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Title: Imperial Finance Author: George Stapleton Date: 2009 Language: en Topics: United States of America, Imperialism, globalization, capitalism, history, financial crisis, Red & Black Revolution Source: Retrieved on 15th November 2021 from http://www.wsm.ie/c/historical-development-global-financial-order-us-hegemony Notes: Published in Red & Black Revolution No. 15 â Spring 2009.
This article tells the story of the historical development of the regime
of global financial order under US hegemony. It begins by examining how
the centre of capital accumulation shifted from Europe to the US in the
first half of the twentieth century, and how following World War II the
global financial order became centred around the US through the Bretton
Woods system. It then looks at how the Bretton Woods System was
undermined, concentrating as much on the role of workers militancy as on
the role of the Eurodollars market. After considering the response to
the crisis of Bretton Woods, it concludes by looking at the Clinton
boom, bringing us up to the current situation of the USâs current heavy
dependence on foreign borrowing
---
During the course of the twentieth century, capitalism, a European
invention, shifted its centre across the Atlantic to the US. In order to
get an understanding of how this happened, itâs worth going back to the
period of European hegemony at the end of the nineteenth century.
The late nineteenth century was the period when the modern economic
system, capitalism, emerged as a world system. Although capitalism had
established itself in Britain at the start of the nineteenth century, it
was not until the end of the century that it emerged as a global system.
This period saw the industrialisation of Germany, the Benelux, France
and America; the era of the scramble for Africa; the opening of the Suez
canal; the switch from sailboats to steamboats; the opening of rail
links all across the world; the telegraph etc. Added to this were the
mass migrations from the old world to the new and from the country to
the cities. All in all, it was an era of unprecedented economic change
as the capitalist system expanded outwards from Britain to define the
lives of millions across the globe.
This newly global form of capitalism rested on a system of international
trade and finance based on the gold standard. The gold standard operated
whereby banks held gold and gave their customers notes entitling them to
a certain amount of gold. So if you had a ÂŁ10 note you could go to the
Bank of England and ask for ÂŁ10 worth of gold and they would give it to
you. As such, the value of a currency fluctuated only with the value of
gold (or on the odd occasion when a currency was revalued). This made
international trade and international finance very safe; it removed a
lot of risk. So for example, if you wanted to buy a French product worth
100F, and 100F were worth ÂŁ10, the French seller would know that he
could go to the bank and get out 100F worth of gold with your ÂŁ10. It
didnât matter what the paper said; as long as a currency was convertible
into gold it was safe and almost entirely risk free.
The rapid expansion of the world economy would never have been possible
without the removal of risk ensured by the gold standard.
However, this era of capitalism came to an end with World War 1. By
November 1918, the world system that tied global capitalism together was
in ruins. World War 1 had marked a major crisis for Europe. Of the
Allied Powers, Russia had had a revolution in 1917, while Britain and
France, the two major European economies of the Allies had borrowed
heavily from America to fund their war effort. This placed Britain and
France, previously two of the worldâs strongest economies, into a
position where they were in massive debt.
The Central powers were both economically and politically destroyed.
Both the Austro- Hungarian and Ottoman Empires were dissolved, while a
Revolution toppled the Imperial German State. Germany was also burdened
with massive war reparations as punishment for âstartingâ the war.
These reparations saw large quantities of money flow from the German
economy to the Allies. This money in turn flowed from the debt- ridden
European powers to their American financiers. Gold flowed from Germany
to Britain and France and then to America and thus greatly empowered the
US on a global scale. In 1913 America had 26.6% of the worldâs gold
reserves, by 1924 it had 45.7%. The result was monetary chaos in Europe.
European banks simply did not have enough gold reserves to continue
operating on the gold standard.
In any market, if supply contracts then, with fixed demand, prices rise.
What this means in the money market is that if you reduce the supply of
money then interest rates increase. If banks have less money to lend
they will charge the people they lend money to more. i.e. the price of
money increases. If interest rates increase then it becomes more
expensive to borrow, so investors donât invest as much. This causes the
economy to slow down, jobs to be lost etc. This is precisely what
happened in Europe in the interwar period. The contraction in the money
supply caused by the flow of money towards America was followed by mass
unemployment and a general economic slow down.
This economic chaos created immense social tension in Europe as the
working class grew more and more militant and organised. In response to
this continent-wide tension, large sections of the bourgeoisie, backed
by landed interests, abandoned the free market and turned to fascism.
Meanwhile, in America, the Smoot-Hawley Tariff Act of 1930 marked the
end of free trade. Quickly the internationally integrated capitalist
system of the prewar period became little more than a memory as country
after country shifted to beggar-thy-neighbour style economic policies.
This turn to autarky (economic self-reliance) was one of the driving
forces behind World War 2. From 1939â1945 Europe again fell into a war
of pointless self- destruction.
When it became evident that the Allies were going to win the Second
World War, 730 delegates from all 44 Allied nations met in Bretton
Woods, New Hampshire, USA to work out how the international capitalist
system would work post-war. What was agreed at Bretton Woods ultimately
brought about the creation of the IMF (International Monetary Fund), the
World Bank and the World Trade Organisation. The World Bank was
originally called the International Bank for Reconstruction and
Development, the WTO was originally called the International Trade
Organisation, the US Congress vetoed the setting up of this organisation
so instead of it being an organisation it was, until 1994, merely an
âagreementâ, the General Agreement on Trades and Tariffs.
The reasoning behind this conference was the Alliesâ ruling classâs fear
of a repetition of the chaos of the interwar period. They wanted a
return to the pre-1914 situation of an internationally integrated and
rapidly growing world economy. However, it was clear that after the war
Europe would not have enough gold to operate under the gold standard.
This turned out to be the case. By 1947, America once again had the bulk
of the worldâs gold reserve: 47%. In place of the gold standard a system
was developed, known as the Bretton Woods system, whereby the American
dollar would be convertible into gold and every currency would have an
exchange rate fixed to the US dollar. Thereby every currency would be
convertible into dollars, which, in turn, were convertible into gold.
The dollar was as good as gold, and every other currency as good as the
dollar.
This gave the rest of the world the economic stability it desired. But,
significantly, it also gave America unprecedented economic power as the
centre of global capitalism. The Bretton Woods system was managed
through the IMF whose headquarters were in Washington DC. The
headquarters of the International Bank for Reconstruction and
Development (i.e. the World Bank), which oversaw post-war international
loans for âreconstruction and developmentâ was also in Washington DC.
The GATT, which facilitated the reduction in trade tariffs and the
increase in international trade, was also based in Washington DC.
The Bretton Woods system, was not a free market system i.e. it was not a
system where things were determined exclusively by the price mechanism,
it was a system that saw intense and constant state involvement in the
international economy. Under Bretton Woods, world trade, economic
integration and globalisation were in the hands of governments, whereas
the central premise of the pre-1914 global system was the absence of
such intervention.
The overtly political nature of the Bretton Woods agreement threw up its
own problems. By the 1960s, these problems had generated a crisis that
threw its continued existence into doubt. The major problems were:
Firstly, the Vietnam War threw the legitimacy of US hegemony into
question within the US itself. An interesting aspect of the Bretton
Woods agreement was the difficulty with which it was sold to the
American ruling class. Although Bretton Woods did see America become the
world hegemon, America had historically been uninterested in world
hegemony, preferring isolationist policy and unilateral action. The
infamous Smoot-Hawley Act of 1930, which effectively quadrupled import
tariffs, drew a large degree of the blame for the total collapse of
international trade in the 1930s. As noted above, even with the Bretton
Woods agreement, Congress vetoed the creation of an International Trade
Organisation. It must therefore be asked why the US agreed to take the
position of world hegemon despite such recent history of strongly
isolationist stances. The answer was given clearly by the contemporary
Republican leader in the House of Representatives, who identified it as
a question of âwhether thereshall be a coalition between the British
sphere and the American sphere or whether there shall be a coalition
between the British sphere and the Soviet sphere.â This question did not
even need to be asked in countries such as France and Italy, which would
surely have gone Communist without American intervention. The legitimacy
of the Bretton Woods system in America was therefore tacked to the Cold
War and the threat that American Capital believed the USSR posed. In the
60s, the Vietnam War threw the legitimacy of the Cold War and the extent
of the Soviet threat into question.
Secondly, and more importantly, the international post-war peace between
labour and Capital was thrown into crisis. The Bretton Woods
international system was not, as noted above, a pure free market system.
This shift from the free market was mirrored on a national level in
almost every Bretton Woods country with the emergence of Social
Democracy. The
threat of the Soviet Union on an international level was matched in most
Western countries by a domestic revolutionary movement. Thus, a major
task in post war reconstruction was the need to bring about the defusing
of the revolutionary labour movements. This was achieved by the âPost
War Settlementâ, which, simply put, meant that capital agreed to low
profit rates, if labour agreed not to have a revolution and, more
immediately, agreed to wage restraint. This post-war period was one of
unprecedented economic growth, negligible unemployment, massive
investment in social housing, education and health care, largely brought
about through this post-war settlement. However, this settlement did not
see the disempowerment of the working class.
Throughout the period, improvements in living conditions were matched by
the increased power of the working class. This period saw the increasing
size of the working class, its increased unionisation, large increases
in unemployment benefit etc. Then, in the mid- to late-sixties, workers
started demanding more than the settlement had granted them.
For instance, some 150 million strike days were taken in France in the
revolutionary period of May-June 1968. These strikes resulted in a 10%
wage increase, an increase in the minimum wage and extensions of union
rights. In Italy, in 1969, some 60 million strike days were taken in a
movement led from the shop floor. These also resulted in a 10% wage
increase, reduced working hours, parity of treatment when sick for blue
and white collar workers and increased union rights. In the UK in
1970â71, 25 million days were taken by striking workers. Such increased
working class militancy was also seen in the US, which topped the OECD
league table in days on strike per worker in 1967 and again in 1970.
These struggles saw a significant increase in wages for workers across
the world, increases in unemployment benefit for unemployed workers
across the world, increased social investment and so on. Perhaps most
significantly, it saw a significant decrease in the rate of profit and
an even more significant decrease in the share of national income going
to capital. The Post War Settlement was over: the working class wanted
more.
These problems were compounded by a further problem for the Bretton
Woods system; the emergence of the Eurodollar market.
The Eurodollar market began in 1957 when, following its 1956 invasion of
Hungary, the Soviet Union grew increasingly worried that the US
government would freeze (i.e. prevent the withdrawal of ) its dollar
deposits held in US banks. For this reason, it started transferring its
dollar holdings into London based banks. Thus the London based banks
were holding dollar deposits outside of the country in which they were
legal tender â the US. As these deposits
were outside of the US they were no longer under the jurisdiction of the
Federal Reserve (i.e. the US central bank). A Eurodollar is therefore a
dollar held outside of the US. You can of course do this with other
currencies creating what are known as Eurocurrencies. A Eurocurrency is
any currency held outside of the country in which it is legal tender.
For example you can have Euro-Yuan, Euro-Yen, Euro-Sterling or even
Euro-Euro. Itâs important to note, however, that Eurocurrencies have
nothing to do with the Euro.
Eurodollars became significant in the 1960s as US Multi-National
Corporations (MNCs) started investing more and more outside of the US.
This Foreign Direct Investment (FDI) by US MNCs was directed primarily
into Europe, and, to a lesser degree, South-East Asia. As US MNCs
started investing heavily outside of the US they kept many of their
deposits in dollars. This migration of capital from the US to Europe
lead to many US banks entering the Eurodollars market. By 1961 US banks
controlled 50% of the market.
These developments created in the Eurodollar market a financial system
outside the control of the worldâs central banks, and therefore largely
outside the control of the Bretton Woods arrangement.
With the growth of this unregulated liberal money market, and with the
growth of US FDI, total US liabilities to âforeignersâ soon far exceeded
the USâs gold reserve (see graph above). To deal with this, President
Kennedy tried to restrict US foreign lending and investment in 1963.
However this attempt backfired. As Eugene Birnbaum of Chase Manhattan
Bank explained, â[f ]oreign dollar loans that had previously come under
the regulatory guidelines of the US government simply moved out of the
jurisdictional reach. The result has been the amassing of an immense
volume of liquid funds and markets â the world of Eurodollar finance â
outside the regulatory authority of any country or agencyâ.
In brief, a situation had been created whereby US finance had simply
migrated from the US into Europe, or more specifically, the City of
London. As Andrew Walter put it, âLondon regained its position as the
centre for international financial business, but this business was
centred on the dollar and the major players were American banks and
their clientsâ.
Combined with the problem of increased liabilities was a decrease in the
USâs gold reserves. This arose due to inflationary pressure as the
increase in government spending pushed down the value of the dollar,
causing foreign dollar holders to convert their dollars into gold.
With the continued growth in the power of the working class, government
investment in social services increased. In 1964 the US saw the start of
Lyndon Johnsonâs Great Society program. As the 60s wore on, this program
increased in scope, with the increased demands of African-Americans and
other sections of the working class for improved living conditions.
Adding to this growth in spending was the war in Vietnam, which cost
$518bn (9.4 per cent of GDP). To fund these spending increases the US
government resorted to deficit spending and this borrowing drove
inflation, so that the dollar was able to buy less; it was worth less.
However, as the dollar was set as being worth a certain amount of gold,
it remained at the same value on the international market despite
domestic inflation; the dollar was artificially strong. Increasingly
holders of dollars became aware of the fact that the value of the dollar
was artificially inflated and started converting their dollar holdings
into gold, running down the USâs gold holding, as shown in the graph
above.
The US government was faced with a choice; it could rein in its economy;
cut spending, thereby deflating the currency and maintaining the gold
value of the dollar. Or it could simply refuse to convert dollars into
gold. In August 1971, Nixon did the latter and by 1973, the Bretton
Woods system had completely collapsed.Stagflation, Workers Militancy and
the
The collapse of Bretton Woods, matched with the explosion of the
Eurodollar market, enabled countries to pursue extremely loose monetary
policies. Countries cut interest rates to stimulate the economy. These
cuts increased the money supply greatly driving inflation. There was too
much money chasing too few goods, so the price of those goods increased.
If prices increase then the real value of wages decrease as they can no
longer buy as much. Therefore, as prices increased, workers demanded
higher wages to compensate for the higher cost of living. This caused
capitalists to charge even higher prices to maintain profit levels. This
system of self-reinforcing inflation was referred to as stagflation
because it saw inflation without increased economic growth or decreased
unemployment.
A theory that many economic planners at the time were relying on was one
element of Keynesian economics known as the Phillips curve. Essentially
the Phillips curve is a graphical exposition of the idea that if you
have high levels of inflation you will have low levels of unemployment
and vice versa. The rationale behind this theory was that if you
decrease interest rates you will stimulate the economy by making it
easier to borrow, thereby stimulating investment. As investment
increases, the demand for labour increases; unemployment falls and the
economy grows.
However, in the 70s, this failed. The West experienced high levels of
unemployment despite the fact that by the end of the 1970s interest
rates around the world had fallen to below zero (i.e. borrowers were
being paid to borrow).
The first reason worth looking at was the aforementioned working class
militancy. Workers knew that capital was using inflation to cut real
wages and the working class was strong enough to respond to this attack
on living conditions. Workers demanded wage increases that at the very
least matched inflation. Labour mobilised itself to protect its standard
of living. British coal miners slowed work and then went out on strike
in early 1974, forcing the country onto a three-day week. Between 1974
and 1979 an average of 12 million days a year were lost to strike action
in the UK compared with an average of below 4 million for the 50s and
60s. In Italy intense class struggle saw the development of an
âescalatorâ, which tied wages to inflation. In Portugal, workers took
over factories during the Carnation Revolution. In Spain, there was an
explosion of class struggle as Francoâs rule came to an end. In Germany,
the Social Democratic government tried to assuage class struggle with
its project of co- determination, which offered workers a voice in the
management of the companies they worked for, while in Sweden the
government developed the much more radical Meidner plan which was
intended to see the gradual transfer of ownership of all enterprises in
Sweden to Labour Unions.
The second reason was the 1973 oil crisis where OPEC massively increased
the price of oil creating sudden and unexpected price increases across
the world for almost every commodity. This increase in oil prices raised
costs and cut into profits, thereby discouraging investment. It also
drove inflation above the targeted level, creating uncertainty in the
economy, further discouraging investment.
Added to these domestic problems was the further growth of financial
markets. The Eurodollar markets received further stimulation from the
surplus funds accruing to OPEC countries due to the 1973 oil price hike.
As the industrial world experienced stagflation, international banks
invested Eurodollar capital in less developed countries, particularly in
Latin America. Combined with innovations in financial techniques and
instruments, the deregulation of the financial market and the
possibilities opened up by modern communications technology, this caused
the financial markets to grow rapidly, causing what some have called
âthe financial revolutionâ. By the end of the 70s, international
financial flows (i.e. movement of money between countries) dwarfed trade
flows (i.e. movement of goods between countries) by a ratio of about 25
to 1. This expansion created a truly global form of capital, capable of
moving from one country to another at the click of a button. This
ability to move money enabled capital to escape government regulation or
manipulation of the financial markets, and empowered capital to put
pressure on government with the threat of disinvestment. By the late
70s, Western capitalism was in crisis. It didnât know how to respond.
When a second round of OPEC oil shocks occurred in 1979, it was clear
that something drastic had to be done.
Neo-liberalism
On August 6^(th), 1979, President Jimmy Carter appointed Paul Volcker as
head of the Federal Reserve. Immediately Volcker made clear his
intentions. As head of the Fed, he would do whatever it took to bring
inflation under control and stabilise the currency. This commitment
became associated in the popular mind with the monetarism of Milton
Friedman, although this is slightly inaccurate. Volcker pushed the short
term interest rate up 5% to 15%, eventually bringing it above 20%.
Persistent in his drive to bring down inflation, he kept interest rates
at these astoundingly high levels until 1982. For capital these interest
rate increases, known as the âVolcker Shockâ were like putting brakes on
the economy as it began to spin out of control. In order to regain
control, the Fed deliberately drove the economy into two successive
recessions over this three year period. This raised unemployment to
nearly 11%, drove down manufacturing output by 10% and drove down the
median family income by an equal 10%.
This attack on working class living standards was secured in 1981 with
Ronald Reaganâs electoral victory. In this election the Professional Air
Traffic Controllers Organisation (PATCO), along with the Teamsters and
the Air Line Pilots Association, had departed from tradition and backed
Reagan, a Republican, and not Carter, the incumbent Democratic
candidate. On August 3^(rd), 1981, PATCO went out on strike for higher
pay, better working conditions and a 32 hour week. This strike was
technically illegal as government unions are not allowed to strike in
the US. However, a number of government unions had gone on strike before
without repercussions. This time it was different. Reagan ordered the
PATCO workers back to work, threatening dismissal if they continued the
strike. Few complied with these orders and on August 5^(th), President
Reagan fired the 11,345 striking PATCO workers.
The PATCO strike and the âVolcker Shockâ marked the defeat of the
working class in the long cycle of struggles that began in the mid 60s,
turning the economy definitively in the interests of capital. High
interest rates massively increased the return on capital. Financial
investors who previously could barely earn rates of return equal to the
rate of inflation could now earn the highest profit rates in memory.
With the end of inflation and the inspiration of the PATCO strike,
employers took a hard line when it came to wage increases. Workers, they
held, could no longer demand wage rises in line with inflation so no
more increases would be forthcoming. Between 1978 and 1983 real wages in
America decreased by over 10%. This decline in real wages was continuous
until 1993, by which time real wages were 15% below 1978 levels.
This transformation had international ramifications. Due to the creation
of the global financial market through the growth of the Eurodollars
market, other countries were forced to follow suit in raising interest
rates. Otherwise, they risked the migration of capital to the higher
interest rates of the US. Investors would not buy German government
bonds at 7% interest if US government bonds had a rate of 15%. The
transformation was also matched by political shifts in Europe. Just
prior to Volcker taking charge of the Fed, Thatcher had been elected
Prime Minster of the UK. In Germany, for the first time since the
mid-sixties, the Social Democrats lost the election in 1982 and the
Christian Democrats came to power. In France, Mitterandâs Socialist
Party had come to power in 1981 amidst much fanfare, but had to abandon
their program for government within two years as Mitterand launched the
âFranc Fortâ policy following the 1983 French macroeconomic crisis. As
Jeffrey Sachs and Charles Wyplosz noted in 1986, âthe government of the
left has in the end introduced a tougher, more market oriented programme
than anything considered by the previous centre-right administration.â
It would be cavalier not to mention here the impact that these interest
rate increases had on the developing world, Latin America in particular.
As mentioned above, billions of petrodollars were lent to Latin American
states in the 70s through the newly global financial markets. When
interest rates increased, Latin American countries had difficulty
meeting their debt obligations and, one after another, defaulted causing
the 1982 Latin American Debt Crisis. Latin America has yet to recover
fully from this crisis, as in the years following, investors were no
longer willing to invest in the region. This prolonged recession is
referred to as âthe lost decadeâ. It was this debt crisis and the
associated crisis of confidence in the Third World economy that caused
and provided justification for the infamous IMF Structural Adjustment
Programs of the 80s and 90s
The 1980s were a turning point which saw the defeat of the working class
both in both the West and the Global South.Capital,through its increased
power via the freedom of movement granted by financial markets was able
to force governments to implement pro-capital, pro- market policies and
abandon the expansion in social spending which had defined capitalism
since the end of World War 2.
Itâs also worth mentioning that the contractionary policies of the
Reagan administration were directly undermined by its deficit spending.
Reagan, while committed to the fairy-tale idea of âthe magic of the
marketplaceâ, was even more committed to the equally fairy-tale idea of
defeating the âevil empireâ (i.e. the USSR). He massively increased
military spending while cutting taxes bringing the top rate down from
70% to 38% in a matter of years. These tax cuts were based on a theory
famously advanced by Arthur Laffer, on the back of a napkin while having
dinner with Dick Cheney, Donald Rumsfeld and others. This theory, known
as the Laffer curve arguedthat as taxes got higher people worked less
and saved less, and therefore that raising taxes could decrease tax
revenue. The idea follows that in order to raise tax revenue you should
cut taxes. Needless to say, it didnât work and the US spiralled into
debt. This continued under the Bush Sr. administration, which followed
Reagan. Between the two administrations the federal debt rose from a
postwar low of 33% of GDP in 1981 to 66% in 1993.
By the mid-nineties the defeat of the left and the working class was
secure. The old communist parties crumbled and the old social democrats
scrabbled for the âthird wayâ. By the mid-nineties, former leftists
began coming to power again. In late 1992 Bill Clinton was elected on
the back of a campaign that focused clearly on the economy. His
unofficial campaign slogan was âItâs the economy, stupid.â After the
long years of the 1980s and the jobless recovery following the 1990/91
recession, Americans were eager for something new.
Fortunately for Clinton he was president during an unexpected surge in
productivity growth, i.e. the amount of value created by an hourâs work.
The average annual rate of productivity growth from 1947 to 1973 had
been 2.8%, but following the crisis of the late 60s/early 70s
productivity growth slumped to 1.4% between 1973 and 1995. Unexpectedly,
productivity growth surged in 1995 and from the second half of that year
through to the second half of 2000 productivity growth averaged 2.7%
annually. This growth in productivity laid the basis for the boom of the
mid-late 90s, the now infamous âNew Economyâ. This boom was further
facilitated by the lax monetary policy of the Fed under Alan Greenspan.
When the Phillips curve ceased to operate in the 1970s, some economists,
most famously Milton Friedman, argued there was a ânatural rate of
unemploymentâ. When unemployment was at this rate, decreasing the
interest rate would fail to stimulate the economy or reduce unemployment
but would simply drive inflation. This was their theory of how
stagflation occurred. As this theory grew in popularity the ânatural
rate of unemploymentâ was quickly renamed the more diplomatic âNon-
Accelerating Inflation Rate of Unemploymentâ or NAIRU.
Through the 1980s and into the 90s the Fed had adhered to this doctrine
and estimated that NAIRU was 6%-6.2%. So, when unemployment fell below
6% in 1990, Greenspan increased interest rates to prevent inflation, or
âoverheatingâ of the economy. This interest rate increase slowed down
the economy and helped cause the 1990/91 recession. Again in 1994 when
unemployment began to fall below 6% he hiked up the interest rate.
However, in the second half of 1995 when unemployment fell to 5.7% and
he saw no inflationary pressures he broke from the NAIRU theory and
didnât increase interest rates. Greenspan then let unemployment fall
even further without increasing the interest rate. It fell below 5% in
1997, went to 4.5% in 1998 and in 1999 and 2000 settled at 4%; the
lowest unemployment rate since 1969. Throughout this there was little
change in the underlying rate of inflation and little change in the
interest rate.
This productivity boom drove a stock market boom. However, another major
factor contributing to the stock market boom worth mentioning was the
increase in stock ownership. This was driven by the changing nature of
the pension industry. Historically, most workersâ pension plans were
âdefined benefitâ pension plans, while today most workers have âdefined
contributionâ pension plans. The names of these plans explain the
difference between them. Under a defined benefit plan, the benefit that
workers receive when they draw their pension is defined. Under a defined
contribution pension plan, the contribution that workers make to the
plan while still working is defined. Defined contribution plans grew in
America following changes in the tax code in the late 70s. These changes
encouraged workers to agree to defined contribution plans where workers
and their employers put money into a tax-sheltered retirement account,
such as 401(k) accounts. The money held in these accounts, these pension
funds, was then invested on the financial markets. This meant that
workersâ pensions were then dependent on the performance of these
investments, as under defined contribution plans the benefit at the end
is not defined.
The growth in productivity, the expansion in demand in the financial
markets caused by the growth of pension funds, a growing amount of
delirium caused by the newness of the technology driving the
productivity boom and the fact that a similar boom hadnât been seen
since the 60s, all combined to cause a massive boom in the stock market
which quickly turned into a bubble. As share prices grew and grew, a lot
of nonsense began to be expounded. Talk developed of a âNew Economyâ
where share prices could only go up, where recessions were a thing of
the past, where the business cycle was over, where productivity growth
could only increase and increase. Many bought into this euphoric idea,
and as shares prices were driven up and up, more and more people started
speculating on the stock market driving shares further upwards. The
demand for shares was seemingly insatiable and as such their price only
went up. New Internet companies, the dotcoms, which had little to no
real assets, saw their share value go through the roof as everyone
looked for the new Yahoo, or AOL. Even people who saw that share prices
were artificially inflated entered the market thinking that, provided
they got out before the bubble burst, theyâd be safe. And, of course, as
with all bubbles, burst it did. In March 2000 the value of shares in
dotcoms and IT companies began to tumble. Between 2000 and 2002, $5
trillion dollars in market value of technology companies was wiped out.
This bursting of the bubble was worsened by the attacks of 9â11. The New
York Stock Exchange, the American Stock Exchange and the NASDAQ were
closed until September 17^(th) following the attacks. When markets
reopened the Dow Jones Industrial Index fell 7.1%, its biggest ever one
day fall. By the end of the week it was down 14.3%, its biggest ever one
week fall. $1.4 trillion dollars in stock value was lost over this week.
The Fed responded by cutting interest rates sharply from 3.5% down to
3.0%. Then following the bankruptcy of Enron and the accounting scandals
that followed, the rates were cut even further to a 50 year low of 1%.It
stayed at this level until 2004 when it was gradually increased until it
reached 5.25% in 2006. These low interest rates stimulated the economy
and it rise out of recession, meaning that the 2000/2001 recession was
one of the briefest and mildest in history.
However, this recovery was not based on growth in employment and did not
result in increased earnings for the working class, but was almost
exclusively fuelled by borrowing. Instead of job growth, 2002 saw net
job losses, which continued into 2003. By November 2004 the economy had
still not regained the number of jobs it had lost in the 2000â2001
recession. Wage growth at first stalled, decreasing from 1.5% per annum
in the late 90s to 0% by 2003. Then wages began decreasing! From mid
2003 to mid 2005 the median hourly wage fell by more than 1%.
People have referred to the post 9â11 recovery as a jobless recovery.
This âjobless recoveryâ was almost solely driven by consumer demand and
government spending. Despite falling income, consumer spending from
November 2001 to August 2004 surged by 9%. This was driven by a $4
trillion increase in household borrowing between 2000 and 2005. The
government was also borrowing heavily, running a current account deficit
of more than $700 billion, the equivalent of 6% of GDP.
This borrowing-driven boom was fuelled firstly by house price inflation
and secondly by foreign borrowing, in particular from China.
Housing prices exploded between 2001 and 2007. The incredibly low
interest rates of 2001- 2004 had made it extremely easy to borrow and
acquire credit. This availability of credit enabled more and more people
to buy or invest in property driving up the price of property and
thereby causing a housing boom.
It important to note that house price inflation is not wealth creation.
House prices do not go up because houses become more productive; they go
up because of a decrease in supply or, as in this case, an increase in
demand. House price inflation does not contribute to the productive
capacities of an economy; it merely transfers wealth from the
house-buyer to the house-seller. As the Economist points out, â[f ]or a
given housing stock, when prices rise, the capital gain to the
home-owners is offset by the increased future living costs of
non-home-owners. Society as a whole is no better off. Rising house
prices do not create wealth, they merely redistribute it.â In August
2007 the housing bubble burst, and more than a year later we are still
feeling the brunt of this.
The US was spending far beyond its means during the 2001â2007 period.
This behaviour was financed primarily by foreign borrowing, largely from
emerging economies, China in particular.
China was buying large amounts of dollar denominated assets, in
particular US Treasury bills or T-bills. By buying these assets it drove
up the dollar, increasing US demand for Chinese goods & driving down the
Yuan keeping the price of Chinese goods low on the international market.
An added reason for China (and other emerging economies) to buy dollar
denominated assets was to mitigate risk. Following the 1997â98 East
Asian Crisis most East Asian countries have tried to accumulate large
stocks of dollar denominated assets in order to be able to respond
should a speculative attack on their economy occur.
The decreased health of the US economy and its increased dependence on
foreign credit has left the US in a significantly decreased position of
world economic power. It is no longer possible to say that there are no
free- market economies that rival the US in terms of size. It is
expected that the Chinese economy will exceed the size of the US economy
by 2030, and added to this is the increased integration of the EU
economy and the growth of India.
How the decreased economic significance of the US will play out over the
forthcoming years is anyoneâs guess. It is worth remembering that Europe
lost its position as global economic hegemon largely due to excessive
borrowing from the US in the first half of this century. Considering how
indebted the US is today, this certainly doesnât bode well for its
future. However, as of yet the US faces no realistic challenger and we
certainly shouldnât rule out the US economy bouncing back and
reasserting its centrality in and hegemony over global capitalism.
---
This is the second of a series of articles covering the financial and
money markets from a critical perspective. However, this article is
completely independent of the first article, âFinancial Weapons of Mass
Destructionâ, which appeared in the previous issue of Red and Black
Revolution. Despite being part of a wider research project, the author,
time-frame and most of the subject matter of both articles are totally
separate and the two need not be read together.
In âFinancial Weapons of Mass Destructionâ Paul Bowman examined the
derivatives market and promised that the succeeding article would cover
the âstory of the historical development of successive regimes of global
financial ordersâ and would explain the role of the Eurodollars market
âin undermining the Keynesian Bretton Woods systemâ.In the interests of
space and relevance however, this article only tells the story of the
historical development of the regime of global financial order under US
hegemony. It begins by examining how the centre of capital accumulation
shifted from Europe to the US in the first half of the twentieth
century, and how following World War II the global financial order
became centred around the US through the Bretton Woods system. It then
looks at how the Bretton Woods System was undermined, concentrating as
much on the role of workers militancy as on the role of the Eurodollars
market. After considering the response to the crisis of Bretton Woods,
it concludes by looking at the Clinton boom, bringing us up to the
current situation of the USâs current heavy dependence on foreign
borrowing.