The International Monetary Fund (IMF) specializes in prescribing solutions to problems created by its own prescriptions, quipped the Uruguayan writer Eduardo Galeano. Half a century later, the same could be said of the major central banks, which are faced with an epic dilemma after a decade and a half of hyper-expansive monetary policies: to control inflation, the new policy of interest rate hikes must be maintained. But this raises the risk of a new financial crisis.
The IMF’s new chief economist, Pierre-Olivier Gourinchas, summed up the problem during last week’s IMF-World Bank meeting in Washington: “After a long decade of very high interest rates reduced (…), we are entering a highly dangerous phase. Financial risks have grown, inflation is still not under control.”
The decade of zero or negative rates inflated financial bubbles and further enriched a global class of investor-speculators who starred in a reckless search for profitability. Private credit – non-bank loans to companies that complemented the unstoppable expansion of private equity – ballooned from $600 billion to $1.6 trillion, according to new IMF data.
The latest turn to tighter policy by the Federal Reserve and the other major central banks has not only been necessary to curb inflation, but also to rein in speculators. But the rate hikes have highlighted problems that “have been lurking beneath the surface of the financial system for years”, warns the IMF.
Now, after the decision to rescue the depositors of Silicon Valley Bank (SVB) and then Sovereign and Credit Suisse, the markets, unaccustomed to being rescued in times of crisis, “anticipate that central bankers will begin to relax monetary policy before than expected” explains the IMF in its report. This despite the fact that inflation, highly harmful for the average wage earner, “is well above the target”, he adds.
The ability of finance ministers and central bankers gathered in Washington to resolve this dilemma will determine the outcome of what US historian Gary Gerstle describes as the final phase of the “neoliberal order”, referring to the last four decades of deregulation and promarket policies.
“Things are changing very quickly,” Gerstle said in an interview. “I had a meeting the other day with people from the financial sector who had participated in the IMF/World Bank assembly; everyone is already talking about the change. Uncertainty drives new thinking”.
The root of the problem – explains Gerstle, author of the new book Auge and Fall of the Neoliberal Order – is a serious crisis of political legitimacy. Its origins lie in the historic public rescue of the financial markets after the bankruptcy of Lehman Brothers in 2008.
Then the injection into the US banking sector of more than a trillion dollars of public money and a similar bailout in Europe supported by multibillion-dollar quantitative easing led by the Federal Reserve, saved the financial system and the investment class The stock market recovery was immediate and spectacular.
Since then, the income of the top 10 percent of Americans has risen three times more than the bottom 50 percent, and their wealth has soared 89 percent, according to data from the University of Berkeley.
But the bailout forever transformed perceptions of this so-called “neoliberal order,” says Gerstle. “Precisely those responsible for the crisis, those who invested in financial assets and the banks, came out unscathed. And people noticed. Wage earners without financial assets had not recovered the income they lost in the crisis even ten years later.
“In that interval – between 2008 and 2016 or 2017 – politics got out of control in the US and Europe,” explains Gerstle. “The Tea Party movement appeared on the right, and movements like Occupy Wall Street on the left. We had Brexit, the yellow vests in France, and then Trump.”
Six years later, the paradigm shift is already underway: “Of the four freedoms that define neoliberalism – the free movement of labour, goods, information and capital – there are none left”, he summarizes.
Now a new crisis is looming. The bankruptcy of the SVB – brought down by a devastating leak of deposits worth 42,000 million dollars – may be “the canary in the mine”, warns the IMF. Markets in the era of neoliberal finance “always look for the weakest link (…) and the next target of attack may be institutions dependent on short-term financing (…)”.
Few foresee a repeat of the catastrophe of 2008. Banks are more capitalized and there is no fear of an underlying crisis like those of subprime mortgages (crap). But nothing is predictable. Karen Dynan, an economist at the Peterson Institute in Washington, recalled that when banks like Bear Stearns failed in early 2008, seven months before the collapse of Lehman Brothers, few were concerned.
