This month the economy is looking in a dire state, with Chinese markets on verge of a recession forecast for a projected growth of 2% GDP as opposed to the 7% predicted, Oil prices looking at dropping to $16 a barrel from the current $30, and a shot across the bow from RBS who are referring to this year as 'a Cataclysmic year' with a warning to investors:
Sell everything except high quality bonds. This is about return of capital, not return on capital. In a crowded hall, exit doors are small.
I will always remember the images etched in my mind. Droves of smartly suited men walking out of their office with a box of their work possessions in their hands.
The date is 15th September 2008, the day the capitalist world of the 21st century was rocked. The unthinkable happened. Lehman Brothers, one of the world's biggest banks filed for bankruptcy and laid-off it's staff. The US allowing it fail because morally banks cannot be 'too big to fail.'
How did we get here? How can our banking system and common markets collapse so spectacularly? How has our world become so absorbed with greed and the accumulation of wealth at the expense of everything we work so hard to protect. Particularly so, in the US and the UK.
Yanis Varoufakis, the charismatic rock-star of Greece's anti-EU austerity movement in 2015 outlines in his book The Global Minotaur the history of how the United States has become in his eyes, similar to the Minotaur from the fabled Greek story of King Minos.
To help understand the core themes of the book, let's dive into a bit of financial history, starting with the financial crash of 1929.
1929 - Wall Street Crash
Prior to the 1929 Wall Street crash, the US market was dominated by an avant-garde of a new era. Entrepreneurs like Henry Ford and Thomas Edison and Westinghouse led the pack, producing innovations that inspired giant conglomerate organisations. From the AC/DC feud of Nikola Tesla and Thomas Edison to the invention that led the modern day automobile.
Some of the major benefits of giant companies are, if there ever happened to be problems with the economy, they could always afford to drop the price of their goods to sell off excess / dead stock so as to float through the bad times. This depression of the value of goods would act as shock absorbers, preventing the US economy from crashing as traditionally it did in the 1907 depression.
However, with the advent of the availability of bank credit and loans in the 1920s, the regular man on the street if they were able to invest $15/wk of their wage in Blue Chip companies from 1921-29 would have witnessed an eye-watering return on investment to the tune of $80,000 in 1929. People were making money hand over fist.
Synonymous with a modern gold rush, things were simply too good to be true and in 1929 the Wall Street stock market crashed. $40bn was wiped off valuations overnight. That $80,000 now worth a mere $4,000. Many would have been better off placing their money under a mattress than in a bank!
If one thing we learned from 1929, it was that our markets were particularly susceptible to Crisis and major Crisis at that. In particular two, that Yanis describes as 'gremlins' - money and labour.
If you were to state you were unable to sell your own home, it would be pretty clear that you were using a turn of phrase. You could in fact sell it. I could offer you £10 right now, but the problem is that you are not willing to sell it at that price. So, it goes with any asset that is in some form of demand or other. If the price is sufficiently low enough it will tempt those who wish to buy.
Money and labour on other hand are not like this. Money loans or the employment of someone do not hold true to this sentiment. Money and labour are drivers in an economy but are at the whims of CEOs and heads of organisations to determine the appetite for it.
So, what drives a CEO to want to invest in employment or borrow money or lend? One word....... Optimism!
Many times on the radio when a bad news article is written or poor projections are made by economists, they are accused of 'talking the economy down.' What is meant by this is that we are essentially creating a 'self-fulfilling prophecy.' By telling others this bad news it makes them less likely to invest. Their pessimism makes them (and others) feel less optimistic about the situation, and so the cycle repeats into a downward spiral of more bad news until it bottoms out at some low point.
Whilst this sensibly explains the behaviour of common markets, how did these common markets come to be so volatile? Let's continue the history lesson....
Bretton Woods: The Beginning of America's Global Plan
Following the end of WWII, America became one of only two creditors in the world (the other being Switzerland who partook no place in the war itself).
To capitalise on this position of financial strength and cement their position as a world superpower, the US government embarked on a big economic plan.
Meeting in July 1944 near a small town called Bretton Woods at Mount Washington Hotel in New Hampshire, USA, 730 delegates converged to create a new post-war economic order. It's dual aim to prevent future economic depressions similar to the Crash of 1929 and to reduce tensions between neighbouring countries by binding them through fiscal markets.
We still hear about remnants of the Bretton Woods agreement to this day, the IMF (International Monetary Fund), the financial equivalent of a 'fire brigade', and the IBRD (International Bank for Reconstruction and Development aka The World Bank - who's job is to funnel necessary funds to war torn countries.
Another incredibly important statute was also signed, the Bretton Woods system. Under this system all nations exchange rates were fixed to the dollar with a permitted fluctuation of anywhere between plus or minus 1% by selling dollar reserves.
The US fixed the exchange rate to gold at a value of $35 per ounce this would guarantee the value of the dollar at that time and provide confidence to America markets. This also meant that anyone could own gold if they so wished.
Taking part in the debates was the father of Macroeconomics, John Maynard Keynes. In his preferences of this system he proposed that all countries should be part of an International Currency Union (ICU) named 'bancor' with it's on international bank and various other capitalist countries having their own matching institutions. This may sound like a completely crackpot idea, but in fact, his ideas have withstood the test of time. More recently Dominic Strausse-Kahn (current Managing-Director of the IMF) in a recent interview proposed a return to this Keynesian idea as the only solution to the post-2008 credit crisis.
Unfortunately, Keynes idea of an International Currency Union was waved off. Keynes believed that without this in place fixed exchange rates were just as susceptible to minor Crisis that form into Major Crisis as the previous system.
Global Surplus Recycling Mechanisms (GSRMs)
Keynes felt that in order for fixed exchange rate markets to survive major Crises, there must be some mechanism in place to support the weakest countries in a tied monetary union. There are traditionally two types of countries in a fiscal market. Producers, who produce surplus goods such as Germany and their automotive industry, and Greece who are very much a Consumer nation relying heavily on tourism; definitely not well known for their manufacturing.
Without some form of Global Surplus Recycling Mechanism, whereby surplus countries invest heavily in deficit producing countries, Keynes believed that a small crisis at any point in the monetary union would result in a major catastrophe for the rest of the union.
But why does this matter?
This matters because deficit producing countries, such as in our example Greece, would much rather go begging to policymakers to de-value their currency rather than to sell off their dollar reserves in an effort to boost demand for their goods.
The Marshall Plan
When the Treaty of Versailles was signed on 28th June 1919, Germany was left wounded albeit not completely beaten. Forced to disarm and make significant territorial concessions which Keynes referred to as a “Carthaginian Peace“, it sowed years of discontent providing the perfect breeding ground for rampant nationalist socialism leading to the rise of Hitler.
The intent of The Marshall Plan, drawn up by George Marshall, President Truman's secretary of state in 12th March 1947, was to provide a massive aid package designed to change the face of Europe forever. The Americans planned to dollarise Europe and rehabilitate a humiliated Germany following the end of WWII, which was a heavily industrialised nation capable of quenching the appetite of a booming growth in America. By 31st Dec 1951 a total of $12.5bn had been invested back into Europe. A stronger Europe and particularly strong Germany meant a stronger US.
Quite obviously the biggest opponent to this was France, who did not wish to see the re-industrialization and a stronger Germany. So what convinced France to allow it? In the short-term, the de-construction and scaling back of some German industries such as steel. They were also made the central acting administrators for the Organisation for European Economic Co-operation (OEEC) which became today's OECD (Organisation for Economic Co-operation and Development).
The Marshall Plan funded just one pillar of America's Global Plan to service their twin deficits (we'll come on to that later). The other pillar was to come in the form of Japan, on the other side of the globe and an initiative dreamt up by United States' General MacArthur.
To further accelerate Japanese prosperity America wrote the countries new constitution, which led to Britain admitting Japan to the General Agreement on Tariffs and Trade (ancestor of the World Trade Organisation) which meant that Japan could trade easily with the US and Europe.
By ensuring there was strong demand for Japanese and German goods America could once again ensure their continued growth.
However, for the prosperity of Japan, and so that it could grow it's industries, it was imperative that Japan have local trade partners. It could not generate enough trade on it's own without nearby neighbours with which to trade.
America, having been a former colonialized nation, had a libertarian attitude and fully sympathised former colonies and held a dim view of Britain, France, Holland, Belgium, and their still further attempts to remain colonial states.
Libertarian movements and coups, ironically, began to present a very clear and present threat to The Global Plan. With Mao Zedong's Communist uprising and the formation of the People's Republic of China on 1st October 1949, it inspired other Libertarian and current/former colonial states to overthrow their former masters.
General MacArthur faced difficulties convincing the US to invest more in Japan since they felt that there was insufficient demand and insufficient appetite in neighbouring countries around Japan to generate significant return on investment. However, as luck would have it, on the 25th June 1950, North Korean and Chinese Communists attacked South Korea with the single goal of unifying Korea under a single banner.
Extending the Marshall Plan yet further, the US switched funds from Europe to Asia, with Germany now able to continue growing under it's own steam. Funnelling funds into Japan so as to help service a military campaign in Korea and later Vietnam with investment equating to a massive 30% of Japanese trade.
The rather brilliance of The Global Plan was in it's great adaptability by US administrators. Not able to use China to fuel Japanese growth, due to Mao's victory, they switch their attention to the state of Korea in defence of it's independence from the South. They also manipulated US allies to more easily allow Japanese trade and finally, changed their own markets to better consume Japanese marketable goods such as cars, electronics and services.
Global Plan Unravels
However, by 1960 US growth tailed off keenly affecting the poorest in society, John F Kennedy used the opportunity to introduce his new initiative New Frontier which involved investment in education, health, urban regeneration, transportation, the arts, environmental protection, public broadcasting etc.
Following the assassination of JFK, his predecessor Lyndon-Johnson continues New Frontier under the guise of the initiative Great Society. This involved the remaining un-acted policies, along with eliminating racism and poverty, in particular raising the number of Black Americans above the poverty line to 55%.
Lyndon-Johnson, fearing for his presidency and with a war in Vietnam that was running away from him was blindly willing to win the war "at any cost". This nearly derailed The Global Plan by allowing funding in East Asia to spiral wildly out of control (costing the US $330bn!).
By 1970 profits were down between 1965-1970 by 17%. With the cost of the Vietnam War and the Great Society initiatives mounting, the US government were left in the position of borrowing (printing money).
The Bretton Woods system stipulated that other countries (than the US) must keep their currency within plus or minus 1% of the central currency exchange rate. Since the US was flooding the market with dollars, causing inflationary pressure, european countries such as France and Britain were left with no choice but to flood their own markets with currency to keep up. The US was essentially exporting inflation due to it's war ambitions in Vietnam.
De Gaulle, France's president at the time, already critical of America's ambitions feeling that the Bretton Woods agreement did nothing but serve America's needs and not others, accused the United States of further borrowing money to build it's imperial reach with little regard for it's allies.
On 29th November 1967 Britain devalued it's currency by 14% (well out of the Bretton Woods bounds) which caused a crisis meeting between the top seven nations (later called the G7) who came to a compromise that gold (that was supposed to back the dollar) would be pegged $35 per ounce whilst also allowing markets to speculate on the price of gold - strange indeed?!
When Paul Volcker, appointed by President Nixon in 1970 as under-secretary to the treasury, in May 1971 presented Henry Kissinger, then head of the National Security Council with a proposal of a contingency plan. To suspend the convertibility of dollars into gold.
In 1971, in response to this change of US policy, the French President, Georges Pompidou, made a decision to publicly display his displeasure by ordering a French destroyer to travel New Jersey, Fort Knox and demand the US dollar equivalent of the gold they currently held. Similarly, Edward Heath demanded gold equivalent to $3bn held by the Bank of England (this was their right under the Bretton Woods agreement!).
President Nixon, naturally furious, announced four days later that gold would no longer be convertible to dollars thereby ending the Bretton Woods system and unravelling the Global Plan.
Wolf of Wall Street
Following this quite incredible meteoric rise and sustained growth of the United States, many other countries with a rather envious gaze, mistakenly believed they could also achieve sustainable growth if they handled their economies well. However, this belief was folly. There can be only one Minotaur.
Between 2000 and 2008, the US devoured 70% of capital flows with Japan and Germany providing the lionshares up until the early 2000s. Once Germany and Japan floundered, China stepped in.
This massive wealth and capital flow was driven by an attitude of 'consolidation' where one large corporation would be merged and devoured by another producing ever more mountainous flows of capital into Wall Street.
A great example of this was the German firm Daimler-Benz which bought Chrysler to become Daimler-Chrysler in 1998 for an eye-watering $36bn. However, in the eyes of the valuation of the merger $130bn this was a good price.
Bubbles will always burst and in 2007, prior to the crash of 2008, they did. DaimlerChrysler broke up and Daimler ended up selling Chrysler for a measly $500m.
There was a similar story with the AOL Time Warner merger being revised down from $350bn to $29bn.
Money Trees and the Crash of 2008
The crash of 2008 has sent shockwaves that have reverberated and still are felt today 8 years later. How though was it caused?
These particularly vile economic products (if you can even call them products because products actually have value!) were cooked up to enable banks to produce mountains full of cash by unlocking mortgages to people who could not afford their own homes.
So, how did financial institutions manage to take on the risk of so many mortgages to those who were plainly unable to afford them? By reducing the risk.
CDOs are essentially packaged up debts that are sold on to buyers who are prepared to underwrite them. Let's say for example we have several other loans, each of which are sold to lower risk candidates such as AAA (triple-A) credit rated individuals or businesses. By packaging multiple lower risk mortgages or loans with a single higher risk loan it makes the lending less risky.
The CDO can then be priced up and sold off to someone else, who is prepared to take on that risk at a price.
However, the problem is that when an individual or business defaults on one of the debts as part of a CDO, pressure is increased in a domino-like effect on the other debts and en-masse if this happens it's like a house of cards. Pressure increases because if Jack loses his job, Susan who borrowed another loan in the CDO, also has an increased chance of losing her job.
The real kicker with CDOs though, is that institutions could purchase CDOs and then leave them on their books as “assets” essentially giving institutions a chance to print money. It was like having an ATM in their bedrooms.
No wonder they were nicknamed Toxic Assets.
Governments believed banks could not be allowed to fail. As a consequence they came up with a plan to float the banks and save them from bankruptcy. This, Yanis Varoufakis, nicknamed an ethos of “bankruptocracy“.
The problem with many of the banks was that they had a significant portion of their assets as CDOs. No one would offer to buy them because they're worthless. Aside from, of course, governments.
Secretary of the Fed, Paulson suggested that they buy the CDO assets at made-up prices that would be just high enough to avoid bank failures but he couldn't secure enough money from Congress to make it happen.
Enter the Geithner-Summers plan. In partnership with banks, hedge funds and pension funds, the US government created a simulated market in which these toxic CDOs were bid for at a minimal price where the risk for institutions was low and rewards potentially great.
The plan was hailed a brilliant scheme, a mechanism for getting CDOs off the books of banks in a government-administered and controlled game where hedge funds use some element of risk but it has one major flaw. Which hedge fund managers would evaluate that coming out on top for each CDO would have greater than a third's chance? And who in their right mind would get involved in such a game.
The answer: the Banks!
Conclusion: The future is bleak
Yanis Varoufakis' take on the global economic crisis is quite an incredible tale and I absolutely loved the book. It gives a compelling narrative and commentary on the economic and political history that the US has forged in the world for over a century. It also clearly demonstrates the very dubious behaviour from the world's greatest superpower and how the wealthy can manipulate situations for their own gain.
It also clearly highlights the reckless attitude and lending of the de-regulated banks.
Many claim nobody predicted the collapse of 2008, however, it appears some did (certainly from the evidence in this book) but chose to ignore the warnings signs.
The book tells the story so much better than I ever could so I highly recommend purchasing The Global Minotaur and giving it a read.
If you ever do, please come back and drop me a comment. It's a truly eye-opening read.