over workers. The entrenchment of subprime employment preceded and, in a way, conditioned the subprime solution to the housing problem as labor market segmentation along with intrafirm dualism deepened further, increasing the gap between the privileged core workers, who enjoyed good pay along with standard employment rewards, and the peripheral workers—casual employees without job security, benefits, and opportunities for promotion. The progressive outsourcing of the labor-intensive Fordist industries to peripheral countries paralleled the reorganization of the labor process. Over time, the share of value added by manufacturing in US GDP decreased from 20 percent in 1980 to 11.5 percent in 2008. For a while, the geographical separation of production (located in low-wage countries) and consumption (occurring in high-wage countries) seemed to work miracles for corporate profits. In the case of the United States, this configuration has been strongly aided by the

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ownership of the key international currency, which provided an apparently unlimited access to foreign funds financing domestic consumption. Under the conditions of stagnant incomes (falling in real terms), domestic demand increasingly came to depend on access to credit, thereby adding a temporal aspect to the spatial restructuring of production and exchange. Consumption patterns in the post-Fordist world have undeniably changed, although not as much as and not quite in the way that many have argued. The claim that the transition from standardized mass production to batch production and the creation of differentiated products for niche markets has drastically transformed consumption patterns should be taken with a grain of salt. Indeed, substantial parts of US manufacturing have been outsourced to peripheral countries. This shift, however, has not eliminated the importance of mass-produced consumer goods for the US market. While this analysis does not discount the fact that important changes in consumerist attitudes and behavior have taken place, it strives to emphasize that these changes have occurred within the particular framework set by the social norm of (mass) consumption, which has remained centered around housing (more or less standardized depending on what individual incomes can afford)—and houses filled with a growing number of consumer durables (more or less differentiated to suit individual taste/purchasing power)—and the automobile (the hallmark of individual self-expression). Thus, while the domestic base of mass production disintegrated, the Fordist social norm of mass consumption was maintained largely through the importation of foreign products as reflected by the ballooning trade deficit. In this process, US-style consumer capitalism has increasingly come to rely on cheap foreign labor in the form of offshore-produced consumer goods and of domestically employed immigrants. US-style consumer capitalism has further come to depend on the willingness of foreigners to pay tribute to the US Treasury by investing a portion of their economic surplus in the purchase of US debt (Ivanova 2010b). This sweet gift of seigniorage, in turn, propped up the series of asset bubbles that, along with the great consumption bubble, powered the US economy for almost three decades.

The Subprime Solution as a Growth Imperative Ever since the Great Depression, the housing sector has occupied a prominent position in the US economy, while the federal government has played a unique role in the creation of an integrated mortgage market and the expansion of homeownership by supplying proper legislation, institutional support, and mortgage guarantees. In time, the housing sector developed as a safety valve, enabling the flow of overaccumulated capital into construction and real estate. This process of “capital switching” from the primary circuit of capital (industry and manufacturing) to the secondary circuit (built envi-

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ronment for production and consumption) relied heavily on the existence of a functioning capital market and a credit system “that creates ‘fictitious capital’ in advance of actual production and consumption” (Harvey 1985, 7). As a result of deepening financialization paralleled by the rise of the services-based economy, a gargantuan parasitic structure grew around housing, cementing its role as a lifeline of the US economy whose condition had to be taken into consideration in the design and conduct of any government policy (Ivanova 2011a; Ivanova 2011d). The fact that eight out of ten US recessions between 1949 and 2001 have been preceded by significant weakness in housing and consumer durables prompted Leamer (2007) to conclude that “housing IS the business cycle.” In this context, the origins of the subprime mortgage crisis could be located at the confluence of two factors: the saturation of the housing market that became apparent by the 1970s and the opportunity offered by the demands of the civil rights movement to dismantle discriminatory lending practices, thereby broadening the horizon of capital accumulation. According to the Decennial Surveys of the US Census Bureau, the US homeownership rate increased from 43.6 percent in 1940 to 61.9 percent in 1960. Over the next decade, however, there was only a meager 1 percent increase: to 62.9 percent in 1970. By the mid-1970s the homeownership rate was approaching 65 percent, but afterward there was a small decline to 64.4 percent in 1980. Apparently, by that time, the potential of homeownership as a key driver of the US economy had been largely exhausted as the overwhelming majority of eligible homeowner candidates had been housed. Population growth was far from sufficient to keep the housing machine going at its previous pace; besides, it was strongly skewed toward minority groups, for whom homeownership rates were lagging behind. Even after the first wave of subprime lending, in 1999 the homeownership rate for African Americans (46.7 percent) was still 26.5 percentage points lower than the rate for whites (73.2 percent). The gap for Hispanics was 28.7 percentage points. In addition, in 1999, households with income below the median had a homeownership rate of 51.2 percent—27.4 percent lower than the rate for households with above-median incomes, which stood at 78.6 percent (US Department of Housing and Urban Development 2000a). In what follows, I argue that the subprime crisis resulted from the common interest and action of government and business—the US “integral state” (Gramsci 1971)—to overcome the limits of private production of housing by expanding the size of the market. Since traditional constituencies had largely been housed by the 1970s, the remaining course of action was to extend the purported gift of homeownership to previously excluded segments of society, such as African Americans, other minorities, women, and the poor. Conservative analysts have been eager to blame the subprime debacle on government policies aimed at extending homeownership to low-income groups, such as the Community Reinvestment Act (CRA), and the afford-

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able-housing mission of Fannie and Freddie. Such accounts can be challenged on a numbers of grounds. For one, the boost given by the CRA on subprime lending can be judged insignificant, as Aalbers enumerates (2009). The CRA applies only to bank lenders, while two-thirds of all mortgage lenders in the United States—including the major subprime lenders, such as Ameriquest, New Century Financial Corporation, and Countrywide until 2008—were nonbank lenders and not subject to the CRA. Furthermore, encouraging fair and nondiscriminatory lending practices may not have taken a subprime turn at all, were it not for the deregulation of the mortgage market that began in the 1980s under the guise of extending credit opportunities to previously excluded groups and neighborhoods. A number of key pieces of legislation adopted then made subprime lending both possible and legal. The Depository Institutions Deregulation and Monetary Control Act of 1980 preempted state interest rate caps and enabled lenders to charge high rates and fees to borrowers. The Alternative Mortgage Transaction Parity Act of 1982 preempted state laws restricting the use of variable interest rates, balloon payments, and negative amortization. The Tax Reform Act (TRA) of 1986 prohibited the deduction of interest on consumer loans, while allowing the deductibility of mortgage interest not only for a primary residence but also for one additional home as well. The first two pieces of legislation made subprime lending more profitable for lenders than prime loans, while the TRA boosted the demand for mortgages for both housing and consumption purposes. These three deregulatory milestones along with the Secondary Mortgage Market Enhancement Act of 1984 enabled the massive growth of securitization and the vertical disintegration of the lending industry epitomized in the transition from the traditional originate-and-hold to originate-and-distribute model of lending. The primary source of capital for the first wave of subprime lending in the mid- to late 1990s came not from the government-sponsored enterprises (GSEs) but from private-label, residential-mortgage-backed securities (MBSs), whose issuance grew from $35 billion in 1993 to $150 billion in 1998; 55 percent of subprime mortgages in 1998 were securitized (US Department of Housing and Urban Development 2000b). These MBSs were predominantly refinancing loans, structured similarly to the traditional thirty-year, fixed-rate mortgages, although with substantially higher fees, interest rates, and in many cases, prepayment penalties and balloon payments. They were heavily concentrated in predominantly black neighborhoods. Mortgage loans during the second wave of subprime lending in the 2001–2006 period became much more innovative, typically carrying adjustable interest rates or “exotic” features such as interest-only payments and negative amortization. Lending standards deteriorated even further as no-documentation loans and low- to zero-down-payment loans became commonplace. Such practices were partially a response to the affordability problems faced by borrowers in light of the spectacular rise in housing

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prices that overshot both the historical trend and the so-called economic fundamentals. As originators’ profits were determined solely by loan volumes and fees, lenders competed for customers by offering ever larger loans for ever larger houses with ever more exotic features (Immergluck 2009). In sum, by the early 1990s the federal government had wholeheartedly committed to spreading homeownership to the lower-income classes, which was reflected in the affordable-housing mission of the GSEs and in the relaxation of the underwriting standards for mortgages insured by the Federal Housing Administration (US Department of Housing and Urban Development 2001). The bulk of subprime lending, however, took place in the private, nonagency market, dominated by nonbank lenders. While the conforming markets peaked in 2003, nonagency markets continued to expand. In 2005–2006, nonagency origination and issuance (including subprime, alt-A, and jumbo mortgages) significantly exceeded the volumes realized in the prime (agency) market. For example, in 2001, banks originated $1.433 trillion in conforming mortgage loans and issued $1.087 trillion in agency securities, while the nonagency sector originated $680 billion in mortgages and issued $240 billion of MBSs. By 2006, nonagency origination of $1.48 trillion was 45 percent larger than agency origination, while nonagency issuance exceeded agency issuance by 14 percent (Ashcraft and Schuerman 2008). In 1994, subprime mortgage originations totaled $35 billion and accounted for only 5 percent of total new mortgages originated in that year. By 2005, the total had soared to $625 billion, or 20 percent of total mortgage originations (McCoy and Renuart 2008). As mentioned above, nonbank mortgage lenders that were primarily responsible for the high-risk subprime boom were not subjected to the regulations that applied to traditional banks and thrifts. However, those who tend to see the lack of regulation in this area as government failure miss one essential point: the “failure” could have been deliberate. The deregulation of the past, much like the reregulation of the present, could have been merely a veil behind which the US government and big business joined efforts to resolve the contradictions of the free market on their own terms. The financialization of the US economy since the early 1980s has been a multidimensional process, in the course of which traditional investment and commercial banking has been radically transformed. On the one hand, the reorientation of large corporations toward market finance and away from bank loans has encouraged the commercial banks’ turn toward direct financial expropriation of workers’ incomes as a key source of profit. On the other hand, commercial banks became increasingly involved in investment-banking activities, such as underwriting and trading of securities, a process that received an official blessing with the 1999 repeal of the GlassSteagall Act (Lapavitsas 2009). The transformation of banking and finance went along with profound changes in the structure of the US economy and society, including a reorien-

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tation toward a service-based economy. Labor market segmentation, characteristic of the US economy in general, has been particularly pronounced in the service sector, where a stratum of privileged professional and managerial cadres has coexisted with a huge underclass of low-skilled, low-paid, marginal, and disposable workers. The key service areas in the financialized economy are centered around finance, investment, and real estate (FIRE), while the managerial and professional cadre of these sectors has acquired the status of a new rentier class. What sets apart the FIRE class from the traditional rentiers is the former’s ability to derive class-monopoly rent not necessarily on the basis of ownership of loanable capital, but because of its position relative to the financial system. This modern form of class-monopoly rent has much in common with traditional usury in that the former is derived not from enterprise profit but from labor income (Lapavitsas 2009). Under these conditions, the bloated US housing sector has had to support not only construction- and housing-related production, but also the gigantic parasitic structure of the FIRE economy feverishly feeding on the homeownership project, and ultimately on the homeowners themselves mortgaged to the hilt. Thus, the subprime turn of the US state was in large part conditioned by the growth imperative of the financialized economy and the needs of the growing parasitic FIRE class to harness the economic benefits of homeownership. Correspondingly, government housing policies were designed in tandem with a broad coalition of interested parties eager to reap the benefits of the subprime road to the homeownership society. Invigorated by the bubble, the homeownership rate peaked at 69.2 percent in the fourth quarter of 2004, only to retreat to 66 percent as of the fourth quarter of 2011.

The End of Suburbia? The subprime crisis marked the beginning of a generalized housing crisis, itself a part of an economic depression, whose end is not in sight. The US government and the Federal Reserve (Fed) have employed a variety of conventional and unconventional means—from the trillion-dollar purchase of MBSs to the sponsoring of mortgage modifications—to halt the collapse of asset values and housing prices. In this context, the present crisis reveals some major fractures in the existing accumulation regime. These fractures, however, are the manifestations of the crisis and should not be confused with its causes (Ivanova 2011b). First, the financial system is still overloaded with massive amounts of fictitious capital—claims that cannot be validated. The only way out of these gargantuan imbalances is devalorization of capital on a grand scale—a development that authorities have gone out of their way to prevent. In the summer of 2007 when the panic in the mortgage market triggered the credit crunch, the Fed’s crisis management

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options revolved around the choice between devaluing money or assets, devaluing labor or capital—in strictly monetary terms, the choice between inflation and deflation. The decision made was to salvage the financial system at all costs. Thus, the first step of Fed Chairman Ben Bernanke was to increase access to liquidity by lowering short-term interest rates and hoping to sustain the bubble. Since liquidity could not solve the underlying problem of insolvency in the financial system, another solution was tried; numerous lending facilities mushroomed throughout the system for the purpose of funneling funds into broken banks and markets. Since none of these measures was quite successful, by September 2008, amid a wave of bailouts and bankruptcies, the most radical action was taken—virtually flooding the credit system with liquidity in the hope that lending would resume (Ivanova 2010a). The artificially propped-up financial system remains vulnerable; any panic may lead to a crash. Furthermore, the ballooning government debt renders it not unlikely that the panic may start in the very beating heart of the US empire: its bond market. The crisis management policies of the US government have been informed by an almost religious belief, deeply ingrained in the structural psychology of US capitalism, that the core government function is to promote private business activity. The hopes are that a fraction of business proceeds will eventually trickle down to the rest of society. Notwithstanding some nuances, liberals and conservatives alike share this belief. The conservative version of the “freedom-as-free-market ideology of the American business state” (Gowan 2004) is paralleled by a liberal pseudoKeynesianism of sorts. One of the key differences between conservatives and liberals concerns the attitudes toward deficit spending. The former lament every dollar spent on social programs for the lower-income classes, while extolling the virtues of tax cuts for the rich. Liberals are bold enough to appeal for limits to the absolute destitution of the poor and underprivileged in the form of more stimulus and bigger deficits. Paul Krugman exemplifies this view: “The point is that running big deficits in the face of the worst economic slump since the 1930s is actually the right thing to do. If anything, deficits should be bigger than they are because the government should be doing more than it is to create jobs” (2010, A25) Government spending can soften the impact of a recession; however, it does not automatically lead to recovery. Moreover, bigger deficits do not always translate into more jobs or a general improvement of the commonweal. In fact, the two government stimulus packages have not significantly contributed to either. The stimuli relied primarily on boosting consumer spending and business activity via tax cuts and correspondingly contributed to exorbitant budget deficits—$1.4 trillion in 2009, $1.29 trillion in 2010, and $1.3 trillion in 2011 (10.0, 8.9, and 8.7 percent, respectively, of GDP). Even the labeling of such policies as “Keynesian” is questionable. As Meltzer notes, there is little evidence that Keynes “favored compensatory

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fiscal policy, and he opposed policies to change consumer spending by unplanned changes in government spending and taxes” (1981, 41). Keynesian full employment does not follow from propping up personal consumption, but comes about through socialization of investment (BrownCollier and Collier 1995). By making a significant contribution to national investment, the government would prevent drastic economic fluctuations, thereby permanently raising labor incomes and effective demand. However, the idea of social control of investment is radically incompatible with a “globalized” economy characterized by a growing structural dependence on cheap foreign imports, often financed by US direct investment abroad. Furthermore, the link between rising labor incomes and rising consumption has been long dissolved. Thus, the core content of Keynesianism as an economic policy is dead and buried. Only its most superficial form, that of pure money artistry, has survived. This pseudo-Keynesianism relies on the use of the government printing press not for the purpose of achieving full employment, but simply to control the damage inflicted on society by the disastrous workings of US capitalism (Ivanova 2011c). Regardless, the present liberalprogressive appeals for more deficit spending—that is, more tax rebates, food stamps, public works, government jobs, and so on—are unlikely to materialize, while the runaway deficits serve as a welcome justification for conservative forces eager to destroy the last remaining artifacts of the US welfare state, such as Social Security, Medicare, and public education. So far there have been few signs of recovery in the troubled area of housing. According to the S&P Case-Shiller 20-City Composite Index, home prices in December 2011 on a seasonally adjusted basis were almost 34 percent below the peak reached in April 2006. Over 2.8 million foreclosures were initiated in 2009, while the new filings in 2010 slightly exceeded that amount. Persistently high unemployment and the deepening degradation of work, manifested in the ongoing transformation of full-time jobs with benefits into casual part-time work, are likely to further undermine the housing market along with any serious prospects for economic recovery. The notion of a “middle-class squeeze”—referring to the largely stagnant incomes of the bottom 80 percent of the population, the growing disparities in the distribution of income and wealth, and the disappearance of traditional “good jobs” has been sorely lamented by Keynesian economists and socially concerned intellectuals (e.g., Krugman 2002; Schmitt 2008; Weller 2008). The significance of this phenomenon within the larger context of the transformation of US capitalism is important to underscore. The ongoing housing collapse has demonstrated the obsolescence of the postwar homeownership project and the type of capitalism that thrived on it. “Capitalism,” Harvey writes, “builds a physical landscape appropriate to its own condition at a particular moment in time, only to have to destroy it, usually in the course of a crisis, at a subsequent point in time” (1985, 247). Suburbanization has

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run its course, along with homeownership as the consumption pattern meant to support it. The “middle class” was an ideological and practical device that adorned the image of suburbia and powered an economy, painfully dependent on compulsive and mindless consumerism, that was the hegemonic reward for mindless but relatively well-paying work. But US capitalism no longer needs a middle class of this kind, for a number of reasons. For one, the amount of “good jobs” is steadily dwindling, and no spontaneous reversal of this process will take place. Paradoxically at first glance, outsourcing and the cost-cutting race to the bottom, while serving the interests of big business, are actually hurting “capital in general,” that is, the reproduction of the existing order. The US state, which by definition should be able to mediate conflicts between these two worlds, has become so entangled with individual big capitals that its ability to articulate and guarantee a modicum of common interest seems seriously impaired. While for now the middle class is surrendering quietly, the chronic lack of good jobs is a potential source of social tensions as a large stratum of young people, who have incurred debilitating financial burdens to purchase college education, awake to a reality in which their overpriced degrees no longer guarantee a decent middle-class existence. For a significant portion of these debt-crippled middle-class aspirants, homeownership is likely to remain a dream, and a very distant one at that. A second reason for the obsolescence of the middle class of the past lies in its inability to further serve its underlying purpose, which was to consume out of proportion to its income. Declining consumer spending has been among the key manifestations of the present crisis. For decades, maintaining high levels of personal consumption has been the overriding aim of government economic policy. Consumer spending in the United States fluctuated between 60 and 70 percent of GDP in the postwar period and exceeded 70 percent of GDP in 2002 and the following years. Buoyant levels of consumption, however, were not due to strong income growth. Quite the reverse—ever since the early 1980s, total private average weekly earnings, measured in constant dollars, have been significantly lower than in the 1960s and the 1970s. Income growth for 95 percent of the population has slowed down over the last three decades, but stagnation has been most pronounced in the lower-income brackets. While the incomes of the bottom 60 percent increased 4.21, 10.04, and 19.51 percent, respectively for every quintile, over the 1978–2008 period the average income of the top 400 taxpayers nearly quadrupled since 1992 (Ivanova 2011b). During the 1966– 2001 period, only the top 10 percent of earners enjoyed a growth rate of real incomes equal to or above the average rate of productivity growth, while the median real income barely grew at all (Dew-Becker and Gordon 2005). In 2009 the median household income was 5 percent lower than the 1999 level, while the poverty rate reached 14.3 percent, the highest since 1994 (US Census Bureau 2010).

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Thus, the high consumption of the neoliberal era, similar to the housing bubble, was enabled by credit expansion and financial innovation. Debt accumulation particularly accelerated after 2000, with most of it due to the rise in mortgage debt, which increased from $6.8 trillion in 2000 to $14.6 trillion in 2007. Household leverage peaked at 136 percent of disposable income in 2007. These high levels of personal indebtedness are clearly unsustainable as rising debt-to-income ratios create solvency problems for borrowers and reduce their access to further credit. But more important, the purchase of housing as well as consumption in general is ultimately limited by the amount of labor income—present and future. Access to credit does not alter this underlying fact; it can only change the temporal allocation of income by allowing the use of future income to purchase a house in the present. Personal debt gives the creditor a legal claim over the worker’s future income. However, if debt rises faster than income, credit saturation— a condition wherein anticipated future income that could be diverted to debt servicing has been exhausted—will inevitably ensue (Gramm 1978). Credit saturation of remarkable magnitude has been a characteristic feature of the great recession; the household sector’s net borrowing, which peaked at $1.17 trillion in 2005–2006, was –$231 billion in 2009, –$279 billion in 2010, and –$114 billion in 2011. This collapse of credit for the working classes, driven by conditions far more fundamental than the popular tale of the unwillingness of banks to lend, has again exposed the limits of production based on capital.

Conclusion The happy coincidence of the factors that enabled the recent high-growth era of US home-centered consumer capitalism has now come to an end. Solvency concerns have made access to credit, and thus consumption on credit, more difficult. Falling housing prices have effectively eliminated home equity withdrawal as a financing option. Actual labor incomes in the United States are not sufficient to sustain the high consumption level of the previous era. Furthermore, rising debt-to-income ratios are inherently deflationary since they divert income from consumption to debt-servicing. Thus, the ongoing economic crisis in the United States is not a regular cyclical downturn, but signifies the end of finance-driven consumer capitalism as an accumulation regime whose key features can be summed up as debtfinanced mass consumption of largely offshore-produced goods and “wealth creation” through rapidly appreciating asset values. While the old model seems damaged beyond repair, a new one is not yet in sight.

10 Working Classes and Transnational Change Magnus Ryner and Matt Davies

The staying power of the thought of Karl Marx makes itself felt exactly at times when it seems conclusively refuted. His statues were still being torn down after 1989, when IPE observers began to note highly prescient statements on determinants of globalization in the 1848 Communist Manifesto (see, e.g., Gamble 1999). It was particularly the cosmopolitical, homogenizing power of the commodity-economic logic that observers had in mind. The driving force that emanates from the constant and invariant capitalist necessity to deploy capital profitably—to make more money out of money—requires the subsumption of ever more territory and ever wider aspects of social life to the abstract logic of exchange value if the system is to survive. It became commonplace in IPE to quote a particular passage from the Manifesto: The bourgeoisie has through its exploitation of the world market given a cosmopolitan character to production and consumption in every country. To the great chagrin of reactionaries, it has drawn from under the feet of industry the national ground on which it stood. . . . The bourgeoisie, by rapid improvement of all instruments of production, by the immensely facilitated means of communication, draws all, even the most barbarian, nations into civilization. The cheap prices of its commodities are the heavy artillery with which it batters down all Chinese walls, with which it forces the barbarians’ intensely obstinate hatred of foreigners to capitulate. It compels all nations, on pain of extinction, to adopt the bourgeois mode of production; it compels them to introduce what it calls civilization into their midst, i.e., to become bourgeois themselves. In one word, it creates a world after its own image. (Marx and Engels 1848, 243–244)

Yet this reception of the Communist Manifesto was partial and, to an extent, misleading. It misses out the central point, namely that, for Marx, transformation and change cannot be read off linearly from dominant social forces. Rather, change is latent in the particular antagonisms between dominant and subordinate social forces. The commodity economic logic was for Marx and Engels merely part of a dialectical dynamic that crucially 179

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involved the direct producers of surplus: the workers, or the working class. Following their particular rendering of Hegel’s master-slave dialectic, the economic logic of the commodity and the power relations it presupposed and generated would encounter their negation. The contradictory developments it conjured up would propel world history forward, in the form of crisis tendencies, grievances, antagonisms, and eventually proletarian revolutionary consciousness and capacity. Workers, brought together and concentrated in the monstrous and alienating conditions created by the capitalist industrial system, would become the central actors of world politics. Marx and Engels envisioned the source of change within the totality of this dialectic, of which the commodity logic was only one moment, and it is in this dialectical sense that they begin the Manifesto with the sentence, “There is a specter haunting Europe.” IPE’s one-sided reading of Marx and Engels is symptomatic of a wider tendency in IPE to neglect the social forces that emanate from the direct producers in the world: the workers or working classes. In contrast, we argue in this chapter that much can be learned from Marx’s original starting point of understanding change—that is, in terms of antagonisms that are latent in the specific power relations that workers experience in their everyday lives as direct producers. After noting some of the limitations and problems in analyzing work and workers in the Marxist tradition, we nevertheless assert that a more profound understanding of the dynamics that drive the global political economy—not the least the politics of permanent crisis—needs to pay attention to Marx and Engels’s spectrology. In other words, we need to pay attention to the dialectics of the world economy and the source of political agency that resides in work. We conclude with a broad outline of the global political economy and the crises affecting it from such a perspective.

IPE and Spectrology Students of IPE might be forgiven if they were to conclude that work was not a central concern of the field or that workers were not important actors. After all, the most sustained debate in the last several years of the leading journals in the field has been concerned with the field itself, whether it is divided by the North Atlantic between a US version preoccupied with the application of quantitative methods to trade issues, international organizations, and conflict management, and a British version with a more social constructivist flavor concerned with the power of ideas (Phillips and Weaver 2010). A rough survey of four of the field-defining journals of IPE—Review of International Political Economy, New Political Economy, Economy and Society, and International Organization—found that from

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1994 until 2009, only 3.29 percent of the content dealt with work: that is, 60 of 1,819 articles. When looking more closely at those articles, work tends to appear as a commodity in circulation in labor markets or migration; as an object of regulation; as a collective political actor; or mediated by trade unions, social movements, or international organizations. Work as an activity and workers as people who work barely make an appearance in these journals (Davies 2009). So what of the specter Marx invoked? Where is the proletariat? Where are those workers of the world with nothing to lose but their chains? What has become of the political project to supersede exploitative social relations, and what became of the political subject that might realize such a project? The reason why the question still remains lies with the limitations of the Manifesto itself, written as it was in the early days of capitalist development and in the wake of the wave of the 1848 antiaristocratic, prodemocratic revolutions. Supporters and critics of Marx alike display a troubling dogmatic adherence to Marx’s two-class model: the bourgeois versus the proletariat, flanked by the “dying” retrograde feudal mode of production, populated by landlords and peasants. As the work of Robert Cox and Jeffrey Harrod (1987) has shown (see also Davies and Ryner [2006]), concrete social formations are highly composite and fractioned social affairs, entailing manifold patterns of social relations of production arranged in patterned hierarchy. Marx overestimated the globalizing and homogenizing tendencies of nineteenth-century capitalism. These were broad in scope and connected the world in vast commercial networks. However, their penetration of social relations was not as deep as Marx supposed. One did not have to go far into the hinterlands of the commercial centers in Europe to find their articulation with rather traditional and local social relations, including those of peasants and landed elites (e.g., Schwartz 1994). Small enterprises in niche industries and the interstices of circuits of capital accumulation (e.g., Sabel and Zeitlin 1985) were unexpectedly resilient. Marx and Engels also underestimated countertendencies, captured, for instance, by Lenin and Trotsky in their analyses of imperialism and “uneven and combined development.” Paradoxically, Marx and Engels may have relied too much on classical liberal political economy regarding the nature and extent of market forces, underplaying the extent to which the specificities of industrial use-values and social institutions refract the homogenizing tendencies of the law of value (Hodgson 1996; Aglietta 1998). Consequently, Marx and Engels overestimated the imminence of a global revolutionary proletarian subject that would find its political expression in their particular spectrology: the Communist International. In capitalist metropoles and parts of the semiperiphery, workers could be integrated into capitalist society through a variety of democratic-corporatist (tripartite)

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and state-corporatist, indeed nationalist, projects (ranging from fascism to social democracy). E. H. Carr (1945) once called this formula the socialization of nationalism and the nationalization of socialism. The Communist revolution instead took place in other parts of the capitalist semiperiphery and periphery, where social relations had undergone much less of a bourgeois revolution and hence were fraught and composite, and based on workerpeasant alliances forged by a party vanguard. This reality led to a deep rethinking of core Marxist concepts: questioning the meaning of emancipation; exploring the analytical disjuncture between economics, politics, and culture; and reconsidering the complex interrelationships between structure and superstructure. To this one should add problems of Marxist discourse ranging from crude Eurocentrism to the unreserved endorsement of European capitalist modernity as a progressive stage, which world systems theory and postcolonial theory have problematized. A changed reality and a range of theoretical developments compel us to reconsider the power relations that shape production and the relations between them, the kinds of consciousness or subjectivity that attend to these power relations, and the politics that can emerge from them. Nevertheless, IPE’s endorsing what Marx and Engels have to say about the causal forces underpinning globalization while disregarding the dialectic nature of their argument results in a missed opportunity to gain insights into the permanent crisis. The notion that politics is socially grounded is hardly in dispute. Political economy requires a robust theory of the subject (Levine 1998), and subjectivity is grounded materially and socially: after the semiotic turn, thinkers from Bourdieu (1991) to Bennett (2009) have highlighted how material habitus shapes dispositions. The Manifesto remains one of the most important political documents of our time as a guide for how to ascertain the limits of the possible of world politics on the basis of developments in social formations. In what follows, we seek to identify the transformations in the nature of capital accumulation in the contemporary global economy and to identify transformations in power relations of production, attendant antagonisms, and therefore in the dispositions and agency of workers in world politics. Hence, while conceiving the concrete situation in a way that is radically different from Marx, we follow his cue that the starting point for understanding change is latent in prevailing social relations of production. We argue that just as the Cold War had a class structure riven by a conflict between capitalist core states, underpinned by Fordist corporatist class compromises, and Communist revolutionary states, underpinned by worker-peasant-based vanguard dictatorships (Saull 2001), contemporary world politics has its own class structure, which we characterize as an ominous polarization of habitus between civic privatism at the apex of the global political economy hierarchy and millenarianism at its bottom, with populism as a possible common denominator (see also Ryner 2006).

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Workers of the World The conventional description of the polarization of the world in the Cold War was given in terms of East versus West. World systems theory and dependency theory provided the major alternative description of these polarizing dynamics in this period, recasting the dynamic along a NorthSouth divide. Thus, in the industrialized “core” during the Fordist period, capital accumulation was autocentric and based on regulated integration of mass consumption and production in the advanced capitalist states. The industrializing semiperiphery was mainly populated by states and social formations that first pursued import substitution strategies but then managed to draw on capital mobility in mercantilist catch-up strategies to engender successful capitalist industrialization. At the bottom of the hierarchy, in the periphery, there remained states and social formations without successful industrialization. The internationalization of production made possible by emerging technologies and their impact on social relations of production, and that accelerated in the wake of the economic crises of the 1970s, began to change the ways that this geographic distribution of industrial sectors, supplies, and markets operated. Robert Cox argued that “[although] the functional characteristics of core and periphery remain analytically valid, their association with specific geographical positions must be considered to be a matter of perhaps transitory circumstance, not of immutable destiny” (1987, 320). Geography did not become irrelevant, nor did the large territorial blocs described by the world systems framework. In the contemporary world economy, capital accumulation and capital flows cluster within and between three macroregions, with North America, Western Europe, and East Asia at the top of the hierarchy (Dicken 2003). But the distributions of cores, semiperipheries, and peripheries could no longer be reduced to particular regions nor assumed to be fixed in space. Beyond examining the structural conditions of the world system à la Frank, analysis of the polarizing dynamics must focus on the social relations and the politics that constitute commodity chains and, indeed, the capital accumulation process as a whole. Fordist crisis management, motivated by efforts to restore profitability through cutting labor costs and by the search for new frontiers of commodification, generated a broad-ranging transnationalization of productivity and of competition norms (Lipietz 1987, cited in Neilson and Stubbs 2011). One important aspect of this has been the commercialization of agriculture and enclosures in the periphery, which has resulted in a massive decrease in peasant and other agrarian forms of social relations along with rapid urbanization (Akram-Lohdi 2007; McMichael 2008; Caffentzis 2010, cited in Neilson and Stubbs 2011). This has not disrupted the uneven nature of capitalist development. Wage flexibility and labor cost cutting also became increasingly central to capitalist profitability at the apex of the world econo-

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my. Demand has been sustained through loans-based consumption underwritten by wealth effects, in the form of increased value of pension funds and homeownership (see, e.g., Montgomerie 2008). This development has been most pronounced in North America. The other regions in the triad have become dependent on loans-based expansion in North America, which in turn depends on the access of savings from the accumulated assets in the other regions, ultimately underpinned by dollar seignorage and interactive embeddedness between the world economy and US social formation, in what has been called the “dollar–Wall Street regime” (e.g., Gowan 1999; Seabrooke 2001; Dumenil and Levy 2004; Konings 2008). An industrial paradigm emerged in the 1980s and 1990s in response to the crisis of Fordism, effecting a transition to a contemporary mode of crisis and crisis regulation. This has been labeled variously as “flexible specialization,” “post-Fordism,” or “flexible accumulation” (Amin 1994). At the most abstract level, this paradigm has been based on the cybernetic automation of industrial processes and a breakdown of information bottlenecks. This facilitates increased capital intensity, corporate organization over a larger geographical space, and economies of “networking and skill to adjust volume to demand without productivity losses” (Amin 1994, 20–21). The latter is made possible through a reconnection of conception and execution through computer-assisted “general purpose machines.” In the core regions, post-Fordism posed a challenge to tripartite forms of national corporatism as dominant forms of social relations of production in a process led by a corporate search of “flexibility” and “lean production.” In essence, corporations sought a promotion of individual contracts, incentives and threats, and numerically flexible wages, all used to promote a bifurcation of tripartite patterns of power relations into enterprise corporate and enterprise relations (Harrod 1987). Corporations seek to connect a skilled and loyal core workforce to the corporation through the former pattern of power relation. They seek a flexible and cost-efficient deployment of a peripheral workforce through the latter, not the least through outsourcing and subcontracting arrangements. The hollowing out of tripartism—that is, the reduction of the state’s role in relations between employers and workers, also known as “deregulation”—and the increased tendency toward enterprise corporatist relations have enhanced a disposition toward civic privatism (Habermas 1975) in the core. Civic privatism refers to a sentiment toward public life whereby one retreats from any active part in its deliberations and more generally processes of legitimization, although one still has an interest in the allocation of outputs and the output performance of the public administrative system. Politics is thus reduced to passive consumption on a political market. We can understand this development against the backdrop of an everyday dialectic between the patterns of social relations of production that involve wage labor. The transition from enterprise pattern in the nineteenth

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century to the other forms took place against the backdrop of the contradictions associated with its “basic consciousness,” which Harrod calls the “iron law of worker organization formation” (Harrod 1987, 193–194). Following the cue of classical Marxism here, Harrod argues that the gathering of workers in one physical space, made to produce collectively in a specialized division of labor where the interdependence of their tasks is apparent, provides the basis of a rudimentary sense of togetherness. This results in a sense of collective solidarity, defined in relation to a concrete other—the owner—rendered transparent by the regular and enforced distinction between those with and without power. These conditions generate an impetus to restrain power, which provides fertile grounds for trade union organization and the transition to bi- and tripartism. In the latter forms of social relations, unions then build, elaborate, and formalize a moral economy of this solidarity and an internal structure of representation (through union officials from shop stewards and upward). Where these relations have been stabilized, this has usually also implied an elaboration of everyday life in working-class neighborhoods through specifically working-class sporting associations, adult education institutions, and networks organizing consumption, such as consumer cooperatives. Lash and Urry (1987, 91–93) have called these “communities in struggle.” The Fordist period also generated a civic privatist countertendency in the everyday life of wage labor. This countertendency first operated on the level of mass consumption, and is in part the paradoxical result of the success of labor organization. In time, mass consumption has been associated with an attenuation of communities in struggle as leisure time is increasingly associated with a retreat into the home, through, for example, television entertainment and suburbanization. With the attendant increased influence of advertisements through mass media, the semiotics of everyday life—the discursive form of Harrod’s macro-rationalities—have become more and more based on subliminal manipulation of instincts as opposed to rationaldeliberative discourse (Lash and Urry 1987). As Habermas (1962) argued, where unions retained a strong position in the workplace, they potentially provided a “discourse ethical” countertendency to this commodification of public spheres. Thus the disposition of tripartism is Janus-faced. Since it has given unions a measure of power to influence the state, it can, at times, produce a highly politicized form of collective class consciousness, where industrial grievances, through the representative organs and negotiations, translate into viable political alternatives (Higgins 1985). But union leadership can also be captured by the bureaucratic politics of interest intermediation in the state, and in these circumstances unions run the risk of becoming transmission belts of state discipline, which alienates the membership and in turn increases the space of operation of civic privatism beyond the sphere of consumption in the core workforce. The latter side of tripartism becomes

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more prevalent in times of weakness and paradoxically tends to weaken the unions further through an inner crisis of representation (Panitch 1985). Such developments, fueled by the need to respond to the demand of higher assetyield ratios in finance-led capital accumulation (“shareholder value”), contributed to the hollowing out of tripartism in Western Europe in the 1980s and the 1990s (on Germany, see Deppe 1999; Beck and Scherrer 2003), the effect of which often is the aforementioned bifurcation toward corporate and enterprise relations. In other words, competitive corporatism and service unionism constitute a hybrid but increasingly weakened organizational form of this substantive development. The corporate pattern, in this context, represents an extension and further strengthening of civic privatism from the sphere of consumption to the sphere of production as it depoliticizes production and encourages a conception of working life as a contractual relation between private individuals. It tends to emerge in civil societies where ideological countertendencies to working-class organizations are strong (such as free-enterprise ideology, the myth of the working boss, and sometimes cross-class discourses of ethnic, national, and religious communities). The extension of civic privatism operates notably through the encouragement of a careerist biography, continuing education, and the discourse of employability (see, e.g., Moore 2010), and the institutionalization of systems of bonuses, stock options, and actuarial pension systems. This changes both the interest of workers and a broader civilizational sense of what and who they are (on pensions, see Harmes 1998). To the extent that these benefits can be maintained for the core workforce, they can help preempt antagonisms in the workplace. It is of course possible that these benefits are not maintained (for example, serious questions have recently been raised about pension plans), which does generate antagonisms. The expression of these antagonisms has taken divergent paths in the capitalist core. On the one hand, for those more secure core workers in the enterprise corporatist pattern of production relations, their dependency on their employers for secure employment in a context of recession and economic uncertainty could be expected to continue to generate the civic privatist consumerism. Their key expectation would be to be protected from the cost cutting associated with austerity, and their disengagement with the public sphere leaves them less reliant on public services for which they are unwilling to pay via increased taxes. On the other hand, among those more vulnerable and isolated workers in enterprise relations, the debt crisis (that is, a crisis of finance-led accumulation as expressed, for instance, by the collapse of the subprime mortgage market) has also generated populist sentiments as their livelihoods become more precarious and the burdens of austerity are placed on their shoulders. For these workers, the civic privatism that led them to define their relation with the public sphere in terms of consumerism frames their demands in the face of austerity in terms of getting

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the burden of government out of the lives of regular people and hostility directed not at those strata of the social formation who are protected from bearing the costs of the recession by their wealth and power but at those subordinate sectors who are more visibly dependent on the state for protection, such as immigrants. The second tier of the global political economy, or semiperiphery, is increasingly connected to the core, and partially shaped through transnational corporate strategies of outsourcing and subcontracting. The advantage of outsourcing is that the corporation can swiftly terminate and establish contracts and orders in relation to market fluctuations. The subcontractors thus carry the cost of these changes and organize their labor processes increasingly around unprotected work. In this context one needs to consider the resurgence of the enterprise pattern in core regions. But in addition, this corporate chain has also provided the basis for a new industrialization, first in Southeast Asia, and later in larger developing countries such as Brazil, India, and above all, China. This transformation has taken place against the backdrop of the shift from import substitution development strategies to export promotion, which was facilitated by the IMF structural adjustment programs that followed in the wake of the debt crisis management strategy outlined by the Baker Plan. One of the results has been the virtual disappearance of what Harrod (1987) and Cox (1987) called state corporatism.2 The patterns of this semiperipheral development depend on the decline of peasant relations, releasing a surplus population to the outsourcing industries. This extensive mode of exploitation also depends on the support of subordinate production relations such as the household and subsistence farming and the circulation of workers between them.3 Observers often associate this form of production with a feminization of work, as women’s subordination in the household can make them a cheaper source of labor power. Intensive academic attention notwithstanding, it is important to underline the limited extent of this development. At the turn of the twentyfirst century, even in countries like Mexico and Malaysia, manufacturing employed no more than one-fifth of the economically active population (International Labor Organization 2000). The popular image of a rapidly growing female industrial proletariat must also be kept in perspective. Twenty percent of the female Mexican labor force works in manufacturing, compared to 70 percent in services (where patterns of social relations are likely to be more heterogeneous). Official corresponding figures for Malaysia were about 30 percent and 60 percent, respectively (UN Development Program 2002). These data are not presented to trivialize what still is an impressive rise of industrial employment (for example, in the case of Malaysia, from 7 percent in 1980, and in the case of Mexico from 12 percent [International Labor Organization 1990]). In this context Harrod’s “iron law of worker organization” is likely to be operative, requiring an

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understanding of the extent to which such organizations are likely to be revolutionary, reformist, or integrative forces. Underdevelopment—understood in terms of the ongoing subordination of regions dependent on low-value-added exports to regulation by power relations emanating from the core—remains the context for a large part of the world’s population in the third tier or periphery of the global economic hierarchy. This situation remains for most of Africa (with some exceptions in the Arabic world and South Africa), and large parts of Latin America, as well as South and Central Asia as well as populous parts of the Middle East. Enclave mineral and cash-crop agricultural production is taking place, as in the classical international division of labor (on Africa, see, e.g., Saul and Leys 1999). The articulations of unequal exchange between modern and traditional agricultural sectors of peasant social relations remain an important feature in many parts of the periphery, especially in Latin America and South Asia. However, as discussed above, the share of the population engaged in agriculture has decreased dramatically since the 1960s. Rural-to-urban migration has expanded the numbers of urban marginals, uprooted from social relations in disintegration such as subsistence and peasant societies. IMF structural adjustment programs have shredded the meager safety nets that existed, as well as the traditional networks of support that subsistence agriculture and peasant communities provide. In the absence of any increased industrialization, the result is an ever larger share of the population that has to make a living in a precarious informal service economy. On the basis of data from the UN Human Settlements Programme (2010) and the ILO (1993; 2008), Neilson and Stubbs (2011) have demonstrated that this “relative surplus population” is six to eighteen times larger than the formally employed population in this category of social formations. In some cases, this relative surplus population is engaged in self-employed production relations, but also all too frequently in what Harrod (2006) calls the casual pattern of relations of production (e.g., International Labor Organization 2002; see also Davis 2006).4 With reference to sub-Saharan Africa, Saul and Leys argue, Growing pressure of population means a constantly expanding landless labor force, partly working for subsistence wages on other people’s land, partly unemployed or underemployed in the cities, sometimes migrating to neighboring countries (e.g., from Burkina Faso to Côte d’Ivoire), living on marginal incomes and with minimal state services including education and health. (1999)

It is difficult to differentiate between those engaged in self-employment and those in the casual pattern of power relations in production, because the term “own account” does not adequately distinguish between the two forms. Self-employment requires a stable and continuous relation to suppliers and

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customers that not all own-account workers have. Nevertheless, ILO’s statistics on microenterprises in Latin America indicate that roughly half the labor force of South America was self-employed in 1997 (International Labor Organization 2002). Similarly, estimates hold that about 56 percent of India’s workforce is in self-employment, which excludes one-third of the Indian population “which has no assets at all” (Harriss-White and Goopty 2001, 90–91) and thus most likely have to eke out an existence through casual employment. Similarly, in the absence of a thriving cottage industry in Africa, these are also most likely the dominant social relations of production of “services” on that continent. The situation has been less desperate in the Maghreb and in the Arab world in terms of absolute destitution (UN Development Program 2002b). Nevertheless, a growing mass of unabsorbed labor supply results from the growth of the working population, decreased employment opportunities in the public sector, and a reduction of agricultural employment from about 50 to 15 percent in the 1960–1990 period (UN Development Program 1996), including not only the lowest strata of society but also the youth who are the children of those employed, or previously employed, in state corporatist relations, who after their education cannot find jobs. Despite some growth in manufacturing, nonwage employment in the informal sector absorbs most of this surplus population (Farsakh 2000). With the growing importance of self-employment and casual production relations, the dispositions of basic consciousness of the periphery stand in stark contrast to the civic privatism predominant in the core. Self-employment constitutes small-scale commodity producers and includes family farmers, shopkeepers, and artisans. It is based on the prospects of the self-employed to sustain profit, to invest to remain competitive through self-exploitation, and to buy inputs at a sufficiently low price. These relations are inherently precarious and operate with tight margins. If they were not, the self-employed would expand production and take on employees, and the relation would be transformed. The self-employed have a disposition toward antistatism, as taxes are a threat to their profit margins. But this outlook does not necessarily lead to radical individualism. To stabilize their market relations, the selfemployed have tended to organize cartels and marketing and credit societies. This combination of a rugged individualist self-image and a sense of confronting the threat of a bureaucratized world, combined with a compulsion to create self-defense organizations such as cartels, have at times “exploded into right wing populist movements” (Cox 1987, 53–55). The defining feature of casual work is that, in contrast to a case in which a formal or informal contract exists, earnings are based on one-off transactions that are not cumulative or continuous. In addition, the transactions are not encoded by formal authority and are therefore extralegal. This form encompasses a wide range of “employment” typically “scavenged” by urban marginals, such as shoe shining, car watching, domestic household

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work, hawking, and prostitution. Given the extralegal character of the activity, which creates a relationship of “violence and deception” in relation to “established society,” the casual laborer typically stands in a subordinate relation to a “protector” (such as a pimp). Alternatively, urban marginals form informal social security and mutual self-help networks that may be based on family, kinship, ethnicity, or religion. This protection ensures access to income-earning opportunities as well as access to the purchaser of services (Cox 1987, 44–48). While the nature of these social relations remains underresearched, Harrod argues that the evidence suggests these relations produce a disposition that oscillates between an extreme instrumentalism, driven by the compulsion to survive, and metaphysical or metapolitical forms of community, such as millenarianism and populism. The latter involves a “vague promise of future salvation from the existing conditions,” often associated with individual leaders and persons who “address themselves to the lowest status and poorest sections of society”: The vague and diffuse nature of the targets or causes of poverty in both millenarianism and populism corresponds to the fragmented nature of primitive labor market relations; the social relations of production do not precipitate a collective consciousness that is immediately directed towards redressing power within production or securing an immediate amelioration of conditions of work. The absence of an immediately identifiable target . . . and the socially fragmented way in which work is done prevents a continuous relationship of solidarity or companionship in the workplace. (Harrod 1987, 156)

According to Harrod, these relational characters combine with physical and psychological tendencies toward fatalism and anomie. These tendencies are related to squalid living conditions (including malnutrition, lack of sanitation, and disease), a sense of uprootedness, lack of belonging, unfamiliarity with values and social signs in new circumstances, as well as shame that comes from a perpetual servant position. It is not that urban marginals are passive victims; in their very struggle for survival they constantly have to show creativity. The fatalism rather pertains to their political disposition, and is related to the fragmented nature of their one-off social relations, which do not provide an easily identifiable enemy and target for plausible immediate improvement. In contrast, the metaphysical or metapolitical orientations of evangelical and millennial movements or populism provide a psychological palliative to their conditions. “They offer total, imminent, and collective salvation from the horrors of the existing world” as well as “a sense of identity, a touchstone for the psyche and a reason for living. . . . Significantly the elements of doctrines are usually a fierce rejection of the prevailing lifestyle of nonadherents, the damnation of established society, and exhortation to clean and uncorrupted living”(Harrod 1987, 160).5

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Conclusion: Ghosts Are Laid, Ghosts Arisen The premise of this chapter has been that the analysis of IPE as a field cannot be done adequately without grasping the fundamental power relations that characterize work and the lives of workers. But while work and workers remain largely invisible to the field, they nevertheless haunt the political and political economic processes that shape world order. At the same time, they are not an undifferentiated mass, subsumable under a singular class banner. There are multiple power relations in a given social formation, articulated into different patterns that change as conflict in and between these patterns shift them and the people affected by them. Changes in the patterns of power relations entail changes in the spatial distributions of power, changes in the basic consciousness of workers, and changes in the political possibilities at a given moment. Change in the world order has rightly been a central preoccupation for IPE. Change has come from multiple sources and multiple directions, from the impasses of the oil crisis and stagflation of the 1970s, to the embrace of the capitalist road in China, to the collapse of the Eastern bloc in 1989, to the perpetual debt crises and bubble economies of the 1980s, 1990s, and into the present moment. A more recent change is the Arab Spring initially seen as pro-Western, but which not surprisingly—given prevailing production relations engendering millennialist dispositions—has benefited political Islam. This chapter has shown how the reconfigurations of the patterns of power relations in production in the core, the semiperiphery, and the periphery have followed on the responses to and efforts to overcome these changes and crises. The approach we argue for here is rather distinct from other efforts to understand the changes that mark the present circumstances. On the one hand, unlike other critical approaches that have tried to look to the politics of the disenfranchised in the global order, such as global civil society studies, studies of the informal sector, or studies of the multitude, we have emphasized the importance of not relying on overaggregated, undifferentiated categories to which wished-for or feared attributes may be attached. On the other hand, we have avoided both the flat-earth tendencies of globalization studies (not limited to Thomas Friedman, it should be noted) and the ongoing failure to address the territorial trap (Agnew 1994) in international studies, a failure that characterizes both mainstream state-centric IPE and critical approaches such as world systems theory that deduce the politics of place from a territory’s position in the world order. Globalization and the twinned approaches of hegemonic stability theory and hegemonic shift take the stick by the wrong end. Rather than analyzing the politics that emerge from the power relations experienced in that most universal of human practices, work, they fix the political moment of IPE in the territorial configurations defined by interstate relations.

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We are not claiming that these latter are not relevant. As we have shown, the core, the semiperiphery, and the periphery continue to be characterized by particular configurations of production relations internally and in relation to the others. Rather, we have also shown that—as Cox argued in 1987, and as Frank (1969) and Galtung (1971) had argued even earlier—the core has its own cores and peripheries, and the periphery has cores and peripheries; moreover, these internal politics condition the articulation of the external relations, and these are all shaped by the patterns of power relations in production. Thus, in the capitalist core—the most highly integrated region in the global political economy through which the vast bulk of trade, circulation, and investment takes place—there are core enterprises with core workers who have increasingly found themselves dependent upon their employers in enterprise corporatist production relations and whose basic consciousness has tended to civic privatism and a withdrawal of support for and participation in the public. At the same time, the core has a growing periphery of workers in (and out of) enterprise labor relations where their increasingly precarious forms of employment have contributed to their embrace of populist and millenarian ideologies. Similarly in the periphery, the prevalence of casual labor markets and the decline of subsistence have also contributed to the growth of populist and millenarian movements. The spatial and political conflicts defining the post-1989 world have both been built upon the older conflict between core and periphery, on the decline of the patterns of production relations that promoted class identity and collective workers’ movements, and the rise of new specters of eternally dissatisfied consumers and diffuse targets for populist or millennial rage. Work and workers continue to suffer a spectral presence in the theories and practices of IPE. The power relations that govern the activities they must pursue for their survival and well-being, that organize the appropriation of their time and their products, that distribute them spatially, and that organize their basic consciousness remain both the practical basis of the field of IPE and relatively invisible to the field. The contours of contemporary international politics—especially the polarization between the managerialism of the dominant international social forces, the civic privatism of the workers of the core, and the populism and millenarianism of the workers of the periphery—will continue to be obscure as long as the power relations ordering the working lives of people remain outside the purview of the analyses of IPE. These new contours have led too many commentators to assume that the ghosts of Marx and Engels’s 1848 Manifesto have finally been laid to rest, but their broad dialectic remains the most apt method for illuminating the forces that shape the contemporary condition.

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Notes The authors gratefully acknowledge the thoughtful comments and criticisms of the anonymous referees and especially the care, thoroughness, and patience of Herman Schwartz and Alan Cafruny in the preparation of various drafts of this chaper. 1. Proxy indicators in Europe, the macroregion where tripartism is the strongest, include the across-the-board decrease of unionization rates, the turn to softer “numberless” framework agreements that give enterprises increased discretionary powers, and ultimately lower coverage rates (e.g., International Labor Organization 1998; Marginson and Schulten 1999; Cohaut and Schnabel 1999). 2. This authoritarian form of corporatism was pioneered in fascist attempts to control industrial development, but it was also typical of bureaucratic authoritarian state strategies of dependent development in the postwar era, which sought to incorporate strategically important segments of workers in the “modernized sectors.” This approach represents an extreme case of external bureaucratization, where official representatives of labor carry out direct coercive as well as doctrinal state functions vis-à-vis their membership. Peaceful labor relations are closely articulated with the national interest, and if unrest occurs it is generally brutally repressed. Little opportunity remains for the institutional forging of an organized, collective, industrial working-class consciousness. At the same time, employment in this form also provided a measure of social protection and security. A vivid indication of the decline of state corporatism is the dramatic percentage decrease of union membership between the mid-1980s and 1990s in states such as Argentina (–48), Colombia (–37), Mexico (–43), Uruguay (–41), and Egypt (–24) (International Labor Organization 1998). 3. One often neglected aspect of East Asian development is the extent to which self-exploitation in subsistence farming, providing a supplementary source for food, operates as a mechanism to suppress market wages and to provide a buffer when demand for labor is low (inter alia Barkin 1990 and Evans 1987). 4. Particularly striking is the emergence and marked increase over time of “not adequately described” types of activities and statistical residues in labor market statistics. These increased, for example, from 3 to 25 percent in Egypt during the 1960– 1999 period and 4 to 21 percent in Colombia (International Labor Organization 1990; 2000). 5. For the rise of millennialism in the form of Islamic fundamentalism and its link to the slums in the Middle East, see International Crisis Group (2004) on the case of the Mahdi Army in Iraq, and Belaala (2004) on the case of Morocco. A prolific literature on the rise of mainly Christian fundamentalism in the wake of globalization in Africa and Latin America emphasizes its role in responding to the condition of alienation and poverty of the slums. For a resourceful literature review, see Garrard-Brunett 2004. See also Peterson 2001; Corten and Marshall-Fratani 2001; Hopkins et al. 2001; Greenfield and Droogers 2001.

11 Why Does It Happen Again and Again? Anastasia Nesvetailova

In August 2007, problems of several financial institutions linked to subprime losses in the United States spurred a liquidity crisis in the international financial markets. Within days the perceived phenomenon of global excess liquidity turned into a problem of lack of liquidity. In the course of the year, as the real estate markets continued to fall, the crisis entered into its second phase—the global banking crisis, heralded by the collapse of several large institutions, including Lehman Brothers. By 2008 the financial crisis had become a global recession despite unprecedented government stimulus measures. At the time of writing, despite some isolated rallies in the financial markets, many analysts warn that the risk of a double-dip recession or even a depression (especially in the case of the United Kingdom) remains high. Unsurprisingly, given the scale of the collapse and the costs it imposed on the economies of the Anglo-Saxon world, observers chart parallels between the credit crunch of 2007–2009 and the Great Depression of the 1930s, evoking theoretical accounts of the crisis and its policy lessons drawn over time (e.g., Almunia et al. 2010; Grossman and Meissner 2010). Along with the specter of the Great Depression, the credit crunch has resurrected a major theorist from the obscurity of heterodox political economy. Hyman Minsky (1919–1996), an original scholar of financial instability and a skeptic of financialized capitalism, foresaw the danger of another Great Depression in advanced economies as early as the 1980s (1982; 1986). Pondering the significance of the institutional transformations in US finance—what he called “money-manager capitalism”—Minsky concluded that the presence of a Big Bank and Big Government can help avoid another major depression. At the same time, he argued that an economy where financial services are deregulated, and where financial institutions are able to embark on a spiral of financial innovation, creates a cumulative tendency toward financial fragility and crisis. This chapter analyzes the credit crunch as a crisis of financial innovation. While in its most immediate form the meltdown has become associated 195

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with the crisis of the securitization industry in finance, its long-term roots lie in the tendency of financial institutions to exploit unregulated financial spaces. Accordingly, the major lessons of the credit crunch can only be understood when placed in the historical context of the long-running tension between regulation and innovation. Engaging with the emergent theories of the credit crunch, this chapter draws out the historical and structural roots of private financial innovation. According to Minsky’s view of financial fragility, this tendency has historically been based on financial institutions’ ability to exploit unregulated spaces. Analyzing the current policy fallout from the credit crunch and regulatory reforms initiated in its wake, I conclude that while policymakers target the most recent practices and products of securitization, the logic behind the innovation and the regulatory space exploited through, and for, the advance of new financial practices are not being addressed by postcrisis reform measures. As a result, in the words of Hyman Minsky, “it”—another Great Depression—can happen again.

Theorizing the Credit Crunch A highly complex set of factors—historical, geopolitical, economic, social, and even cultural—that extend beyond the fiasco of the US subprime market caused the global credit crunch. Three major, broadly overlapping analyses of the credit crunch exist. First, structural explanations of the crisis interpret it as an outcome of deep-seated, worldwide imbalances (of savings, capital flows, markets and broadly, economic power). Here, the crisis is commonly explained as the problem of structural discord between the world’s savers (namely, East Asian exporters) and the world’s spenders (Anglo-Saxon economies). At the global macro level, the key mechanism of the crisis has been the large inflow of capital subsidy from the world’s exporting nations to the Anglo-Saxon economies relying on consumptiondriven growth (Schwartz 2009). In more contained analyses of structural rupture, the meltdown has been interpreted as a crisis of a particular stage of capitalism that had been dubbed “money-manager” capitalism, “debt capitalism,” or consumer-driven capitalism of the Anglo-Saxon type (Wade 2008; Gamble 2009; Gowan 2010). In this sense, the credit crunch is also the crisis of the democratized, or inclusive financialized capitalism that has been continually widened to encompass more sectors of society and has come to rely on the real estate market as a major source of expansion and profits (Dymski 2009). Indeed, housing bubbles were present not only across the Anglo-Saxon economies, but also in some European countries (Schwartz and Seabroke 2009). While the subprime sector dominated the headlines in the crisis, the impact of the

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crisis has been most pronounced in those economic systems where consumer credit generally, including housing credit, has replaced wage-led growth (Montgomerie 2009). The second group of crisis theorizations stresses its institutional dimensions. These readings tend to diagnose the credit crunch as a failure of a particular industry, market development, and policy practice. In the context of the financial system, the credit crunch is an outcome of the market practice of securitization, and more particularly, resecuritization. Securitization describes a long and complex chain of financial innovation, the essence of which is to convert previously untradeable and illiquid assets into liquid financial securities, by pricing them, valuing their risks, and creating a market for these securities. While the subprime market became a major segment of the expansion of securitization activity during the last decade, the process of securitization in general was fueled by the global rise of financial derivatives and related risk-optimizing techniques (Wigan 2010). These two developments in turn reinforced a profound change in the nature of the banking system, the shift toward the “originate and distribute” (ORD) model of banking. As Kregel (2010) explains, in this new type of financial system, banks no longer are constrained by deposit-making capacities and the so-called acceptance function.1 Instead, they are able to pool together a variety of assets, many of which are of very low credit quality and, by redistributing the risk of these assets off the books, to reduce the levels of risk in their portfolios. At least, this was the idea until the crisis broke out in August 2007. With regard to the foundations of economic policy, the global credit crunch represents a multiple failure of financial regulation. Theoretically, the dominant approach of light-touch regulation has been based on flawed assumptions of the efficient market theory of finance (EMT) (Soros 2008; Masters and Parker 2010). In practice, existing policy initiatives in the area of financial regulation were made impotent by the massive efforts of the financial lobby to liberate finance from intrusive oversight or regulation (Tett 2009). The third major group of emergent crisis theories can be summed up under the heading of behavioral explanations. In the framework of formal economics, these types of analyses emphasize the skewed structure of incentives in the financial industry that has produced a suboptimal outcome—namely, an inefficient price mechanism for allocating risk in the financial system. Outside the boundaries of economic orthodoxy, behavioral accounts emphasize the dominant role of the human factor, and more precisely, human failure, in precipitating and escalating the global crisis. Stressing the role of sheer incompetence, greed, and fraud, behavioral accounts of the crisis reveal the incompetence of senior management at individual financial institutions; unaccountable traders and salespeople who knowingly sold risky products to their customers; the financial space

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exploited by individual crooks of various calibers; the warnings about the risk of the coming malaise that were repeatedly dismissed or silenced; and finally, the untrained, unskilled, and not sufficiently savvy regulators, statespersons, and even academics who did not discern or were not sufficiently clued in to the real developments in finance (Lawson 2009; Nesvetailova 2010). The three sets of theoretical explanations are certainly not mutually exclusive. All three groups of theories would concur that the crisis came as the end of a (super)-bubble of financial excesses; all three, to a larger or lesser degree, note how overpowering the sense of success and the magic of easy money had been for the cast and the audience in the big financial spectacle of the 2002–2007 period. All three would also concur that the crisis centered on financial innovation. At the same time, however, the three schools of thought differ fundamentally in the explanatory emphasis they place on the collective and systemic factors of the crisis vis-à-vis its isolated mechanisms and idiosyncratic characteristics. At the heart of the controversy is the understanding of the political economy of financial innovation. Indeed, financial innovation proves to be a highly divisive issue in the analyses of modern political economy. According to mainstream economics and business studies, capitalism thrives on innovation; the invention of new products, advances in technology, new practices of management, and marketing ultimately promote competition, efficiency, growth, and hence prosperity. Financial innovation, similarly, by mobilizing the resources of the rest of the economy, advances economic growth and well-being. One needs to be a firm skeptic of the very essence of capitalism to doubt the benefits of financial innovation. Such a skeptic did exist. Hyman Minsky devoted his life to the study of financial instability in capitalism, but he did not live to witness the meltdown of 2007–2009. Yet the global credit crunch, commonly dubbed a “Minsky moment” in the world economy, or a crisis of Ponzi finance, has lifted his name from the relative obscurity of heterodox political economy to the very center of public debate about the crisis and its long-term lessons.

Financial Innovation and Stability “Stability is always destabilizing,” Minsky famously stated in his financial instability hypothesis. Amid the ostensible rehabilitation of his name, this message from his scholarship seems to inform most commentaries on the credit crunch. According to Minsky, good times breed complacency, exuberance, and optimism about one’s position in the market, which leads to heavier reliance on leverage and underestimation of risks. As follows from the brief survey of crisis theorizations presented above, most accounts of the credit crisis

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indeed concur that the crisis emerged from a boom (or bubble), which led economic agents to severely underestimate the risks they were taking on: The creation of new securities facilitated the large capital inflows from abroad. . . . The trend towards the “originate and distribute model” . . . ultimately led to a decline in lending standards. Financial innovation that had supposedly made the banking system more stable by transferring risk to those most able to bear it led to an unprecedented credit expansion that helped feed the boom in housing prices. (Brunnermeir 2009, 78)

At the same time, once we follow Minsky’s insight into the origins of financial fragility and his focus on the contentious place of innovation in the stability of a financialized economy, it appears that most scholarship uses only a selective version of Minsky’s theory of finance to read the global meltdown. Most mainstream analysts of the crisis note the risk-numbing effects of the general macroeconomic environment and investor expectations. But they overlook the core of Minsky’s framework, which is that the very ability of private financial intermediaries to stretch the frontier of private liquidity ultimately accentuates financial fragility in the system and thus magnifies the probability of a structural financial collapse and economic crisis. Minsky’s main theoretical framework, the financial instability hypothesis, is founded on the premise that financial instability is inherent in advanced capitalism, which in turn can take a variety of institutional forms. The main source of instability, according to Minsky, is a mode by which economic units raise their finance and, specifically, rely on debt as a source of cash flows. 2 Over the course of an economic cycle, he argued, the expanding web of debt-driven financial innovations produces a twofold effect on the system’s liquidity. On the one hand, as financial innovations gain ground, the velocity of credit increases. Yet on the other hand, Minsky warned, “Every institutional innovation which results in both new ways to finance business and new substitutes for cash decreases the liquidity of the economy” (Minsky 1984 [1982], 173). Most controversially, therefore, Minsky showed that the mechanism that spreads fragility and crisis throughout the system centers on the complex chain of liquidity-stretching financial innovations that appear to enhance liquidity; in fact, however, by replacing high-quality and more reliable assets, such as state-backed money, with privately created financial instruments, the financial system becomes progressively illiquid. Therefore while at first cut the global crisis is just an inevitable collapse of a super-bubble of credit, a Minskyan focus on the process of financial innovation and its effects on systemic liquidity reveals that the crisis of 2007–2009 has deep structural roots. One element of the historical significance of the credit crunch lies in the fact that it became the first systemic rupture of risk-trading capitalism (Bernstein 1996; Shiller 2004). The ability to locate, price, and then shift

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risk from one’s books has been the engine of the securitization industry, including the subprime mortgage market. The key to financial institutions’ ability to shift risky products to other parts of the financial system, in turn, lay in their newfound control over risk and ability to create liquidity. “There was this sense that we had found this fantastic technology which we really believed in and we wanted to take to every part of the market we could” (Bill Winters, one of the senior officers behind the creation of a credit derivative at JP Morgan; cited in Tett 2009, 6). The very essence of financial innovation and securitization more narrowly was to transform inherently illiquid assets into liquid securities. For a while, the alchemy seemed to have worked wonderfully: banks reaped more and more profits because they were able to remove credit risk from their books; customers and clients were happy as they felt better off; credit ratings agencies, while occasionally suspicious, were glad to charge high fees for their stamps of approval; politicians were content as they gained on the political benefits of the economic boom. The continually expanding frontier of liquid assets, as well as talks about a global liquidity glut (Bernanke 2005) or excess liquidity during 2002–2007, only reinforced the idea that financial innovation creates liquidity, and therefore, wealth. At first cut, the subsequent burst of the bubble is simply the unraveling of a grandiose illusion of wealth and liquidity (Nesvetailova 2010). At the same time, the function and performance of liquidity—long a confusing subject in political economy and financial theory (Langley 2010)—leads us to focus on the role of financial innovation in precipitating the crisis. In this instance, the mechanics of the rupture are best understood in a twofold way. First, technically, the credit crunch is a crisis of the industry of securitization, and more specifically, the practice of resecuritization.3 The credit crunch was propelled by the advances in scientific finance, the advance of credit derivatives, and crucially, the belief that sophisticated techniques of parceling debts, creating new products, arranging structured deals, and opening up new markets create additional and plentiful liquidity. In reality, the proliferation of obscure techniques of valuing risk and even more obscure financial securities have driven the financial system into a structurally illiquid, and crisis-prone, state. At the level of the financial system, securitization has produced an incredibly complex and opaque hierarchy of credit instruments, whose liquidity was assumed but in fact never guaranteed. Once the market process of valuing these products malfunctioned—as inevitably it would have, given the size and nature of the subprime mortgage market—the continuity of the practice of securitization and resecuritization was jeopardized. The second impact of financial innovation in the crisis is more longterm. Indeed, innovations in the financial markets rarely emerge out of the blue. Although comparatively less costly and more fungible than inventions

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in other areas of business (such as automobile manufacturing, for instance), modern financial products require analytical and technical effort, as well as institutional support and a receptive market environment. Most importantly, however, financial innovations are introduced for a reason: They help financial institutions gain profits by circumventing existing barriers on profitmaking. These barriers, in most cases, tend to arise out of the introduction of official regulations and rules. In this sense, the credit crunch is a culmination of a series of consequences of introducing the Basel accord of banking regulation, the essence of which was to establish the concept of riskweighted capital requirements for banks. The introduction of the concept of risk-weighted capital, in turn, gave banking institutions the motive and the means to start searching for ways to redistribute the official amount of risk held on their books. The tension between regulation and financial innovation, often manifested in an ensuing crisis, has marked financial capitalism throughout its evolution during the twentieth century. In this reading, the foundations of contemporary finance can be traced back to the depression of the 1930s, and the policy reaction to it. The banking crisis of the 1930s centered on the banks’ involvement in the business of securities underwriting, which was further aggravated by the underlying structure of the US banking system at the time.4 In drafting their response to the crisis, the US Congress aimed to curb the scope for speculative activities by commercial banks. The GlassSteagall Act, enacted in 1933, aimed to restore the integrity and safety of banks by legally separating the business of commercial banking from other types of financial institutions (Kregel 2010). The act was implemented into a system that historically had been characterized by a tendency toward concentration of market power (Palan et al. 2010). Operating in this environment, and facing legal restrictions on business, US financial institutions have always been driven by the search for new ways to conduct business and gain profits. According to Kregel (2010), this structural conflict between the legislatively defined regulatory space of commercial banking and the real operating realm of other types of financial institutions eventually eroded the logic behind the 1933 Glass-Steagall Act. As Kregel explains, the New Deal legislation was built around the concept of narrow banking. Namely, the Glass-Steagall Act designated the member banks of the Federal Reserve that would provide transactions deposits to the public, backed by deposit insurance and required reserves, and lend funds to businesses on a short-term basis. In reality, however, the formal legislation of 1933, by separating commercial from investment banking, left a large area of liquidity-providing financial techniques unregulated. Over time, nonmember banks found ways and techniques of providing liquidity without having to conform to the formal restrictions of GlassSteagall. As a result, once investment banks could provide liquidity-creating

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services more cheaply than regulated banks, the business model of commercial banking became untenable, and with it, the logic of the Glass-Steagall separation of commercial and investment banking. Therefore, the major reason for the eventual failure of the 1933 act was its focus on the protection of customer deposits of currency and not on the liquidity-creating functions of financial institutions (Kregel 2010). Innovations in the international financial markets led to further transformations in the structure of the US banking model, thereby eroding the effect of official regulatory measures. In the late 1950s, just as the Euromarket was emerging in London, US banks were straining against existing US regulations. During that period, US multinationals began to expand international operations, and US banks had difficulties servicing their large corporate clients. 5 Once they discovered the facility of the Euromarket, corporate clients began to bypass the banks and tap directly into the Euromarket to earn higher rates of interest (Burn 2006; Sylla 2002). Gradually, US banks also learned that the unregulated environment of London allowed them (or their London branches) to circumvent all the New Deal regulations. They were able, therefore, to establish large diversified banks in the City of London, capable of competing in every aspect of finance. German and Japanese banks then followed suit (Palan et al. 2010). Thus, both in the context of the US financial system and in the international realm, securitization has been the banking sector’s reaction to the imposition of institutional, liquidity, capital, leverage, or product restrictions. According to Victoria Chick, for instance, the experience of the first Basel accord—a first major attempt at international banking regulation— illustrates the law of unintended consequences. Regulations intended to strengthen the balance sheets of banks by weighting assets on the basis of their riskiness (thus rewarding the holding of safe assets) actually drove risky assets off the balance sheet. As a result of the introduction of the Basel rules, securitization was undertaken not just as a small part of bank operations when banks needed liquidity but on such a scale as to change the whole manner in which banks operate (Chick 2008). Plainly, the Basel requirements made it unprofitable for banks to hold safe and liquid assets on their balance sheets (Wigan 2009). Unsurprisingly, banks reacted to the new regulations by accelerating leverage, exploiting their capacity to move assets off-balance-sheet by selling them off. In practical terms, then, securitization meant that risky (but profitable) assets were removed from the balance sheets of banks into the unregulated realm of the financial system. This shift, in turn, has redefined the very essence of banking. Under the new type of banking known as the ORD model, “The loans are aggregated and transformed into ersatz fixed-term capital market assets that are

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sold to a variety of private sector final investors who are the ultimate lenders. It is the widows and orphans who own the loans; the banks only serve as intermediaries in this process” (Kregel 2010, 5). Crucially, from the point of view of financial fragility, the banker today has no motivation to conduct proper credit evaluation, simply because the interest and principal on the loans originated will be repaid not to the bank itself, but to the final buyers of the collateralized assets. In the words of Robert Wade, banks and hedge funds became careless because they were acting as intermediaries, not as principals (Wade 2008), thus propagating the risk around the financial system. The adoption of the ORD model of risk-trading has underpinned a phenomenal rise in commission fees and income from capital-market-related activities for banks. These transformations of the banking system in turn have had their own, ultimately destructive repercussions for the stability of the financial system as a whole, which were mainly transmitted through their impact on liquidity. As Minsky foresaw, “To the extent that either the most liquid assets leave the banking system for the portfolios of other financial institutions or the debts of the newly grown and developed financial institutions enter the portfolios of banks, the liquidity of the banking system declines” (Minsky 1984, 174). Kregel recently identified two key mechanisms of this process: the fusion of the banking and financing function; and the process of financial layering (Kregel 2010). Both mechanisms reveal the fundamental problem with securitization: it allows financial layering based on the financial institutions’ capacity to exploit unregulated spaces. Although complex techniques for creating and marketing new securities do create the appearance of greater liquidity in the financial system, in reality the process of financial innovation has made the financial system fragile and prone to collapse. Once the liquidity boom that sustained markets and economies during the 2002–2007 period unraveled, a global crisis started to unfold. The ensuing credit crunch exposed sophisticated AAA-rated securities as toxic assets. It also brought to the surface a disturbing amount of evidence of incompetence, greed, and fraud at all major levels of the international financial system. Fundamentally, as Goldin and Vogel put it, the financial crisis was “a systemic risk that began with the advent of an unregulated subprime mortgage market in the United States, which ultimately destabilized the market for credit default swaps, collapsed markets for securitized instruments across global financial systems and triggered a global liquidity crisis” (2010, 8). In other words, therefore, while securitization has conventionally been defined as the technique of transforming illiquid assets into liquid securities, the crisis exposed the practice of securitization as a process that propagated systemic risks throughout the economy.

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Taming Financial Innovation . . . Yet Again Most of the earlier outbreaks of financial crisis have led to some type of rethinking of financial regulation principles. The crisis of the 1930s gave rise to New Deal regulations, which, as was noted above, were gradually crowded out by the progress of financial innovation. The crises of the 1970s led to the demise of the system of fixed exchange rates; the debt crisis of the 1980s produced the Basel Accord and the idea of the Washington Consensus, while the crises of the late 1990s initiated a series of ultimately futile debates about designing a new international financial architecture (NIFA) (Crotty 2009; Toporowski 2009). Against the somewhat meager record of earlier policy moves in the area of global financial stability, the credit crunch of 2007–2009 has launched the most profound and far-reaching discussion and policy reform in finance since the 1930s. As this chapter goes to press, many of the most significant changes to the world financial architecture included in the so-called Basel III Accord are being finalized. Continuing national as well as international disputes over the new set of norms make it difficult to comment definitively on the concrete outcomes of the reform proposals. However, three key areas of new regulatory scope can already be identified: the products and techniques of financial innovation, the rewards and profits of the financial sector, and the structure of the banking system per se. While all three areas of policy focus stem from the recognition that the self-regulating market mechanism of regulation did not deliver, disagreements over specific steps of action derive from political differences over how radical the policy response to the crisis should be, and to what extent the banking and investment model of the late twentieth century should be overhauled. Regulating the Products of Financial Innovation The first major area of new regulatory focus concerns the products of private financial innovation. The postcrisis reform measures, both in the European Union and in the United States, aim to address those areas of financial practice that the precrisis regulation had ignored. Major plans here include new controls over credit ratings agencies (such as licensing, registration, and widening the competition in the industry), establishing organized exchanges for derivatives trading (in order to make these types of trade standardized and transparent), new restrictions for the previously unregulated hedge fund industry (these include registration and publication of previously uncollected data on positions), and greater scrutiny of offshore financial havens. If implemented fully and internationally, this set of measures would mark a departure from the principles of light-touch regulation, which were

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based on the notion that private authority is the most efficient regulator of the market mechanism. At the same time, analysts have already identified the differential effect of the new regulations on the financial markets. For instance, while the move to standardize derivatives is intended to generate greater transparency in these complex and obscure instruments, the move is also likely to impose higher costs on corporate clients who use derivatives for hedging. As a consequence of the new restrictions, profit margins in derivatives will shrink, and globally operating banks could shift some trading from the United States to the European Union. The new rules requiring hedge funds to register and provide more data about their investment activities are expected to make this area of business harder for US managers operating in Europe. The American side of the reform measures exempts private equity and venture capital. The EU on the other hand, wants to go much further by including private equity and requiring third-country funds and managers to abide by strict requirements if they want to solicit European investors. As a result of the new rules, US managers will find the European regulatory environment too restrictive, and some of the hedge fund activity is likely to leave the EU regulatory space for looser niches, such as Switzerland. If all the planned reforms of the hedge funds materialize, it will also be difficult for private asset managers to continue their business in the City of London. Disciplining the Financial Industry The second major area of new regulatory norms is based around the idea of reining in the financial excesses of the boom years. The underlying principle here is to reduce the social costs of a financial crisis in the future, and specifically, to avoid using taxpayer funds when rescuing financial institutions. To these ends, new rules target the incentive structure in the banking industry. Specifically, various restrictions on bonuses and remunerations across the financial system are being introduced, and a number of proposals for orderly bankruptcy procedures in the banking sector are being institutionalized. In both the United States and the European Union, new consumer protection agencies are being set up.6 The area where new regulations have come closest to the idea of preserving the socially usefully function of banking is in new restrictions on banks’ proprietary trading. The so-called Volcker rule adopted by the US Senate in 2010 prohibits risky trading unrelated to customers’ needs at deposit-insured banks. At the same time, however, the principle is unlikely to be adopted in the European Union, as key European states would want to preserve their universal banking model. As a result, over time, some trading could switch to the European Union from the United States inside global banks. Moreover, the new rules do not accommodate the possibility that

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banking groups would simply rename their proprietary desks and continue their earlier practice of portfolio trading through risk arbitrage. Overall, it is unlikely that newly introduced restrictions on remuneration would have a significant effect on the overall level of profits for the banking system in the future. Reforming the Banking System: New Standards of Behavior The third area of reform measures concerns the nature and function of the banking system per se. Here, although the ORD model of banking remains the foundation of the new architecture (Knight 2008), new behavioral standards are being introduced for the banking industry and for regulatory institutions. First, at the level of the banking system, the so-called Basel III Accord identifies new and tighter capital, liquidity, and leverage ratios for banks (alongside other measures), while the focus on systemic risk in the financial system has led regulators to proceed with their earlier (unsuccessful) attempts to formulate a macro-prudential framework of financial governance (Cechetti 2010). The essence of the new framework lies in a continuing exercise of testing the resilience of the banking system, and complementing the micro-prudential principles of the Basel Accords (I and II) with a national set of policy instruments adapted to national macroeconomic context (Boyer 2009). In the European Union, the focus on systemic risk regulation, while according to many critics conceptually underdeveloped, led to consolidation of regulatory powers in one single institution, the systemic risk council, headed by the ECB president. Comprising the EU’s central bankers, the pan-European body will issue warnings and recommendations when it detects major financial danger ahead, and follow up by asking member states to take appropriate steps at the national level. In the United States, the new set of regulatory institutions include the Financial Stability Oversight Council and a new early resolution authority. The move is designed to prevent a repetition of the market shock from Lehman Brothers’ bankruptcy and end implicit government guarantees that reduce funding costs for banks deemed too big to fail (Braithwaite 2010). Critics have noted that instead of consolidating the task of financial supervision in one single institution, the Dodd-Frank Act has maintained the extremely fragmented nature of financial regulation in the United States. As a result, by leaving many of the more special details vague, the bill also leaves scope for financial institutions to exploit. As mentioned above, most of the proposals are yet to be finalized and put into implementation. Indeed, the new norms of Basel III are not to be fully implemented until 2018. Many of the new restrictions and controls

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have met with severe opposition from the banking industry and are likely to be, or have already been, softened in the final version. Indeed, even the radical Dodd-Frank Act of 2010 has left many loose ends in the new design of the regulatory system, which, critics note, will provide plenty of opportunities for regulatory arbitrage and avoidance (Crook 2010). All three areas of reform proposals fall within the general paradigm of fine-tuning the products, institutions, and functions of financial innovation. Although seemingly radical in tone, none of the new measures is set to overhaul the foundations of the contemporary banking industry, where banks act as risk arbitragers rather than providers of credit (Kregel 2010). While critical of some of the recent products of financial innovation, neither does the new framework challenge the very notion that financial innovation spurs economic growth. Critics have also argued that without a proper conceptual insight into the nature of systemic risk in finance today, the new macro-prudential approach is likely to be, at best, inefficient. Against the background of the official policy reaction to the crisis, calls for a return to traditional values in banking and a more conservative style of banking are being heard, from inside and outside the banking industry (Cameron et al. 2010). Among the most common alternative proposals is the idea of separating the socially useful side of banking (i.e., commercial banking) from the casino or gambling side of finance (investment banking) (King 2009). Here, commentators draw parallels with the 1933 GlassSteagall Act, and even envisage a new Bretton Woods system of international financial governance (e.g., Vercelli 2010). Amid the public anger about the exigencies of bankers and the social costs of the credit crunch, it is perhaps natural to romanticize the so-called golden age of capitalism and the Keynesian welfare state. There are indeed important historical parallels between the 1930s crisis and the credit crunch of 2007–2009, both of which were triggered by a collapse of the financial market, were magnified by bank failures, and spread internationally (Almunia et al. 2010). In reality, however, financial innovation has unleashed irreversible changes in the structure of banking and finance that have made the financial system of today vastly different than in the economy of the 1930s and 1940s. The rise of the capital markets has meant that, today, the commercial banking functions and investment banking functions have become fused, since short-term commercial lending is conducted through capital markets. In this context, a return to a Glass-Steagall separation of commercial banking and investment finance would be “extremely difficult, if not impossible” (Kregel 2010, 16). According to Kregel (2010), asset securitization challenged the core idea behind the 1933 act. Under the act, lending, and hence profits, of deposit-taking banks were restricted by the requirement that the bank has liquidity equal to that of currency issued by the Fed. In contrast, in a securi-

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tized lending structure, liquidity is created on the balance sheet of a separate institution (technically a trust or a special-purpose entity or vehicle) that, by the magic of financial alchemy and regulatory manipulation, appears to create liquidity out of illiquid assets (Kregel 2010). The new financial architecture needs to address this control over shadow liquidity. While governments made some tentative steps to address this shadow side of contemporary finance and increase transparency in the wake of the 2007–2009 crisis, critics have noted that the most obvious regulatory steps that have bred opacity in the financial system—such as Section 8 of the National Bank Act of 1863, which allows a very liberal interpretation of the concept of banking—are not being reversed (Kregel 2010). Furthermore, while the focus of the regulatory oversight seems to be deeper and more technical in scope, it remains confined to the old formula: regulation is focused on financial institutions rather than the functions they perform. As a result, important areas with potential for regulatory avoidance are being left outside, yet again, the new set of regulations. The real sources of credit, liquidity, and systemic risk therefore remain unaddressed in the financial system, a large part of which, despite the recently pronounced moves toward transparency, remains in the shadows.

Conclusion What effects are these changes likely to have upon the topography of the global financial system? As this chapter has shown, regulation will not significantly affect the size and nature of global banks. Current regulation still leaves too much space open for regulatory arbitrage and avoidance internationally, given the vague detail characterizing many regulatory measures and their implementation. The most pronounced effect of new measures will be felt through higher costs for consumers and investors, and will probably make certain areas of financial trade more competitive. In this environment, the weaker and smaller banks will suffer from competition from larger structures that are able to raise new capital more easily. At the same time, given that a large part of banking activity in recent decades has focused on performing risk arbitrage in the financial markets (rather than lending services to the real economy, as noted above), it is unlikely that new restrictions on capital and liquidity per se will seriously jeopardize economic growth. Can the new set of regulatory principles suffice in preventing a contagious financial crisis in the future? Most likely not. What is quite possible is that the new regulation of the products of securitization will limit the market for these assets; perhaps the policy will even succeed in helping diagnose a potential problem at an individual bank. However, in light of the analysis presented above, the potential for a systemic financial crisis on a global scale has not been eradicated.

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The fundamental reason for this continuing risk is that the regulations initiated in light of the credit crunch, like most earlier attempts at financial regulation, merely target some of the repercussions and specific practices of financial innovation, rather than the structural logic and institutional environment facilitating it. As a result, the regulatory, judicial, and financial space that gives rise to various forms of financial innovation remains unaddressed by the current reform plans. Specifically, critics have noted that regulatory progress to date has focused on raising market risk capital charges, reducing the possibility of resecuritization, and increasing oversight of portfolio risk in individual banks. Conceptually, the new reform proposals ignore the issue of interbank relationships and leave banks’ internal ratings and proprietary risk assessment models intact (Goldin and Vogel 2010). On the whole, critics argue, the Basel Committee reforms could exacerbate the probability of systemic risk in the future (Acharya 2009, in Goldin and Vogel 2010). A paradox of the global credit crunch is that, on the one hand, it has launched the most radical reform of the world financial regulation since the 1930s. Notwithstanding the critique outlined above, new measures targeting banks’ trading in derivatives, new restrictions imposed on the credit rating agencies, and new controls on the hedge fund industry would have been inconceivable had the crisis of 2007–2009 not exposed the failure of the privately regulated financial system. On the other hand, however, the cumulative change that private financial innovation has produced in the world of finance since the 1930s is simply too gigantic to be resolved by a new, however refined set of policies and rules. Control over the products of this complex process—the largely invisible yet highly significant industry of risk arbitrage—would require a new conceptual approach to understanding systemic risk in finance and banking, as well as a different understanding of the role of finance in the system of political economy.

Notes I gratefully acknowledge the support of the Leverhulme Trust Study Abroad Fellowship on the basis of which the research work on this chapter was completed. I am also grateful to the editors of this volume, as well as to Victoria Chick, Jan Toporowski, and Ronen Palan, for constructive discussions and comments on an earlier version of the chapter. 1. Receipt of public deposits and the creation of liquidity by commercial banks. 2. Minsky distinguished between hedge, speculative, and Ponzi modes of financing. Each stage represents a more aggressive (and thus unsafe) mode of relying on borrowed funds to finance one’s outstanding obligations. 3. Securitization is a process through which an issuer creates a financial instrument by combining different types of financial assets and then marketing different tiers of the repackaged instruments to investors. Mortgage-based securities are a typical example of securitization. By combining mortgages into one large pool, the issuer divides the large pool into smaller pieces based on each indi-

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vidual mortgage’s inherent risk of default and then sells those smaller pieces to investors. 4. First, a general loss of confidence in financial institutions, primarily commercial banks, and the widespread insolvency of debtors. Second, financial panics that magnified the vulnerability of the banking system, which was dominated by small, poorly integrated banks, whose financing structure made the system prone to bank runs (Bernanke 1983). 5. On the one hand, they could not lend to any one customer more than 10 percent of their capital. On the other, under Regulation Q, they could not offer multinational firms the same rate of return on deposits as banks operating in the Euromarket. 6. In the United States, the Consumer Financial Protection Bureau would be set up inside the Federal Reserve, but with complete independence from the central bank. It would tackle abusive mis-selling of mortgages, credit cards, and other loan products. In the European Union, a series of legal changes proposed by the European Commission will enhance the consumer protection (for bank account holders and retail investors) maintained by the existing directives on deposit guarantee schemes and investor compensation schemes.

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The Contributors

Alan W. Cafruny is Henry Platt Bristol Professor of International Affairs at Hamilton College. His research focuses on international political economy and European politics. His most recent book is Europe at Bay: In the Shadow of US Hegemony (2007, coauthored with Magnus Ryner). Ariane Chebel d’Appollonia is associate professor at Rutgers–State University of New Jersey. She is also senior researcher affiliated with the CEVIPOF (Center for Political Research, Sciences Po Paris). Her most recent publications include Les Frontières du Racisme (2011), and Frontiers of Fears: Immigration and Insecurity in the United States and Europe (2012). Matt Davies lectures in international political economy at Newcastle University. He is the author of various articles and chapters on work and culture, including, “‘You Can’t Charge Innocent People for Saving Their Lives!’ Work in Buffy the Vampire Slayer,” International Political Sociology 4, no. 2 (2010); and Poverty and the Production of World Politics: Unprotected Workers in the Global Political Economy, coedited with Magnus Ryner. Maria N. Ivanova teaches political economy at the University of Kassel,

Germany. Her main research interests include money and finance, radical social theory, political economy of the United States, and international political economy. Her most recent publications include “Marx, Minsky, and the Great Recession,” Review of Radical Political Economics (2012); “Money, Housing, and World Market: The Dialectic of Globalised Production,” Cambridge Journal of Economics 35, no. 5 (2011); and “The Dollar as World Money,” Science & Society (2012).

247

248

The Contributors

Peter Kingstone is professor and coordinator of the Program on Emerging Markets at King’s College London. He is author of The Political Economy of Latin America: Reflections on Neoliberalism and Development (2010) and coeditor with Deborah Yashar of The Handbook of Latin American Politics (2012). He has published work on Latin American political economy in journals such as Latin American Politics and Society, World Development, and Political Research Quarterly, as well as policy journals such as World Politics Review and Americas Quarterly. Timothy Lehmann is assistant professor of government at Hamilton

College. His publications include articles and book chapters on the Iraq War, the failure of the League of Nations, and contemporary US-China energy relations. His work has appeared in Security Studies, Global War Studies, and the New Left Review, as well as in edited volumes on the financial crisis and the Iraq War. R. Taggart Murphy is professor and chair of the MBA Program in International Business at the Tokyo Campus of the University of Tsukuba. The author of the Weight of the Yen (1996) and, with Akio Mikuni, of Japan’s Policy Trap (2002), he has written for such publications as the New Left Review, the Socialist Register, the London Review of Books, the New Republic, Harvard Business Review, Fortune, the National Interest, and the New York Times. He is a coordinator of Asia Pacific Journal: Japan Focus. Anastasia Nesvetailova is reader in international political economy at City University London. She is the author of Fragile Finance: Debt, Speculation and Crisis in the Age of Global Credit (2007) and Financial Alchemy in Crisis: The Great Liquidity Illusion (2010).

Magnus Ryner is reader in international political economy, King’s College London. His publications include Capitalist Restructuring: Globalisation and the Third Way (2002), and Poverty and the Production of World Politics (coedited with Matt Davies) (2006). Herman M. Schwartz is professor, Politics Department, University of Virginia, and author of In the Dominions of Debt, States Versus Markets and, most recently, Subprime Nation: American Power, Global Capital and the Housing Bubble. He also co-edited books on Denmark’s welfare state, OECD employment policy, and the politics of the recent housing bubbles, and has published over forty other articles and chapters. www.people .virginia.edu/~hms2f.

The Contributors

249

Leila Simona Talani is reader (associate professor) in international political

economy at King’s College London. She earned a PhD in international political economy with distinction at the European University Institute and has worked at the LSE, UCLA, and University of Bath. She is author of various books, among which are Globalisation, Hegemony, and the Future of the City of London (2012), The Arab Spring in the Global Political Economy (Palgrave, forthcoming), and From Egypt to Europe (2010). Hubert Zimmermann is professor of international relations at Philipps

University, Marburg, Germany. He is author and editor of books and articles dealing with global economic relations and European politics, most recently, with A. Duer, Key Controversies in European Integration (2012).

Index

ABM. See Antiballistic missile Acceptance function, 196 Acción Democrática (AD), in Venezuela, 82 Account deficits, 20, 27, 44–45, 72, 96; of US, 15, 16, 35–36, 154 Accounting, in Japan, 49 Acheson, Dean, 136 Achnacarry cartel, 135 ACS. See American Community Survey AD. See Acción Democrática Addax Petroleum, 142 Afghanistan, 38 Africa, 91–92, 141, 188 Agriculture, 188 AIG, 1 Akio Mikuni, 58 Alianza Bolivariana para las Américas (ALBA), in Venezuela, 82 Alperin, María Noel Pi, 74 American Community Survey (ACS), 93 Ameriquest, 171 Anchor currency role, 153 Andrews, David, 153 Anglo-Japanese Alliance, 41 Antiballistic missile (ABM), 31 Arab Spring, 3 Aramco, 130 Argentina, 69, 73, 74, 86n5 Asian Flu, 63, 66 Austerity, 6, 7, 14, 19, 26; civic privatism and, 186–187; neoliberalism and, 30, 32 Austria, 2, 24 Automobiles, 15, 138, 169 Autonomy, 20, 32, 121, 143, 153–155

Bailouts, 25, 28 Baker Plan, 187 Balance of Payments Statistics Yearbook, by IMF, 88 Baldridge, Malcolm, 138 Bangladesh, 94, 95 Banks, 197; in Brazil, 79; in China, 120; in Europe, 22–23, 202, 206; in Great Depression, 201; in Latin America, 72; reforms for, 206–208; regulation of, 172, 202–203; subprime mortgages by, 172; in US, 201. See also specific banks Bank of America, 3, 17 Bank of Japan, 58 Basel Accords, 204, 206–207 BASF, 30 Bergsten, C. Fred, 35 Bernanke, Ben, 174 Bin Laden, Osama, 52 Biofuels, 142 BNDES. See Brazilian National Bank for Economic and Social Development Bolsa Família (Family Stipend), in Brazil, 74, 81 Bond markets, 25, 68, 160–161; in Greece, 158, 158fig; in Hungary, 159, 159fig. See also Eurobonds; Treasury bonds, US Brazil, 61–62; Bolsa Família in, 74, 81; exports from, 69, 75; growth in, 68, 73, 78–81; inequality in, 81; oil and, 69; PAC in, 73–74, 80; subcontractors in, 187; trade wars with, 3 Brazil, Russia, India, and China (BRICS), 6

251

252

Index

Brazilian National Bank for Economic and Social Development (BNDES), 80 Bretton Woods system, 4–5, 37, 59, 207; collapse of, 6, 15, 18; exchange rates and, 127; US and, 15 Bretton Woods II, 6, 37–39, 45, 156 BRICS. See Brazil, Russia, India, and China British Petroleum, 130 Brzezinski, Zbigniew, 133–134 Budget deficits. See Account deficits Buffett, Warren, 35 Bush, George H.W., 35, 155 Bush, George W., 16, 35, 46, 52, 140; Iraq War and, 132–133 Caldera, Rafael, 83 CAP. See Common Agricultural Policy Capacity utilization, 2, 15 Capital: China and, 118; EMU and, 19; Fordist model and, 183; labor and, 9; outsourcing and, 176; trilemma and, 121 Capital gains, 152, 162n8 “Capital switching,” 169–170 Capitalism, 198–203; in Japan, 46; Keynesian model and, 7; in Latin America, 63; in US, 152. See also specific types Cardoso, Fernando Henrique, 78 Carr, E.H., 182 Carson, Johnnie, 141 Carter, Jimmy, 16 Case-Shiller 20-City Composite Index, 175 Casual work, 189–190 CCTs. See Conditional cash transfers CEE. See Central and Eastern Europe Census Bureau, US, 93, 170 Central and Eastern Europe (CEE), 27. See also specific countries Chávez, Hugo, 61, 67, 81–84 Cheney, Dick, 126 Chevron, 144 Chick, Victoria, 202 Chile, 3, 68, 73; budget surplus in, 72; exports from, 69, 75 China, 3; Africa and, 141; automobiles and, 138; banks in, 120; bond markets and, 160; Bretton Woods II and, 38–39; Bush, G.W., and, 52, 140;

capital and, 118; dollar and, 7, 8, 37, 51–54; euro and, 58–59; exports by, 8, 50, 54, 114–115, 128; FDI by, 53; Germany and, 21, 31, 160; globalization and, 6; growth cycle of, 113– 116, 113fig; inflation in, 120; interest rates in, 116; Iran and, 140; Iraq and, 132–133; Japan and, 51, 125, 137; Latin America and, 7–8, 69– 71, 76; liquidity and, 115–116; manufacturing in, 118; Marxism and, 52; Middle East and, 129; natural resources and, 8; oil and, 121, 125– 144; remittances to, 90; renminbi of, 54–55, 58, 115, 116; Saudi Arabia and, 140; stimulus programs in, 2; subcontractors in, 187; trade surplus of, 8, 112, 121, 122; US and, 3, 7, 8, 107–124, 109fig, 125–144; yuan of, 54–55, 115fig, 129 China National Oil Corporation, 129 “Chinese Professor” (video), 108 Christian Democratic Party (COPEI), in Venezuela, 82 Christian fundamentalism, 193n5 Chrysler, 1 Citigroup, 17 Citizens Against Government Waste, 108 Civic privatism, 184–187, 192 Clinton, Bill, 16, 35, 132, 155 Clinton, Hillary, 141 Cohen, B., 153 Cold War, 183 Colombia, 69, 72 Commodities, Latin America and, 69–71 Common Agricultural Policy (CAP), in France, 18 Communist Manifesto (Marx), 179–180, 181, 182 “Communities in struggle,” 185 Community Reinvestment Act (CRA), 170–171 “Competitive austerity,” 19 “Comprehensive concept of control,” 29 Conditional cash transfers (CCTs), 74 Connelly, John, 154 Conservatives, debt spending and, 174, 175 Consumer Financial Protection Bureau, in Federal Reserve, 210n6 Consumer-driven capitalism, 196

Index Consumerism, 128; decline of, 176; in US, 165–177 COPEI. See Christian Democratic Party Corporations, 17, 20, 22, 50, 56, 187; authoritarian form of, 193n2; currency options and, 86n4; working class and, 184 Corrales, Javier, 83–84 Countrywide, 171 Cox, Robert, 181, 183 CRA. See Community Reinvestment Act Credit creation, 9, 18 Credit crunch, 196–198 Credit-Anstalt, in Austria, 2 Croatia, 27 Currency: anchor currency role, 153; autonomy and, 20, 153–155; devaluations of, 2, 21, 24; distributive and political benefits of, 149–150; EMU and, 24; for exports, 2; Germany and, 149; international, 150–153, 151fig, 169; IPE and, 147; Japan and, 149; Latin America and, 63, 70; liquidity and, 160; options, 86n4; vehicle, 151–153. See also Exchange rates; specific currencies Daniels, Joseph, 135 Debs, Eugene, 35 Debt: consumerism and, 177; in US, 7 “Debt capitalism,” 196 Debt service payments, 27, 65, 71 Debt spending, 174, 175 Decennial Surveys, 170 “Deficits without tears,” 37 DEI. See Dutch East Indies Demint, Jim, 109 Democratic Party of Japan (DPJ), 55–56 Deng Xiaoping, 53 Depository Institutions Deregulation and Monetary Control Act, 171 Deregulation, 6, 13, 14, 16, 184; of hedge funds, 204; subprime mortgages and, 172; in US, 6, 118–119 Derivatives trading, 9, 197, 200, 204 Deutsche Bank, 22 Deutsche mark, 28 Disinflation, 112 Division of labor, 166 Dodd-Frank Act, 206–207 Dollar, 129; Brazil and, 78–79; China and, 7, 8, 37, 51–54; East Asia and,

253

35–60; EMU and, 154; euro and, 8– 9, 13, 58–59, 147–162, 162n5; exchange rates for, 8, 115fig, 117, 154–155; Federal Reserve and, 38; Germany and, 18; global role of, 7, 15; gold and, 18, 154; Hong Kong and, 37; interest rates and, 16; Japan and, 37, 38, 45, 57–59; Latin America and, 100; renminbi and, 116; Saudi Arabia and, 37, 38; South Korea and, 37; Taiwan and, 37; US Treasury and, 38; US Treasury bonds and, 109–110; World War II and, 147 “Dollar-Wall Street regime,” 16, 149, 184 Downs, Erica, 142 DPJ. See Democratic Party of Japan Dubai, 98 Dulles, John Foster, 136 Dumas, Charles, 20 Dutch East Indies (DEI), 134–135 Earthquake-tsunami, in Japan, 54, 56– 57, 58 East Asia, 35–60, 193n3. See also specific countries EBA. See European Banking Authority ECB. See European Central Bank Economic and Monetary Union (EMU), 7, 13–32, 151; austerity in, 14, 26; currency devaluations and, 24; dollar and, 154; Germany and, 31; inflation in, 18; labor and capital and, 19; politics and, 29–31 Economic and Social Stabilization Fund (FEES), in Chile, 73 “Economic governance,” 26 Economy and Society (journal), 180 Efficient market theory (EMT), 196 EFSF. See European Financial Stability Fund Egypt, 131 Eichengreen, Barry, 54 EIOPA. See European Insurance and Occupational Pensions Authority Eisenhower, Dwight, 135–136 El Salvador, 99 Electronics industry, 44 Emergency lines of credit, 1, 25, 27 EMT. See Efficient market theory EMU. See Economic and Monetary Union

254

Index

Energy sector, 30, 125. See also Oil Engels, Friedrich, 179–180, 181, 182 E.ON, 30 ERT. See European Round Table ESAs. See European Supervisory Authorities ESFS. See European System of Financial Supervisors ESMA. See European Securities and Markets Authority ESRB. See European Systemic Risk Board EU Money Laundering Directives, 90 Euro: bond markets and, 160–161; devaluation of, 21; dollar and, 8–9, 13, 58–59, 147–162, 162n5; liquidity and, 9 Eurobonds, 32 Europe, 3, 32, 182, 193n1; banks in, 22– 23, 202, 206; deregulation in, 13. See also specific countries European Banking Authority (EBA), 28 European Central Bank (ECB), 9, 19, 26, 29; bank reform and, 206; crisis management by, 23; eurobonds and, 32; Federal Reserve and, 24; zerointerest-rate policy of, 24–25 European Commission, 22, 23 European Council, 24–25 European Financial Stability Fund (EFSF), 24, 25, 159–160 European Insurance and Occupational Pensions Authority (EIOPA), 29 “European polity,” 29 European Round Table (ERT), 19 European Securities and Markets Authority (ESMA), 28–29 European Stability Mechanism, by European Council, 25 European Supervisory Authorities (ESAs), 29 European System of Financial Supervisors (ESFS), 29, 32 European Systemic Risk Board (ESRB), 29 European Trades Union Confederation, 32 Euro-Plus Pact, 25 Eurozone. See Economic and Monetary Union Exchange rates, 15, 121; Bretton Woods system and, 127; for dollar, 8, 115fig, 117, 154–155; IMF and, 37;

in Latin America, 66; PBoC and, 117, 122; remittances and, 99 Exports: Bretton Woods II and, 156; by China, 8, 50, 54, 114–115, 128; currency devaluations for, 2; by Germany, 20, 27, 128; by Japan, 50; by Latin America, 69, 75–76; liquidity and, 116; PBoC and, 114; by US, 122; yuan and, 129. See also Trade deficits; Trade surplus Exxon-Mobil, 130, 133–134 Falun Gong, 52 Family Stipend. See Bolsa Família Fannie Mae, 1, 110, 119, 171 FATF. See Financial Action Task Force FDI. See Foreign direct investment Federal Reserve, 2, 14, 18, 23, 24, 207; Consumer Financial Protection Bureau in, 210n6; dollar and, 38; interest rates and, 112–113, 155, 174; MBSs and, 173; QE2 and, 123; subprime mortgages and, 173–174 FEES. See Economic and Social Stabilization Fund Filene, Edward, 166–167 Fillon, Francois, 2 Finance, investment, and real estate (FIRE), 172 Financial Action Task Force (FATF), 90 Financial innovation: capitalism and, 198–203; regulation and, 201, 204– 305; speculation and, 9 Financial layering, 203 Financial Services Action Plan, by European Commission, 22 Financial Services Agency, in Japan, 47 Financial services industry, 17, 125; banks and, 203, 207; disciplining, 205–206 Financial Stability Oversight Council, 206 Finland, 19 FIRE. See Finance, investment, and real estate Fiscal compact. See Treaty on Stability, Coordination and Governance Fiscal deficits, 2 “Flexible accumulation,” 184 “Flexible specialization,” 184 Ford, Henry, 166 Fordist model, 18, 182; civic privatism and, 185; crisis with, 167–168, 183– 184

Index Foreclosures, 175 Foreign direct investment (FDI), 27, 30, 64, 71; by China, 53; remittances and, 90, 96; by US, 175 Foreign exchange reserve, 128, 156, 162n4 Fortis, 2 Franc, in Switzerland, 153 France, 18, 30, 89 Fraud, 196–197 Freddie Mac, 1, 110, 119, 171 Friedman, Thomas, 191 Fukushima Daiichi nuclear plant, 57 Full employment, Keynesian model and, 175 G8, GRWG by, 100–101 Galbraith, James K., 36 Gallagher, Kevin, 69, 75 Gang of Four, 52–53 Gang Xiao, 121–122 Gates, Bill, 48 Gates, Robert, 143 GATT. See General Agreement on Tariffs and Trade Gause, Gregory, 143 Gazprom, 30 GCC. See Gulf Cooperation Council GDF Suez, 30 Geithner, Timothy, 57, 123 General Agreement on Tariffs and Trade (GATT), 5–6 General Motors, 1, 144 Georgia, 31 Germany: bailouts and, 28; banks in, 22, 202; bond markets in, 25; China and, 21, 31, 160; corporations in, 20; costcutting by, 20; currency and, 149; dollar and, 18; economic recovery by, 20; emergency lines of credit in, 1, 25; EMU and, 31; energy sector and, 30; exports by, 20, 27, 128; FDI by, 30; Greece and, 24; migration to, 89; military industry in, 30; nuclear industry in, 30; ostpolitik in, 32; outsourcing by, 20; PIIGs and, 22; Russia and, 30–31; trade surplus of, 21; TSCG and, 28; unemployment in, 128; US and, 18, 21, 22 GET. See Global Employment Trends Glass-Steagall Act, 172, 201–202, 207 Global Employment Trends (GET), 101n12

255

Global imbalance, 14–15 Global Remittances Working Group (GRWG), 100–101 Globalization, 175; China and, 6; Japan and, 44; working class and, 19, 179– 192 Gold, 15, 37; dollar and, 18, 154; Japan and, 40–41 Goldman Sachs, 17, 22 Government-sponsored enterprises (GSEs), 171–172 El gran viraje (Venezuelan neoliberal reforms), 82 Great Britain, 3; deregulation in, 6; East Asia and, 41; financial services industry in, 17; hegemony of, 5; migration to, 88, 92–93; oil and, 134–136 Great Depression, 5, 7, 9, 195, 201; consumerism and, 167; Latin America and, 64; migration in, 98 Greece, 3, 19–20, 22, 32; bailouts to, 25; bond markets in, 25, 158, 158fig; EFSF and, 159–160; Europe and, 3; Germany and, 24; Switzerland and, 153; unemployment in, 27 Greed, 196–197 Green, Michael, 139–140 Greenspan, Alan, 125, 128 GRWG. See Global Remittances Working Group GSEs. See Government-sponsored enterprises Gulf Cooperation Council (GCC), 95 Guruppu gaisha (Japanese business grouping), 51 Hamilton, Alexander, 144 Harrod, Jeffrey, 181, 185, 187–188, 190 Hartz IV labor reforms, 20 Hatoyama Yukio, 56 Hedge funds, 22, 204, 205, 209n2 Hegemony: of Great Britain, 5; of US, 5, 8, 44, 127 High-tech bubble, 1 Home-centered consumer capitalism. See Consumerism Homeownership. See Housing market Hong Kong, 37, 54, 108, 120 Horie Takafumi (“Horiemon”), 47–49 Housing market, 155, 166–167; interest rates and, 111–112; in Ireland, 24; in Portugal, 24; in Spain, 24; unem-

256

Index

ployment and, 175; in US, 1, 9, 169–173 Hu Jintao, 129 Hull, Cordell, 5 Human Settlements Programme, of UN, 188 Hungary, 27, 159, 159fig Iceland, 156 IKB Deutsche Industriebank, 1 ILO. See International Labor Organization IMF. See International Monetary Fund Immigration Act of 1924, 98 “Import-substitution-industrialization” (ISI), 64–65, 70 Incompetence, 196–197 India, 6, 90, 92, 187 Indian Currency and Finance (Keynes), 41 Inequality, 3, 22, 81, 113 Inflation, 15, 65; in Argentina, 73, 86n5; in Brazil, 79–80; in China, 120; in EMU, 18; in Venezuela, 73, 82 Informal value transfer systems (IVTSs), 101n8 Insurance companies, 22 Interest rates, 14, 16, 25; in China, 116; ESFS and, 32; Federal Reserve and, 112–113, 155, 174; housing market and, 111–112; India and, 92; in Italy, 20; Latin America and, 65; PBoC and, 121; on US Treasury bonds, 110; zero-interest-rate policy, 24–25 International currency, 150–153, 151fig, 169 International Labor Organization (ILO), 88, 101n12, 188 International migrants, 96, 101n2 International Monetary Fund (IMF), 24, 25, 26, 27, 187; agriculture and, 188; Balance of Payments Statistics Yearbook by, 88; exchange rates and, 37 International Organization (journal), 180 International Organization for Migration (IOM), 88 International political economy (IPE), 4–6, 147, 179–183 IOF. See Tax on Financial Flows

IOM. See International Organization for Migration IPE. See International political economy Iran, 129, 132, 134, 140 Iraq, 38, 129, 131, 132, 134 Iraq War, 59n1, 132 Ireland, 19–20, 22, 25, 27, 32, 92–93; banks in, 33n3; housing market in, 24 “Iron law of worker organization formation,” 185, 187–188 ISI. See “Import-substitution-industrialization” Islamic fundamentalism, 193n5 Italy, 18, 19–21, 22, 25 IVTSs. See Informal value transfer systems Japan: account deficits of, 44–45; accounting in, 49; banks in, 202; Bretton Woods II and, 38–39, 45; capitalism in, 46; China and, 51, 125, 137; corporations in, 50, 56; currency and, 149; dollar and, 37, 38, 45, 57–59; DPJ in, 55–56; earthquake-tsunami in, 54, 56–57, 58; euro and, 58–59; exports by, 50; Federal Reserve and, 24; Financial Services Agency in, 47; globalization and, 44; gold and, 40–41; history of, 39–51; Latin America and, 96; LDP in, 47; manufacturing in, 43; METI in, 57; migration to, 88, 99; MOF in, 46–47; neoliberalism in, 46–47; oil and, 135; Philippines and, 99; Soviet Union and, 137; stock market and, 44; US and, 42– 43, 50, 60n4; US debt and, 7; US Treasury bonds and, 57, 109; in World War II, 42; yen of, 57–58, 115fig Japan as Number One (Vogel), 44 Jefes y Jefas de Hogar Desempleados (Unemployed Heads of Household program), in Argentina, 74 Jobs, Steve, 48 Johnson, Lyndon, 136 J.P. Morgan Chase, 17 Kamei Shizuka, 48 Kan Naoto, 56 Kansas, 100, 103n19

Index Keiretsu (Japanese business grouping), 51 Keynesian model, 6, 7, 168; Bretton Woods system and, 37; full employment and, 175; Japan and, 41; stimulus programs and, 112, 174–175; stock market and, 36 King, Mervyn, 28 Koizumi Junichiro, 46, 47–48, 55 Kregel, Jan, 201–202, 203 Krona, in Iceland, 156 Krugman, Paul, 36, 174 Kuwait, 129 Labor, 7, 9, 19. See also Trade unions; Working class Lagarde, Christine, 28 Landesbanks, 22 Latin America, 61–86; agriculture in, 188; China and, 7–8, 69–71, 76; commodities and, 69–71; debt service payments by, 65, 71; dollar and, 100; exports by, 69, 75–76; FDI to, 64, 71; Great Depression and, 64; history of, 63–67; internal adjustments in, 71– 72; Japan and, 96; manufacturing in, 76; neoliberalism in, 65, 85n1; privatization in, 62, 66; remittances to, 90; self-employment in, 189; stabilization funds in, 73–74; stimulus programs in, 73–74; underdevelopment in, 188; unemployment in, 66–67; vulnerability of, 74–75, 86n4; Washington Consensus and, 66, 77, 85. See also specific countries Lawful permanent resident (LPR), 98 LDP. See Liberal Democratic Party “Lean production,” 184 Lehman Brothers, 1, 2, 18, 23, 61, 206 Lenin, Vladimir, 181 Liberal Democratic Party (LDP), in Japan, 47 Liberals, debt spending and, 174, 175 Libya, 31, 100 Light-touch regulation, 204–205 Liquidity: bank reform and, 208; capitalism and, 199; China and, 115– 116; currency and, 160; euro and, 9; exports and, 116; interest rates and, 25; international currency and, 151; securitization and, 200; subprime mortgages and, 195

257

Lisbon “competitiveness project,” 13 Liu Xiaobo, 52 Livedoor, 47–49 Long Term Refinancing Operation (LTRO), 25 Long-Term Credit Bank, 46 LPR. See Lawful permanent resident LTRO. See Long Term Refinancing Operation Maastricht treaty, 19 Malaysia, 98 Manufacturing: in China, 118; in Germany, 21; in Japan, 43; in Latin America, 76; in US, 16, 144, 168– 169; women in, 187 Mao Zedong, 52, 107 Marx, Karl, 9, 168, 181, 182; IPE and, 179–180; on workers as consumers, 167 Marxism, 5, 6, 52, 182 MasterCard, 99 Master-salve dialectic, 180 MBSs. See Mortgage-backed securities McDougall Report, 19 McKinsey Global Institute, 152–153 Medvedev, Dmitry, 31 Meins, Robert, 99 Merkel, Angela, 24, 31, 160 METI. See Ministry of Economy, Trade, and Industry Mexico, 38, 63, 66, 68, 74; exports from, 69, 75; oil in, 135; remittances to, 92, 96; voluntary return programs in, 96 Middle East, 145n8; oil and, 127, 129, 131–134, 136, 145n7; underdevelopment in, 188. See also specific countries “Middle-class squeeze,” 175–176 Migration, 8, 87–101; in Great Depression, 98; remittances and, 89–100; unemployment and, 94; to US, 93, 98–99 Military, 16, 30, 32; oil and, 126; of US, 43, 143 Millennialism, 193n5 Ministry of Economy, Trade, and Industry (METI), in Japan, 57 Ministry of Finance (MOF), in Japan, 46–47 Minsky, Hyman, 9, 195–196, 198–203, 209n2

258

Index

Misiones (missions), 84 MOF. See Ministry of Finance Mondale, Walter, 35 The Monetary Sin of the West (Rueff), 37–38 “Money-manager capitalism,” 195, 196 Monopoly capitalism, 165–166 Montenegro, 155–156 Monti, Mario, 20 Morgan Stanley, 17 Mortgage guarantees, 169 Mortgage-backed securities (MBSs), 120, 171, 173, 209n3 Movimiento Quita República (MVR), in Venezuela, 83 Mubarak, Hosni, 131 Mundell-Fleming trilemma, 121 MVR. See Movimiento Quita República National Bank Act of 1863, 208 NATO. See North Atlantic Treaty Organization Natural resources, 8, 125. See also Oil Neoliberalism, 30, 32; in Brazil, 79–80; in Japan, 46–47; in Latin America, 65, 85n1; in Venezuela, 82–83 Neomercantilism, 22 Nepal, 93, 99 Netherlands, 2, 19 New Century Financial Corporation, 171 New Deal, 16, 167, 204 New international economic order (NIEO), 4–5 New Political Economy (journal), 180 NIEO. See New international economic order Nissan Motors, 46 Nixon, Richard, 37, 154 North American Free Trade Agreement, 6 North Atlantic Treaty Organization (NATO), 31–32 Northern Rock, 1 Nuclear industry, 30, 57 Obama, Barack, 24, 36, 56, 101 Ocampo, José, 67–68, 84 Occupy Wall Street, 3 ODA. See Official development aid OECD. See Organisation for Economic Cooperation and Development

Official development aid (ODA), 90 Offshore financial havens, 204 Oil, 8; Brazil and, 69; China and, 121, 125–144; Great Britain and, 134– 136; Japan and, 135; Latin America and, 65; in Mexico, 135; Middle East and, 127, 129, 131–134, 136, 145n7; Russia and, 30; US and, 125–144; Venezuela and, 82–84, 134 Oklahoma, 100 Olympus, 49 OPEC. See Organization of the Petroleum Exporting Countries Oportunidades, in Mexico, 74 ORD. See “Originate and distribute” model Organisation for Economic Cooperation and Development (OECD), 87 Organization of the Petroleum Exporting Countries (OPEC), 38, 65 “Originate and distribute” model (ORD), 197, 202–203, 206 Ostpolitik, in Germany, 32 Outsourcing, 16, 176, 184, 187; Fordist model and, 168; by Germany, 20 PAC. See Program for the Acceleration of Growth Pakistan, 92 Partidocracia (partyarchy), 82 PBoC. See People’s Bank of China PDVSA. See Petróleos de Venezuela S.A. People’s Bank of China (PBoC), 109, 114, 117, 121, 122 Perez, Carlos Andrés, 82 Perot, Ross, 35 Peru, 68, 69, 75 Peso, of Mexico, 38, 63, 66 Petrobrás, 61 Petróleos de Venezuela S.A. (PDVSA), 83 Pettis, Michael, 54, 120 Philippines, 93, 94, 95, 98–99 PIIGs. See Portugal, Ireland, Italy, and Greece Plastics, 129, 138 Pohl, Karl Otto, 24, 33n3 Poland, 27, 101n9 Ponzi financing, 209n2 Portugal, 24, 25, 27

Index Portugal, Ireland, Italy, and Greece (PIIGs), 19–20, 22 Porzecanski, Arturo, 63, 70 Porzecanski, Roberto, 69, 75 “Post-Fordism,” 9, 167–169, 184 Prebisch, Raúl, 70 Privatization, 62, 66 Program for the Acceleration of Growth (PAC), in Brazil, 73–74, 80 Protectionism, 5 Protests, 3 Punto Fijo, in Venezuela, 82, 83 Quantitative easing, round three (QE3), 8, 36 Quantitative easing, round two (QE2), 8, 36, 123 Race to the bottom, 176 Rachman, Gideon, 3 Rare-earth-elements, 125, 139 Ratha, Dilip, 91 Reagan, Ronald, 16 Real Plan, in Brazil, 78 Real wage decline, 3 Regulation, 3, 16; of banks, 172, 202– 203; financial innovation and, 201, 204–305; of hedge funds, 205. See also Deregulation Remittances: to Africa, 91–92; to Bangladesh, 95; to China, 90; exchange rates and, 99; FDI and, 90, 96; to India, 90, 92; to Latin America, 90; to Mexico, 92, 96; migration and, 89–100; to Pakistan, 92; to Philippines, 95, 99; to Poland, 101n9; from Russia, 91–92; service pricing for, 101, 101n7; to Sri Lanka, 92; taxation of, 99–100; trends in, 95–97; from US, 101n3; World Bank and, 91 Renminbi, of China, 54–55, 58, 115, 116 Repsol, 142 Resecuritization, 200 Reshaping Europe (European Round Table), 19 Resutora (restructuring), 46 Review of International Political Economy (journal), 180 Risk, 203; in capitalism, 199–200; regulation of, 206 Rogers, Jim, 139

259

Rojas-Suarez, Liliana, 73 Roosevelt, Franklin D., 135 Ross, Dennis, 140 Ruble, of Russia, 63 Rueff, Jacques, 37–38 Rupee, in India, 92 Russia, 6, 30–31, 63, 91–92 Rwanda, 99 Sarkozy, Nicolas, 32 Saudi Arabia, 37, 38, 89, 129, 140 Savings, 156–157, 157fig, 196 Savings and loan crisis, 3 Schaede, Ulrike, 57 Schauble, Wolfgang, 28 Schwartz, Herman, 155 SEA. See Single European Act Securitization: Glass-Steagall Act and, 207; of MBSs, 209n3; subprime mortgages and, 196, 200 Self-employment, 10, 188–189 SGP. See Stability and Growth Pact “Shareholder value,” 186 Single European Act (SEA), 13 Single European Market, 6 Sino-Japanese War, 41, 51 Sinopec, 142 Smith, Adam, 144 Social movements, 9–10 South Korea, 37, 188 Soviet Union, 137 S&P. See Standard and Poor’s Spain, 3, 20, 24, 25, 27, 97 Specie kept outside (zaigai seika), 41 Spectrology, 180–183 Speculation, 9, 209n2 Sri Lanka, 92 Stability and Growth Pact (SGP), 23, 33n4 Stabilization funds, in Latin America, 73–74 Stagflation, 5 Standard and Poor’s (S&P), 4, 175 State corporatism, 187 Stimulus programs: in China, 2; Keynesian model and, 112, 174– 175; in Latin America, 73–74; in US, 2, 23–24, 36 Stock market, 9–10, 22, 36, 44, 67 Strauss-Kahn, Dominique, 28 Subcontracting, 187 Subprime mortgages: by banks, 172;

260

Index

credit crunch and, 196–198; deregulation and, 172; Federal Reserve and, 173–174; interest rates and, 14; liquidity and, 195; risk in, 203; securitization and, 196, 200; suburbanization and, 173–177; in US, 169–173 Subprime Nation (Schwartz), 155 Subsistence farming, 193n3 Suburbanization, 167, 173–177 “Survival crisis,” 14 Sweden, 19, 24 Switzerland, 89, 153, 205 Taiwan, 37, 94 Tajikistan, 95 Tax cuts, 16, 35, 38 Tax on Financial Flows (IOF), in Brazil, 79 Tax Reform Act (TRA), 171 Taylor, Fredrick Winslow, 166 Tea Party, 3, 9 TEPCO. See Tokyo Electric Power Tequila effect/crisis, 66, 90 Tett, Gillian, 160 Thailand, 98 Tiananmen Square, 53, 113 Tietmeyer, Hans, 28 Tillerson, Rex, 142 Tokyo Electric Power (TEPCO), 57 “Too-big-to-fail,” 3, 17 TRA. See Tax Reform Act Trade deficits, 35; gold and, 37; of US, 6, 43, 45, 108, 116, 118, 169 Trade surplus: Bretton Woods II and, 156; of China, 8, 112, 121, 122; of Germany, 21; of US, 18 Trade unions, 16, 17, 167, 185–186 Trade wars, 3 “Transnational capitalist class,” 29 Transnational corporations, 187 Treasury, US, 14, 16, 23, 38 Treasury bonds, US, 3, 18; China and, 108, 109; dollar and, 109–110; Iraq War and, 59n1; Japan and, 57, 109 Treaty on Stability, Coordination and Governance (TSCG), 24–25, 28 Trichet, Jean-Claude, 28 Tripartism, 185–186, 193n1 Trotsky, Leon, 181 TSCG. See Treaty on Stability, Coordination and Governance

Twitpay, 99 UAE. See United Arab Emirates Ukraine, 31 UN, 188 Underdevelopment, 188 Unemployed Heads of Household program. See Jefes y Jefas de Hogar Desempleados Unemployment, 2, 19; in Brazil, 79; in Germany, 128; in Greece, 27; housing market and, 175; ILO and, 101n12; in Latin America, 66–67; migration and, 94; in Portugal, 27; in Spain, 27; in US, 120; in Venezuela, 82 United Arab Emirates (UAE), 98 United States (US): account deficits of, 15, 16, 35–36, 154; automobile industry in, 15; autonomy of, 143; banks in, 201–202, 206; Bretton Woods system and, 15; Bretton Woods II and, 37–38; capitalism in, 152; China and, 3, 7, 8, 107–124, 109fig, 125–144; consumerism in, 165–177; consumption by, 3; debt in, 7, 127; deregulation in, 6, 118– 119; exports by, 122; FDI by, 175; financial services industry in, 17; Germany and, 18, 21, 22; gold in, 15; growth of, 15, 68, 111–113, 111fig; hegemony of, 5, 8, 44, 127; housing market in, 1, 9, 169–173; industrial decline of, 143–144; inequality in, 113; inflation in, 65; interest rates in, 155; international currency and, 169; Japan and, 42– 43, 50, 60n4; macroeconomic policies of, 14; manufacturing in, 16, 144, 168–169; mental map of the world by, 5; Middle East and, 131– 134, 136, 145n8; migration to, 89, 93, 98–99; military of, 43, 143; monetary policy of, 3; oil and, 125– 144; remittances from, 101n3; stimulus programs in, 2, 23–24, 36; stock market in, 22; subprime mortgages in, 169–173; trade deficits of, 6, 43, 45, 108, 116, 118, 169; trade surplus of, 18; unemployment in, 120; Wall Street Reform and Consumer Protection Act in, 101.

Index See also specific organizations and associated topics US. See United States USA Patriot Act, 90 Uzbekistan, 99 Van Rompuy, Herman, 14, 31 Van Wolferen, Karel, 48 Vehicle currency, 151–153 Venezuela, 68, 81–84, 134; exports by, 76; inflation in, 73, 82 Vietnam, 118 Vietnam War, 15, 127 Vogel, Ezra, 44 Volcker, Paul, 6, 16, 35 Wage stagnation, 22 Wall Street Reform and Consumer Protection Act, 101 Washington Consensus, 6, 66, 77, 85, 204 Wells Fargo, 17

261

Wen Jiabao, 123 Werner Report, 19 White, Harry Dexter, 37 Williamson, John, 66 Women, in manufacturing, 187 Woodford, Michael, 49 Working class, 19, 179–192 World Bank, 73, 88, 91 World Trade Organization (WTO), 6 World War I, 134, 136 World War II, 2, 5, 42; dollar and, 147; oil and, 126–127, 136 WTO. See World Trade Organization Yen, of Japan, 57–58, 115fig Yuan, of China, 54–55, 115fig, 129 Zaigai seika (specie kept outside), 41 Zero-interest-rate policy, 24–25 Zoellick, Robert, 139–140

About the Book

Have the financial crisis of 2008 and the subsequent recession rearranged the basic structures of the global economy? To answer that fundamental question, the authors of Exploring the Global Financial Crisis tackle a number of related questions: What has happened, for example, to global flows of people, goods, and capital? Will the euro and the dollar persist as global currencies? Can governments that bailed out failing banks by vastly expanding public debt manage to regain solvency, and at what political cost? Ranging across regions, and from the factors that gave birth to the crisis to current politico-economic rivalries, the authors present both mainstream and critical views on the central issues involved. Alan W. Cafruny is Henry Platt Bristol Professor of International Affairs at Hamilton College. His most recent publications include A Critical Introduction to the European Union and Europe at Bay: In the Shadow of US Hegemony, both coauthored with Magnus Ryner. Herman M. Schwartz is professor of politics at the University of Virginia. He is author of Subprime Nation: American Power, Global Finance, and the Housing Bubble and States vs. Markets: The Emergence of a Global Economy.

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