The Great Shock


Yanis Varoufakis

The Great Shock by Brian Collins

The crisis occurred and persists because an alternative was and is mostly unthinkable.

October 17th, 2011 reset - +

I found a flaw... . a flaw in the model

— Alan Greenspan, October 2008

Photograph © Dan Tague

It's almost three years since the bubble burst. If understanding really does abhor a vacuum, something about why it happened ought to have been learned. Much has been written on the subject, to be sure, lots of it terrifically trenchant. Journalists like Matt Taibbi (in his superb Rolling Stone screeds) and Andrew Ross Sorkin (Too Big Too Fail) establish incontrovertibly that there was colossal greed at work on Wall Street. (The bankers, one can't help noting, admit as much. It's only the criminal charges they're a little defensive about.)

But moral narratives alone will never suffice; what's being reckoned with here, recall, is arguably the greatest systemic failure of all time. The bankers cannot have been the only ones responsible. A more circumspect explanation is to be found in what might be called the "regulatory capture" version of the moral tale, found in books Simon Johnson's 13 Bankers or Joseph Stiglitz's Freefall. In this version of the crisis, self-interested elected officials and the regulators they appointed are (quite rightly) seen to have stood aside for the banks.

Such finger-pointing accounts are even less satisfying in view of our situation today: The global financial system still teeters on the brink of collapse, and virtually nothing has been done to avert another disaster. One would have to be pretty cynical to accept that only greed and personal political ambition are to blame for such thoroughgoing paralysis. In view of the spectacle of "extend and pretend" presently unfolding in power centers from Washington to Frankfurt, what needs explaining is why even the well-informed and quite high-minded remain committed to so unpromising a status quo.

At long last there is progress in this area: Two new books, conjoined twins of a kind but each of them quite extraordinary in their own way, from a trio of economists fronted by Yanis Varoufakis, who teaches at the University of Athens and writes with great command of the European debt crisis on his blog. The first is Modern Political Economy: Making Sense of the Post-2008 World, co-authored by Joseph Halevi and Nicholas Theocarakis, an astonishing tour de force of math, metaphysics, and political economy in the grand tradition, all unfolded in fugal counterpoint. The second, just out from Zed Books, is The Global Minotaur, Varoufakis's short course for a more general reader, Modern Political Economy minus the more abstruse material. According to both, the 2008 financial crisis was the result of two more or less mutually reinforcing conditions: First, a major reorganization of the global economic order in the late twentieth century; and, second, the inherent limits of what economics can say about the outcome of such shifts. The great insight here is that, along with whatever reckless self-interest was at work, the crisis occurred and persists because an alternative was and is mostly unthinkable.



The Global Minotaur of the shorter book's title is what Varoufakis and his co-authors call "today's international economic system," whose stability is seen to depend on a kind of tribute, as in the ancient myth, offered up to a voracious beast. The book itself is their brief history of this system, from its origins as strange sequel to the first postwar order — the "Global Plan," as they call it — to its near self-extinction in the Great Shock of 2008. It arose as the late 1960s unfolded, with the erosion of the victor's advantage the United States had enjoyed since the end of World War II. With the exception of just a few industries (oil and Eisenhower's "military-industrial complex"), American manufacturing was by the second half of the twentieth century becoming an also-ran to those of Germany and Japan, which the Global Plan had raised up from the ashes. First Kennedy and then Johnson had to expand social programs to address the resulting contraction, and by 1971, when America was also waging war in Vietnam to protect its Asian interests, the deficit rose to nearly $60 billion. To close the gap, the Fed simply printed more money, but the international consequence was grave: The rest of the world saw its dollar-reserves devalue sharply and primary commodity prices spike.

It's no surprise that America's allies — caught between the rock of the Bretton Woods rules and the hard place of inflation brought on by the system's only fiat-participant (i.e., as issuer of the reserve currency) — took this all pretty poorly. How serious the ensuing crisis was can be gauged by the French response: Ordering a battleship to the United States to retrieve France's dollar holdings in gold. A few days later, Richard Nixon countered by simply changing the rules. Henceforth the dollar would not be gold-convertible, and a quarter-century-old international economic order was abruptly transformed.

The authors take a very different view of these developments than the conventional wisdom, whereby the inflationary nineteen-seventies are seen as (in their words) "an exogenous shock brought about by a few recalcitrant sheiks." The case they make is compelling, drawing on diplomatic history, policy memoranda and the public statements of key players; they show that American decision makers were driving the train and inflation was actually their objective. None other than Paul Volcker, who as Undersecretary of the Treasury first proposed the suspension of gold-conversion and would later become Federal Reserve chair, wrote of the U.S.'s pursuing a "controlled disintegration" of the world economy during this period. 

(It's hard not to add, as an aside, just what a singular figure Volcker cuts in Varoufakis's story. Until his resurfacing among Obama's economic advisors after the Crash, one remembered him a little dimly as the lumbering Fed Chair, first of the Carter and then of the Reagan administration, and the implementer at that time of a very unpopular interest rate regime. The Global Minotaur presents a very different picture of the economist: Here, Volcker emerges as not just one of the most prescient technocrats at the Treasury under Nixon, but an exceedingly masterful manager of the economy as Fed chair during a time of difficult global transition, and, finally, acerbic critic of American finance. (He was an advocate of what's become known as the "Volcker rule," which would separate the business of deposit-taking institutions from riskier activities of investment brokers and hedge funds.) What clearly separates Volcker from many of those advising the current President (Rubin, Geithner, Summers, et al.) is his riposte to financiers who defend deregulation as a great innovation of the times. "The only financial innovation I recall in my long career," Volcker responded, "was the invention of the ATM.")

But what about the policy of "controlled disintegration" described above? How was such a policy in the U.S.'s interest? "Unhinge and stay ahead," is how the The Global Minotaur describes the strategy. The rise in energy and primary commodity prices increased the costs of production, but not everywhere. Decades of lagging wages and relatively low inflation in the US shored up its competitiveness vis à vis Germany and Japan. A now more profitable domestic industrial sector began to attract foreign investment, not the least of which was a tidal wave of Middle Eastern oil profits. When the Fed began to raise interest rates in earnest during the Carter administration, the new flow of capital to the US increased. Et voilà! That nasty little overspending problem was now solved. All that capital meant much easier credit — the Minotaur was appeased — and as long as Americans kept using it to consume all the rest of the world's commodities, the tap would remain open. 

And Americans did keep spending, though it wasn't just easy credit that made this possible. The Global Minotaur includes a brilliant short take on what Varoufakis calls the "Wal-Mart effect." The Wal-Mart model is already pretty well covered terrain in the economic literature: The supply chain innovations, using scale to squeeze producers, and workplace discipline that insures low-wage labor remains low-wage. What Varoufakis adds to this picture, building on work by Charles Fishman, is how Wal-Mart and the wider big-boxification of American retail capitalized on the social discontent caused by a half-century of declining wages. By offering commodities in super-sized quantities at ultra-low prices, Wal-Mart was selling its customers more than they could possibly consume (the one gallon jar of pickles is the illustrative example), but what came along with it was the consoling illusion of a wage that had greater purchasing power.

It all worked beautifully, but only for a time. The capital surge referred to above — three to five billion dollars per day at its peak — armed the bomb, as it were, whose explosion in 2008 nearly vaporized the world economy. The U.S. financial sector — banks, hedge funds, and the like — were radically transformed by this flood of capital. The flood kept asset prices rising; ever-rising asset prices expanded leveraged investing; to meet this leverage-fueled demand for more investment vehicles, there proliferated that now infamous array of derivatives, the nominal value of which, by 2007, was eight times world income. The authors describe these new instruments as a great, dark alternate universe of private money, and here at last their second major concern arises: That economics is inherently limited in what it can tell us about the full nature of such things. In this instance, no one could have predicted that, under circumstances like those of September 2008, the value of all those derivatives would be exactly zero.

To see what Varoufakis's story adds to the discussion about why the Great Shock occurred, one needs to keep in mind that the global economic order whose origin it relates — the eponymous Minotaur — wasn't just some abstraction, but something lived at almost every level, from the very personal (as in consumption and working conditions) to the well-nigh cosmic (where the individual is subject in various ways to super-powerful transnational corporations and their allied institutions). For three or four decades this was, if nothing else, a relatively stable form of life, exercising its baleful enchantments on all of us: fundamental, all encompassing, and continuous. Part of why the Global Minotaur was left to run off a cliff — and will now be turned loose again — is that, for as long as most people from Los Angeles to Bonn, London to Cairo, can now remember, this was simply what the world was.



Modern Political Economics sketches the same half-century-long rise of the Minotaur, where the driving forces were the general tendencies of capitalism and the politics of the postwar era, both domestic and international. But where The Global Minotaur sticks to history, well near three quarters of this much longer work (almost 500 pages) focuses on economic theory, from Aristotle's Nichomachean Ethics to Li Xianglin's Gaussian copula function for the pricing of those nasty derivatives discussed above. The justification for going on at such length is that — in a world whose most powerful agents are modern states, multinational corporations, and institutions like the IMF and World Bank — economic theory matters: it shapes policy, and politics. 

But economic theory — not just the dominant strain of postwar economics, but economic thought as a whole — never delivers anything like the understanding of natural science, because, Varoufakis argues, "unlike physical (even biological) processes, capitalism's path is predicated upon a human element that infuses it with radical indeterminacy." For this insight, he and his co-authors rely on modernity's great philosophers of consciousness — Hegel, Marx, Nietzsche and Freud — and their view of human nature as fundamentally divided, driven by an impulse toward freedom on one hand,and toward subjugation (including self-subjugation) on the other. For economics to have the epistemological authority of a science, it would thus have to be able to predict with Newtonian certainty which of these forces would dominate and when, to see clearly into the murky depths of the human psyche, and to do so on a collective level.

The way this problem expresses itself in economic thought is related to the character of production itself, how it's changed over time, and the concepts that have evolved in order to make sense of it. Modern Political Economics starts with Aristotle, who saw economic exchange as need-based and trending toward happiness. It has that great classical proportion, doesn't it? One pictures a simple meal of grain, olives and wine. But there's just nothing in it that would allow one to account for a producer who keeps producing even after she's fulfilled all of her needs. To be fair, the type — economists call her a commodity producer — was scarce in Aristotle's world, but by the twenty-first century they'd be everywhere and there'd hardly be time for that simple meal. No, happiness does not quite seem to have been the telos. One can begin to see that Hegel and the rest might have grasped a thing or two. 

It's not until the late eighteenth century when economics of the modern sort (i.e., as a more or less separate discipline) begins to gather steam, but its object remains just as elusive. As capitalism evolves, its tendencies become clearer; at each stage, economists come to think they've finally figured it all out, then History proves them wrong again, from Quesnay and the Physiocrats to Smith and Ricardo, forward to Marx and beyond. The full import of one of the more technical issues the authors raise is perhaps best grasped by economists themselves, but even the general reader will see they've uncovered a fundamental limit here, what they call the discipline's "inherent error." What they're saying can be simplified as follows: One can model an economic system in a coherent way either at some particular moment (as Marx did with the industrial capitalism of Great Britain in his time) or explain in reasonable fashion how it will work over time, but not both, because to do either of these, the other has to be quietly neglected. 

Among the most fascinating parts of the discussion is that which covers the main currents of economic thought after Marx: Marginalism, Keynesianism, and neoclassicism. But this can only be touched on, and the main point is the same. Both marginalism and what the authors call "marginalism's bastard" (neoclassicism) think of capitalism as market, where the only thing that matters is price, and through this radical over-simplification of real economic activity, these theories could promise that capitalism would deliver uninterrupted growth if the state stayed out of the way. Modern Political Economics traces in detail the convergence of forces that, by the 1980s, had secured monolithic authority for this school of thought (dubbed the "Econobubble") and led to the deregulation and pricing theory that encouraged derivative trading to go thermonuclear. As the economic order of the Global Minotaur came to seem ever more like second nature, a strain of economic thought purporting to have established with scientific rigor that the economy was simply a market, a natural (read "self-regulating") system, became more and more dominant. In this way too, a crisis of the kind that was just around the corner was, and still is, for all practical purposes unthinkable. The authors themselves provide the best metaphor for summing it all up: As with Neo of The Matrix before he swallowed the red pill, one virtually can't imagine an alternative to something like a global economic order, and contemporary economists, by ignoring their discipline's own inherent limits, may be blinder than anyone in this regard.

At this point I'd like to make mention of the very different take on the problem that the Los Angeles Review of Books published in July (7/18/2011). In an artfully written and terrifically knowledgeable essay called "Autumn of Empire," Joshua Clover points to clear warnings of the 2008 crisis in the work of great contemporary historians and economists like Robert Brenner and Giovanni Arigghi. It's perfectly sound to remind us of the continuing relevance of these thinkers, but when it comes to the question of why their contributions had so little influence among mainstream economists, Clover seems to be sketching yet another version of the moral tale told by Taibbi, Sorkin, Johnson, and Stiglitz, albeit from a hard-left rather than a moderate liberal perspective. Clover suggests that contemporary economists failed to predict the crisis because they were all just following the money, acting like the bankers themselves, no more than "stock pickers" and "touts."

But does this really cover the main ground? The class at issue here would certainly include the world's public economists (in government and allied institutions like the IMF), along with great numbers of university professionals. These are sometimes deeply public-spirited individuals, and often smart, highly educated, social scientists, which is to say they're guided in some significant degree by the conventions of rational inquiry: objectivity, logic, consistency, etc. These characteristics might be reasonably expected to describe even some of the economists who work for the banks. If this is so, then Varoufakis et al. are telling us the more plausible story about the failure of mainstream economics. There's the "inherent error" discussed above, along with a profound tendency inside most capitalist institutions to reproduce the economic status quo after about a half-century of market fetishism. To illustrate this problem, the authors offer a parable, featuring "a graduate student who wants to make her mark." They imagine someone "intellectually honest and curious" that aspires to develop economic models adequate to complex, real-world activity.


She embarks down that road hopefully ... manipulates for months, or even years, in order to allow into her models the type of phenomenon she wants to study. [But] here is the rub: Once committed to this type of modelling, she sooner or later realizes that no determinate "solution" can be had; that the mathematics has become terribly complex; that something radical must be done to get it sorted out; that unless it is done, she will never get the paper published or the thesis passed. Only then ... does our well-meaning theorist realize what the price for "solving" her model is: it is the loss of its very soul on the altar of "closure". ... So, she bites the bullet and "closes" her model . ... Her reward is a career in a profession where success is as divorced from the theory's truth status as the theory is from real economies.


Mainstream economists failed to predict the crisis because — though smart, hardworking, and for the most part well-meaning — they are formed in a discipline where adherence to market theory, and only market theory, is rewarded, and the fact that it doesn't tell the whole story is unimportant. The theory works well enough. Until it doesn't.



From Aristotle to Marx to the Austrian school to Greenspan, the Great Crisis and its aftermath, we arrive at the question where all good critiques inevitably arrive: What is to be done? Yes, after their long and richly interdisciplinary re-reckoning with almost three centuries of capitalism and its investigators (longer if you count the discussion of Aristotle), the authors risk a brief "sketch of an idea of a vision of what a future ... might look like." The good humor that runs through this challenging book is most welcome, but if this particular formulation also seems over-hedged, recall the skepticism about what economics can reveal, and nowhere more so than in looking into the future. The proposal itself, though, compared with what's currently on the table where policy is being forged, could hardly be called modest. Varoufakis, Halevi, and Theocaraki propose the creation of structures for a distribution of wealth that promote the common interest, i.e., away from the overdeveloped financial sector and toward productive activity, and away from the economies that have dominated mainly by virtue of their historical advantage to those that Western imperialism has squeezed for five centuries. If that seems a little sketchy, it's important to consider what one faces in trying to write about a transformation of the global economic order without falling into utopian model-making. They do, however, have one or two concrete ways of getting at the thing. Imagine a world economy, they invite us, that's run like the NFL!


[A] paragon of aggressive competitiveness. On the pitch, extremely well prepared players give their all for victory, wealth and glory. Teams pull no punches to win. The road to the Grand Final is littered with injured bodies, broken egos but, in the process, a great deal of satisfaction and camaraderie is shared by everyone, winners and losers, both on and off the pitch. Meanwhile, the League is based on a Central Plan. Teams cannot spend highly differential amounts on salaries and the best new players are forced to sign with the weakest teams. The market works but to do so it must be severely circumscribed by the Common Pursuit. The constraints liberate the true spirit of competition, preventing the successful from monopolising the best players and killing off the interest of most matches. Thus, planning and competition are fused into a League that minimises predictability and maximises excitement.


To be clear, this is more sly than loopy; the aim of the analogy is surely evoking an alternative to the current system with a figure from the heart of late capitalist culture itself. To put it in terms of their other rich metaphor, they're calling attention to a glitch in the Matrix. And they're perfectly capable of more prosaic prescriptions in the very same spirit, as in Varoufakis's "Modest Proposal" for resolving the European debt crisis: The IMF, ECB and head of the Eurozone would lead the banks in a restructuring of the debt of high-deficit countries (payment postponement and a reduction of interest rate to LIBOR), which could then in turn adopt fiscal measures more likely to permit the repayment of that debt. In contrast to the highly counterproductive "austerity" regimes now being pursued, such measures would redirect expenditures away from unproductive activity like military procurements to more socially necessary areas of the public sector, but maintain the state's total wage bill at current levels. The simple elegance of the plan lies in its advocating an arrangement that would permit high-deficit states to discharge their debts in regular fashion and in full, guarantee to the banks a return on their loans no less than that which they derive from lending to one another, and advance the Eurozone toward a capacity for fiscal coordination much more like that of the United States.

How such a major reorientation of the economy, in Europe and beyond, might actually be accomplished today is, of course, the first question one wants to ask. The power of vested interests, as shocking as it is to consider, seems little diminished by the catastrophic failure of the old system; popular consciousness ("a triumph of pessimism and the privatization of hope") has yet to really stir outside the long, long suffering Mideast. The authors of Modern Political Economics are clearly mindful of these things. "The only hope for a rational future," they tell us, "is a massive transfer in social power away from the 'markets' (i.e. the banks) to those who cannot be captured by them because they are too many to bribe, threaten and extort." The "who" in this case is global labor, "those who earn by actually working (and who do not rely on speculating with other people's money or default probabilities), independently of whether they live in the United States, China, India, Africa or Europe."

At the same time, they admit that "[h]ope may not, currently, shine brightly. The light on the hill may be dim, imperceptible." But the radical indeterminacy of human action is of course also some consolation at a moment like this, and it would have been strange had Varoufakis and his colleagues not understood this. It's indisputable that the hands on the levers of power still continue to operate mainly in the interest of corporations while ordinary people seem only more befuddled as to their recourse, but as the authors themselves put it, "the Crisis gives us an opening." A great shock always at least teaches there is something we don't yet know. If human action is really so unpredictable, then there is also a fair chance we'll learn what that something is.