And the Weak Suffer What They Must?

CHAPTER 1

AND THE WEAK SUFFER WHAT THEY MUST

            My philosophy is that all foreigners are out to screw us and it’s our job to screw them first.

            —John Connally¹

It was midsummer at Camp David when Richard Nixon’s treasury secretary and former governor of Texas John Connally convinced his president to unleash the infamous Nixon Shock upon Europe’s unsuspecting political leaders. At the end of a crucial weekend of consultations with key advisors, President Nixon decided to make a startling announcement on live television: the global monetary system, which America had designed and had been nurturing since the end of the war, was to be dismantled in one fell swoop.² The calendar read Sunday, August 15, 1971.

A few hours after the president’s televised address, exactly at the stroke of midnight, a military transport plane took off from Andrews Air Force Base heading for Europe. On board, Paul Volcker, Connally’s under-secretary, was intent on confronting European finance ministers who were already on the verge of a nervous breakdown.³ Meanwhile, Connally himself was preparing an address to the nation before flying to Europe to tell a gathering of uppity European prime ministers, chancellors and presidents that it was “game over.” Washington was intent on pulling the plug from a global financial system that it had designed in 1944 and that it had been nurturing lovingly ever since.

While Volcker dealt with European finance ministers and bankers in London and in Paris, trying to steady their nerves, Connally was conveying, up close and personally, a blunter message to European heads of state. In effect, what he was saying was, “Gentlemen, for years you have been disparaging our stewardship of the postwar global financial system—the one we created to help you rise up from ashes of your own making. You felt at liberty to violate its spirit and its rules. You assumed we would continue, Atlas-like, to prop it up whatever the cost and despite your insults and acts of sabotage. But you were wrong! On Sunday, President Nixon severed the lifeline between our dollar and your currencies.⁴ Let’s see how this will work for you! My hunch is that your currencies will resemble lifeboats jettisoned from the good ship USS Dollar, buffeted by high seas they were never designed for, crashing into each other and, generally, failing to chart their own course.”⁵

And in a sentence still resonating across Europe today, Connally summed it all up succinctly, painfully, brutally: “Gentlemen, the dollar is our currency. And from now on, it is your problem!”⁶

Europe’s leaders realized immediately the gravity of their situation. They responded quickly with a sequence of knee-jerk reactions that led them from one error to the next, culminating forty years later in Europe’s current circumstances.

In 2010 Europe came face to face with the consequences of these forty years of accumulated mistakes (see chapters 2, 3 and 4). The crisis of its common currency known as the euro was due to failures traceable to the events of 1971, when Europe was jettisoned from the so-called dollar zone by Nixon, Connally and Volcker.⁷ The comedy of errors with which European leaders responded to their post-2010 euro crisis (see chapters 5 and 6) is also attributable to Europe’s clumsy reaction to the Nixon Shock. It is this critical moment in history that will occupy this chapter.

A LONG TIME COMING

Nixon had not acceded to Connally’s crude philosophy lightly. Nor was Connally’s philosophy as crude as he loved to make it sound. The postwar global financial system that Nixon’s midsummer announcement assigned to the dustbin of history had been creaking like a doomed hull whose inevitable sinking threatened to bring down with it America’s postwar hegemony.

Lyndon B. Johnson, Nixon’s immediate predecessor in the White House, and Connally’s fellow Texan and political mentor, had also understood that the American-designed postwar financial system could not continue.⁸ In a discussion he had in 1966 with Francis Bator, his deputy national security advisor, President Johnson was adamant that he was ready to end it, and by severing the link between the dollar and the value of gold on which that global system depended: “I will not deflate the American economy, screw up my foreign policy by gutting aid or pulling troops out, or go protectionist just so we can continue to pay out gold to the French at $35 an ounce.”⁹

Distracted, however, by his Great Society programs, his intensification of the Vietnam War and his reluctance to destroy a global system that President Franklin Roosevelt’s administration (the so-called New Dealers) had put together two decades earlier, Johnson allowed it to chug along.¹⁰

Nixon too, once in the White House, tried to delay the inevitable. Even though his squabbling team of policy makers were increasingly coming to the view that the global monetary system was broken, their warnings alone would not have sufficed to convince Nixon to unleash his shock (and John Connally) upon the befuddled Europeans.

In fact, as we shall see below, it took several aggressive moves by the French, the Germans and the British, between 1968 and the summer of 1971, to free his hand. These were foolhardy challenges to America’s management of global capitalism that gave Connally and “that goddam Volcker”¹¹ the opportunity to impress upon the president that there was no alternative: he had to ditch the international monetary system known as Bretton Woods and he had to dump Europe along with it.

Could things have turned out differently? By 1971 everyone knew that the Bretton Woods postwar global financial system had been undermined by powerful economic forces beyond the control of either the United States or of Europe. As we shall see, Europe’s error was that, instead of seeking to reform a faltering system by negotiation, its leaders overplayed a weak hand against a bold hegemon.¹² They would now have to suffer the consequences. And suffer them Europe did. In fact, Europe is still suffering them from Dublin to Athens and from Lisbon to Helsinki.

A SIMPLE IDEA FOR A STRICKEN EUROPE

The financial system that President Nixon “terminated” in 1971 was born in July 1944 in the conference rooms of Mount Washington Hotel, perched in the New Hampshire town of Bretton Woods. The pristine setting could not have been more at odds with developments forged of blood and steel in Europe and the Pacific.

D-day had preceded the Bretton Woods conference by only three weeks, its dreadful toll not yet digested by thousands of grieving, largely American, families. During the conference itself, the Red Army liberated Minsk at great human cost, the US Air Force bombarded Tokyo heavily for the first time since 1942, Sienna fell to Algerian troops under General Charles de Gaulle’s command and V-1 rockets were pounding London mercilessly. On July 20, the day before the Bretton Woods Conference was successfully completed, Claus von Stauffenberg led the conspiracy to assassinate Adolph Hitler at his bunker in Rastenburg. Even though the conspirators failed, the writing was on the wall. July 1944 was, undoubtedly, the right time for the Allies to begin planning the postwar order of things.

With their heads full of the conflict back home, and considerable uncertainty about their own position in the postwar order, the delegates from the forty allied nations attending the conference hammered out an impressive financial deal in the space of three weeks. In anticipation of the guns falling silent in Europe, and before the Soviet Union had emerged as the dragon to be slain, the New Dealers in power understood that America was about to inherit the historic role of remaking global capitalism in its own image.

In the conference’s opening ceremony, on July 1, 1944, President Roosevelt declared his administration’s abandonment of any remnants of American isolationism. “The economic health of every country,” he announced, “is a proper matter of concern to all its neighbors, near and far.” Clearly, the United States, the only country that came out of the war (save perhaps for inconsequential Switzerland) with its monetary system intact, its industry booming and with a healthy trade surplus, was intent on taking a war-torn world under its wing.

One of the casualties of the European war was money. Nazi-affiliated regimes in occupied countries had printed so much of the local currencies to support the Axis’s war effort that the money in Europeans’ pockets was not even worth the paper it had been printed on. And even in countries that had escaped occupation, such as Britain, the costs of war and the collapse of trade had led to a combination of government indebtedness and value destruction that rendered the currency worthless, at least in the arena of international trade. In short, the greenback was the only currency left standing and capable of lubricating world trade.

Washington understood that its first task, once the German armies had been defeated, was to remonetize Europe. This was, of course, easier said than done. With Europe’s gold either spent or stolen, its factories and infrastructure in ruins, hordes of refugees roaming its highways and byways, the concentration camps still reeking with the stench of humanity’s unspeakable cruelty, Europe needed much more than freshly minted paper money. Something had to give value to the new notes. It was not surprising, perhaps, that the “something” the New Dealers came up with was none other than their own dollar. America was about to share its greenback with the European countries standing, at war’s end, under its geopolitical umbrella.

In practice this entailed new European currencies backed by dollars at a fixed rate, meaning that a certain number of deutsche marks, of French francs, of British pounds, of even Greek drachmas, would be worth a prespecified, constant number of dollars. It was this dollar guarantee that would instantly impart global value to Europe’s new money.

Would this not risk debasing the dollar? If the dollar was to be the anchor for the new European currencies, what would underpin the dollar’s own value? Tapping into a long tradition of tying paper money to precious metals that no alchemist could fake, the answer was that America would guarantee a fixed exchange rate, and full convertibility, between the dollar and the gold that it held in a bunker under the New York Federal Reserve building, as well as in Fort Knox.

It was a simple idea for a simpler world. The holder of a given number of dollars ($35 was the figure finally chosen) was to be offered an unqualified claim to an ounce of gold owned by the United States, regardless of the holder’s nationality or location on the planet. Equally, the holder of another amount of Europe’s new money would be guaranteed a given amount of dollars, which would in turn guarantee access to America’s gold. In essence, gold-backed greenbacks became the guarantors of the currencies within a new global financial system that has gone down in history, grandiosely, as the Bretton Woods system.

A DISCIPLE TO TRUMP THE MASTER

In the Bretton Woods negotiations, President Franklin D. Roosevelt was represented by Harry Dexter White, an economist who had entered public service on the coattails of Roosevelt’s New Deal.¹³ New Dealers like White had cut their teeth in the 1930s, following the collapse of unfettered financial markets in 1929 and the ensuing Great Depression. Their ambition was to counter deprivation and hopelessness by beefing up the federal government’s existing institutions and creating new ones that would make another 1929 impossible. Bretton Woods offered White an opportunity to project the New Deal onto a global canvas. His brief for the Bretton Woods conference was nothing less than to design from scratch a stable, viable, worldwide financial system for the postwar era. At the same time, White’s brief entailed staving off ambitious Europeans whom Washingon was expecting to have a go at skewing the new financial system’s design in their favor.

White’s economics had been influenced heavily in the 1930s by the writings of Cambridge economist John Maynard Keynes. In a delicious twist of fate, the one European he had to face down at Bretton Woods was none other than John Maynard Keynes himself, dispatched to Bretton Woods by Winston Churchill’s wartime national unity government to represent Europe’s last, and fading, empire.¹⁴

Keynes had it all planned well before he even arrived in America. He brought with him a razor-sharp perception of global capitalism’s ways, a unique grasp of the economic forces that had caused the Great Depression, a splendid plan to refashion global finance and, last but not least, a poet’s way with words and a novelist’s talent for narrative.¹⁵ The only person at the Bretton Woods conference who could deny him the crowning glory of putting his stamp on the new global system was his American disciple, Harry Dexter White. And this is precisely what White did.

Keynes’s proposal was brimming with intellectual power. White was overflowing with the power vested in him by America’s economic and military might.

As we shall see, Keynes advocated a global system that could stabilize capitalism for a fabulously long time. White’s brief was to push through a system consistent with the United States’ newfound strength but viable only as long as America remained the surplus nation extraordinaire.

It was surely inevitable that the two men would clash and that White would prevail, even if Keynes succeeded in persuading his adversary on every theoretical point that mattered.

And so it was that, in July 1944, with D-day fresh in the background, with American troops advancing in both Europe and the Pacific, and with the rest of the world in America’s debt, Keynes returned to London a defeated man, refusing to discuss in any detail either the agreement that ultimately had been imposed by the American side or his plan that White had trashed in the Mount Washington Hotel.

Shortly afterward Keynes put his remaining energies into another negotiation with Washington’s New Dealers, at a conference in Savannah, Georgia, this time in a bid to convince them to write down Britain’s gargantuan wartime loans. It did not go well. During the negotiation, which Keynes described as “hell,” he had his first heart attack. Soon after his return to England, at the age of sixty-two, another heart attack ended his life.

VICTORS BEHAVING BADLY, FAILING TO BE GOOD AT BEING SELFISH, AND CAUSING THE WEAK TO SUFFER MORE THAN THEY MUST

Forty years later, in 1988, while looking through Keynes’s papers and books at King’s College, Cambridge, I noticed a copy of Thucydides’s Peloponnesian War in the original ancient Greek. I took it out and quickly browsed through its pages. There it was, underlined in pencil, the famous passage in which powerful Athenian generals explained to the helpless Melians why “rights” are only pertinent “between equals in power” and, for this reason, they were about “to do as they pleased with them.” It was because “the strong actually do what they can and the weak suffer what they must.”¹⁶

These words were ringing in my head during the spring of 2015 as I faced Greece’s lenders and their unwavering commitment to crush our government. Keynes’s head, I am certain, must also have been ringing with these words at Bretton Woods. I wonder, however, if he was tempted, as I was, to address White with a version of a line from the Melians who, in a bid to save themselves, attempted to appeal to the Athenians’ self-interest:

Then in our view (since you force us to base our arguments on self-interest, rather than on what is proper) it is useful that you should not destroy a principle that is to the general good—namely that those who find themselves in the clutches of misfortune should . . . be allowed to thrive beyond the limits set by the precise calculation of their power. And this is a principle which does not affect you less, since your own fall would be visited by the most terrible vengeance, watched by the whole world [emphasis added].¹⁷

In the case of the arrogant Athenians, these words surely resonated years later when their mortal enemies, the Spartans, scaled the walls of Athens intent on destruction. After the Great War, in 1919, Keynes had used a logic similar to the Melians’ argument to warn the victorious allies that the vengeful Versailles Treaty they had imposed on defeated Germany would be a menacing boomerang that would come back to strike at the foundation of their own interests,¹⁸ which is, of course, what happened after the Versailles Treaty engendered an economic crisis in Germany that brought Adolph Hitler to power. Perhaps the Melians’ words also reflect how the surviving New Dealers felt in the mid-1960s when the Bretton Woods system that White had forced through, against Keynes’s better judgment, began to unravel. By then it was, of course, too late to do much about it. Bretton Woods was at the end of its tether and the Nixon Shock simply demonstrated the ruthless efficiency with which American officials come to terms with new, unpleasant realities, in sharp contrast to their European counterparts, who will hang on to failed projects for as long as possible.

When it came, the Nixon Shock saw to it that America, unlike Athens, would continue to enjoy the trappings of uncontested hegemony—at least till 2008. That was, in essence, what John Connally had proposed to his president. Screw them before they screw us! Europe and Japan were, consequently, badly “screwed,”¹⁹ but so was the political project of the New Dealers who had pushed aside Keynes’s proposals in 1944.

Indeed, after 1965, the New Dealers and their successors lost every domestic battle they fought against the resurgent Republicans. Their abject failure to revive the spirit of the New Deal, even by democratic presidents who may have wanted to revive it (such as Jimmy Carter, Bill Clinton, Barack Obama), can arguably be traced to their dismissal of Keynes’s proposals back in 1944.²⁰

FAIR-WEATHER RECYCLING

Keynes’s proposal was internationalist and multilateral to the core. It was historically informed (by the calamitous Wall Street crash of 1929) and theoretically buttressed by a thought obvious to everyone, except of course to most professional economists: global capitalism differs fundamentally from Robinson Crusoe’s solitary economy.

What this means is that a closed, autarkic (meaning “self-sufficient”) economy, like that of Robinson Crusoe in literature, or perhaps North Korea today, may be poor, solitary and undemocratic but at least it is free of problems caused by other economies, by external deficits or surpluses.²¹ In contrast, all modern economies can expect to be in an economic relation with others, and in addition they can expect that these relations will almost all be asymmetrical. Think Greece in relation to Germany, Arizona in relation to neighboring California, North England and Wales in relation to the Greater London area or indeed the United States in relation to China—all cases of imbalances with impressive staying power. Imbalances, in short, are the norm, never the exception.

In 1944 Keynes conceded that, in view of Europe’s frightful state, there was no alternative to a regime of fixed exchange rates relying extensively on the dollar. However, while dollarizing Europe would fix one problem, a dollar-backed fixed exchange rate system would create other misadventures down the road; misadventures that would, he predicted, cause these trade imbalances to grow with, ultimately, terrible effects first upon the deficit countries and then upon everyone else.

His logic as to why fixed exchange rates would beget instability in a world of persistent surpluses and deficits was rooted directly in the experience of the events leading to the Great Depression, which the New Dealers understood so well, and it went as follows.

Just as one person’s debt is another’s asset, one nation’s deficit is another’s surplus. In an asymmetrical world, the money that the surplus economies amass, from selling more stuff to the deficit economies than they buy from them, accumulate in their banks. But these banks are then tempted to lend much of it back to the deficit countries or regions, where interest rates are always higher because money is so much scarcer. In this way, banks help maintain some semblance of balance during the good times. If the exchange rate is likely to remain stable or even the same, banks will tend to lend more to the deficit country, unworried by the prospect of a devaluation further down the line that might make it hard for debtors in the deficit country to repay them. Bankers, in this sense, are fair-weather surplus recyclers. They profit from taking a chunk of the surplus money from the surplus nations and recycling it in the deficit nations.

But if the exchange rate is fixed, they go berserk, transferring mountains of money to the deficit regions as long as the storm clouds are absent, the skies are blue and the financial waters calm. Their “credit line” allows those in deficit to keep buying more and more stuff from the surplus economies, which thrive on a spree of exports. Import-export businesses grow fatter everywhere, incomes boom in surplus and deficit countries alike, confidence in the financial system swells, the surpluses get larger and the deficits deeper.

As long as the fair financial weather continues, fair-weather surplus recycling endures. Only it cannot endure forever. With the certainty and abruptness that a pile of sand will collapse once the critical grain is added on top of it, vendor-financed trade will always go into sudden, violent spasm. No one can predict when, but only fools doubt that it must. The equivalent of the critical grain of sand is one container full of imported goodies that goes unclaimed by an insolvent importer, or one loan that is defaulted upon by some overleveraged real estate developer. It takes one such bankruptcy in a deficit country to raise a whirlpool of panic among the surplus nations’ banks.

Suddenly, confident globetrotting bankers turn into jelly. Lax lending turns to no lending at all. Importers, developers, governments and city councils in the deficit regions, who had grown dependent on the banks, are hung out to dry. House prices collapse, public works are abandoned, office buildings turn into ghostly towers, shops are boarded up, incomes disappear and governments announce austerity. In no time, bankers are left holding “nonperforming loans” the size of the Himalayas. Panic reaches its deafening crescendo and Keynes’s inimitable words resonate once more: “As soon as a storm rises,” bankers behave like a “fair-weather sailor” who “abandons the boats which might carry him to safety by his haste to push his neighbor off and himself in.”²²

It is the destiny of fair-weather surplus recycling to prompt a crash and occasion a complete halt to all recycling. This is what happened in 1929. It is also what has been happening since 2008 in Europe.

POLITICAL SURPLUS RECYCLING, OR BARBARISM

By contrast, when the value of a nation’s money is flexible, it operates like a shock absorber soaking up the jolt caused by a banking crisis occasioned by unsustainable trade and money flows. When unsustainable banking practices caused Iceland to collapse in 2008, its currency slumped, the fish the island exports to Canada and the United States became dirt cheap, revenues picked up and, crucially, debts that were denominated in the local currency shrank (at least in terms of dollars, euros and pounds). This is why Iceland recovered so quickly after a terrible shock.

But when a deficit nation’s currency is exchanged in unchanging proportions with the currency of its surplus trading partners, its international value is fixed. This sounds great if you live in such a country and possess a lot of its money. Only it is a terrible thing for the vast majority of its people who hold little of it. Once the sequence of bankruptcies has begun, incomes are destined to fall while the private and public debts to the foreign banks remain the same. The price of a fixed exchange rate is a bankrupt state in a death embrace with impecunious citizens and an insolvent private sector. A doom loop, a hideous vortex, leads the majority to debt bondage, the country to stagnation and the nation to ignominy.

John Maynard Keynes knew this too well.²³ And so did Harry Dexter White, who had lived through the desolation of the 1930s that gave him firsthand experience of what happens when the burden of adjustment falls crushingly upon the weakest of shoulders: on the debtors languishing in the deficit regions where incomes are squeezed, investment disappears, and the only thing looming increasingly larger is the black hole of debt and banking losses. White understood all this perfectly well, just as the Greeks, the Irish, the Spaniards and assorted Europeans do today.

It was because White appreciated this problem that he agreed with Keynes on one crucial point: some alternative shock-absorbing mechanism had to be introduced into the global system they were designing. One that the gold standard lacked in the 1920s and which, tragically, Europe is desperately missing today. A mechanism that can kick in the moment the bankers’ fair-weather surplus recycling disappears, so as to prevent the doom loop from taking hold and plunging first the deficit countries, and then global capitalism, into another spiral of depression and barbarous conflict. What was this “mechanism” to be? The answer was a set of political institutions that step in and recycle surpluses once fair-weather surplus recycling runs aground.

The New Dealers, whom White represented at Bretton Woods, had already tackled that problem at home. They had created federal institutions whose role was, at times of crisis, automatically to recycle surpluses to where they were most needed. Political surplus recycling, in short. The very point of the New Deal, which had preceded the Bretton Woods conference by a decade, was precisely that: Social Security, a federal deposit insurance scheme (run by the Federal Deposit Insurance Corporation [FDIC]²⁴