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(en) Ireland, Red and Black Revolution #15 - ECONOMIC HISTORY - IMPERIAL FINANCE and WSM Global Finance Research Project

Date Sun, 19 Dec 2010 14:01:52 +0200

WSM Global Finance Research Project ---- George Stapleton charts the historical development of the global financial order under US hegemony since World War 2. ---- 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, ‘Financial Weapons of Mass Destruction’, which appeared in the previous issue of Red and Black Revolution. ====== In ‘Financial Weapons of Mass Destruction’ Paul Bowman examined the derivatives market and promised that the succeeding article would cover the ‘story of the historical development of successive regimes of global financial orders’ and would explain the role of the Eurodollars market ‘in undermining the Keynesian Bretton Woods system’. ---- 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 US’s current heavy dependence on foreign borrowing. =====

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.=====


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, it’s 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 £10 note you
could go to the Bank of England and ask for
£10 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 £10, the
French seller would know that he could go to
the bank and get out 100F worth of gold with
your £10. It didn’t 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.

World Wars, Economic Ruin and the Turn to Autarky

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 world’s 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 ‘starting’ 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
world’s 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 don’t 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 1939-1945
Europe again fell into a war of pointless self-

The Bretton Woods System

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 ‘agreement’, the General Agreement
on Trades and Tariffs.

The reasoning behind this conference was
the Allies’ ruling class’s 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 world’s 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 ‘reconstruction and
development’ 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 Bretton Woods System Begins to Unravel

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:

1.The Cold War and Vietnam

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 “whether there
shall 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.” 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.

2.The Post-War Settlement and Workers’ Militancy

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 ‘Post War Settlement’, 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.

The Vietnam War
The cost of the US
war against South East
Asia were such that the
US became a major
international debtor, rather
than its traditional role as a
creditor. The Graph on the
right shows the rise in US
debt and the decline in US
gold reserves between 1950
and 1972 (at this stage debts
were redeemable with gold).

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 1970-71,
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.

3. Control of Financial Markets and 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 - 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. It’s 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 world’s 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 ‘foreigners’
soon far exceeded the US’s 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, “[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 - the world
of Eurodollar finance - outside the regulatory
authority of any country or agency”.

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,
“London 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

Collapse of Bretton Woods

Combined with the problem of increased
liabilities was a decrease in the US’s 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

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 Johnson’s 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 US’s gold holding, as shown in the graph

1973 oil crisis

The Organisation of Arab Petroleum
Exporting Countries (OAPEC) proclaimed
an oil embargo “in response to the U.S.
decision to re-supply the Israeli military
during the Yom Kippur war.” Meanwhile
the OPEC decided to try to stabilize their
real incomes by raising world oil prices. This
action followed several years of steep income
declines after the end of Bretton Woods. It
caused the price of oil to increase by a factor
of five in the U.S.

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

Stagflation, Workers Militancy and the Collapse of Keynesianism

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

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 “escalator”, 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 Franco’s 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 ‘the financial revolution’. 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 didn’t 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.

Smashing the Unions, the ‘Volcker Shock’ and the Emergence of Neo-liberalism

On August 6th, 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 ‘Volcker Shock’
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 Reagan’s
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 3rd, 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 5th, President Reagan fired the
11,345 striking PATCO workers.

The PATCO strike and the ‘Volcker Shock’
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, Mitterand’s 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 ‘Franc Fort’ policy following the
1983 French macroeconomic crisis. As Jeffrey
Sachs and Charles Wyplosz noted in 1986,
“the government of the left has in the end
introduced a tougher, more market oriented
programme than anything considered by the
previous centre-right administration.”

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 ‘the lost decade’. 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

========= Picture =============
Bill Clinton repeals
the Glass-Steagall
act in 1999. This
act, introduced
during the great
depression in
1933, separated
from consumer
banking. Its repeal
contributed to the
financial bubble
that collapsed
with devastating
consequences in

The ‘End of History’: The defeat of the Left

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.

It’s 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 ‘the magic of the
marketplace’, was even more committed to
the equally fairy-tale idea of defeating the ‘evil
empire’ (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 argued
that 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 didn’t 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 ‘third way’. 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 ‘It’s the economy, stupid.’ After the
long years of the 1980s and the jobless recovery
following the 1990/91 recession, Americans
were eager for something new.

The Clinton Boom

Fortunately for Clinton he was president
during an unexpected surge in productivity
growth, i.e. the amount of value created by
an hour’s 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 ‘New
Economy’. This boom was further facilitated by
the lax monetary policy of the Fed under Alan

When the Phillips curve ceased to operate
in the 1970s, some economists, most famously
Milton Friedman, argued there was a ‘natural
rate of unemployment’. 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 ‘natural rate of unemployment’
was quickly renamed the more diplomatic ‘Non-
Accelerating Inflation Rate of Unemployment’

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
‘overheating’ 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 didn’t
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.

The Stock Market Boom and Bubble

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 workers’
pension plans were ‘defined benefit’ pension
plans, while today most workers have ‘defined
contribution’ 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 workers’ 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 hadn’t 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 ‘New Economy’ 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, they’d 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 9-11. The New York Stock
Exchange, the American Stock Exchange and
the NASDAQ were closed until September
17th 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.

Post 9-11 Jobless Recovery, Property Bubble, Debt

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 2000-2001 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 9-11 recovery
as a jobless recovery. This ‘jobless recovery’ 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.

Global Capitalist Crisis
who, why, where, when and what next
14 Red & Black Revolution

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, “[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.” In August
2007 the housing bubble burst, and more than
a year later we are still feeling the brunt of this.

US Debt and its Dependence on China

The US was spending far beyond its means
during the 2001-2007 period. This behaviour
was financed primarily by foreign borrowing,
largely from emerging economies, China in

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 1997-98 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 anyone’s 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 doesn’t bode well for its future.
However, as of yet the US faces no realistic
challenger and we certainly shouldn’t rule out
the US economy bouncing back and reasserting
its centrality in and hegemony over global

First published in Red & Black 15, Spring 2009
[Download the PDF] http://www.wsm.ie/attachments/oct2009/rbr15.pdf
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