Framing Crashed II: 2008, the Crisis of the National Macroeconomics and the “Revolution” of Macrofinance

In 1916 the total output of the continental United States overtook that of the British Empire, marking a decisive moment in the shifting global balance of power. At least this is what Angus Maddison’s data for purchasing power parity adjusted GDP purport to show.

In Deluge I tried to draw out the implications of this shifting global balance.

It might seem anachronistic to invoke such data in relation to a period when national income accounting was still in its infancy. But it is only slightly so. When in the 1930s the technocrats of the Third Reich’ military-economic bureaucracy tried to size up their chances in the global arms race, they did so on the basis of Colin Clark’s pioneering estimates of purchasing power adjusted national income that were being published at the time.

In Wages of Destruction I tried to figure out what happened next.

The period between the 1890s and the 1930s is when national accounting and macroeconomics definitively established themselves as the lingua franca of power. For that story see another post last week.

Not coincidentally this was also a period in which key elements of economic activity were reorganized along national and inter-national lines, through explicit state-to-state agreements such as Bretton Woods or the geopolitics of oil so brilliantly charted by Tim Mitchell and others.

A hundred years on from World War I, at the beginning of the 21st century, in a phase of economic development generally characterized as globalization, these same national economic statistics were being used to chart another transition: this time from America to China. Growth in China’s GDP did not need to be projected very far into the future to show the Chinese economy overtaking that of the United States.

In the mean time the interdependence between the two national economies was measured in terms of the current account side of the balance of payments – another conceptual innovation of the 1920s. This showed how America’s giant trade deficit with China was financed by an import of Chinese capital that was invested in American government debt.

This fragile balance generated ominous warnings of a “balance of financial terror” (Larry Summers), an impending “dollar crash”, a collapse in global demand for US Treasurys, surging interest rates etc.

In 2008 a crisis did arrive. And it did shake America and much of the rest of the global economy to their foundations. But the crisis of 2008 was not the crisis predicted by the conventional macroeconomic analysis based on “global imbalances”.

Intellectually, 2008 was a failure of macroeconomics as much as it was a failure of microeconomics and financial engineering. The macroeconomic schema that had become institutionalized as common sense since the early twentieth-century were profoundly misleading as to the crisis dynamic of 2007-2008. As I explicated in an earlier post, the collapse of 2008 was driven by the implosion of bank balance sheets, which then triggered macroeconomic adjustment, not the other way around.


This was an economic disaster. It was a huge policy problem. It was also a cognitive crisis, which was registered as it happened within the apparatus of power-knowledge. One of the tasks that Crashed sets itself is to register the seriousness and historical significance of that cognitive crisis.

In reconstructing the history of the crisis, Crashed eschews a conventional macroeconomic framework in favor of what has become known as a “macrofinancial” approach. This is owed to a group of economics led by members of Princeton’s economics department, the New York Fed and the BIS. Amongst its earliest contributors were Tobias Adrian and Hyun Song Shin.

Their work and that by contributors at the BIS including Claudio Borio, Piti Disyatat and R McCauley marks a moment when economic experts at the heart of the power apparatus butted up against the limits of conventional macroeconomics.

The following might not be endorsed by all the practitioners but with only a small amount of license and drawing on more heterodox figures like Perry Mehrling, Daniella Gabor or the radical IR scholar Peter Gowan and with a nod to Hyman Minsky one might draw up the following list of key contentions of the macrofinancial approach:

  1. money/financial-cycle matter for the business-cycle both at a national and global level.
  2. money is endogenously generated by the credit “system”.
  3. that credit “system” consists of an oligopolistic and heterogeneous collection of banks, shadow banks, funds of various types and the money market.
  4. the “system” is profit-driven and has strong pro-cyclical tendencies i.e. it expands during an upswing, amplifying the updraft. It is liable to implode during downswings.
  5. this means that microeconomics of balance sheets and macroeconomic dynamics cannot be cleanly separated, hence the proliferation of hybrid terms such as macrofinance and macroprudential regulation.
  6. the credit “system” and in particular the banks live in an incestuous relationship with the state represented by both the treasury (which issues the chief safe asset in most financial systems i.e. government bonds) and the central bank.
  7. the credit “system” is constitutively transnational, historically it grew out of evasions of Bretton Woods by way of the City of London and other offshore financial centers.
  8. the credit “system” relates, therefore, not just to “its” respective “nation state”, but to the state system and to the US state apparatus (Treasury-Fed) above all.

A special mention for publicizing this new genre of international economics should go to the team at the FT’s Alphaville blog and notably its editor Isabella Kaminska who made brilliant bank economists like Zoltan Poszar into the talk of finance twitter.

It was not by accident that one observer who immediately seized on the significance of what was being proposed was the brilliant Peter Gowan. His dazzling last essay, “Crisis in the Hearland”, which appeared in the NLR in 2009  summed up the implications of a macrofinancial analysis brilliantly:

““An understanding of the credit crunch requires us to transcend the commonsense idea that changes in the so-called real economy drive outcomes in a supposed financial superstructure. Making this ‘epistemological break’ is not easy. One reason why so few economists saw a crisis coming, or failed to grasp its scale even after it had hit, was that their models had assumed both that financial systems ‘work’, in the sense of efficiently aiding the operations of the real economy, and that financial trends themselves are of secondary significance. …. Breaking with the orthodoxy that it was ‘real economy’ actors that caused the crisis carries a political price: it means that blame can no longer be pinned on mortgage borrowers for the credit crunch, on the Chinese for the commodities bubble … Yet it may allow us to understand otherwise inexplicable features of the crisis …. We will thus take as our starting point the need to explore the structural transformation of the American financial system over the past twenty-five years. I will argue that a New Wall Street System has emerged in the us during this period, producing new actors, new practices and new dynamics. The resulting financial structure-cum-agents has been the driving force behind the present crisis.”

Peter Gowan “Crisis in the Heartland” New Left Review 55 2009

Read the rest of Gowan’s essay! It is simply jaw-dropping in its prescience. For an appreciation of Gowan’s life and work see this and this.

Gowan came from the Marxist left. In the mainstream  the emergence of the macrofinancial approach might be described as the moment when economics began to take seriously (a.) the reality that the dominant force in the global economy are no longer national units but giant corporations and (b.) the size and force of global finance, which is clearly gigantic but is far too often “netted out” of conventional macroeconomic analysis.

As Shin has put it in one of his most telling images, the new approach involves a shift from viewing the global economy as a series of national “islands” which engage in trade with each other, to viewing the global economy as consisting as a massive matrix of interlocking corporate balance sheets.

These are the stock images Shin uses in his slide deck to illustrate the point. For once they actually work!

The BIS economists like refer to this conceptual move as “breaking with the triple coincidence”. By this they mean the move to free international financial economics from the assumption that national currencies, national economic areas and decision-making by economic actors overlap.

In the instance of a sovereign wealth fund, a nationalized industry, or national corporate champions this alignment makes sense. In a world of exchange controls and capital regulation an identity of currency area and national economy is imposed on private actors. Chinese exporters accumulate export earnings in dollars, they are expected to exchange them into yuan, the China Investment Corporation then recycles the dollars into investments in global markets. The national economy, the currency area and the locus of decision-making are congruent. But this clearly no longer represents an adequate description of global economic activity. The question is how to reconstruct economic analysis if that assumption no longer holds.

In one particularly striking comment, Stefan Avdjiev S, R McCauley and H S Shin note:

“By its nature, the task of building a general equilibrium approach that departs from the triple coincidence faces modeling difficulties. General equilibrium models deal with GDP components and hence start with the GDP area as the unit of analysis. However, financial flows and balance sheets often do not map neatly on to the traditional macro variables that are measured within the GDP boundary. … Take the concrete instance of a US branch of a global European bank that borrows dollars from a US money market fund, and then lends dollars to an Asian firm through its Hong Kong branch. The bank may be headquartered in London, Paris or Frankfurt, but the liabilities on its balance sheet are in New York and the assets on its balance sheet are in Hong Kong SAR. No obvious mapping relates this bank’s balance sheet to a GDP area or to GDP components within the GDP area.

In spite of the conceptual difficulties, some progress can be made in developing an analytical framework that transcends the triple coincidence if the task is limited to delineating the decision-makers through their consolidated balance sheets, irrespective of where the balance sheets lie in GDP space. … Once behavioural features are projected on to the consolidated balance sheets, and provided that such frameworks are limited to addressing global conditions rather than individual country GDP components, useful lessons can be gleaned on key macroeconomic questions.”

Stefan Avdjiev S, R McCauley and H S Shin (2015): “Breaking free of the triple coincidence in international finance”, BIS Working Papers , no 524, October.

One can analyse the movement of the global system through the balance sheets of the major global banks but one cannot make any assumptions about how that maps onto “individual country GDP components”.

Another helpful way to think about the cognitive break being propose is by way of the analogy to the value-chains approach to international trade. If an increasingly significant share of global trade is conducted not between stand-alone nationally or regionally distinctive businesses – Egyptian cotton growers and Manchester spinners, for instance – but runs within and between the production networks of giant transnational firms, the same is true to an even higher degree to the global generation of money.

This may sound abstract. But as I attempt to show in Crashed it had spectacular practical consequences in the crisis of 2008. A system characterized by massive corporate interlock faced meltdown. But it lacked an equivalent transnational stabilizing agency. De facto it was therefore the central bank of the United States, the Fed that emerged as the lender of last resort for the entire global banking system.

The national economic regime was a political paradigm. An entire repertoire of politics could be built around national growth agendas. I’ll come back to the question of the politics of macrofinance in another post.

But the adjustment in terms of regimes of financial stability, monitoring and control has been real. Since the crisis, the new regime of stress testing and monitoring for the Globally Systemically Significant Financial Institutions explicitly registers the need to track the global economy not in terms of national aggregates, but transnational balance sheets.

To return to our starting point, what this means is that a hundred years after its emergence, the national economic model is being systematically relativized. The BIS economics team has continued its searching exploration of the ways in which transnational economic activity escapes national economic statistics. A paper on “Tracking the international footprints of global firms” by  Stefan AvdjievMary EverettPhilip R Lane and Hyun Song Shin is particularly noteworthy.

Closely related work is also being done by analysts like Brad Setser. In the fascinating work that he posts to the Follow the Money blog, Setser starts from the balance of payments. He is one of the great savant when it comes to global balance of payments data. But what he has been doing in recent work is to track how those classic macroeconomic indicators are distorted by the tax avoidance strategies of global corporations. The distortions in the Irish balance of payments are large enough to affect the entire eurozone balance.

As recent work by business economists has confirmed, this kind of result can be generalized. The vast majority of trade is conducted by a tiny handful of corporations. 35 % of US industrial firms in 2007 exported, but 80 % of the value of exports was accounted for by 5 % of those firms i.e. 1.75 % of all firms, which export many products to many locations. Their financial management is key to which flows appear in the balance of payments under which rubric.

At the level of formal modeling there are now efforts to model the business cycle and the transmission of monetary policy as it is mediated by heterogeneous corporate balance sheets and corporate strategies. The transmission of monetary policy shocks can be modeled through the way that it impacts the balance sheet of individual financial institutions. Thanks to new levels of regulation, the highly confidential business data necessary to track these movements is now available in the repositories of the central banks.

As a recent abstract describes it:

Global financial institutions play an important role in channeling funds across countries and, therefore, transmitting monetary policy from one country to another. In this paper, we study whether such international transmission depends on financial institutions’ business models. In particular, we use Dutch, Spanish, and U.S. confidential supervisory data to test whether the transmission operates differently through banks, insurance companies, and pension funds. We find marked heterogeneity in the transmission of monetary policy across the three types of institutions, across the three banking systems, and across banks within each banking system. While insurance companies and pension funds do not transmit homecountry monetary policy internationally, banks do, with the direction and strength of the transmission determined by their business models and balance sheet characteristics.

What all this means is that economic statistics, and economic analysis are finally catching up with the endlessly repeated cliché about the dominance of large transnational corporations in the global economy. The significance of the 2008 crisis in provoking this cognitive break is that it was simply unintelligible in terms of the national economic balances. How could South Korea, Russia and Germany – countries with world-beating exports and substantial currency reserves (at least in the case of South Korea and Russia) – find themselves facing crippling financial crises? What mattered were not their national balance sheets, but the massive dependence of their banking systems on short-term dollar funding.

Are we witnessing the end of the national economic paradigm? The answer is that it is too early to tell.

The massive disruption threatened by Trump’s protectionism gives some indication of how anachronistic the national economic paradigm has become with regard to the US. The US is amongst the least internationalized of the Western economies. One should nothing passed the Trump administration. But to reconstruct an economic entity in which national protectionism would actually correspond to a clearly identified corporate interest, looks like it will take massive and hugely expensive reengineering of value chains and global production systems.

How about China? Surely the “rise of China” is a classic story of ascendant national economic power. As a first approximation, at least in its first decades it might be said that the Chinese growth story was one major reason that the national economic model retained its current relevance. It was a triumph of national economic development, accumulation and labour mobilization, driven largely by domestic demand. China’s financial system remained relatively insulated. Its system of pegged exchanges and currency controls resembled those of Europe in the 1950s and 1960s. Not for nothing there was talk of Bretton Woods II.

But that national reading of China’s development was never uncontested. It was undercut by the way in which China’s industrial development was interconnected with global value chains. Particularly in its early growth, China’s export economy depended not only on imported technology but on imported components. To that extent it was less of a national triumph than it might appear. It was foreign, above all American, capitalists who were profiting. Coming out of the “Toronto school” Sean Kenji Starrs has tracked the way in which American ownership remains pivotal to Pacific economic development, not just in China but in Australia as well.

Those industrial dependencies have attenuated more recently as the Chinese economy becomes ever more sophisticated. It is possible that the new competition between the United States and China in the tech arena will institutionalize and entrench a new age of national industrialism. But there also countervailing tendencies, above all in the sphere of financial interconnection.

The dynamics of the 2015-6 yuan crisis in China had an ominously “macrofinancial” feel.

The crisis was driven by a dangerous interaction between capital flight and adjustment pressures on the balance sheets of exposed dollar debtors. How far China remains a national economy will depend on the extent to which it resists the forces of financial integration. This may be a matter of strategic choice on Beijing’s part. It depends to some degree on policy and regulation. But one has also to reckon with the basic economic driver of cheap dollar funding which exerts an irresistible pull on the global financial system. As globalized, dollar-based finance expands, it stretches the ability of the PBoC to control the Chinese balance of payments and its currency. For details see this recent post by Brad Setser.

As Brad notes: the “errors” in the Chinese balance of payments are private hot money flows, “flows that cannot be accounted for, and thus cannot be controlled or managed.” Currently other elements of the Chinese balance of payments offset those flows. “But … if portfolio inflows dried up and errors structurally marched higher, and consistently topped the current account …”, “China would eventually lose its ability to control its currency”.

As the Bank of England recently warned that has implications not just for China, but for western financial systems, first and foremost the City of London. Another graduate of the Toronto school, Jeremy Green has been doing brilliant work on the Sino-British financial connection.

The development of global finance since the 1950s may have exploded the bounds of the national economy-Bretton Woods framework. But into the 21st century, the geography remained anchored in that North Atlantic matrix. Even at the beginning of the twenty-first century its geography was still shaped by the world of the early 1900s. The system that imploded in 2008 was a direct descendant of the reconfigured Atlantic financial economy whose outline began to emerge in 1916, the year of Verdun and the Somme.

In this sense, at least, 2008 was still very much a North Atlantic, 20th century crisis. The question for the future is: What if the “near miss” Emerging Markets crisis of 2014-2016, with China at its heart, is the shape of things to come?

NB: this post was inspired in part by a joint event with Mark Blyth and the UCLA Center for Social Theory and Comparative History. You can catch the video here. It was fun!

related posts