VLADISLAV INOZEMTSEV

         Many experts, among which Russians, are inclined to assume that the main cause of the 2007-2009 economic crisis was the policies implemented by the financial institutions of Western powers, and particularly those of the United States of America. It appears as if problems had been created, on one hand, by the policies of USA Federal Reserve system in 2001–2003, which tried to make credit resources as very cheap as possible; and on the other hand by the deregulation of speculative financial operations and the disappointment of investors, which in the end disrupted the market. Sometimes, there is even talk about a conscious agreement between Wall Street and the American government, whose goal would have been to facilitate to a maximum the operations of financiers earning only from speculation.
         Partly agreeing with the first two ideas, I believe that they do not however exhaust the causes of the financial upheaval; the third idea looks, and basically is, very strange, and seems to distract analysts from the real causes of the crisis.

1

         The contemporary crisis has a long-running prehistory. The fundamental starting point is the change in the perception of risk, which took place during the 1990s. In those years, three events took place, the consequences of which led to the 2008 crisis.
         First of all, it is in the 1990s that the traditional stock-exchange and bond market became second compared to all the new financial instruments, usually called derivatives, – options, credit-default swaps – you name it. From 1988 to 1991 the volume of operations on stock-exchange and bond markets ($0,5–0,55 trillion a day) was six times superior to the volume of derivative operations; whereas in 2002 the latter were 2,5–3 times more massive in volume than the former, reaching $7–9 trillion a day.
         This market most certainly involves more risk, because even insignificant oscillations of economic conditions can lead to the loss of all financial input. In all, from 2000 to 2008, the total volume on the derivatives market grew from $5,2 to $700 trillion, but even this estimation is approximate, if one takes into account its permanent volatility.
         The crisis had a serious impact on this market: since the end of 2007, 1.7 thousand Hedge-Funds in the world were interrupted and went broke, and the total losses for the investors exceeded $2,3 trillion. This market started to expand rapidly precisely in the middle and during the second half of the 1990s.
         Secondly, it is in the 1990s that the buoyant dynamic on the stock and capital markets appeared. This dynamic was inhibited neither by the «Asian» financial crisis of 1997–1998, nor by the fleeting recession of 2001 and the correction of the exchange indexes it entailed.
         In toto, from 1995 to 2007, the exchange markets in the USA grew by 3,3–3,6 times, in Europe by 3,7–4,2 times, in Russia by 18 times and in China more than 20 times. Prices for Real Estate went up in the main American cities 3,2 times, in Britain 3,9 times and in continental Europe from 3,7 to 4,2 times. This caused a feeling it was preferable to invest in investment assets rather than buying equity with a fixed income, which resulted in an acute increase in the capitalization of the stock market and a rise in real estate prices. All leading western countries neglected the experience of Japan, which had gone through a catastrophic fall in the price of capital assets from 1989 to 1992. «Cash is trash» was the motto of the end of the 1990’s.
         And thirdly, on the threshold of the century, and in the first years of the XXI century, there were some serious changes in the behavior of developing countries, which are not of least importance when considering the causes of the appearance of the crisis (but which are for some reason never mentioned). After 1998, the governments of these countries (of which the most part were in the 1980’ and 1990s encumbered with serious debts) agreed that to maintain financial stability, it was necessary to limit expenses and to form currency reserves.
         Consequently, from 1999 to 2008, the net growth of their currency position exceeded $4.7 trillion, while in 1997 the currency reserves of all the central banks in the world did not overtop $1.3 trillion. In fact, an amount which sums up to the American two-year budget was absorbed by the exterior world which supplied America with raw materials and merchandise in unprecedented volumes¹. This widening of demand eventually provoked a protracted period of growth in the USA, which was doomed to be brought to an end by a radical economic recession.
         Ultimately, on one hand, these three trends were brought about by objective circumstances and not linked to the policies implemented by the monetary or political institutions of the USA or other western countries. On the other hand, they all changed the attitude of economic subjects to risk and made the situation less stable.

2

         To characterize the background context, in which the subsequent events unfolded, we need to concentrate on the policies of the main economic powers, and mainly of the USA.
         Let’s note straight away: in the period of the «first rise», from 1993 to 1999, these policies were generally responsible and adequate. The Federal Reserve kept interest rates high, fearing an economic overheating. The credit expansion was impressive, but not unprecedented. The government tried to limit spending. From 1998 to 2001, the federal budget of the USA was profitable, which had not occurred during the preceding 30 years.
         The situation started to change in 1999– 2001, first in the context of feeling prosperity, then after the event of September the 11th. In 1999, the government rescinded the provisions of the 1933 Glass-Steagall act, which required, among other things, a separate functioning of «usual» and investment banks. As a matter of fact, since that time, most banks, which had not had the opportunity to use clients’ money to invest in high risk assets, got this opportunity, and shareholders demands in high income forced banks to commit most of their funds to these operations. However, this decision was made straight before the beginning of the slump on the stock exchange market, and consequently funds were not invested in the market before the beginning of the crisis. The change went practically unnoticed.
         In 2001–2002, the government responded to the terrorist attacks without reminding the population about the necessity to save up during the war, but on the contrary – by encouraging consumption². This effect was achieved by bringing down the Federal Reserve interest rate (to 1% a year in 2003) and spurring on credit. We know of many cases when the governments of federal states, in the process of approving the creation of bank subsidiaries and branches, conditioned their opening to their disbursement of a fixed number of mortgage and consumer loans to people living in the region.
         During this period, regulatory bodies in the USA became less vigilant in the corporate sphere. Such symbolic events as the bankruptcy of the companies «WorldCom» and «Enron» during the 2000–2002 stock-exchange crisis indicated that the accounting standards established in the country were defective, and enabled companies to hide for years their insolvency. Extra proof of this took place in 2008, when it was revealed that the commission for bank securities and markets did not notice for five years obvious misuses in the company «Bernard Madoff Securities». From the first years of 2000s, the monetary institutions of the USA started to reduce volumes of public statistics in the financial sphere: from 2001, they stopped publishing a very important indicator of money supply, the aggregate M2; and likewise, they stopped making public OECD reports on the stability of the American banking system. (In 2006, the other countries of OECD obtained the American administration’s agreement on making available data for a new report, but they promised to do so only in 2008).
         At the same time, the scale of obvious misuses on the part of government authorities cannot be considered the main cause for the contemporary problems in the world financial system. It is well known that these kinds of financial scandals (let alone crashes of financial pyramids) take place during crisis periods, because in these times, liquidity problems increase, and investors try to analyze more finely the different investments opportunities which are offered to them.
         Much more important is the link between the role of the USA in the world and their economic development during the last few years. The crisis which has broken out testifies not so much to the cronyism and misuses in American business and politics, but more to the fundamental mistakes made in defining what is nowadays referred to usually as «the limits of American power». The United States virtually lost control of its own economy. Even though the foundations of this accumulation of misbalances were set as early as 1971, after the renunciation of the gold standard dollar, it was only in the last few years that its effects became significant.
         The monopoly the US dollar in the world financial system served the USA in a favourable, but also in a detrimental way. On one hand, it deprived the country of external commerce and external debt³, and it opened for Americans the opportunity to improve their quality of life more quickly. The deficit of the external balance (products and services) grew from $1,3 Billion to more than $735,9 billion at the end of 2007⁴, and its negative external investment position grew from $1,33 trillion to $2,44 trillion only between 2000 and 2007⁵. The inflow of investments from abroad, which came as a concurrent effect of the outflow of dollars from the USA, brought to America innovation and technology, the best specialists and new economic opportunities. Hence, the rate of growth stayed one of the fastest among developed countries, but American households’ consumer spending from 1996 to 2007 grew 1,46 times faster than that country’s GDP. All this enabled America to maintain a wealth gap with other western countries, a gap which is inexplicable when considering productivity and a number of other indicators.
         On the other hand, the unlimited external commerce deficit and investment policies coupled with unrestricted borrowing for the Federal budget contributed to a feeling of all mightiness. It pushed up American strength in the world political arenas, to wars in Afghanistan and Iraq, and interms of internal politics, to a practically complete deregulation of the financial sector, whose task was to pump-up the economy with cheap credit. However, maintaining this sector profitable was only possible if new and ever newer products were designed, and these turned out in reality to be riskier, even though they seemed more reliable at first glance.
         The problem of the American financial system, which in the end turned into the problem of the world economy, is not the corruption of bureaucrats or representatives of regulatory bodies and all the more, not the misuse on the part of the heads of administration (Statistics show that for every scheme ending in collapse or financial scandal from 2000 to 2007 at least 37 illegal financial manipulations were thwarted), but the deeply rooted (among Americans) belief, in the strength and opportunities offered by a free market. In my opinion, it is this factor which explains all (or nearly all) the disproportions in the American economy. Half a century sufficed the Americans to forget the lessons from the 1929–1933 Great Depression.
         Since the end of the 1970s, the movement in favour of enhancing economic freedom and refusing state regulation became far stronger. As a result of three decades of permanent deregulation in America, a situation appeared in which private institutions (financial corporations, banks, rating agencies and insurance companies) either took on financial risks they were unable to deal with, or started to create products they were not able to take responsibility for. The conditions, which enabled them to do this, was the ‘global status’ of these structures, and their being based in the USA, the biggest economy in the world, the main issuer of the world reserve currency and the main borrower among other major powers. This unique status of the USA enabled American companies and banks to benefit from (and sometimes abuse) a totally unique position in the international financial system.
         Such a ‘status’ which automatically added to the value of many American assets, was absent in most other western countries and primarily in continental Europe. There, the indicators of capitalisation of stock markets were 1,5-2 times lower than in the USA (compared to the GDP of the given countries), external commerce stayed balanced, the «financial pump-up» of the economy stayed two to three times lower than in America. Banks and financial institutions operated under tighter control of the government than in the USA. And it is for this very reason that the crisis has not taken on such an importance in the countries of the EU as in the USA (although in Russia many think otherwise), and aid to the economy is delivered in more modest doses in Europe compared to the other side of the Atlantic⁶.

3

         Actions taken by states are only an indirect cause of the contemporary crisis. What had a much bigger impact on the formation of its causes was the passiveness of governments and their unwillingness (especially during the first stage of development of crisis tendencies, between October 2007 and the summer of 2008) to interfere in the situation. Starting from the first quarter of 2008, governments in most western countries started to do all they could, to ease the situation. The significant support to the banking sector prevented a collapse which could have turned out similar to the one that took place in 1930–1931. The measures to lower interest rates lightened the pressure on the production sector, and saved entrepreneurs tens of millions of dollars. The input of money in major industrial corporations supported the labour market. This is why now in the USA there is only a hint at processes, similar to those which occurred during the years of the «Great depression» (some of the similarities of the first year and a half of the actual and previous crisis are exposed in table 1), but there are no prerequisites for a grave worsening of the crisis and its transformation into a full-blown depression⁷.

Table 1.
Comparing the indicators of recession of 1929 and 2008 in the USA

         One should also notice that the particular position of the USA in the world economy allows America to relatively painlessly get out of this crisis phase. After a certain number of attempts to solve the problem of refinancing banks and industrial companies with «conventional» methods (borrowing money thanks to market emissions of government obligations, treasuries, and a larger crediting policy to the banking sector on the part of the central bank), the USA government tried out unprecedented methods. First, the Federal Reserve announced the direct dispatch of credits to non-financial corporations, and not long after that, the program of direct buying of Treasury securities. This meant the beginning of dollar emission, which enabled the Federal Treasury to borrow money at non-market interest rates.
         By doing this, the USA, most likely, will chose to pay off its obligations with unwarranted money, which will in the end have two consequences. On one hand, it will result in the lowering of the dollar exchange rate and a reanimation of the export sector. On the other hand, it will entail a new flow of investments in the USA, as the emission of money, with which America will pay off its foreign creditors, will lead to an explosive rise in the demand for assets in the USA (because America will physically not be able to put the corresponding amount of products and services on the world market). This emission, unquestionably, will enable the USA to make its way out of the contemporary economic crisis relatively quickly, leaving once more the rest of the world, to face the question of how tolerable it is to have one natural reserve currency and how fair the actual economic order is.
         It is hard to say what will be the answer to these questions. However, to be fair one has to mention that during the last decade, the USA played a mainly constructive role in the world economy, acting as one of the main promoters of real demand, and leading to economic growth on a global scale. Without American over-consumption there would not be, not only the contemporary economic crisis, but also the significant rise of the Asian economies in 1980–1990.Without the formation of a «bubble» on the American stock market, the «new economic» sector would not have appeared, and would have not entailed in large part the technological boom of the last ten years. Without the status of the dollar and the role of the USA in its emission, there would have not been any effective financial help to developing countries in Latin America and South-East Asia in 1994-1998. Finally, without futures and forwards in 2007–2008, there would have not been exorbitant prices for gas and other natural resources, which showered Russia with a «gold rain».
         Is it sensible to deprive the world of such an economic and financial engine as the USA? In my opinion, the time for this has not yet come. No matter what mistakes were committed by the USA, this country is a fairly reliable player, and the main lesson of this crisis is not the necessity for international financial regulation but the demand for a more realistic evaluation of what is happening in different corners of the financial system. The logic of free market is at times peculiar, but it is clear and predictable. That is why when the next phase of economic growth steps in, it is important not to get carried away by favourable tendencies, even if this does not mean that they should be inhibited for the sake of «a united financial order», which is unlikely to be implemented. What we need it not necessarily to limit risk, which is an important driver of the financial system, but to provide for clear, accessible and truthful information about this risk.

* * *

         The most important thing that Western governments accomplished during this crisis is that they stayed highly independent from corporate lobbying and interests of the financial sector. Regardless of the large-scale aid which has been and continues to be provided to businesses by governments, these authorities keep control on the distribution of the dispensed funds and assure them with guarantees in the shape of securities from banks and companies, to whom this assistance is rendered. As one could realise, this ensures the return of a big part of the funds lent to the financial sector, allows cutting down on government spending and after a while will help to reprivatise the firms which have been under government control.
        

Notes

 ¹  Wolf M. Fixing Global Finance, Baltimore (Md.): The Johns Hopkins Univ. Press, 2008. P. 11, 57, 123 и др.
 ²  Bacevich A. The Limits of Power: The End of American Exceptionalism, New York: Henry Holt & Co., 2008. P. 60-61
 ³  Krugman P. Peddling Prosperity. Economic Sense and Nonsense in the Age of Diminishing Expectations, New York, London: W.W. Norton, 1994. P. 231
 ⁴  Economic Report of the President. Transmitted to the Congress February 2009, Washington (DC): United States Government Printing Office, 2009, table B-103. P. 402
 ⁵  Table B-107. P. 407
 ⁶  Inozemtsev, V. «One crisis, two Wests» // Vesdomosti, 2009, 2 April.
 ⁷  Inozemtsev, V. «The Non-Great depression» // Novaya Gazetta, 2009, 1 April.