Globalized Finance and Varieties of Capitalism

H. van Zon, Kenneth A. Loparo

• Publisher: Palgrave Macmillan
• Year: 2016
• ISBN:
  9781137560278
• Topic: Politics & International Relations
• Subtopic: Trade & Tariffs
• Index: Politics & International Relations

Hans van Zon analyzes the financialization of developed capitalism, and argues that the emergence of finance as a dominant force has contributed to the relative decline of the West. He demonstrates that the neo-liberal model is inherently unstable and undermines capitalist economies, which can only function if they are embedded in institutions that are non- or even pre-capitalist. He shows how a toxic combination of financialization, corporate globalization, and a deregulated and parasitic financial industry have led to structural economic stagnation in both the USA and the greater part of the EU.

1

The United States: Casino Capitalism Unleashed

The shareholders’ revolution

The Great Depression of the 1930s convinced the US political elite that the economy needed to be properly regulated in order to prosper. The Depression stands out because of its depth and the fact that the whole capitalist world was affected. It occurred after a period of deregulation of the financial sector and creation of cheap money (quantitative easing) that pushed bubbles, and in the United States led to unemployment levels of 27 per cent (1933).¹ A third of all banks failed, and credit provision came to a halt.

Output in the United States between 1929 and 1933 contracted by 46 per cent, and world trade by two thirds while a new wave of protectionism inhibited trade. Initially, counterproductive policies were pursued that included cutting state expenditures that in turn exacerbated the crisis. A breakthrough occurred with the New Deal of President Roosevelt, who created jobs by massively investing in infrastructure and education.^. Later, the government backtracked, with the result of deepening the crisis. Only with the massive state spending on armaments during World War II did the economy start to grow again. During the last years before the war, per capita GDP was 25 per cent lower than in 1846, but by1945 the United States had approximately a 60 per cent share of the world’s industrial production.

The boom of the 1950s and 1960s was built upon: (1) consumer liquidity, (2) the second great wave of automotive production, (3) a period of cheap energy, (4) the rebuilding of Europe and Japan, (5) two regional wars in Asia and (6) US hegemony (Foster, 2012). The federal government pursued redistributive policies. For example, during 1945–80 the top tax rate was more than 70 per cent, and the capital gains tax was 35 per cent (in 2015, 15 per cent).

In the United States during the 1970s many interest groups opposing the perceived trends towards the welfare state and ‘socialism’, stagnating production and lower profit rates, started to converge, and a counter-movement took shape.² As a result of a regrouping of corporate interests, corporate lobbying exploded. Wealthy donors founded conservative think tanks to influence public opinion in favor of market fundamentalism. The Ford Administration of the mid-1970s began a deregulation campaign. A new consensus emerged between the conservative right and liberal left to contain inflation, which attained almost 6 per cent in 1970 and double digits in 1974, while ‘staying away from the aggressive interventionism that started under Kennedy’ (Greenspan, 2007, p. 72). During the 1980s, under the presidency of Ronald Reagan (1980–88), a managerial/capitalist counterrevolution took place that quickly shifted the balance of power in the direction of big corporations. It had unified support from the ruling elites. According to Schlesinger (1999, p. 21), the Reagan attack on affirmative government was

the sharpest and shrewdest mounted (in the USA) in the twentieth century. ( ... )

Like his conservative predecessors, Reagan aimed to shrink the role of government. Unlike the others, he discovered a way to do it. His innovation was to use tax reduction and defense spending to create a vast budgetary deficit and then to use the deficit as a pretext for a permanent reduction in the functions of the national government.³

Above all the tax bill for the rich was reduced.

Shareholders emerged as the moving force in corporate affairs. A key idea was that the sole function of enterprises is to enhance value for their shareholders. During the 1970s, share ownership began to shift from individuals to large institutional investors such as pension funds. The feeling emerged that corporations paid too little attention to the shareholders’ interests. Economists and shareholders joined in an attempt to restore property rights of shareholders. This led to a shareholder-value revolution. It resulted in an enormous wealth transfer from enterprises to shareholders during the following decades. The typical American firm is nowadays owned by shareholders who are only interested in short-term profit.

Immediately upon entering office (1980) President Reagan embraced monetarism – the idea that by influencing the money supply one can steer the economy. The Federal Reserve chairman, Paul Volcker, had already in 1980 (during the Carter Administration) started raising interest rates. He raised the federal funds rate, which had averaged 11.2 per cent in 1979, to a high of 20 per cent in June 1981. Inflation, which peaked at 13.5 per cent in 1981, was successfully lowered to 3.2 per cent by 1983.

President Reagan also implemented ‘supply-side economics’, a code word for reducing all impediments to capital accumulation. He immediately lowered taxes and organized a frontal attack on trade-union power. When, on 5 August 1981, at the height of the vacation season, 13,000 air traffic controllers walked out, causing 7,000 flights to be cancelled daily, Reagan fired all striking controllers, imposing a lifelong ban on rehiring them.

Long before the 1980s, the American financial system was already under pressure. The system that emerged after the New Deal was highly compartmentalized, with distinct institutions serving discrete functions and protected from direct competition with one another. Credit was scarce and rationed. The economy was far from a typical liberal market economy, as portrayed in economic text books. The financial sector was divided into diverse interest groups that found it difficult to rally behind a unified agenda (Krippner, 2011, p. 60). Politicians played a prominent role in the allocation of capital through the regulation of the financial sector. Especially during the 1970s, cracks appeared in this system due to huge pressures to find capital. For example, thrifts that financed home-buying managed to repackage mortgages and sell them as mortgage-backed securities in order to expand their capital base (Krippner, 2011, p. 63). An important step was the abolition of fixed rates for brokerage commissions on Wall Street – rates that had made trade (and speculation) in stocks much cheaper (1975).

Under the presidency of Reagan, deregulation of finance accelerated, which increased financial volatility that made financial crises more frequent. The 1980s was also the decade of a leveraged buy-out boom. Debt-financed takeovers were fueling stock prices. The result was ‘Black Monday’, 19 October 1987, when stock markets crashed (the Dow declined almost 23 per cent in one day). A disaster was narrowly avoided by the Fed, which promised a safety net for banks (by serving as a source of liquidity) and convinced them to continue lending (Ferguson, 2008, p. 166). Earlier, in dealing with the Latin American debt crisis, the United States had pushed the International Monetary Fund (IMF) to protect creditors (above all US banks lending to Latin America) at any cost. Volcker told the Federal Open Market Committee that the United States should be ready to bail out banks ‘too big to fail’ (Panitch and Gindin, 2014, p. 179). Gradually, banks became convinced that it was worthwhile to take more risks, because the Fed (or the IMF) was always there to assist.

Deregulation also resulted in increased fraud. By the late 1980s, 747 out of the 3,234 savings and loan associations (S&Ls), institutions that could accept deposits and give mortgages) went bankrupt. By 1987 these institutions had $1.5 trillion in assets (Greenspan, 2007, p. 114). A lot of money had been stolen,and the debacle cost taxpayers initially $124.6 billion (Lanchaster, 2010, p. 222); 326 S&L executives went to jail.

President Reagan also allowed current account deficits to boom. The liberalization of capital accounts in the rest of the world, coupled with high interest rates in the United States with the Volcker shock, enabled a rapid increase of capital inflows that neutralized the current account deficits (see Figure 1.3). Under Reagan, the process started in which the United States was transformed from the world’s leading creditor to become the world’s leading debtor. Concomitantly, investment and savings ratios in the United States went down. In the 1970s Americans saved almost 10per cent of their income, slightly more than in the 1960s. It was after the Reagan deregulation that thrift gradually disappeared from the American way of life. Also, government deficits started to rise, financed with Treasury paper that was increasingly sold to foreigners. At the start of the Reagan Administration the budget deficit was $700 billion, at the end,$2 trillion (Greenspan, 2007, p. 102). As J.K. Galbraith noted in an interview for The Progressive (October 2000), American society became ‘privately rich but publicly poor’.

The transformation of finance

Deregulation of finance under President Clinton

President Clinton (1992–2000) considered deregulation of the financial sector as a substitute for social policy. Under his presidency, mortgage lenders were pushed by the federal government to lend to subprime mortgage lenders with the aim of bringing affordable housing to the poor. At the same time social expenditures were cut. To allow the poor to borrow, interest rates should be low. According to Scheer (2010, p. 100), in the first year of his presidency, Clinton made an informal deal with Fed Chairman Alan Greenspan: if the Fed kept interest rates low, the president would reciprocate with financial-market deregulation. The Glass-Steagall Act that separated commercial from investment banking, was repealed, to be replaced by the Financial Services Modernization Act (signed by Clinton in 1999 and passed in 2000), which opened the door for banks to speculate with the customer’s money. Among others, financial derivatives escaped regulation. This allowed a boom of fraudulent financial derivatives. Politicians and civil servants who protested against fraudulent practices were intimidated and/or fired. The fates of two companies, Long Term Capital Management (LTCM) and Enron are exemplary.

LTCM was a hedge fund founded in 1994 by, among others, Nobel Prize winners Scholes and Merton (awarded 1997). In 1998 it had assets of only $6.7 billion but liabilities of $126.4 billion. Financial derivatives amplified the possibility of bankruptcy. After the Russian default (1998), leverage increased to 42:1, and in order to avoid collapse LTCM needed a New York Fed brokered bail-out of $3.6 billion, from 14 Wall Street banks. This hedge fund had placed massive bets on interest derivatives. The rescue was organized by the Fed under very opaque conditions.⁴ Again, the problem of ‘moral hazard’emerged.

Enron developed from an energy producer and deliverer to a trading company that was making bets on the rise and fall of the very energy prices it was manipulating. Enron was involved in Congress’s adoption of a law that would exempt from regulation the energy trade that Enron, itself, was conducting (Lanchaster, 2010, p. 220). For six years Enron was proclaimed by Fortune magazine as the most innovative company in the United States. In December 2001, Enron went bankrupt, with $20 billion in the red. It had formed thousands of subsidiaries in order to avoid taxation and obscure the books.

Generally, volatility on financial markets increased. This already had become visible in 1994, when the bond markets collapsed and knocked off $600 billion from the value of US securities.

The 1990s stood also out because the globalization bonanza started and enterprises began to massively undertake off-shore production. Deregulation and globalization helped to enable the longest postwar US economic boom. This prolonged boom confirmed policymakers in the rightness of their economic policy.

The 2000s

In 2001 the ‘dotcom bubble’ burst. Because of the hype around new technologies, large sums of money had been poured into startup firms, but with nothing to show for it.⁵ The Fed had the idea that the exuberance of that bubble could be counteracted by enabling other bubbles to emerge, such as the housing bubble. Initially, the strategy worked. In 2001 the Fed started lowering interest rates, from a peak of 6.5 per cent to 1.25 per cent by October 2002. This inaugurated debt-fueled growth enabled by cheap credit. In 2003, the Bush Administration encouraged mortgage lenders not to press subprime borrowers for full documentation (Ferguson, 2008, p. 268).

Subprime mortgage lending became big business, and the major banks packaged bundles of subprime mortgages into derivatives that sold for a good profit to (often foreign) banks and pension funds. The banks were asking fewer and fewer questions of borrowers. Ninja loans – loans for people with No Income and No Assets-became common. Borrowers were also misled (and were even cheated) when faced with high interest rates soon after having signed the mortgage contract. The floodgates were opened for an unprecedented soaking of the poor. This process had already started under President Clinton. Annual subprime lending shot up from $3.4 billion to $600 billion in just ten years (Documentary: ‘Inside Job’).

Due to tax cuts for the very rich, spending on the wars in Iraq and Afghanistan and Homeland Security, government budget surpluses immediately transformed into deficits under President George W. Bush. Public debt as a percentage of GDP rose sharply after declining during the Clinton Administration.

As a result of deregulation of the financial sector, the share of finance and real estate in the economy increased tremendously, although employment in finance had remained flat since 1990. While, in 1980, employees in the financial sector earned, ...

Table of contents

• Cover
• Title
• Introduction
• 1  The United States: Casino Capitalism Unleashed
• 2  The United States: The Great Financial Crisis and Its Aftermath
• 3  The Variety of Capitalism and Neoliberalism
• 4  European Monetary Union and Freedom for Capital
• 5  The Euro as a Divisive Force
• 6  Globalization, Financialization and US Power
• 7  The Variety of Capitalism after the Great Financial Crisis
• 8  Why Did Economists and Neoliberals Get It So Wrong?
• 9  Reclaiming Sovereignty
• Conclusion
• Notes
• References
• Index