(Bloomberg) -- “The crisis was not a failure of the free-market system,” declared George W. Bush in November 2008. “And the answer is not to try to reinvent that system. It is to fix the problems we face, make the reforms we need and move forward with the free markets principles that have delivered prosperity and hope to people across the world.”
He has been proven wrong about this. Very few politicians in the western world would voice such thoughts now, let alone Bush’s assertions that capitalism was “by far the most efficient and just way of structuring an economy,” an “engine of social mobility,” and “the highway to the American dream.” This year’s US election delivered the ultimate repudiation to those ideas. Bush’s own party, in particular, now rejects most of them outright.
While old orders fall quickly and suddenly, the new ones that replace them take longer to form. As a new model for the economy takes shape, the forces of markets and the macroeconomy are the drivers, while politics and elections — despite appearances — tend merely to ratify decisions and changes that have already been made.
When the global financial system suddenly collapsed in 2008, it seemed obvious that it had swept away an entire way of organizing the world. If capitalism were to survive, it would need to be turned upside down. And so it is proving. And yet 16 years and five presidential elections after Lehman Brothers collapsed, the alternative is still emerging.
The two key moments of economic crisis in the 20th century were the Great Crash of 1929, and Richard Nixon’s ending of the gold standard in 1971. It took years of turmoil for first the Keynesian New Deal version of capitalism, and then the Milton Friedman-inspired globalized free markets of Ronald Reagan and Margaret Thatcher to arise from these crises. Yet from the perspective of history, the building blocks for a new order were steadily falling into place throughout the chaos of the 1930s and the 1970s. History will probably perceive the same process at work in the even longer reaction to the Global Financial Crisis of 2008.
The Great Crash and Keynesianism
The version of capitalism that fueled the Gilded Age and the Roaring ‘20s perished suddenly in October 1929. It was replaced by a model which would be labeled Keynesianism — even if John Maynard Keynes, who died in 1946, might not have liked the policies enacted in his name. This process took time.
Initially, Herbert Hoover’s administration trusted capitalist creative destruction. They let banks fail, hoping the system would be cleansed, while America took a disastrous turn towards protectionism with the Smoot-Hawley tariffs. Franklin D. Roosevelt arrived in 1933 determined to balance the budget.
The New Deal was FDR’s response to desperate circumstances; it hadn’t received any mandate from voters. He soon grasped that deficits were unavoidable. “To balance our budget in 1933 or 1934 or 1935 would have been a crime against the American people,” he said as he faced reelection. “When Americans suffered, we refused to pass by on the other side. Humanity came first.” He explained the key New Deal reforms:
This vicious tightening circle of our declining national income simply had to be broken. The bankers and the industrialists of the Nation cried aloud that private business was powerless to break it. They turned, as they had a right to turn, to the Government. We accepted the final responsibility of Government, after all else had failed, to spend money when no one else had money left to spend.
The financial system was brought to order and tightly regulated, most famously by the Glass-Steagall Act that forbade commercial banks from dabbling in investment banking. Massive spending to defeat Hitler led to a model of fixed exchange rates under the wartime Bretton Woods agreement, based on a dollar tied to gold, and spawned the Marshall Plan, the GI Bill, the International Monetary Fund and the World Bank. Governments blessed corporatism: Unions were powerful, companies were generous to their employees, and spending to fight the Cold War kept the whole system going. The crash-prone US banking system survived for several decades in a quiet period without any major crisis.
By 1944, FDR had come full circle, “True individual freedom cannot exist without economic security and independence. Necessitous men are not free men,” he said. Hunger and unemployment are the stuff of which dictatorships are made. For decades after the war, the western world proceeded on this basis; market forces were useful, but could be contained and were of secondary importance.
Goodbye Bretton Woods, Hello Milton Friedman
That consensus ended in 1971 when Richard Nixon suddenly abandoned the Bretton Woods gold standard, which was buckling under the spending needed to finance generous social programs and the war in Vietnam. This allowed Nixon to spend money in his successful push for reelection. It also pushed up the price of gold, which led to the 1973 Arab oil embargo, as producers forced up the oil price, in dollars, to restore the value in gold it had held in 1971. Gold had given way to an oil standard.
The miserable stagflationary 1970s ensued, but pieces of a new order steadily fell into place. In 1976, Britain’s high-tax Labour government (“one for you, nineteen for me” as the Beatles complained) asked for a loan from the IMF. The conditions included austerity. Three years before he was defeated by Margaret Thatcher, Labour Prime Minister James Callaghan admitted that the Keynesian game was up:
We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists and that in so far as it ever did exist it only worked on each occasion since the war by injecting a bigger dose of inflation on every occasion followed by a higher level of unemployment as the next step.
The death of Keynesianism was proclaimed by an avowed socialist, not by the prophet of free markets who followed him.
In the US, Jimmy Carter appointed Paul Volcker the new Federal Reserve chairman. Volcker embarked on rate hikes that forced the world into another recession and at last gave the Fed sufficient credibility to act as an alternative to the gold standard. That would create the stability that had been denied the world during the decade when finance was effectively tied to the volatile oil price.
Thus the key decisions had already been made before the landmark elections of Margaret Thatcher in 1979 and Ronald Reagan in 1980 validated them. The full Thatcher-Reagan model involved financial deregulation, as well as globalization that was aided by the fall of the Communist bloc and the conversion of Deng Xiaoping to a Chinese version of capitalism. There were problems under the surface, of course, but the model was virtually unchallenged until 2008.
The Global Financial Crisis and… Trump?
The collapse of the Thatcher-Reagan world in 2008 was absolute, but a response took a while to take shape. Rahm Emanuel, Barack Obama’s first chief of staff, said “you never want a serious crisis to go to waste.” But that is exactly what the Obama team allowed to happen.
The new government opted against nationalizing the banks in favor of a timid and rules-bound re-regulation in the sprawling Dodd-Frank Act. They also chose not to prosecute financiers who might have been deemed responsible (a big difference from the 1930s). These decisions contributed to growing public mistrust, fostering the impression that it was the bankers and not their customers who had been bailed out, paving the way for Donald Trump.
Under pressure from the Tea Party revolt, thoughts of New Deal-style big fiscal spending were abandoned, but by printing money, the Federal Reserve turned what might have been a screeching conflagration into a slow-burning train wreck. A second Great Depression was averted, but growth remained painfully slow, and low interest rates rewarded those who already had assets, intensifying inequality.
The Obama team did broaden the social safety net with its huge health insurance reform — and easily defeated Mitt Romney in 2012 by painting him as the representative of Thatcher-Reagan capitalism. Trump’s election in 2016 left Obamacare in place (largely because Republicans found it politically impossible to change it for anything better), and he cheerfully allowed the deficit to balloon through an unfunded tax cut (the Tea Party qualms could be forgotten now) and made a big turn toward protectionism. During Covid-19, Trump spent money on a scale unseen in generations, as did many other governments around the world.
Joe Biden then intensified the Trump tariffs, bringing Chinese imports down as he embarked on the boldest industrial policy since the New Deal, investing in infrastructure and green technologies to create jobs. This keystone of Bidenomics was potentially transformative, and it was barely ever mentioned in the 2024 campaign.
The US is not alone in stepping back from globalization and allowing a greater role for the state. Xi Jinping reasserted the power of the Chinese state over the private sector, while European nations tried austerity and fostered a populist backlash. Much more populist and interventionist governments of different political stripes gained power in India, Turkey and Brazil. And now Trump is returning with a mandate for continued and intensifying economic nationalism.
Ignore the hesitancy of the Obama years, the head fake of the Tea Party and the fact that central banks slowed everything down for years by printing money, and you are left with a steady and inexorable shift away from Friedmanite capitalism, and even from Keynes, toward a new model with a bigger welfare state, trade blocs protected by tariffs and a government that is entitled to enforce its priorities on companies. Protectionism has returned, but the financial sector will not be shackled. Trump’s return largely ratifies a new order that is already in place.
21st-Century Mercantilism
Keynes once commented that “Practical men who believe themselves to be quite exempt from intellectual influences are usually the slaves of some defunct economist.” If there is a defunct economist who should take the credit for the model now emerging, the best option might be Jean-Baptiste Colbert, who ran Louis XIV’s treasury in the 17th century and whose name is now synonymous with the doctrine of mercantilism — a philosophy of economic nationalism, with intervention by the state if necessary to advance their interests at the expense of others.
We can see mercantilism clearly enough at the “macro” level, through the rise in tariffs and in China’s moves to create a bloc of countries that rely on its investment. In the US, the victory of the concept at the micro level is even more telling. After 2008, companies attempted to reform and improve capitalism, along the lines that George W. Bush had suggested, setting up groups with names like the Council for Inclusive Capitalism and Focusing Capital on the Long Term, to “support a sustainable and prosperous economy.” ESG (Environmental, Social and Governance) investing, in which big money managers tweaked their criteria to send some of their capital to the companies that most deserved it, grew into a huge Wall Street marketing effort.
Most famously, Klaus Schwab of the World Economic Forum proposed a “Great Reset” of capitalism in the wake of the pandemic. The idea was that companies’ owners should act in the interests of all stakeholders (including, for example, employees, or those who might suffer from pollution) and not just attempt to maximize value for shareholders, which, it was held, had led to short-termism and an emphasis on financial engineering. This didn’t go well. People don’t trust the institutions that brought the world into this mess to get us out of it, and Schwab’s Great Reset became the subject of a popular conspiracy theory.
Schwab’s approach still holds sway in Europe, but in the US the letters “ESG” have been demonized to the point where Larry Fink, who runs the world’s largest fund manager, BlackRock Inc., said that the term had been weaponized and was too toxic for use. Republican-led states now boycott any financial group that even offers ESG as an option, even though this costs money for their taxpayers.
The philosophy behind anti-ESG lawsuits has changed profoundly. A first wave of legal opposition was based on the orthodox Milton Friedman view that investment managers had a fiduciary duty to maximize return for their clients through shareholder value and nothing else. But the animating spirit of the latest ESG boycotts is that governments and companies are entitled to deploy their money to advance their own interests versus everyone else’s, rather than to maximize returns.
In a letter to Fink by John Schroder, Louisiana’s state treasurer explained why the state was pulling out from his company altogether, even though BlackRock is a huge investor in fossil fuels:
This divestment is necessary to protect Louisiana from actions and policies that would actively seek to hamstring our fossil fuel sector. In my opinion, your support of ESG investing is inconsistent with the best economic interests and values of Louisiana. I cannot support an institution that would deny our state the benefit of one of its most robust assets. Simply put, we cannot be party to the crippling of our own economy.
This is exactly the opposite of the Friedmanite approach, which leads the world’s largest sovereign wealth fund, Norway’s Norges fund, not to invest in Norway or in fossil fuels, on the logic that this would merely double down on the country’s exposure to oil.
But the new mercantilist approach is that owners don’t have the right to drive corporate changes. Schroder’s letter continues:
You call for a “transformation” of our entire economy that will not be made through a democratic process. Instead you talked about how, “[b]ehaviors are going to have to change and this is one thing we are asking companies. You have to force behaviors. And at BlackRock, we are forcing behaviors.” So much for democracy.
Keynes himself was a brilliant value investor, who absolutely believed that shareholders should throw their weight around with managements. And the power of shareholders over the companies they own was central to the more liberal ideas of Friedman. The idea that governments can exert such influence over the private sector, as well as international trade, has been absent from the west (if not from China) for more than a century. Now, the notion has taken hold that the free market system really did fail in the Global Financial Crisis, and efforts to mend it from within haven’t worked.
History is ambiguous on whether it will work this time. The UK, the Netherlands and France all built big empires, and created great wealth using the mercantile model. But all abandoned it — amid revolution, in the case of France. It turned out that trade and the economy aren’t zero-sum games, and Industrial Britain managed to grow more by following the principles of free trade. It looks as though the world is going to have to learn that lesson again — and this time it will do so in an environment where colonizing large tracts of the world to gain access to trade and resources is no longer an option.
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