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Part 1
Financial Capitalism: From the Neoliberal Revolution to the Multifaceted Crisis of the Twenty-first Century
Nothing ever comes to pass without there being a cause or at least a reason determining it that is, something to give an a priori reason why it is existent rather than non-existent, and in this wise rather than in any other.
(Leibniz, 1710)
Introduction
It's hard to get students born in the 1990s to imagine what the world was like when this old professor was their age. It was a world where people feared that the Soviet bogeyman could ultimately overtake its nemesis, America; where the price of oil tripled in three weeks, and gasoline at the pump soared; a world of double-digit inflation, mortgage rates over 15%, ex-post index linked wage adjustments, etc.
That world vanished in less than 10 years, making way for the globalization of the economy, the opening up of new countries to the market economy, and more deregulated financial standards.
How did such a radical shift occur so rapidly? And what were its underlying causes?
Disinflation and its companion, falling interest rates, created the conditions for a stock market golden age (market capitalization in the United States increased 14-fold in less than two decades). Yet the economic and fiscal record of this revival of capitalism is still far from conclusive. Increasingly brutal crises took place in close succession and the disappearance of the economic cycle, the Holy Grail of deregulation proponents, sadly foundered on the shoals of the worst recession of the postwar era.
Meanwhile, global growth continued to slow over 30 years. Middle classes of industrialized countries, which reigned supreme over the glorious years following the World War II, and powered the engine of the Fordist Model, have been destroyed. Meanwhile those of the emerging countries, though admittedly rising very rapidly, were not enough to overcome economic insecurity or persistence of extreme poverty (according to the World Bank, nearly 800 million people still live on less than USD 1.90 per day). Such subdued performance has not prevented the attachment of these middles classes to the principle of individual accumulation savings thanks to which they have become staunch allies of the holders of capital.
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The Great Turn
From Postwar Boom to Stagflation
US President Franklin D. Roosevelt and the New Deal, the UKâs Lord William H. Beveridge and his Report, 1 championed by Winston Churchill, and the French National Council of the Resistance, laid the groundwork for the postwar reconstruction of the industrialized world on a shared or socialized âcitizensâ protection floor,â providing a bulwark against life's multiple hazards (illness, unemployment, old age, disablement, etc.). This system, which we know today as the Welfare State, provided tremendous momentum for prosperity. 2 Sustained by a fair pro-labor redistribution of productivity improvement, consistent with Fordist principles, this strong growth led to the emergence of a middle class in all Western countries until these safeguards started to go wrong in the late 1960s.
The disregard for the most fundamental economic laws and the hubris fueled by the extraordinary rise in living standards in the Western world slowly but surely strengthened the rigid mechanisms of wage indexation and redistribution. Confronted by the cost of the Vietnam War, the end of convertibility of US dollars into gold brought about by the Bretton Woods Agreement, followed by the rising price of oil, plunged Western economies into stagflation (Fig. 1).
Fig. 1. Stagflation 1973â1981. Source: World Bank.
For finance professionals, the end of the 1960s and the beginning of the 1970s were seen as dark times. Despite soaring interest rates (peaking at 15.8% on 10-year US Treasury bonds in the summer of 1981 and at 17.4% in France in November of the same year), bond yields net of inflation were paltry and stock exchanges entered a 17-year-long period of erratic stagnation, marked by one of the worst bear markets in history: between October 1973 and October 1974, the Dow Jones fell 41%.
Liberalism's Great Comeback
History is still made from a series of ad hoc events reflecting basic trends at the appropriate moment. This is why the historianâs task always involves two phases: the relatively easy search for the âhowâ and the harder task of discovering the âwhy.â The complete ideological U-turn away from Keynesianism-Fordism and social democracy toward the most liberal version of conservatism in which the postwar boom (in France âles trente glorieusesâ lasted less than 25 years) would disastrously end is no exception to this rule.
The âhowâ of this complete about-face is attributable to four events that occurred between 1979 and 1981. The âwhyâ is related to the great pendulum that is history, which worked to produce the resurgence of the rentier capitalists.
1980: The Turn of the Decade
Four events took place within the span of 18 months that would radically change the picture and determine most of the central political-economic landscape for the next three decades: the start of the Soviet Union conflict with Afghanistan (February 1979); the arrival of Margaret Thatcher at 10 Downing Street (May 4, 1979); the appointment of Paul Volcker as the Chair of the Fed (August 6, 1979); and the election of Ronald Reagan as US President (November 4, 1980).
It is in this landscape that the Digital Revolution and the entry of emerging countries into the globalized economy occurred. 3
The Collapse of the Soviet Union
As the final crisis of the Cold War, the Afghan conflict would mark the start of the irreversible decline of the Soviet empire. US support to the Afghan resistance fighters would also give rise to conflicts in the Middle East. Until the fall of the Berlin Wall (November 1989) and the breakup of the Soviet Union (December 1991), the crumbling of the Soviet empire along with the bankruptcy of its planned economic model would undermine Western labor unions. Deprived of the ideological (and, on occasion, operational) support they had enjoyed since the end of the World War II, labor unions would become powerless witnesses to the drift of a significant portion of the added value from work (wage earners) to capital (shareholders), all well before a massive entry onto the scene of low wage workers.
Paul Volcker
On August 6, 1979, Volcker succeeded Arthur Burns (1970â1978) and the short-lived G. William Miller (March 1978 to August 1979, when President Jimmy Carter picked him to be Secretary of the Treasury) as Chair of the Fed. A Democrat, Volcker would be reconfirmed by the Reagan administration in 1983 but stepped aside in 1987 to make way for Alan Greenspan. When Volcker took over the reins, inflation stood at 10% (it would peak at 14% in 1981) and the economy had been mired in stagflation for a number of years.
Observing that inflation destroys growth and convinced that results from the overissue of money as dictated by monetarist principles, Volcker decided to break the cycle by halting the creation of money through the bank lending system. To do this, he raised the federal funds rate (the interest rate at which banks loan money to each other on the money market) from 10% to 20%, making the refinancing of banks impossible.
This monetary tightening on such an unprecedented scale led to a serious economic slowdown in 1980 and a severe recession in 1982. Conducted against the advice of Congress and severely criticized, it marked the beginning of actual central bank independence.
Beginning in July 1981, these rates would enter a downward trend that would, despite some disruptions, ultimately drive them to zero 30 years later. This downward trend, which spread to long-term rates, would bring about a virtually permanent appreciation of financial and real estate assets, which would feed investors' addiction to easy financial gains and reinforce the idea that home prices would never fall (Fig. 2).
Fig. 2. Fed Funds Average Interest Rate from 1979 to 2016. Source: Saint Louis Fed.
Margaret Thatcher and Ronald Reagan
With stagflation hitting investors and savers hard, Western economies' voters at the turn of the decade started supporting conservative leaders whose economic programs were clearly rooted in neoliberalism. The exception was France under François Mitterrand's socialist-communist coalition. Frustration with the inability of an interventionist State to provide alternatives to an overall feeling of gloom (âthe light at the end of the tunnel,â according to Raymond Barre's unfulfilled 1976 prophecy) was largely responsible for this trend reversal.
Placing liberalism back in business after decades of Fordist New Deal, including the United States under Republicans Eisenhower and Richard Nixon, had been planned long in advance. It had already been running on an experimental basis in Chile after the 1973 military coup dâĂ©tat, whose de facto rulers were young economists trained at the University of Chicago (the âChicago boysâ). The operational implementation of this revival in the United States and the United Kingdom relied on two pillars:
- Tax cuts: In 1986, Reagan reduced the marginal tax rate on income tax, which had been raised to 90% by Roosevelt and was still at 75%, down to 28%. A similar step in the United Kingdom saw this rate fall from 83% to 40%.
- Reversal of the wage balance of power, symbolized by two decisive labor union defeats: that of US air traffic controllers, following their 1981 strike, and the 1984-85 UK miners' strike.
In France, the âmove to austerityâ that began in March 1983 confirmed the spectacular failure of the policy of stimulating demand due to its anachronism and isolation (the world economy was then in a recession). The new policy focused on the same elements. Pierre BĂ©rĂ©govoy ended ex post wage indexation in 1984 and in 1986 Jacques Chirac did away with requiring administrative approval for lay-offs and the left-leaning solidarity tax on wealth (l'impĂŽt sur les grandes fortunes). Simultaneously, French governments achieved the âmodernizationâ of the financial markets under the leadership of Jean-Charles Naouri, directly inspired by the American model (creation of the French OAT bonds and coupon-bearing French government bonds (BTAN) issued by auction, plus the opening of a Futures market).
The pegging of the French franc to the Deutsche mark (âle franc fortâ) and the independence of Banque de France (1993) marked the final acceptance of ordoliberalism arguments, which would continue throughout the alternating left-right governments between 1986 and 2012. The nationalization/privatization ping-pong game ended with the re-election of Mitterrand and his âneither-norâ 1988 campaign mantra. The final victory of the latter, notably marked by the privatization of banks nationalized in 1946, would be subsequently broadened under the cohabitation government led by Lionel Jospin which took in 31 billion euros in sales proceeds between 1997 and 2002 and would also create a number of âopportunities for capital.â
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Neoliberalism and the Revenge of Rentier Capitalists
The modern conservative is engaged in one of man's oldest exercises in moral philosophy; that is, the search for a superior moral justification for selfishness.
JK Galbraith, 1963
Ordoliberalism and Neoliberalism
It is not the aim of this chapter to embark on an in-depth study of a topic that Serge Audier (2012) addressed very ably in his e...
