B005HFI0X2 EBOK (50 page)

The strategy of relying on undervalued currencies to promote export-led industrialization required China, Japan, and other governments to accumulate either dollars or dollar-denominated assets like US federal debt and the debt of government-backed entities like Fannie Mae and Freddie Mac, thereby keeping the US dollar high and crippling rival American export industries. The massive purchases of US federal debt by the Chinese and Japanese central banks, in return, allowed the US Treasury, and, through it, American banks and other financial institutions, to keep interest rates low.

Exporters of manufactured goods like the East Asian countries and Germany were not the only countries to run chronic surpluses with the United States. In the first decade of the twenty-first century, American oil imports accounted for about half of the American trade deficit. Like the mercantilist manufacturing exporters, the petrostates helped to enable America’s debt-led consumption by recycling their earnings into US Treasury securities and dollar-based assets, permitting lower interest rates and more borrowing in the United States.

Some economists claimed that the system of currency manipulations and global imbalances was stable, sustainable, and beneficial for all sides; they dubbed it “Bretton Woods II” after the Bretton Woods system of exchange rates that had existed from the late 1940s until the 1970s.
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It should have been clear that Bretton Woods II was a Ponzi scheme, in which excessive borrowing by American consumers permitted overinvestment in manufacturing and infrastructure by East Asian mercantilist economies, doomed to end when American consumers hesitated to borrow and spend.

WORKSHOP OF THE WORLD

By the early twenty-first century, China was the workshop of the world economy. In 2005, the world’s leading container ports of origin were Singapore, Hong Kong, Shanghai, and Shenzhen. The leading receiving ports were Rotterdam, Los Angeles, Long Beach, and Hamburg.
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There was far more to China’s successful mercantilist program of crash industrialization than currency manipulation. In addition to manipulating their currencies to help their export industries, East Asian mercantilist regimes steered credit toward targeted industries on the basis of national goals rather than market logic. The East Asian mercantilist model is usually described as export-oriented growth; it can also be described as “investment-driven growth.”
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Following the death of Mao Zedong, China’s government abandoned Communist economic policy, even though the one-party Communist dictatorship remained. In the 1980s, Deng Xiaoping’s reforms helped township and village enterprises (TVEs), to the benefit of the entire country and rural China in particular. But in the 1990s, the emphasis shifted toward a version of the export-led development model focused on exports to the US consumer market like the strategies of of Japan, South Korea, Taiwan, and Singapore. Export-processing zones in coastal areas used young, low-wage workers from the rural hinterland to produce goods for multinational corporations that would be sold in foreign markets—primarily the American market.

Following the 1997 Asian financial crisis, the older hub-and-spoke system of Pacific trade, in which Japan and the Little Tigers individually targeted the US consumer economy, was replaced by a new, China-centered system. In the new system, Japan, South Korea, Taiwan, Hong Kong, Singapore, and other regional countries exported components to Chinese production facilities, which then incorporated them into goods for export to the United States and elsewhere. While high-value-added components from industrial countries flowed into China’s factories, commodity-exporting countries from Australia, Chile, and Brazil to African countries supplied China with raw materials and food. Chinese workers mostly assembled components imported from Japan, Singapore, Taiwan, South Korea, and other, more advanced countries. In 2003, China, including Hong Kong, had trade deficits with Japan, South Korea, and Taiwan, even as it enjoyed a growing surplus with the United States.

A major feature of the early-twenty-first-century Chinese model was state capitalism, or state ownership of major banks and businesses. All major Chinese financial institutions were state controlled, so that lending tended to reflect government priorities, not market logic. By the second decade of the twenty-first century, three of the world’s four largest banks by market value were Chinese.
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In 2010, forty-one Chinese state-owned enterprises (SOEs) were among the world’s five hundred largest companies; three were among the top one hundred.
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In 2008 one SOE, China Mobile, the state-controlled wireless phone company, was the world’s fourth largest company by market value.
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As China used currency manipulation, credit steering, subsidies, wage suppression, and other mercantilist techniques at the expense of its trading partners and rivals, its economy grew at the rate of 10 percent a year from 2003 to 2005, 11.6 percent in 2006, and 13 percent in 2007. China’s current-account surplus swelled from 3.6 percent of GDP in 2004 to 7.2 percent in 2005 to an unsustainable 11 percent in 2007.
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In 2010, China surpassed Japan as the world’s second largest economy.

AMERICA’S CHRONIC TRADE DEFICITS

In 1971, America was shocked by its first trade deficit of the twentieth century, of $1.5 billion. From 1989 to 1997, the US current-account deficit hovered below 2 percent of GDP. Following the East Asian financial crisis of 1997, the deficit rose in 1998 to 2.4 percent of GDP. In 2006, just before the crash that began the Great Recession, the US current-account deficit had grown to 6 percent of US GDP and nearly 2 percent of global GDP.
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The US trade deficit between 1976 and 2010 added up to more than $7 trillion; of that, more than 70 percent was accumulated after 2000.
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Between 1998 and 2008, the US merchandise trade deficit with China alone rose 375 percent. The top US sales to East Asia were semiconductors, aircraft parts, waste and scrap metal, basic organic chemicals, and soybeans.
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Other than “waste and scrap metal” and “organic chemicals,” the major American exports to China were from industries that relied on US government support—the Defense Department, in the case of aircraft parts, and federal farm subsidies, in the case of soybeans.

Between the early 1980s and 2006, the US economy grew by a factor of 12 and the current-account deficit grew by a factor of 158.
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Because of the artificial strength of the dollar that resulted from foreign-currency manipulation, as well as other mercantilist techniques used by foreign governments to promote their industries, US exports lost one-fifth of global market share in the first decade of the twenty-first century.
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The deindustrialization of the United States accelerated. In 1980, manufacturing accounted for 21 percent of US GDP and finance for only 14 percent. By 2002, the proportions were reversed, with 14 percent of GDP accounted for by manufacturing and 21 percent devoted to finance.
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While manufacturing as a share of employment declined in all Organization for Economic Cooperation and Development (OECD) countries, from around a quarter in 1970 to an average of 15 percent in 2008, it declined least in countries with export trade surpluses like Germany (19 percent) and most in countries running large merchandise trade deficits like the United States (9.5 percent in 2008).
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Meanwhile, the share of total corporate profits accounted for by the financial sector exploded from 18 percent in 1980–1990 to 36 percent in 2001–2006.
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RISE OF THE MEGABANKS

By the early twenty-first century, three banks—Citibank, JPMorgan Chase, and Bank of America—dominated the American commercial-banking sector. Citibank grew by turning itself into a conglomerate with commercial banking, investment banking, and other services. JPMorgan Chase was the product of mergers by Chase Manhattan, Manufacturers Hanover, JP Morgan, Chemical Bank, First Chicago, and National Bank of Detroit. North Carolina National Bank, based in Charlotte, North Carolina, took the name of A. P. Giannini’s old California-based Bank of America in the course of an acquisition spree beginning in the 1980s. By 2007, shortly before the Great Recession began, Bank of America’s assets were the equivalent of 16.4 percent of US GDP, JPMorgan Chase’s were 14.7 percent, and Citigroup’s were 12.9 percent. To put this into perspective, in 1983 Citibank, then America’s largest, had controlled assets amounting to only 3.2 percent of US GDP.
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The Big Three grew even more as a result of the global financial crisis, as Bank of America absorbed the investment bank Merrill Lynch and America’s largest mortgage lender, Countrywide, while JPMorgan Chase swallowed up America’s largest savings and loan, Washington Mutual, and the investment bank Bear Stearns.
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From 1980 to 2000, the financial assets of commercial banks and securities firms swelled from 55 percent to 95 percent of GDP.
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In the decades of the bubble economy, the culture of investment banking changed. Brokers had worked on fixed commissions. The inflation of the 1970s resulted in a bear market and low securities yields. Pension funds and other institutional investors lobbied to end fixed commissions on trading, so that they could negotiate discounts with brokers. The abolition of fixed commissions in 1975 shifted the business of Wall Street from traditional investment banking to securities trading, with traders motivated to rake in commissions by frequent “churning” of investment portfolios. In 1968, volume discounts were authorized; then commissions were deregulated in 1975. As a percentage of industry revenues, brokerage commissions declined from 53.8 percent in 1972 to 17.3 percent in 1991.
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Before 1970, the New York Stock Exchange (NYSE) required that member firms be partnerships, on the grounds that partners would take fewer risks than managers of corporations enjoying the shield of limited liability. Over the objections of the NYSE, a brokerage firm called Donaldson, Lufkin & Jenrette became a publicly traded corporation in 1970 and by 1999 all the major investment banks had become public corporations. Within investment banks, there was a shift away from members of the social elite who could fraternize with old-school CEOs toward “quants” who could maximize revenue for the investment bank with ever more complex computer programs.

In a 2009 interview with the London
Times
, Goldman Sachs CEO Lloyd Blankfein, who was awarded a $9 million bonus that year, explained that Goldman “does God’s work” by helping “companies to grow by helping them to raise capital.”
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But in 2007, the year before the crash, the activity of helping companies by underwriting stock for them accounted for only 3 percent of Goldman’s revenues. Sixty-eight percent of its revenues came from trading and principal investments.
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The New Deal financial order had been almost completely dismantled by the time Glass-Steagall was repealed in 1999. No adequate new system of financial regulations replaced those that had been torn down. Taking advantage of “regulatory arbitrage,” the increasingly large, rich, powerful firms engaged in activities that were poorly supervised by a miscellany of agencies, from the Securities and Exchange Commission (SEC) to the Commodity Futures Trading Commission (CFTC), not to mention state agencies. Many of the regulators looked forward to jobs in the firms that they regulated.

Free-market ideology led government officials to resist new regulations and enforce existing regulations lightly or not at all in what became known as “the shadow banking system.” For example, Fed chairman Alan Greenspan rejected calls for regulating over-the-counter (OTC) derivatives: “In the case of the institutional off-exchange derivatives market, it seems abundantly clear that private market regulation is quite effectively and efficiently achieving what have been identified as the public policy objectives of government regulation.”
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FROM MANAGERIAL CAPITALISM TO FINANCIAL-MARKET CAPITALISM

The rise of a few universal banks from the wreckage of the New Deal financial system was only part of a larger story: the replacement of managerial capitalism by a new system that can be described as “financial-market capitalism.” Even as traditional banking activities shrank to a portion of the activities of financial markets—some regulated, some part of the unregulated shadow banking system—pressures emanating from Wall Street were reshaping the American corporation.

Wall Street investment bankers and free-market theorists shared a hostility to midcentury America’s corporate oligopolies with their bureaucratic managers. Some of the debt incurred by conglomerates in takeovers, or in fending off hostile takeovers, was rated as junk bonds that were below investment grade. Michael Milken, then working for Drexel Burnham, began selling these high-risk but high-yield junk bonds to institutional investors. Milken and other corporate raiders borrowed money to take over conglomerates in leveraged buyouts and then sold off various parts, repaying lenders while pocketing profits.

Sometimes the takeover artists made companies more efficient, refocusing companies on single lines of business. In many cases, however, the raiders simply broke up corporations in order to sell their assets, raising short-term shareholder returns at the expense of America’s long-term productivity base. Jack Welch, the CEO of General Electric, sold off Bell Labs to a French company, Lucent. Many once-great corporations were reduced to brands, euphemistically known as “original equipment manufacturers” (OEMs), that were attached to products made largely by other firms (outsourcing) or foreign manufacturers (offshoring). The chairman of Ford, William Clay Ford Jr., remarked: “It’s easy to build a car. It’s harder to build a brand.”
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The dismantling of the vertically integrated, oligopolistic industrial behemoths that had formed in the merger waves of the 1890s and early 1900s and the 1920s and had survived the decades of the New Deal era until the 1970s was evident from the statistics. The same companies were in the list of the four top American corporate employers in both 1960 and 1980: GM, AT&T, Ford, and GE (1960) and AT&T, GM, Ford, and GE (1980). In 2007, the top four employers were Walmart, UPS, McDonald’s, and IBM. AT&T had been broken up as a result of a federal antitrust suit in the 1980s, and GM and Ford had dropped out of the list not only of the top four employers but also of the top ten. In 2007, only GE remained among the top ten employers, below the four listed above and Citigroup, Target, and Sears Holdings.
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