Crashed (Adam Tooze)

The period from the mid 1980s until the 2007 financial crash has been dubbed The Great Moderation, a time when boom and bust had supposedly been eliminated from business cycles, and where monetary policy had brought about a state of steady growth and low inflation. Derided as a prediction of the future state of the world, one can look at the events of 2007 to the present day and conclude that by comparison (at least in the west), it was a moderate period indeed. Adam Tooze’s Crashed chronicles economic history from the financial crisis through to the election of Donald Trump, concentrating on Europe and the U.S., but also giving account of Eastern Europe, Russia, China and elsewhere. Tooze shows that the seemingly disparate political and financial turbulence in this period is in fact interconnected. An insightful, clearly written, and comprehensive account, Crashed encompasses geopolitical, economic and financial factors to give a persuasive account of the events over a ten year period. 

Much of the conventional narrative from both the 2007-2008 financial crisis and the European debt crisis from 2009-2012 is challenged in Crashed, not least the idea that these are separate, unrelated occurrences. In 2007, Europe found itself ideologically at odds with George Bush’s U.S, with the Iraq war punctuating what would already be a significant divide between the ‘Washington Consensus’ neo-cons, and social democratic French and German governments. When it became clear that rampant speculation on U.S. property debt by Wall Street banks was likely to cause financial meltdown and a worldwide economic slump, there was a degree of triumphalism from European politicians that would colour future events. The idea that the financial contagion ‘spread’ to Europe, and that the ‘reckless’ Anglo-Saxon (read U.S. and British) free market policies caused all these problems was an attractive story in Europe. 

Upon closer examination however, this is not the whole story. Prior to 2007, China’s massive trade imbalance with the U.S. was offset by China holding equivalent U.S. treasury bonds. The fear amongst many policy makers was that China might choose to sell these bonds, making bonds cheap and U.S. cost of borrowing high. This never happened, not least because a weaker dollar would have damaged Chinese exports, but the state of affairs had another, unexpected consequence. Investment banks everywhere were required to hold reserves relative to the riskiness of their portfolio according to the Basel (and later Basel II) accord, whereupon holding Triple-A rated assets meant lower capital requirements. Since banks wanted to invest as much capital as possible, they wished to hold these AAA assets on the books. With China gobbling up triple-A rated U.S. Treasuries, other safe assets were sought out. When the newly privatised rating agencies gave AAA to collateralised mortgages (essentially bunched together home mortgages, whose riskiness was difficult to individually assess), it made sense for banks to hold these in massive quantities. In a form of alchemy, banks, pension funds and even states could hold supposedly ultra-safe assets that paid out significantly higher returns than U.S. treasuries. On the other side of the deal, those who issued the mortgages to new homeowners no longer held the debt, and so had no incentive at all to check on the likelihood of the borrower being able to pay their mortgage. (As an aside, surely an asset paying significantly higher-than-usual returns but deemed ultra safe must ring alarm bells that the risk is hidden?)

All this is well documented. Less well known is that European banks had gotten deeper in on the act than even those on Wall Street. By 2007, the 3 biggest banks in the world were Royal Bank of Scotland, Deutsche Bank and the French BPN, all with huge, leveraged balance sheets. Basel II was actually less stringent on European banks, because Congress had restricted those on Wall Street beyond the original accord. Not publicly known at the time is the degree to which the Fed’s actions averted a worldwide currency crisis. Although slow to initially react, after the failure of Lehman Brothers, central banks in Europe and the Fed pumped liquidity into the system, stepping in to replace the overnight loans banks relied on for their operations. This was decisive but insufficient. If French or German banks had borrowed in dollars, the German authorities couldn’t help - and the flows were such that no governments had dollar reserves enough to fix the problem. So the Fed quietly lent to banks against assets (often troubled assets like CDOs) for dollars, in massive quantities - over $6 trillion. 52% of CDOs bought by the Fed in this period were from European banks, at a time when European leaders were decrying U.S. recklessness. Eventually the Fed set up facilities to supply unlimited dollars to 14 central banks around the world. The narrative of 2008 marking the end of U.S. dollar hegemony was exactly backwards - the U.S. was the backstop for the world’s economies, and showed a willingness and ability to perform that role. 

Another major lesson from Crashed is the importance of finance in macroeconomics, and more significantly, in politics. Many accounts of the financial crash cite allowing Lehman Brothers to fail as the policy blunder that turned the crisis into a catastrophe. On the surface this is true. But a closer examination shows that until that point, politicians were reluctant to fund bailouts at all. Only the deepening of the crisis itself created the political will for strong action. 

A corollary is the treatment of Greece from 2010 as part of its own, but also a wider debt crisis in the EU. Because they shared a currency, Eurozone countries also shared a central bank (the ECB), whose mandate was solely the control of inflation; in contrast to the Fed which was responsible for both inflation and employment in the U.S. Because of Germany’s strong aversion to Quantitative Easing, the ECB’s policy tools consisted almost solely of setting one interest rate for all of the Eurozone, despite the diversity of nations and their situations. This often meant favouring Germany and France at the expense of smaller nations. By 2010 Greece’s debt levels had become unsustainable, and markets’ reluctance to buy Greek bonds were increasing the cost of borrowing, exasperating the problem. It is a characteristic of modern international finance that such self-sustaining feedback loops can become extremely large extremely fast, and can overwhelm national governments. This is the reason that U.S. authorities favoured gargantuan force when intervening in markets - traders need to believe they have no chance of succeeding in order to change tack - a lesson that was yet to be learned in Europe. Unfortunately for Greece, the solution brokered was akin to pretending the situation was something other than it was. A series of short term loans, first by Eurozone states then by the ‘Troika’ of ECB, IMF and Eurozone states involved essentially delaying the inevitable by a couple of years, whilst imposing crushing conditions on the Greek people. The fear of a wider debt crisis involving Ireland, Portugal, Spain, Italy and even France stopped the troika from writing down the debts - even though to any sane observer this was an inevitability. The power of financial market sentiment drove leaders to impose on Greece actions that were against their interests, and against their democratic wishes. As the new leftwing Greek government was told in 2015: “Elections cannot be allowed to change economic policy.” 

Tooze shows that the US attempt to deleverage the previous 5 years of Quantitative Easing caused a worldwide ‘Taper Tantrum’ in 2013, in which capital fled emerging markets and caused widespread disruption. Even China is subject to the whims of international finance. When in 2015 it’s stock market halved in value and capital fled from the country, massive use of reserves were required to stabilise the situation, something that would not have been possible had the U.S. not kept interest rates flat for that express purpose. 

The painful logic of economic policy in a world dominated by finance, is that actors often must behave in a manner that appears to be contrary to all evidence, because an admittance of the truth makes it so. So central banks lend to investment banks against assets that are virtually worthless (such as CDOs) - because if they don’t the assets become officially worthless. If the truth is admitted, other assets must be sold to cover shortfalls, reducing their value further, causing a self-feeding downward-spiral. The mere action of unwinding a bubble, however obviously fictitious, entails the destruction of wealth, and so must be avoided using other fictions.

The most important lessons of the period 2007-2016 I think, come from the governmental responses to crises, and the second-order consequences of these responses. Contrasting Greece and China will be instructive. By October 2008, as world trade collapsed, China had as many as 36 million unemployed. China sprung into action, authorising an unprecedented fiscal expansion, concentrating spending on healthcare, superhighways, affordable housing, environmental protection, education and railways. Health insurance was extended from 30% to 90% of the population, and 7000 new hospitals and clinics were built. Over the next 6 years, China expanded high speed rail (HSR) from 1000km to 11,000km. The lending target for banks for 2009 was doubled, and reserve ratios for smaller banks were cut by 25%. In short, China launched a massive stimulus, comparable to anything ever undertaken in Soviet Russia or Maoist China, and it worked; China’s growth in 2009 was 9.1%. Says Tooze, “for the first time in the modern era, it was the movement of the Chinese economy that carried the world economy.” 

Greece by contrast, upon accepting loans in 2010 were required by the IMF to take austerity measures, in an effort to rebalance public finances. This involved cutting public sector workers pay, increasing VAT and not renewing contracts for public works projects. Greek GDP fell 4.5% in 2010, and more again in 2011. There were riots in the street, and $14 billion was emptied from Greek bank accounts. By 2012 Greek unemployment had reached 25%. Only then did the IMF begin to acknowledge that in imposing cuts to an economy whose demand was weak and deteriorating would further reduce its ability to pay down debt. As tax receipts dwindled and automatic government spending (such as unemployment benefits) rocketed, outsiders imposed upon Greek citizens years of misery through bad economics. 

Between these two extreme responses lie European and U.S. reactions to the crises. Despite a chaotic political situation, the Obama administration was able to pass a $700 billion stimulus, which in hindsight was effective but likely lower than what was required. However, gigantic monetary stimulus from the Fed helped stave off disaster. Europe’s response, led by Germany, was not to run budget deficits, and initially Germany led the chorus against American Quantitative Easing. The idea that massive debt would be the undoing of market trust led to premature programmes of austerity, at a time when recovery was fragile and incomplete, and Britain especially suffered a slow recovery as a consequence. Germany was partially shielded from the results of its folly by strong exports, aided by the weak Euro artificially keeping down German prices. 

Tooze calls the response in many quarters the ‘Household Budget Fallacy’, the mistaken idea that government budgets are equivalent to a household. The ability of governments to create unlimited quantities of their own currency makes this a bad analogy, and the political imagery of ‘mortgaging our children’s future’ is a potent but ultimately false one. China showed that the counter intuitive idea of spending one’s way out of a slump is the most effective. Whilst Tooze is openly a centre-left leaning economist, this is Monetarism as much as it is Keynesianism; in a time where inflation is unlikely and the money supply has demonstrably fallen, recapitalising the economy makes logical sense. German political pressure stemmed from its experience with hyperinflation in the 1930s, but also from the cost to West Germany of reunification with the East. The undoubted greed and recklessness that caused the crash were wrongly conflated in spirit by Angela Merkel with the idea of massive stimulus spending and loose monetary policy. But the horse had bolted, and closing the gate was no longer an option. 

Conversely, the political fallout from these policy reactions was equally unpredictable. Saving the financial system undoubtedly was a necessary priority in 2008, when companies like McDonalds couldn’t get an overdraft facility - but it didn’t sit well with the public. Economist Thomas Piketty showed in 2013 that 95% of the recovery since 2008 had gone to 1% of the population, inspiring the Occupy Wall Street movement (later these figures were shown to be less extreme). The idea of a rigged system was also propagated on the extreme right by websites such as Brietbart, often with an anti-semitic slant. As Tooze states, “the liberal centrists were the last to get to the truth of the matter”. Across Europe and the U.S, dissatisfaction with the status quo and the seeming collusion between high finance and government, led to popular anti-establishment movements. These were often incoherent in terms of proposals, but able to prey on the anger and fear of ordinary citizens who neither caused the crash nor benefited from the solutions, but were adversely affected in some way. Tooze shows direct links from the political decisions made during the crisis to the political realities of 2016, and to both Brexit and the election of Donald Trump.

Whilst Crashed is written by an author with an unabashed political stance, it is well balanced and thoroughly researched. Having read many books on the financial crisis, none give such breadth and context as this. This review leaves out Tooze’s wonderful coverage of Eastern Europe, Russia, Ireland and more; and is worth reading for the colourful depiction of the political actors involved alone. It demonstrates that economics can shape history, but that it doesn’t exist in a vacuum. That finance is as powerful a force in the world today as there can be, and that the consequences of folly in one place are virtually inescapable in others. That people will be forced to pay for mistakes of others at the altar of ‘stability’, democracy be damned. That those who pay will react, and the consequences of that reaction are unknowable, even ten years later.