THE FINANCIALIZATION OF THE U.S.

ECONOMY:

OR HOW THE REAGAN ADMINISTRATION DISCOVERED GLOBAL CAPITALISM*

Greta R. Krippner

Sociology Department
University of California-Los Angeles

December 22, 2003

Paper Prepared for the 2004 Annual Meeting of the American Sociological Association

ABSTRACT

This paper examines the role of the state in promoting the financialization of the U.S. economy
over the last quarter-century, locating the origins of the turn to finance in Reagan-era economic
policies. I argue that financialization solved a number of intractable problems for the Reagan
Administration as it sought to extricate itself from the dilemmas that marked the crisis of the
1970s. But the Reagan Administration did not seek to create a rentier regime. Rather,
financialization was an indirect (and, at the time, misunderstood) result of opening global capital
marketsa development that allowed the Reagan Administration to sidestep the hard budget
constraints that had confronted previous administrations. As such, I argue that an analysis of the
financialization of the U.S. economy offers an important corrective to the view commonly
associated with the globalization literature that capital has escaped the control of the state.
Rather, at least in the case of the leading state in the world economy, the state has been able to
harness developments in global capital markets to domestic political objectives.

*
Direct correspondence to Greta Krippner, Sociology Department, UCLA, Los Angeles, CA 90095-1551
(gkrippne@soc.ucla.edu). I gratefully acknowledge the contributions of Giovanni Arrighi, Sarah Babb, Fred Block,
Jane Collins, Jamie Peck, Mark Suchman, and Erik Wright, all of whom commented on an earlier version of this
paper. I also acknowledge the assistance of Jennifer Sternaman at the Ronald Reagan Presidential Library in locating
archival materials. In addition, I would like to thank the following individuals who graciously agreed to be
interviewed for the research reported in this chapter: C. Fred Bergsten, Alan Blinder, Douglas Cliggott, Jane
DArista, Jeffrey Frankel, Donald Kohn, William Niskanen, Beryl Sprinkel, Albert Wojnilower, and Janet Yellen.
This research was supported by the National Science Foundation (Grant #: SES-0117048).
Introduction

One of the most remarkable developments in recent decades has been the increasing

salience of finance in the economya phenomenon that is evident in a variety of national

contexts but no where more dramatically than in the United States (Arrighi 1994). Scholars have

pointed to a number of different indicators of this trend,1 but perhaps the most powerful is the

simple observation that in the period since the 1970s the ratio of financial sector profits to profits

generated in the nonfinancial sector of the U.S. economy has increased three to five times over

the 1950s and 1960s (Krippner 2003). Moreover, even nonfinancial firms have become heavily

dependent on financial sources of income as a supplement to (or, in the limit, substitute for)

earnings from more traditional productive activities (Ibid.; cf., Froud et al. 2002). Writers as

diverse as Giovanni Arrighi (1994), David Harvey (1989), Kevin Phillips (2002), and Neil

Fligstein (2001) have all pointed to the growing weight of finance in the economya

development that I refer to as financializationas key to understanding the nature of

contemporary capitalism.

In this paper, I examine the role of the state in sowing the seeds of the turn to finance,

locating the political origins of financialization in Reagan-era economic policies.2 In doing so,

my purpose is to suggest that financialization has important implications for our understanding

of recent transformations occurring in the relationship between state and market. In particular, I

1
Common indicators of the rise of finance include: 1) the ascendancy of shareholder value as a mode of corporate
governance (Davis and Stout 1992; Davis and Thompson 1994; Froud et al. 2000; Fligstein 2001); 2) the growing
dominance of the capital markets over systems of bank-based finance (Phillips 2002); 3) the increasing political and
economic power of a rentier class (Dumenil and Levy 2001; Epstein and Power 2003; Greider 1997); 4) and the
explosion of financial trading associated with the proliferation of new financial instruments (Felix 1998; Henwood
1997; Sassen 2001)
2
Financialization is often analyzed as reflecting either technological or market developments (e.g., Greider 1997;
Phillips 1996; Strange 1998). By emphasizing the role of the state in promoting financialization, I do not mean to
suggest that markets and technological change are not important, merely that the role of the state has been
underplayed in the emerging literature on this topic. See Helleiner (1995) for an analogous argument with respect to
the globalization literature.

1
argue that an analysis of the financialization of U.S. economy challenges the view commonly

associated with the globalization literature that capital has escaped the control of the state and

that all states, albeit in differing degrees, are disciplined by this process (Harvey 1989: 165).

Rather than capital escaping the control of the state, I argue that at least one statethe leading

state in the world economyhas been able to harness developments in global capital markets to

domestic political objectives. Thus, an analysis of the financialization of the U.S. economy

offers an important corrective to the globalization literature, which has not paid sufficient

attention to how specific states are differently constrained (and enabled) by processes associated

with the liberalization of global capital markets.

The following section of the paper elaborates on the standard view of the relationship

between state and market contained in much of the globalization literature. I then present a

historical account of the rise of finance in the U.S. economy, suggesting how this account

challenges and refines the standard view. This analysis is based on archival research at the

Ronald Reagan Presidential Library and on a series of interviews conducted with former Reagan

Administration officials and other policy experts. A final section of the paper extends the

discussion into the 1990s, exploring reasons for the persistence of financialization under quite

different economic conditions.

The Globalization Narrative

The conventional narrative about the state contained in many accounts of globalization is

that of capital escaping the control of the state. In simpler versions of the narrative, capital

wrests itself free of the nation-state as international economic integration proceeds, a process that

begins in the 1960s and then accelerates dramatically in the 1970s (Greider 1997). The image of

2
hyperactive capital whipping around the globe is ubiquitous in this strand of the literature.

Subtler versions of the story recognize the states paradoxical, even perverse role in setting

capital free. These accounts suggest that capitals escape was not simply a matter of clever

market actors, aided by technology, outwitting state regulators. Rather state actors were

themselves actively involved in deregulating markets and constructing a liberal economic order

(Kapstein 1994: 6; Moran 1991; Strange 1986). Yet, according to this second narrative, while

state support was key to the construction of a liberal economic order, state actors did not

properly understand or foresee the consequences of this development. Thus, whether the story is

told in terms of a straightforward contest between state and market (in which the state, alas,

loses) or in terms of the somewhat more complicated narrative of Frankensteins monster, either

version of the globalization literature involves a retreat of the state and a corresponding

expansion of the realm of the market (Strange 1996).

Both versions of the globalization narrative have been subject to intense criticism by

scholars who have noted the alarmism and hyperbole implicit in these accounts. A number of

researchers have scrutinized the empirical data, suggesting that the degree of international

economic integration has been overstated in much of the globalization literature (Gordon 1988;

Hirst and Thompson 1999; Wade 1996). Others have argued that while the autonomy of the

state has undoubtedly been compromised by increased capital mobility, there are complex trade-

offs involved, and the state still has room for maneuver (Cohen 1996). Global financial markets

may discipline states, but as Louis Pauly (Pauly 1995: 373) remarks, states can still defy

markets. Finally, a third group of scholars qualifies the view of the absolute dominance of

global capital by arguing that globalization pressures are mediated through domestic social and

political institutions (Berger and Dore 1996; Sobel 1994; Swank 2002).

3
 What both the conventional globalization narrativein either its strong or weak form

and critics of this narrative share in common is a view of the state put on the defensive by the

growth of global marketsthe point of contention being how far this process has proceeded, and

how optimistic or pessimistic we ought to be regarding the ability of the state to repel the

infidels. In contrast, financialization offers a distinct perspective on the evolving relationship

between the state and global capital, at least with respect to the leading state in the world

economy. An analysis of the financialization of the U.S. economy suggests that the appropriate

metaphor is not that of capital escaping the control of the state, but rather the state harnessing

capital to domestic policy objectives. As Eric Helleiner (1994) has noted, the integration of the

U.S. economy into global financial markets in the post-Bretton Woods3 era underwrote the

policy autonomy of the U.S. state at several critical junctures. What an account of

financialization can add to Helleiners observation is a more precise understanding of the nature

of this autonomy and its limits.

How the Reagan Administration Discovered Global Capitalism

I now want to illustrate this argument by presenting a historical account of the rise of

finance in the U.S. economy. I argue that the turn to finance solved a number of intractable

problems for the Reagan Administration as it sought to extricate itself from the dilemmas that

marked the crisis of the 1970s. But it is important to note in this regard that the strategy of

Reagan policymakers was more accidental than deliberate: Reagan did not seek to create a

rentier regime. Rather, financialization was an indirect result of the collision between the

3
Bretton Woods refers to an international conference held in 1944 in which the major industrialized nations
established the main features of the postwar monetary system, including fixed exchange rates and capital controls.
The Bretton Woods system broke down in 1973 when fixed exchange rates were abandoned and currencies were
allowed to float freely in the market.

4
Reagan Administrations expansive fiscal policies and the Federal Reserves newly invigorated

campaign against inflation under the leadership of Paul Volcker. In particular, in the context of

open global capital markets, the conflicting objectives of Reagan Administration and Federal

Reserve policymakers produced a transition from a low-interest-rate to a high-interest-rate

regime. High real interest rates created punishing conditions for productive investment and drew

economic activity inexorably toward finance.4

In the following account of the evolution of Reagan Administration policies, I argue

against the view that these policies reflected the capture of the state by financial capital (e.g.,

Greider 1987; 1997; Dumenil and Levy 2002). However accidental an outcome, state actors

quickly realized their own interest in supporting (or at least acquiescing to) the financialization of

the U.S. economy. In particular, high real interest rates attracted foreign capital into the United

States in unprecedented quantities. While policymakers did not plan (or even foresee) this

development, tapping into newly liberalized global capital markets allowed the Reagan

Administration to sidestep the hard budget constraints that had confronted previous

administrations. These same policies also allowed the American people to live beyond their

means. In both cases, I argue, reliance on foreign capital eased domestic social and political

conflicts. Once policymakers fully absorbed this lesson, Reagans policy package became

irresistible, even if maintaining foreign capital inflows required sustained high real interest rates.

Thus, in the process of discovering global capital markets, policymakers inadvertently

reinforced a set of macro-economic policies thatas a quite unintended by-productfueled the

financialization of the U.S. economy.

4
Because capitalists are constantly in the position of comparing returns available from different forms of investment,
a high-interest-rate environment makes borrowing to fund productive projects less attractive than simply diverting
capital into financial activities (Block 1996; Eatwell and Taylor 1998).

5
 Our story begins with the crisis of the 1970s, which as Arrighi has noted, was

simultaneously a crisis both of profitability and of legitimacy (2002: 17). The crisis of

profitability resulted, first, from increased international competition as producers from Germany

and Japan took their place on the world stage of capitalism, and second, from the effectiveness of

labor unions in pressing demands for higher wages during this period. The crisis of legitimacy,

in turn, manifested itself in a number of foreign policy debacles, beginning with Vietnam and

ending with the Iranian hostage crisis, in which the resources of the U.S. state to manage its

interests abroad were shown to be increasingly strained. Both aspects of the crisis intersected in

the eruption of inflation, which was not primarily an economic problem, but a political one,

reflecting the inability of the U.S. state to decide how the burden of its declining position in the

world economy would be distributed and shared among its citizens (Wojnilower 1980).

In this regard, Lyndon Johnsons failure to choose between funding the Vietnam War and

pursuing an activist social policy at home was perhaps the critical event in generating the

inflation of the 1970s (Collins 1996). The resulting budget deficits introduced what in retrospect

were mild but persistent inflationary pressures into the economy, pressures which built over the

decade, especially in the wake of the oil price hikes.5 Worse, inflation was accompanied by

relatively high levels of unemployment, something that was not supposed to occur under the then

prevailing Keynesian theories of the business cycle. The inability of state managers to

effectively respond to economic malaise in this period posed, in general terms, what James

OConnor (1973) labeled the fiscal crisis of the state: how could the state promote economic

growth without itself becoming an albatross, weighing down the economy and stifling

accumulation?

5
In accounts of the 1970s, the OPEC price hikes are typically treated as exogenous shocks to the U.S. economy.
Given that oil producers were responding to the steady erosion of their earnings caused by the depreciation of the
dollar in the wake of the Vietnam-era budget deficits, the exogenous nature of these shocks is subject to question.

6
 The answer, it seemed in the Carter years, was that it could not. Indeed, it was this

growing conviction on the part of liberal and conservative economists alike that gave rise to a

general rethinking of the proper role of the state in the economy. Initially, supply-side

economics referred to a broad range of policies, from activist worker training programs to

deregulation schemes, that aimed at removing obstacles to the smooth functioning of markets. In

this sense, Carter was the first supply-sider, before the radical Reagan tax program usurped the

mantle. Nevertheless, during the Reagan administration the term came to have a much narrower

meaning: that tax cuts would stimulate economic activity and drive an investment boom. Under

the most extravagant claims of the supply-siders, the tax cuts would pay for themselves,

generating sufficient new economic activity so as to offset revenue losses. Notwithstanding such

claims, the tax cuts were to be accompanied by an aggressive program of expenditure slashing.

Thus, the supply-siders believed that they had found their answer to the fiscal crisis of the state:

by withdrawing from the market, the state not only could reduce expenditures, but actually

support accumulation more effectively.

Only events transpired differently: the result of the supply-side program was the return of

the fiscal crisis with a vengeance. The failure of supply-side economics was aptly characterized

by Reagans Office of Management and Budget Director (OMB), David Stockman (1986), as

the triumph of politics. Stockman discovered, to his horror, that in a society in which elections

are won and lost by competing parties, the needed expenditure cuts would be difficult, if not

impossible, to obtain. Exacerbating the situation was the fact that Reagan remained stubbornly

wedded to his program of military expansion even as the increasingly grim fiscal projections

began to impinge upon his grand plan for exerting American power abroad. As a result, when

7
the 1981 tax cuts were passed in advance of any agreement on offsetting expenditure reductions,

the budget deficit ballooned to levels that made the Carter deficits seem trivial by comparison.

By late 1981, the budget projections showed, as Stockman (1986: 370) colorfully put it,

deficits as far as the eye can see. While the supply-siders remained confident that Reagans

tax proposals would unleash a vigorous recovery and that the economy would outgrow the

deficits, the financial markets were less certain. The forecast that haunted Wall Street was that

of an imminent collision between private borrowers and the federal government in the credit

markets, a collision in which the federal government would inevitably prevail. According to the

textbooks, crowding out occurs when the government preempts capital from private borrowers;

as private borrowers bid amongst themselves for the remaining funds, interest rates rise so high

as to price these borrowers out of the market. That unhappy outcome, analysts feared, would

grind economic activity to a halt, suffocating the budding recovery by making it impossible for

firms to obtain financing for new investment. For most of 1981 and 1982, the stock and bond

markets lurched along in anticipation of this crowding out scenario, their dreadful performance

the source of considerable consternation among Reagan officials.6

But, to the surprise of both Washington and Wall Street, no such scenario materialized.

Several factors kept the dreaded calamity in the credit markets at bay. First, recovery proved

elusive for many months, and private demand for investment funds remained sluggish well into

1983. Second, firms were able to fund investment projects directly out of retained earnings,

which had received a significant boost as a result of the liberalized depreciation allowances

6
Lawrence Kudlow and Beryl Sprinkel, Financial Warnings, April 28, 1981, Cabinet Councils: Box 12, Ronald
Reagan Presidential Library; Jerry Jordan, Economic Summary, October 6, 1981, Cabinet Councils: Box 16,
Ronald Reagan Presidential Library; L. Kudlow, Financial and Economic Outlook, January 21, 1982, Cabinet
Councils: Box 19, Ronald Reagan Presidential Library; L. Kudlow, Financial Markets Update, August 6, 1982,
Cabinet Councils: Box 26, Ronald Reagan Presidential Library.

8
associated with the 1981 tax cut.7 Finally, most importantly, just as the recovery was finally

underway in mid-1983, a major new source of capital emerged, quite unexpectedly, to finance

the federal budget deficit. Internationalespecially Japaneseinvestors had developed a

voracious appetite for Treasury securities.

This development was largely unanticipated. As strange as it may seem from the

perspective of the present, in the early 1980s, policymakers had not yet fully adjusted to thinking

of the world in terms of a sea of open global capital flows. David Stockman later admitted that

no one among Reagans close advisers foresaw the role that foreign investors would play in

rescuing the Reagan economic program (Murphy 1997: 148). Moreover, Reagans advisers were

slow to grasp the significance of capital inflows once they emerged. As late as October of 1984,

CEA member William Niskanen wrote a memo for the Cabinet Council on Economic Affairs,

explaining that the gap between domestic saving and domestic investment was being financed

through foreign borrowing.8 Niskanen recalled, That was a surprise to nearly everybody in the

Cabinet meeting!9

One reason that many members of the Reagan administration did not immediately

recognize foreign capital inflows as representing a watershed in U.S. political economy was that

these flows first developed during the extraordinary years of the Volcker Shock. Determined

to conquer inflation at any cost, Federal Reserve Chairman Paul Volcker sharply raised interest

rates during his famed conversion to monetarism between 1979 and 1982. As a result of

soaring interest rates, foreign capital was attracted to the U.S. economy, but these inflows were

expected to endure only as long as Volckers experiment. But while inflation was suppressed

7
Business Week, June 6, 1983.
8
William Niskanen, Characteristics of the Current Recovery, October 5, 1984, Cabinet Councils, Restricted
Materials: Box 31 , Ronald Reagan Presidential Library.
9
Interview with the author, July 18, 2002.

9
and monetarism quickly abandoned, interest rates did not return to historical levels. Volcker

observed the budget wrangling going on inside the administration with distaste and feared that

the large deficits would reverse the progress he had made in reducing inflation. As a result, he

stubbornly refused to accommodate the deficits by steering the economy towards an easier

monetary policy. Instead, Volcker ratcheted up interest rates higher, determined to smother any

inflationary spark.

In principle, such a development was not unwelcome by the Reagan administration

economists. Their version of supply-side economics was married to a particular brand of

monetarism, the theory being that a high-growth, non-inflationary economic policy could be

achieved by combining stimulus, in the form of the tax cut, with restraint, in the form of tight

monetary policy. The idea that the two policy levers could pull in opposite directions was, to say

the least, an odd one. But Volcker took the policy to an extreme that discomfited even the hard-

core monetarists in the Reagan administration. Treasury Undersecretary for Monetary Affairs,

Beryl Sprinkel, noted, We had hoped that this movement toward tighter money could be done

very gradually, so that we would have a reasonable possibility of eating our cake and having it

tooWe [wanted] the Fed [to] come down gradually over a period of 2 to 3 years anddo it

without creating a recession. [But] we got a full dose of monetary restraint, regardless of what

we had urged.10 Volckers goal was not to usher in the triumph of Reaganomics, but as a senior

staff member of the House Banking Committee commented, to defeat and embarrass the

administrations policies.11

10
Interview with the author, August 16, 2002. See also Beryl Sprinkel, Financial Strategy for Reducing Inflation
and Interest Rates, October 6, 1982, Cabinet Councils, Restricted Materials: Box 23, Ronald Reagan Presidential
Library.
11
Interview with Jane DArista, July 16, 2002.

10
 What Volcker did not envision was the way that such a plan would backfire in the context

of open global capital flows: Volcker wanted to counter the effects of the easy fiscal policy, but

compounded them by an interest rate policy that encouraged capital inflows.12 Rather than

producing the crowding out that would force the administration back on to the path of fiscal

austerity, high interest rates brought capital pouring into the U.S. economy: $85 billion in 1983,

$103 billion in 1984, $129 billion in 1985, and a staggering $221 billion in 1986.13 It was the

best of all possible worlds: the state virtually unchained from hard budget constraints, inflation

kept at bay, and plenty of wonderful capital to ensure that the day of reckoningin which the

needs of private and public borrowers finally collided in the credit marketsnever came.

But if crowding out was not occurring in the textbook fashion, another, more insidious

form of crowding out was reshaping the American economy. As capital came pouring into the

United States, the dollar began to appreciate rapidly. In order to invest in the U.S. economy,

foreigners had to exchange their currencies into dollars, with the result that demand for the dollar

increased, driving up its price. This, in turn, placed American exporters at a competitive

disadvantage in foreign markets for the reverse reason: in order to sell in those markets,

exporters converted dollar prices into local currencies. Thus, as the dollar rose, sectors of

manufacturing and agriculture dependent on exports found themselves increasingly under

pressure.

Domestic opposition to the strong dollar came from all quarters, but was spearheaded by

the Business Roundtable and its very vocal leader, Caterpillar Tractor Chairman, Lee Morgan

(Destler and Henning 1989). In 1982, Morgan commissioned two academics, David Murchison

and Ezra Solomon, to study the causes of the strong dollar and propose appropriate policy

12
Interview with Jane DArista, July 16, 2002.
13
Data compiled from the Economic Report of the President 1989.

11
responses. Their report argued strongly in favor of the view that the Japanese had taken

deliberate steps to hold down the value of the yen in order to undersell U.S. producers. In

particular, the Caterpillar report argued that restrictive capital market policies discouraged

inflows of capital into Japanese markets, thereby suppressing demand for the yen, and increasing

demand for other currencies, such as the dollar. As such, the report called for correcting the

strong dollar by further opening Japanese financial markets.

This analysis turned out to be erroneous. In fact, the most significant controls in

Japanese capital markets restricted outflows, not inflows, of capital.14 As a result, liberalizing

Japanese financial markets would have the effect of increasing capital flows from Japan to the

United States. As Paul Krugman, then a staff economist at the CEA, noted in a memo, It is hard

to believe that liberalization of Japans capital markets would make Japan a major importer of

capital. Japan has the worlds highest savings rate. With free movement of capital we would

expect it to invest some of these savings abroad, i.e., become a capital exporter rather than a

capital importer.15 Nevertheless, prompted by the Caterpillar report, the Treasury Department

launched a diplomatic offensive aimed at liberalizing Japanese financial markets in November of

1983 (Frankel 1984).

The question is: Did Treasury adopt the Caterpillar report knowing that the reports

conclusions were faulty and that in fact opening Japanese capital markets would augment capital

flows to the United States, assisting the Treasury in financing the budget deficit, but also further

strengthening the dollar? Or did Treasury, along with Caterpillar, simply miscalculate the effect

of liberalizing Japanese markets on the direction of capital flows? This is difficult to know

14
Paul Krugman, Is the Yen Undervalued? September 30, 1982, Martin S. Feldstein, Files: Box 1, Ronald Reagan
Presidential Library.
15
Paul Krugman, Caterpillar Tractors Yen Study: An Evaluation, October 25, 1982, Martin S. Feldstein, Files:
Box 1, Ronald Reagan Presidential Library.

12
definitively, but there can be no doubt that the convoluted economic logic of the Caterpillar

report solved at least two sticky problems for Treasury.

First, and most importantly, Treasury needed to respond to the increasingly vociferous

complaints of the business community without compromising the laissez faire principles of the

Reagan administration. As Jeffrey Frankel, an economist then working at the CEA explained,

For Treasury, this seemed like a way of responding to this pressure [from business] without

abandoning free trade principles.16 In 1983 and 1984, protectionist pressures were growing, as

were demands that the Treasury intervene in the foreign exchange market to bring down the

dollar. Both of these were anathema to the free market economists at Treasury. Fortunately, the

Caterpillar report allowed Treasury to redirect pressure to do something about the dollar

toward an initiative about which it was considerably more enthusiastic: removing barriers to the

free flow of capital internationally. Not for the first time in the Reagan administration did

ideology fit hand in glove with more practical imperatives.

The second problem solved for Treasury by the Caterpillar report was that it deflected

attention away from an alternative explanation of the strong dollar articulated within the Council

of Economic Advisers. The Council of Economic Advisers argued that the dollar had

appreciated because the budget deficit contributed to high interest rates; high interest rates, in

turn, made the dollar a desirable asset, attracting a capital inflow.17 For Treasury, this analysis

with its unpleasant emphasis on the budget deficitamounted to selling short the Reagan

program. From Treasurys perspective, foreign capital was attracted to the United States because

the pro-business policies of the Reagan administration created a favorable environment for

investment. Even if the logic was a little erroneous, then, the Caterpillar report at least put the

16
Interview with the author, July 12, 2003.
17
Minutes of the Cabinet Council of Economic Affairs, April 12, 1983, Cabinet Councils, Restricted Materials:
Box 26, Ronald Reagan Presidential Library.

13
emphasis where it belonged: the dollar was strong because deregulated U.S. markets drew capital

in, whereas shackled markets abroad repelled capital. For the Treasury economists, if not for

Caterpillar Tractor, the soaring dollar was a sign not of some underlying pathology but of all that

was right in Reagans America.

But there was one thing on which the Treasury Department and the Council of Economic

Advisers could agree: whatever their cause, the capital inflows associated with the strong dollar

were a welcome development. Over the course of two years, the Reagan administration

economists had learned that they lived not in a closed national economy, but in a world of global

capital. Consequently, when the Reagan recovery began to accelerate in mid-1984 and fears

again turned to an imminent crowding out of private borrowers in the capital markets, the

Treasury Department was prepared.18 While Volcker startled the financial markets by repeating,

loudly, his earlier warnings that he would not under any circumstance accommodate deficits,

administration economists calmly analyzed the role that foreign capital would play in financing

the coming investment boom.19

Whether or not the liberalization of Japanese capital markets represented a deliberate

attempt on the part of the Treasury to harness Japanese capital flows to finance U.S. deficitsor,

as some have argued, was simply a policy mistakethere can be no ambiguity about

Treasurys intentions as the economic recovery progressed.20 Beginning in the summer of 1984,

Treasury took several concrete steps to make U.S. financial instruments more attractive to

18
William Poole, Interest Rates, Stock Prices, and Monetary Policy, June 19, 1984, Cabinet Councils: Box 52,
Ronald Reagan Presidential Library.
19
J. Gregory Ballentine, International Capital Flows, October 26, 1984, Cabinet Councils, Restricted Materials:
Box 31, Ronald Reagan Presidential Library; Sidney Jones, Report of the Working Group on International Trade
on the Probability of Large Merchandise and Current Account Deficits Continuing for Several Years, December
14, 1984, Cabinet Councils: Box 55; Roger Porter, Minutes of Cabinet Council on Economic Affairs, January 22,
1985, Cabinet Councils, Restricted Materials: Box 31, Ronald Reagan Presidential Library. Volckers comments
and their effects on the financial marketsare reported in Business Week (February 20, 1984; March 5, 1984; March
19, 1984; October 15, 1984).
20
See Destler and Henning (1989) for the former view and Frankel (1994) for the latter.

14
foreign borrowers (Frankel 1994: 301-2). In July of 1984, a tax imposed on interest earned by

foreigners on U.S. investments was eliminated. In September of 1984, Treasury initiated its

foreign-targeted securities program, in which several special issues were prepared for European

and Japanese markets. The auction was extremely successful; one observer called the Reagan

Treasury Department, [T]he greatest bond salesmen in history (Destler and Henning 1989: 29).

Finally, in October, Treasury began issuing so-called bearer bonds, consistent with the

preference of international investors for unregistered securities that could be held anonymously.

What the Reagan policymakers discovered in the early 1980s, then, was that integration

into global financial markets brought not constraint, but freedom. The discovery marked a sea

change. Only a handful of years had passed since Carter presided over the malaise of the 1970s,

and yet the dilemmas confronted by Carter seemed the chains of another, long past era. Indeed,

rather than disciplining the Reagan policymakers, global financial markets allowed the United

States to defer indefinitely the difficult political choices that had confronted previous

administrationsand sunk the Carter Presidency, finally, into crisis. As Treasury

Undersecretary for Monetary Affairs, Beryl Sprinkel, noted, global capital flows underwrote

high U.S. standards of living and permitted investment at a level that would not have been

possible had capital movements been restricted.21

Sprinkels observation underscores a point often neglected by contemporary theorists of

globalization: whether or not the state is constrained by internationally integrated financial

markets, the previous era was not one in which the state was free from constraint. In particular,

under the Bretton Woods regime of fixed exchange rates and controls on capital movements,

budgets were binding in a way that they ceased to be in the Reagan era. In the absence of

21
Beryl Sprinkel, Lehrmans Paper Protectionism or Monetary Reform: The Case for a Modernized Bretton
Woods, October 21, 1985, Beryl Sprinkel Files: Box 2, Ronald Reagan Presidential Library.

15
foreign capital inflows, deficits of the magnitude generated by the Reagan administration would

have precipitated a full blown financial crisis. Instead, the financial strain imposed on the

economy by the Reagan deficits was deferredat least until the October 1987 crash, which,

while calamitous, was very quickly contained. That Americans could live so well, for so long,

and seemingly avoid paying the cost was a powerful lesson indeed.

Financialization: The 1990s and Beyond?

It was also, as it turned out, an enduring lesson. In the summer of 2002, Donald Kohn,

recently appointed as a Governor of the Federal Reserve Board, noted, The globalization of

finance . . . has enabled us to attract huge volumes of [foreign] savings in this country.22 That

policymakers in 2002 still articulate essentially the same view first expressed by Reagan

administration officials two decades before provides some clue as to why financialization has

been such a durable feature of the U.S. political economy. To recapitulate, I have argued that,

from the perspective of the state, the critical development in explaining the growing weight of

financial activities in the U.S. economy is the shift from a low-interest-rate to a high-real-interest

rate environment. The question is why this shift, which occurred around 1980, has proved so

persistent, extending over two decades.23 Answering this question, I have suggested, requires

understanding financialization as a response to the crisis of the 1970s.

The outbreak of inflation in the 1970s, I have suggested, reflected the inability of the

political system to decide how declining U.S. affluence would be allocated across different

22
Interview with the author, July 18, 2002.
23
The conventional wisdom is that, spurred by deficit reduction, real interest rates were low in the 1990s. In fact,
interest rates were low in the 1990s only relative to the astronomical levels of the 1980sthey remained high
relative to the experience of the 1950s, 1960s, and 1970s. It is difficult to know for certain whether the experience
of the last two yearsin which short-term interest rates have been reduced to very low levelsrepresents a shift in
interest rate regime, or is only a temporary response to economic weakness.

16
political projects and shared by different social strata (Wojnilower 1980). As Gowan (1999: 34)

notes, the ability of the state to carry out a program of macro-economic adjustment to balance its

budget or correct a trade deficit depends upon the political capacity to impose the costs of such

adjustmentsin terms of lower living standardson various social groups. In the late 1970s,

the U.S. state lacked this capacityand the result was a roaring inflation. Reagans economic

program aimed to crush inflationand with it, the damage done to U.S. power and prestige at

home and abroadbut not by resolving the underlying problem. In a sense, that dilemma would

now be borne on the backs of foreign savers.24 The unusual marriage of supply-side economics

and monetarismtax cuts plus tight moneyattracted inflows of foreign capital, allowing the

United States to live beyond its means.

Once the Reagan policymakers had stumbled upon the formula, they were not inclined to

change course, even if that meant locking in high real interest rates in order to maintain the

attractiveness of the United States as a site for foreign capital investment. Neither were

subsequent administrations, even though such a policy exacerbated rather than corrected

fundamental imbalances in the economy. In particular, the high real interest rate regime of the

last two decades has distorted patterns of economic activity, siphoning investment toward

finance.25 But as long as the capital continues flowing, political deliberation about how to

distribute the burden of declining U.S. affluence can be put off for another day. David

24
This is not to imply that redistribution did not take place during the Reagan years, merely that the terms of that
redistribution were much less severe than would have been the case in the absence of foreign capital imports.
25
To be sure, capital inflows in the 1990swhich actually accelerated from their levels in the 1980smay have
been drawn less by high interest rates per se than by the stock market boom powering U.S. economic growth. As
Alan Blinder, former Vice-Chairman of the Federal Reserve noted, I think of the active force in [the 1990s] as
being foreign investors wanting to get in on a good thing. When that happens, you dont have to offer high interest
rates, because the money is being thrown at you (Interview with the author, July 8, 2002). Blinders point is valid
in part, but it is important to remember that the economy of the 1990s was shaped by experience of the 1980s. In
particular, it was the surge of liquidity released into U.S. financial markets by foreign capital inflows beginning in
the 1980s that produced the soaring stock market of the subsequent decade (Evans 2003).

17
Stockmans (1986) triumph of politicsby which he referred to the endless budget wrangling

that destroyed the supply-side revolutionhas become the supersession of politics altogether.

In this context, it is appropriate to reevaluate the claimassociated with the globalization

literaturethat global financial markets discipline states. The experience of the U.S. state in

the 1980s reminds us that we must, at the very least, ask which governments are disciplined,

when, and by whom. Not all states are equally at the mercy of global capital (Pauly 1995).

Indeed, I have argued that, during the Reagan period, the appropriate image is not that of a state

dominated by financial markets that have escaped its control. Rather the experience of the

Reagan administration suggests that the state was able to harness global capital flows in order to

extricate itself from the dilemmas that marked the crisis of the 1970s. This is not to suggest that

the autonomy of the U.S. state during the Reagan period was entirely unconstrained by global

financial markets. Indeed, it must be remembered thatprofligate or nothe overall thrust of

the Reagan administration was extremely friendly to capital, and this is part of what made the

United States so attractive to international investors.

In this sense, the experience of the Clinton administration may provide a truer test of

the autonomy of the leading capitalist state vis--vis global capital. The U.S. states return to

solvency in the 1990swidely interpreted to be in acquiescence to bond market pressures (Reich

1997; Woodward 1994)appears to fit the conventional story about financial markets

disciplining states more closely. But it is important to remember that deficit reduction in the

1990s was accompanied byand arguably, predicated upona buildup of debt in the private

economy unprecedented in the postwar period. As The Economist magazine (January 22, 1999)

remarked, Americas public prudence has gone hand-in-hand with private profligacy. Herein

lies the underlying continuity between the experience of the 1980s and 1990s: as in the Reagan

18
era, financing this debt depends on the enduring ability of the U.S. economy to preempt global

capital flows. In this context, one might argue that it is not the capacity of global financial

markets to discipline, but their inability to discipline, that is the problem.

I have argued that the specific response of the U.S. state to the crisis conditions of the

1970s has helped to launch U.S. (and global) society on a path of development in which finance

is king. But it should be obvious that financialization did not resolve as much as displace the

crisis conditions to which it was a response. There are two aspects to this displacement: a

temporal displacement, accomplished through the accumulation of debt by the American state,

households, and corporations, in which the distributional conflicts of the 1960s and 1970s have

been deferred indefinitely into the future; and a spatial displacement, in which the United States

usurps the worlds liquid wealth. A crisis deferred may produce prosperity for a time, but

eventually such borrowings must be repaid.

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