Has America’s Use of Finance as a Foreign Policy Tool Backfired?

Yves Smith

From the 1980s onward, one of the major aims of American foreign policy has been to make the world safer for US investment bankers. That might seem like an exaggeration until you look at the priorities of American economic policy as well as the actions of US-dominated international institutions like the World Bank and the IMF. The World Bank, though its International Finance Corporations, pushed emerging economies to set up capital markets. The posture was that more open markets were always better.

Now that we’ve had repeated tsunamis of hot money flows in and out of small economies wreak havoc with them, conventional wisdom among development economists is more along the lines of “protectionism in emerging economies is desirable so they can develop companies and/or export sectors that are capable of competing internationally, and also serve domestic markets, so that the economy isn’t too export dependent. Open capital markets produce too much volatility in interest and foreign exchange rates and thus undermine internal development.”

Similarly, the US has pressed advanced economies for more open financial markets. America’s insistence that Japan deregulate its banking system was a prime driver of its 1980s bubble (I had a bird’s eye view of how the Japanese banks went full bore into all sorts of products and markets they didn’t understand and incurred huge losses as a result).

A cynic might point out that Japan’s speculative boom and bust put a decisive end to Japan’s status as serious challenger to American economic dominance. The Chinese, the poster children of successful development, have made a close study of the Japanese experience. Among other things, the Chinese decided to maintain tight control over the banking system and have restricted international capital flows. Note these curbs have become less effective over time, perhaps due to neglect. Regional governments have helped spawn a large shadow banking system and wealthy company owners have been able to evade capital controls through over-invoicing. Nevertheless, the Chinese financial system is a long way away from being deregulated. As a result, the consensus among Western securities analysts is that China will be able to engineer a soft landing despite the scary size of its credit bubble.

Now of course, there has been pushback against the American model of open capital markets since they can and do upend the real economy. After the Asian financial crisis of the 1997, when the IMF put in place “shock doctrine” style reform programs, countries throughout Asia concluded that they never wanted to suffer through that again. They pegged their currencies low relative to the dollar to build up foreign exchange reserve warchests. Economists have argued that this use of currency pricing to increase exports to the US has been a major culprit in the decline of US manufacturing and job losses. So to the extent that this strategy might have produced foreign policy advantages, it has come at considerable domestic cost.

But has this use of “open markets/’free markets’” as an ideological and policy tool really been a plus for the US, even in its own terms? A thorough analysis is well beyond what can be accomplished in a mere post, but let’s look at some recent evidence.

One can argue that the effectiveness of economic sanctions is evidence that America’s dominant role in international finance has translated into policy gains. Witness the pain inflicted on Iran and more recently, on Russia (although Russia’s European energy trump card has imposed restrictions on how aggressive a sanctions game the US can play).

But dial the clock back in Russia to the early 1990s, and you see a different picture. The US lost Russia thanks to full bore implementation of neoliberal policies, and its finance-centricity was a major component. We’ve chronicled this sorry chapter in part due to the prominent role that Harvard played. It bears repeating long form, since it is not as well known in the US as it ought to be. From a 2013 post:

Summers’ second big problem is the scandal that led to his ouster at Harvard, which was NOT his infamous “women suck at elite math and sciences” remarks. The university has conveniently let that be assumed to be the proximate cause.
In fact, it was Summers’ long-standing relationship with and protection of Andrei Shleifer, a Harvard economics professor, who was at the heart of a corruption scandal where he used his influential role on a Harvard contract advising on Russian privatization to enrich himself and his wife, his chief lieutenant Jonathan Hay, and other cronies. The US government sued Harvard for breach of contract and Shleifer and Hay for fraud and won. This section comes from a terrifically well reported account in Institutional Investor by David McClintick:

The judge determined that Shleifer and Hay were subject to the conflict-of-interest rules and had tried to circumvent them; that Shleifer engaged in apparent self-dealing; that Hay attempted to “launder” $400,000 through his father and girlfriend; that Hay knew the claims he caused to be submitted to AID were false; and that Shleifer and Hay conspired to defraud the U.S. government by submitting false claims.
On August 3, 2005, the parties announced a settlement under which Harvard was required to pay $26.5 million to the U.S. government, Shleifer $2 million and Hay between $1 million and $2 million, depending on his earnings over the next decade. Shleifer was barred from participating in any AID project for two years and Hay for five years. Shleifer and Zimmerman were required by terms of the settlement to take out a $2 million mortgage on their Newton house. None of the defendants acknowledged any liability under the settlement. (Forum Financial also settled its lawsuit against Harvard, Shleifer and Hay under undisclosed terms.

And while Harvard can’t be held singularly responsible for the plutocratic land-grab in Russia, the fact that its project leaders decided to feed at the trough sure didn’t help:

Reinventing Russia was never going to be easy, but Harvard botched a historic opportunity. The failure to reform Russia’s legal system, one of the aid program’s chief goals, left a vacuum that has yet to be filled and impedes the country’s ability to confront economic and financial challenges today.

And while Summers was not responsible for Shleifer getting the contract, he was a booster and later protector of Shleifer:

Summers wasn’t president of Harvard when Shleifer’s mission to Moscow was coming apart. But as a Harvard economics professor in the 1980s, a World Bank and Treasury official in the 1990s, and Harvard’s president since 2001, Summers was positioned uniquely to influence Shleifer’s career path, to shape US aid to Russia and Shleifer’s role in it and even to shield Shleifer after the scandal broke. Though Summers, as Harvard president, recused himself from the school’s handling of the case, he made a point of taking aside Jeremy Knowles, then the dean of the faculty of arts and sciences, and asking him to protect Shleifer.

And the protection Shleifer got was considerable:

Knowles tells Institutional Investor that he does not remember Summers’ approaching him about Shleifer… However, not long after Summers says he intervened on the professor’s behalf, Knowles promoted Shleifer from professor of economics to a named chair, the Whipple V.N. Jones professorship.
Shleifer’s legal position changed on June 28, 2004, when Judge Woodlock ruled that he and Hay had conspired to defraud the U.S. government and had violated conflict-of-interest regulations. Still, there was no indication that the Summers administration had initiated disciplinary proceedings. To the contrary, efforts were seemingly made to divert attention from the growing scandal. The message from the top at Harvard was, “No problem — Andrei Shleifer is a star,” says one senior Harvard figure…
One instance was a meeting early in the academic year that began in September 2004, less than two months after the federal court formally adjudicated Shleifer’s liability for conspiring to defraud the U.S. government. A faculty member asked [Dean] Kirby why Harvard should defend a professor who had been found liable for conspiring to commit fraud. The second confrontation came early in the current academic year when another professor asked Kirby why Harvard should pay a settlement of $26.5 million and legal fees estimated at between $10 million and $15 million for legal violations by a single professor and his employee, about which it was unaware. On both occasions Kirby is said to have turned red in the face and angrily cut off discussion.
On at least one other occasion, Summers himself told members of the faculty of arts and sciences that the millions of dollars that Harvard paid in damages did not come from the budget of the faculty of arts and sciences, but didn’t say where the money came from. Those listening inferred he meant that the matter shouldn’t be of concern to the faculty and that they shouldn’t raise it, a curious notion, given that Shleifer was one of their own…
Shleifer has never acknowledged doing anything wrong. Summers has said nothing. And so far as is known, there has been no internal investigation or sanction. “An observer trying to make sense of the University’s position on Shleifer, Ogletree and Tribe is driven to an unhappy conclusion. Defiance seems to be a better way to escape institutional opprobrium than confession and apology. . . . And most of all being a close personal friend of the president probably does one no harm.”

And before you think this sorry performance of US AID was a mistake, the only part that appears to have been unintended was the hand-over-fist looting by Shleifer and Hay. Mark Ames, who witnessed the plundering of Russia by its elites and their Western allies at close range, pointed out that US AID has used its humanitarian image as a cover for covert operations for decades. Russia saw the expansion of US AID’s role from helping “train” foreign police forces to a vehicle for having CIA operatives infiltrate every possible foreign power nexus of interest, be it governmental, religious, or social programs. Naturally, finance and financial flows would become recognized as being on the list. And we can see how well this mission creep worked. From Ames:

There were many ways to transform Russia in the 1990s, but thanks to funding from USAID, the path chosen was the most brutal and disastrous of all: Shock therapy, mass privatization, and the mass impoverishment of 150 million people. As Janine Wedel and my former eXile partner Matt Taibbi documented, USAID funding and support empowered a single “clan” from St. Petersburg led by Anatoly Chubais, who oversaw the complete destruction of Russia’s social welfare system, and the handing over of lucrative assets to a tiny handful of oligarchs.
Under Chubais’ stewardship, Russia’s economic output declined some 60% in the 1990s, while the average Russian male life expectancy plummeted from 68 years to 56 years. Russia’s population went into a freefall, Russia’s worst death-to-birth ratio at any time in the 20th Century — which is amazing when you think that USAID’s privatization program had to compete with the ravages Hitler, Dzerzhinsky and Stalin wreaked on Russia.
USAID funded Chubais through public-private organizations and a Harvard program that was so patently corrupt, Harvard and its program directors including economist Andrei Shleifer were sued by the US Department of Justice for “conspiring to defraud” the US government (not to mention Russians). USAID also paid public relations giant Burson-Marsteller to sell the disastrous voucher program to the Russian public, in a mass media advertising blitz that promoted Chubais’ political party on the eve of parliamentary elections. It was this USAID funded privatization, and the USAID-backed Russia “democrats,” which soured Russians on market capitalism and democracy (renamed “dermokratsia” or “shitocracy” in Russian).

So while the West likes to decry the popularity of Russia’s strongman Putin, it’s the result of its citizens getting a taste of an American effort to impose democracy, except imposing “free markets” was the real aim of this project. And as experience in Latin America, starting with Pinochet, has shown, rapid deregulation leads to plutocratic land grabs. There was no reason to think Russia would be any different. Putin’s high approval ratings rest in no small measure on his having imposed some curbs on the oligarchs and improving living conditions for ordinary Russians.

And one big reason that Russian oligarchs remain powerful is that they have been able to put their plunder in the safekeeping of US and UK tax havens. Reutersreports tonight that London has more billionaires per capita than any city, followed by Moscow.

A new article at American Interest by Ben Judah titled How Offshore Finance Sank Western Soft Power makes a forceful case that unbridled finance, specifically, the nexus between tax havens and looting plutocrats, has undermined one of the West’s most important assets, its claim to have a more virtuous political and economic model. I strongly suggest you read the article in full. Key extracts:

When most people think about offshore finance, they don’t think about the future of Europe: They think about palm trees, about shell corporations headquartered in a P.O. Box, and about secret Swiss bank accounts. But this is not what people in Eastern Europe think.
When Russians, Ukrainian, Azerbaijanis—I will spare the reader from a roll call of the 15 fraternal republics—when these countries think offshore finance, they think about their stolen futures. But isn’t that a good thing? Won’t that make them realize that West is best?
Not so fast. First, a few figures. The offshore economy has grown into a gargantuan parallel financial system. There may be more than $20 trillion hidden in more than fifty tax havens. The colossal treasure hidden in British tax havens alone is more than $7 trillion. And a disproportionately large share of that money is Eastern European. Take Russia’s missing $211.5 billion: That’s the conservative estimate for illicit financial flows out of Russia alone between 1994–2011…
East European corruption fighters are discovering that Western countries and their systems of offshore economies have enabled the colossal theft of their countries’ resources. Bubbling up from beneath the surface of both the Russian opposition and the Ukrainian Maidan is a new sense of disdain for the West…
This is what happened to Daria Kaleniuk at Kiev’s Anti-Corruption Action Centre. The director of one Ukraine’s most important NGOs battling corruption spent years investigating how corruption actually works. But the more she learned, the more she viewed both America and the European Union as hypocrites.
Kaleniuk explains:

What we found was that the money stolen in Ukraine was heading into British and European tax havens and hidden using shell companies inside the European Union. This was very uncomfortable to find out. What we felt is the Western elites were being hypocritical to us—preaching anti-corruption but allowing this offshore world to flourish.

…..Ukrainian MP Lesya Orobets is running for Mayor of Kiev on a platform that flirts with nationalist outrage. She is enraged by Western complicity with the offshore black hole into which Ukraine’s national wealth has long disappeared:

What you need to understand is that Western tax havens have resulted in Ukrainian deaths. Take for example the theft of Ukraine’s HIV budget. The national budget for fighting HIV was stolen and hidden in tax havens and in Great Britain. But this has consequences—we are now approaching a 2 percent HIV infection rate in Ukraine, which is near the no-return point of pandemic. This corruption will kill British men too. I hear they come to Ukraine. But they also return home. What will happen if the British do not close down their tax havens? I will be deeply, negatively, impressed.

….The West has gotten used to enjoying a hero’s reputation amongst Eastern European democrats. But get to know the Moscow opposition or the Maidan and you soon learn that London is now a byword for corruption, and the names of whole European countries—Luxemburg, Cyprus, Switzerland, Andorra, and even the Netherlands—are synonymous with “theft.”

As I stressed, please read this important article in its entirety. Despite America’s record of CIA thuggery and undeclared wars, we used to be clean enough internally and involved in enough of the right sort of international activities so as to be able to maintain the appearance of being a reluctant imperialist (this from the imperialism enthusiast Niall Ferguson, who hectored America for its lack of enthusiasm in his 1990s book The Cash Nexus), and on balance, to be a useful ally. The rapid rise of open corruption and the power of America’s new oligarchs has laid waste to what little was left of America’s good name. The tacit assumption seems to be that with no credible competitor for superpower role, the US position remains secure despite increasingly reckless and destructive behavior.

But as Ed Luce of the Financial Times has pointed out, the alternative to the weakening of US power isn’t to accelerate the rise of a replacement, but to usher in more instability. Yet even commentators like Luce are constitutionally unable to see how rank corruption is playing into this process, not doubt because far too many well-placed people benefit directly or indirectly. This road to hell is not paved with good intentions, but with willful blindness.

Via Naked Capitalism