Disorder, page 17
An employment shock was not what the Clinton administration had promised would follow from permanently normalized trade relations with China. In 2000, Bill Clinton said that ‘this is a hundred to nothing deal for America when it comes to the economic consequences15.’ His agricultural secretary said of the permanent normalized trade relations legislation that ‘this deal is really a no-brainer’ and that since American markets were already open to China ‘all the concessions are on their side, and all the benefits are on ours16.’
The disjuncture between this promise and the reality quickly yielded a backlash in Congress. Much of this anger was directed at China’s exchange rate policy. If China had let its currency float, China’s expanding trade surplus would have pushed the renminbi upwards, making Chinese imports more expensive. But, since 1994, China had operated a fixed peg against the dollar. Rather than allow the renminbi to appreciate, the Chinese central bank engaged from 2003 in large-scale intervention to stop that happening. That same year, anger about China’s trade-centric approach to the renminbi began to be articulated by influential members of the Congress. The Democratic senator Chuck Schumer and the Republican senator Lindsey Graham introduced the first of a succession of bills to impose substantial tariffs on Chinese exports unless China revalued the renminbi.17 Their efforts reached a climax in the first half of 2005 when it appeared that they had sufficient votes in the Senate to pass legislation.
But the post-2000 US–China trade relationship had quickly become politically entrenched in Washington. Schumer and Graham’s legislative push lacked support from George Bush Jr’s administration. Since there was no security dependency to exploit, Bush could not demand change from China as his three predecessors had done from Japan. China had also become the United States’ largest state creditor. Indeed, China’s determination to preserve the currency parity had incentivized its central bank to buy large volumes of US government debt as a macro-economic strategy. Concerned that the Schumer–Graham legislation could still pass, China repackaged its exchange rate stance in July 2005. On the surface, these moves ended the renminbi–dollar peg and allowed the renminbi some latitude to float. But in practice, China conceded only a 2 per cent revaluation against the dollar. The following autumn, Bush’s treasury secretary, Hank Paulson, persuaded China to accept an institutionalized framework for discussing exchange rate and trade issues. His expressed aim was to procure a meaningful renminbi revaluation.18 But, again, only a minimal adjustment was forthcoming. In May 2007, China agreed to widen the bands within which the renminbi floated. Thereafter, the renminbi did appreciate, but the effects were diluted by the dollar’s depreciation against other currencies too.
On the surface, the political stand-off in Washington looked like a replay of past congressional protectionist pressure on the executive from Hoover to Reagan. But the degree to which some American corporations were advantaged from the scale of transnational production and supply chains around China represented a substantial difference. Tech and electronic manufacturers massively benefited by assembling their goods in China, as did large discount retailers, like Walmart, from selling cheap Chinese imports.19 Once upon a time, Apple, for example, made almost all its products in the United States. Indeed, Steve Jobs, the company’s co-founder, boasted in the 1980s the Apple computer ‘was a machine that is made in America’.20 But, from 2004, almost all Apple products were manufactured abroad, mostly in China. As one Apple executive put it to the New York Times, ‘What US plant can find 3,000 people overnight and convince them to live in dorms?’21 In part, these selective rewards reduced the resonance of confrontational anti-China rhetoric: manufacturing iPods in China might have added to the American trade deficit, but most of the value of the product was still being captured in the United States.22 But they also spurred class conflict in American democratic politics: those who gained were shareholders and extremely well-paid executives; those who lost were factory workers.23
* * *
Although trade became its visible face in American politics, the China shock dramatically extended to oil. China was self-sufficient in oil production until 1993. This oil independence distinguished China’s early trajectory in industrial development from those of other East Asian states, not least Japan’s. Only in the mid-2000s did rising Chinese oil consumption have an impact on the rest of the world. By 2008, China was using the equivalent of 70 per cent of Saudi production. With demand from other Asian countries, especially India, also accelerating, world oil consumption soared from 68 million barrels per day in 1994 to 77 million in 2000 to 87 million in 2008, despite falls in some European economies. (By contrast, in the two decades between 1973 and 1993, it rose only from 57 to 67 million.24) In 2005, as the China demand shock took hold, oil production stagnated—as discussed in chapter four–until the shale boom began.25 Consequently, after more than a decade of low prices, from the mid-2000s the world economy experienced unprecedentedly high prices. By May 2006, oil prices reached $90 a barrel, around 80 per cent higher adjusted for inflation than they were in March 1974 when the first oil price shock ended. At their peak in June 2008, they were around $150, more than a third higher in real terms than their previous peak during the second oil price shock.26
This oil price shock was rather different from the two in the 1970s, the 1981–85 shock the dollar delivered, or the mini price spike that stemmed from Iraq’s invasion of Kuwait. None of those had a significant demand side component. Nor had they had such structural causes. The Arab oil embargo was temporary. Iranian output, at least partially, recovered after the revolution, as did Iraq’s until the post-1990 sanctions. The dollar fell from 1985, and so spectacularly, from 1986, did oil prices. But this time, additional large-scale demand from China and India became a permanent feature of the world economy. Only new supply, or significantly lower levels of economic growth, could prevent much higher prices becoming a normal state of affairs. Paradoxically, the conditions for additional production to meet accelerating consumption turned out to run through the 2007–8 crash, even as—as will be discussed later in the chapter—the very problem oil prices caused played its part in that crash occurring.
Eurodollar Banking
The Eurodollar banking story begins back in the 1970s. The Eurodollar markets that had played their part in ending Bretton Woods were given a large boost by the two oil shocks. Fuelled by the dollars earned by Middle Eastern oil producers, American and European banks had huge dollar deposits to lend. The need for oil-importing states, including those in developing countries, to finance large trade deficits made the Eurodollar markets extremely useful, especially since the International Monetary Fund was ill-equipped to deal with such sizeable and structural deficits. Banks became the mechanism for providing dollars to those who needed them through Eurodollar loans.27 In part as a consequence, finance, and internationalized banking in particular, would assume a significantly larger part in the American and West European economies than it had done in the three decades after the Second World War.28 But the size of the European banks’ Eurodollar operations raised the old question of who regulated this activity, and who would serve as the lender of last resort to these markets, even more emphatically than in the 1960s.29 In practice the only answer to the second question could be the Fed. But spelling out this reality was a step too far. When, in 1974, the Group of Ten (G10) central bank governors discussed the problem, they could only express confidence that at the moment of crisis a solution would be forthcoming.30
That definitive crisis would arrive in August 2007. In the interim, the Eurodollar markets grew beyond recognition. As they expanded, the means by which banks funded their operations in these markets became increasingly dependent on repurchase (repo) agreements: a form of short-term—often overnight—collateralized borrowing in which one party sells securities in exchange for cash and agrees to buy them back in the future at a slightly higher price. By the 1990s, what had been the Bundesbank’s earlier frustration that the ability of banks to create dollars to lend in Eurodollar markets undermined national interest rates had spread to the Fed. In a speech in 1996, the then Fed chairman Alan Greenspan noted that ‘unfortunately, money supply trends veered off path several years ago as a useful summary of the overall economy’ and ‘we cannot in the future expect to rely a great deal on money supply in making monetary policy’.31 In this world, Greenspan continued, monetary policy would have to be conducted by assessing banks’ balance sheets and asset prices.32
This was, however, much easier said than done. As he said in the same speech, there was an ‘irrational exuberance’ that was ‘unduly escalat[ing] asset values’.33 Even regulating banks’ balance sheets was difficult. Under the Basel Accords, agreed by the G10 states from 1988, bank regulation was concentrated on the asset side of banks’ balance sheets. Yet by the late 1990s, banks, as well as other financial corporations, had figured out how to use derivatives to disguise the size of their balance sheets. Moreover, the European banks were big players in the Eurodollar markets and the Fed was in no position to regulate the balance sheets of foreign banks.
Neither did Greenspan actually wish to make interest rate changes in response to movements in asset prices. The years from the mid-1980s had seen ever-larger fluctuations in asset prices.34 These had been most manifest in the developing countries and emerging markets, culminating in the 1997–98 Asian financial crisis. But they had also been evident in Western economies, including the 1987 share market crash. By the time of Greenspan’s ‘irrational exuberance’ speech, there was already a growing bubble in US share markets driven by the dot-com boom where investors piled into internet start-up companies. But even after it burst in March 2000, Greenspan still proclaimed that bubbles could be neither identified in advance nor contained once they emerged.35
As for banks themselves, their internationalized operations grew from the late 1990s to another level. Again, this deepening internationalization was driven by European banks, and in the first instance German banks.36 These ever bigger and ever more internationalized bank balance sheets contributed very significantly to a massive increase in international capital flows from the turn of the century.37 A good proportion of these flows were generated by the Eurozone. Once monetary union created apparently unified credit conditions across much of the EU, Northern European banks lent large volumes of money to corporations and governments in the Southern Eurozone and Ireland.
These same Northern European banks also massively increased the international assets on their balance sheets by lending in the United States, through both loans and bond and security purchases. This lending was financed by short-term dollar funding from money markets, including repo and Eurodollar markets, leaving these banks with large liabilities in a foreign currency and a mismatch between their longer-dated American assets and their short-term dollar borrowing.38 After this same dynamic played out disastrously during the Asian financial crisis, the East Asian central banks, not least China’s, had responded by amassing large-scale dollar reserves through the 2000s. But the European Central Bank (ECB) and the Bank of England acted as if the huge currency misalignments with which their banking sectors operated could never actually require them to provide foreign currency support, apparently trusting instead in the 1974 assumption that if and when a crisis arrived the Fed would provide a solution.
The Great Moderation, for a While
In the decade before the 2007–8 crash, the combined consequences of China’s rapid economic growth and ever more internationalized banking appeared to deepen the benign monetary and credit environment that had first emerged for the United States in the mid-1980s from lower interest rates and oil prices. In a speech in 2004, future Fed chair Ben Bernanke described what he called the Great Moderation as ‘a substantial decline in macro-economic volatility’, which translated into much lower inflation compared to the 1970s and early 1980s.39 The causes of this change were disputed. Some, including Bernanke, thought that economic policy decision-making, particularly on monetary issues, had significantly improved.40 Others pointed to the good fortune of the fall in oil prices, or structural economic changes, including financial innovation and the reduced importance of manufacturing sectors.41 But, whatever their relative causal weight, China’s exports after 2001, by reducing the costs of clothes and other consumer goods, served as a crucial anti-inflationary force, especially as China’s rising oil demand was simultaneously inducing inflationary conditions via energy prices.42
At least from the 1990s, the Great Moderation also brought across the world a decline in interest rates that could not be explained simply by changes in inflationary expectations.43 This looked like a historical anomaly. In the twentieth century, there had been periods before of low real interest rates, but not under conditions when inflation was low and banks were lightly regulated.44 Again, the causes of this apparently structural monetary easing of credit conditions were disputed.45 Some, including Greenspan and Bernanke, were convinced China’s monetary and exchange rate policies were decisive. China was, Bernanke alleged in 2005, in good part responsible for a ‘global savings glut’ that was driving interest rates down.46 Certainly, by any standards, China, and other East Asian countries, did provide a massive flow of capital into the United States at low rates of interest. China acquired a huge portfolio of US Treasury bonds, and eventually bonds and securities issued by the two congressionally chartered mortgage corporations, Fannie Mae and Freddie Mac. These purchases allowed the Fed to let the effective federal funds rate fall below 2 per cent in 2001 and remain there until the second half of 2004. This easy credit environment financed a swift increase in the American budget deficit during George Bush Jr’s first term in office, albeit it left the country more fiscally reliant on a single state than it had ever been before.47 It also furnished conditions in which the tech companies like Amazon, Google, and eBay that had survived the bursting of the dot-com bubble could grow without business models that generated profits.
The United States’ monetary gains and the trade advantages China acquired in the early twenty-first century world economy appeared to some to establish a de facto new international monetary order that would keep interest rates low for the foreseeable future. Some presented this order as a semi-resurrected Bretton Woods.48 Economic historians Niall Ferguson and Moritz Schularick labelled this economic world ‘Chimerica’.49 If President Clinton’s former treasury secretary Lawrence Summers saw instead a fear-driven ‘balance of financial terror’ held together by the devastation each would experience if the dollar were to collapse, he still judged there was ‘enormous, short-run functionality and comfort’ in the Sino-American economic relationship.50
In actuality, there was considerable short-term instability that would work its way through the entire world economy. Above all, oil ensured that China’s economic growth was far from straightforwardly creating a benign credit environment. Indeed, from the mid-2000s, Chinese oil demand, allied to the growing supply constraints, had monetary repercussions, beginning in June 2004, when the Fed tightened monetary policy in response to what it feared might be the inflationary effects of rising oil prices.51 For the top central bankers, the return of high oil prices was a decisive turning point. For Alan Greenspan, trying to avoid them had justified the Iraq War.52 Removing Hussein had been ‘essential’, he told the Washington Post in an interview, for oil markets to function.53 More pessimistically, in a speech in 2005, the then governor of the Bank of England, Mervyn King, pronounced that rising oil prices had ended what he termed NICE, a period of non-inflationary consistently expansionary growth that had begun in 1992. In this new environment, King argued, inflation and growth would be more volatile than they had been in the recent past. After the end of NICE, King continued, it was an illusion to think central banks could use monetary policy to achieve stability.54 Three years later, the president of the European Central Bank (ECB), Jean-Claude Trichet, went further, pronouncing that a ‘transfer of income from commodity-importing to commodity-exporting countries’ was occurring and this change had to be ‘accepted’ by Western governments and their populations.55
Yet internationalized dollar banking complicated this picture. In King and Trichet’s telling, the economic world was returning in part to the 1970s, albeit with higher global returns to capital and lower returns to labour in North America and Western Europe. But central banks already could not achieve their stated monetary purposes. As Greenspan told a Senate committee in February 2005, there was a ‘conundrum’ at work: the Fed’s oil-driven tightening from June 2004 had had no impact on long-term rates.56 Indeed, the ten-year bonds the US Treasury issues were, as he spoke, yielding less than before the Fed moved the federal funds rate upwards. Whether this was quite as an unusual occurrence as Greenspan claimed, or could be explained by Chinese and other Asian central bond purchases, is open to question. But his remarks that credit conditions were not what might have been expected from the Fed’s monetary policy was indicative of something consequential about this period of oil-induced monetary tightening: although higher interest rates did have considerable effect on the non-financial economy, especially housing, they had little effect on credit conditions in the financial sector. In part, credit default swaps and other credit derivatives acted as a buffer between monetary policy changes and the availability of credit by providing de facto insurance to financial market participants against their risk-taking. But at least as significantly, whatever effect the Fed’s tightening had on dollar credit arising from American banks operating in the United States, it had little effect on Eurodollar credit, and this dollar credit readily found its way back into the American banking system.57 Not having found a remedy for the problem of aligning monetary policy with the international dollar-credit markets, Greenspan handed over the problem at the beginning of 2006 to his successor, Ben Bernanke.
