Vicious Disequilibrium

Vicious Disequilibrium by Yanis Varoufakis

April 3rd, 2014 reset - +

BEFORE THE CRASH OF 2008, the world’s policy-making elites were not worried about the startlingly unbalanced flows of trade and money crisscrossing the planet. The great and the good, the movers and shakers attending Davos or on the golf courses where deals of note are struck, dismissed all concerns that the world was becoming dangerously unstable as economic illiteracy. Captivated by the soothing fiction of the “Great Moderation” and the toxic fantasy that finance had invented the holy grail of “riskless risk,” the powers-that-be were adamant: we were living in a “new paradigm” where (i) physical production was naturally shifting to countries where labor was cheaper, (ii) profits were naturally flowing the other way (from the periphery to Wall Street and the City of London), and (iii) Western banks had discovered the magic formula to stabilize these unbalanced flows: financialization, a mystical notion that nevertheless had enough discursive power to silence the doubters. In brief, the official story was that there were trade and capital imbalances, but they were part of a larger, stable, and dynamic “equilibrium,” which market forces were sustaining on a global level.

Then came the Crash of 2008. Suddenly, it became fashionable to blame the hitherto “benign” global imbalances for the crisis. America’s gargantuan precrisis trade deficit (amounting to six percent of the largest national income in the world) and its relation to China’s surplus (amounting to 10 percent of its national income) were no longer thought of as innocuous. Similarly, imbalances within the Eurozone — pre-2008, Germany and the Netherlands had a combined annual surplus of $47 billion in traded goods and services, while Portugal, Greece, and Spain amassed a deficit of $42 billion — that were considered mere growing pains before the crash, now looked more like death spasms. In short, the events of 2008 turned trade imbalances into the villains of the piece.

Six years have passed since those heady days, and it is now clear that the global imbalances are waning. America’s goods and services deficit has fallen from six percent to less than three percent of its national income, while China’s equivalent surplus has diminished from the breathtaking 10 percent to a reasonable 2.5 percent. Even within the long-suffering Eurozone, quasi-insolvent nations like Spain and Italy are eliminating their trade deficits (despite the rise and rise of Germany’s surplus). From a global perspective, German surpluses and Turkish or Indian deficits seem like minor problems that should perhaps be of concern to Europeans or Asians, but not to the world at large. From this angle, the world seems better balanced now than at any time since the 1980s. But is it actually so? In what follows, I wish to pose three intertwined questions:

  • Is the world rebalancing?
  • Was the Crash of 2008 caused by global imbalances?
  • Or was it the laxity in financial regulation that caused the global imbalances in the first place?

While there are important kernels of truth hidden in each of these questions, the answer to every one of them is a resounding “no.”

Are we witnessing a new global balance?

Judged only in terms of trade imbalances, there is no doubt that the yawning discrepancies have narrowed considerably. Contrary to the belief that the Chinese currency has remained pegged to the dollar, it in fact rose by 40 percent in relation to the greenback between 2005 and 2013, making Chinese imports into the United States more expensive at a time when American consumers were cutting down on their overall consumption, boosting their savings ratios (despite the low interest rates), and, generally, “deleveraging.” Meanwhile, the Chinese government’s cranking up of investment funding on infrastructure increased the demand of machinery and other capital goods produced in countries like the United States, Germany, and the Netherlands. The imbalance in China’s trade with the West has been “corrected” substantially since the crash. This has been done both through exchange rate flexibility and by behavioral changes, domestically and overseas (involving US consumers, but also the Chinese government).

Similar reductions in trade imbalances are evident everywhere. But does that prove that the world economy is rebalancing?

Before 2008, conventional wisdom (aka the Washington consensus) implored us to recognize that the world was in an equilibrium sustained by two counterbalancing forces. One was the tsunami of goods that sailed across the oceans to flood (mainly) the Anglosphere with a multitude of consumer delights. The other was the torrent of capital that gushed in the opposite direction (from Germany, Japan, China, Russia, and oil-producing Arab countries to Wall Street). The two were thought to cancel each other out, yielding a harmonious, dynamically stable global equilibrium.

Of course, it was all nonsense. The “equilibrium imbalance” thesis neglected the simple truth that the equilibrium in question was about as steadfast as a toddler’s Lego tower. Wall Street, the City of London, Frankfurt, and Parisian banks were building inherently unstable pyramids that could tumble down with a great thump. The difference was that, unlike small children who gleefully anticipate the collapse, our financiers had convinced themselves that their pyramids would remain standing forever.

Today, a new error is taking its cue from that older one. Just as it was wrong to imagine that the pre-2008 situation was a form of stable “equilibrium imbalance,” so it is mistaken to think that the “rebalancing” we are witnessing (vis-à-vis trade accounts) represents an “equilibrium balance.” There is no such thing.

Try to imagine the mountain of cash on which corporations in the United States and Europe are sitting, too terrorized by the prospect of insufficient consumer demand to invest in the production of things that society needs. We now have it on good authority that some $2 trillion of surpluses are slushing around within corporate America. Another $700 billion is loitering within the United Kingdom’s circuits of finance, refusing to be channeled into productive investments. A further $2 trillion is “lost” in the no man’s land of idle savings, which circulate in continental Europe, Asia, and Latin America. Nearly $5 trillion of idle money is hardly a sign of a world in the process of “rebalancing.”

There is nothing new in this, except the scale of the crisis. Every crisis “generates” two distinct mountains: one of debts and losses, another of idle, fearful savings. Unless they start “eliminating” each other, talk of a new “balance” or of a world that is “rebalancing” is unfounded. For such a verdict to be valid, the currently idle savings need to turn into investments — that is, investments that stand a chance of producing enough income to extinguish the mountain of debts and losses. So far, such “recycling” of profits into investment has been conspicuous in its absence.

Since 2008, we have been living in Keynes’s Paradox of Thrift, a realm in which widespread Presbyterian prudence impedes the growth of income. Today, global investment remains anemic due to the sloth of global savings; accordingly, labor markets produce fewer quality jobs. People’s disposable incomes are in steady decline in relation to their debts, which refuse to fade away. Our world’s “debt dynamics” are deteriorating, and they’re bound to deteriorate more rapidly if our governments continue to insist on austerity, a self-defeating solution. That was the case in the 1930s, just as it is the case today. Focusing on debt is to mistake a symptom for the cause. The real cause of our troubles is that we inhabit a world that saves more than 25 percent of the planetary income (a historic high), but which wastes a large part of it in a glut of self-fulfilling negative expectations.

So, while trade is more or less rebalancing, this “new balance” is pregnant with the most catastrophic of instabilities: the one that comes from long-term global stagnation and a level of aggregate demand that’s too low to create a modicum of equilibrium between global savings and global investment. The investment that’s not happening is a catastrophiein its own right, because it could be going into things humanity urgently needs: advances in energy technology, education, and modern health care.

Was the Crash of 2008 caused by global imbalances? Or was it the laxity in financial regulation that caused the global imbalances?

In a recent piece titled “A Requiem for Global Imbalances,” Barry Eichengreen argues that global imbalances were not the cause of the 2008 meltdown. I am in full agreement with this. But I beg to differ from what he thinks actually caused it: “The principal culprits in the crisis,” Eichengreen writes, “were […] lax supervision and regulation of US financial institutions and markets, which allowed unsound practices and financial excesses to build up. China did not cause the financial crisis; America did (with help from other advanced economies).”

  • Did lax supervision and the cronyistic regulation of Wall Street not turn finance into “a bubble on a whirlpool of speculation” — to quote John Maynard Keynes’s General Theory? It most certainly did!
  • And did this whirlpool not culminate in a cataclysm that brought down the West’s financial centers? Of course it did!
  • Was this natural repercussion of lax regulation not the reason politicians and central banks felt obliged to bail out the bankers, along with their banks, at the expense of the multitude that were left saddled with negative equity, the impact of hideous austerity drives, and the long-term repercussions of what Larry Summers recently referred to as “secular stagnation”? Absolutely!

And still, I disagree with Eichengreen that “the principal culprits in the crisis were […] lax supervision and regulation of US financial institutions and markets.” In my estimation, Eichengreen, like many other well meaning commentators, is mistaking symptoms for causes. He might consider the following questions: What caused the laxity in supervision or the gutless regulation of Wall Street? Why were banks kept on a tighter leash in the 1960s than in the 1980s and 1990s? Was there a steady loss of character (unconnected to economic developments) on the regulators’ part in the 1980s? How else does one explain the blind eye they turned to the corruption of financialization? Is greed a fairly new feature of the human condition, one relatively absent from pre-1980 Wall Street? Even if that were so, how do we explain the deterioration of character? Why did greed come to dominate? What are the deeper causes of the regulators’ corrupt practices and moral decline?

On the true causes of lax regulation and global imbalances.

In 1971 US policy makers made an audacious strategic decision: faced with the rising twin deficits that were building up in the late 1960s (the budget deficit of the US government and the trade deficit of the American economy), Washington decided to turn a blind eye to them. Rather than imposing stringent austerity, whose effect would be to shrink both the twin US deficits and America’s capacity to project hegemonic power around the world, they allowed the deficits to rise.

The question, of course, was: who would pay for the red ink on America’s trade account and federal budget? In my book, The Global Minotaur, I propose a simple answer — the rest of the world. How? By means of a permanent influx of capital, which would fund America’s ever-increasing twin deficits. And why would investors from around the world send their money to Wall Street to finance American deficits? Because Washington has pursued policies that reliably appeal to non-US investors (who choose to put their money on Wall Street), ensuring higher and safer returns than they could secure elsewhere. (For more on this, follow the link.)

If my hypothesis is correct, the twin deficits of the US economy, in conjunction with Wall Street, operated for decades like a giant recycling unit, equipped with a vast vacuum cleaner that absorbed other people’s surplus goods and capital. While the “unit” was the embodiment of the grossest imbalance imaginable at a global scale, and required what Paul Volcker described in 1978 as the “controlled disintegration of the world economy,” nonetheless it did give rise to something resembling global equilibrium: an international system of rapidly accelerating asymmetrical financial and trade flows, capable of presenting a semblance of stability and steady growth. In other words, it begat what we now call “global imbalances.”

For more than 20 years (from the early 1980s to 2008), the world’s leading surplus economies (e.g., Germany, Japan, and, later, China) kept churning out goods for American consumers. Thus, the expansion of US deficits generated the increases in aggregate demand that kept factories in the surplus countries going. On the other hand, almost 70 percent of the profits made globally by Eurasian capitalists were transferred to the United States, in the form of capital flows to Wall Street. But for Wall Street to act as a “magnet” of other people’s capital returns, it had to be unshackled from the US government’s stringent, 1960s-style regulations. Once finance was unshackled, greed had a field day.

Wall Street’s greed and the laxity of regulation by the US government are usually taken as “givens,” as sociopolitical processes somewhat exogenous to the dynamics of US capitalism. They are explained, if at all, along the lines of pop sociology or “cultural studies.” In sharp contrast, my argument is that the laxity of regulation, the so-called “revolving doors,” as well as the increasing greed of Wall Street personnel, were all byproducts of a remarkable phenomenon: the emergence of the first global hegemon whose strength grew in proportion to its deficits. These deficits had to be financed by a constant influx of foreign capital into Wall Street, which required authorities to turn a blind eye to Wall Street’s shenanigans.

The Crash

The Bretton Woods system oversaw capitalism’s Golden Era (1950-1970) in America. What tripped it up on 15 August 1971, causing the economic system itself to lose its footing? It was the US government’s inability to restrain abuse of its exorbitant privilege — its ability, as custodian of the world’s reserve currency — to print global public money at will to finance (without substantial new taxes) a stupendous military-industrial complex, the Vietnam war, the space program, Lyndon Johnson’s (otherwise splendid) Great Society policies, et cetera.

And what brought us the Crash of 2008? Again, it was the failure of American self-restraint. Only this time it was not the fault of the US government (even if a case can be made that it happened on its watch) but of the private sector — the banks, in particular. This time, the American financial sector failed spectacularly to restrain abuse of its great privilege: its ability, as custodian of world financialization, to print global private money at will. This ability (a) functioned to maintain the pre-2008 unstable global dynamic equilibrium on which American hegemony relied, and (b) was at odds with any serious regulation of the bankers.

Alas, the bankers’ freedom from regulatory constraint and lack of self-restraint led to the erection of pyramids whose collapse hampered global capitalism’s capacity to invest its surplus money into real economies. That is why our world is not rebalancing, even though trade flows have evened out considerably.


Global imbalances were not the cause of the Crash of 2008, just as their diminution is not a sign that the world is rebalancing. A quick look at excess savings and idle productive capacities (including labor) in the United States, Europe, and Asia reveals that the world is out of kilter. As it was analytically feeble, prior to 2008, to argue that global capitalism was in a state of “equilibrium imbalance,” so it is false today, if not insulting, to claim that we are shifting toward a state of “equilibrium balance.” (See also M. Pettis’s excellent book The Great Rebalancing.)

Before 2008, the observed unbalanced equilibrium was rife with the instability brewing inside the circuits of finance. Today, once more, the observed tendency toward balance (at least in trade accounts) is a symptom of vicious underground forces that are begetting disequilibrium, despondency, and discontent in the core of our societies.



B. Eichengreen (2014). “Requiem for Global Imbalances,” Project Syndicate, 13 January 2014.

M. Pettis (2013). The Great Rebalancing: Trade, Conflict and the Perilous Road Ahead for the World Economy, New Jersey: Princeton University Press.

Y. Varoufakis (2011/2013). The Global Minotaur: America, Europe and the Future of the World Economy, London and New York: Zed Books (second edition, 2013).


Yanis Varoufakis is an economist and head of the Department of Economic Policy at the University of Athens.