8     The Coin of Whose Realm?

Give me control of a nation’s money and I care not who makes her laws.

—Mayer Amschel Rothschild

So you think money is the root of all evil. Have you ever asked what is the root of all money?

—Ayn Rand

One day, in the waning months of the worst of the financial crisis of 2008 and 2009, I had lunch with the U.S. National Economic Council director, Larry Summers, in his office in the White House. Our conversation turned to the crisis, its consequences, and how it might have changed his thinking since our years in the Clinton administration.

“Do you ever think,” I asked, “that we went too far with reforms, went too far in the direction of ‘leaving it to the markets,’ and that now the pendulum is going to swing the other way?”

He paused for a second, then said, “Do you mean do I think we’re going to go backwards to what it was before? That somehow we’re going to have government much more involved in the marketplace? Play a much bigger role as a regulator?”

I nodded.

“No,” he said without hesitation. “I don’t think we can or want to turn back the clock. I don’t think you should worry about the Obama administration undoing everything we did like some critics are suggesting we will. Frankly, I’m not sure we could even if we wanted to. It’s a different time.”

I think he thought this would comfort me, that I would think he was saying that despite the crisis, President Obama was not going to be the cryptosocialist he was accused of being by some of his more over-the-top critics. But to be honest, I wasn’t sure I found the response comforting. In the years since the Clinton administration, even before the crisis, my sense was that the needle had swung too far in favor of what were called market freedoms but were really opportunities for members of the financial community to act recklessly, to profit grotesquely from trading in risks they shouldn’t be taking, and to lead the development of an international financial system that had usurped control of everything from monetary policies to market stability from representatives of the public.

I was under no illusions that those representatives of the public were terribly well equipped to add value at the moment, given their generally stunning ignorance of much of what was going on in financial markets and their repeated (and I believe not accidental) inattentiveness to worrisome developments in those markets and among leading financial institutions. The fact was that Obama himself rode into office on the largest wave of donations from the financial community in history; he brought with him many with a firmly Wall Street frame of mind and related biases, and if anything, the U.S. Congress had been even more corrupted by a campaign finance process that made it totally dependent on donations from the companies it was supposed to regulate. It all smacked of the days of the British Parliament when 10 percent of all members were in some way direct beneficiaries of, or related to beneficiaries of, the British East India Company. In systems like that, skewed outcomes are inevitable.

The broader question, however, was whether the financial upheavals that had taken place were actually in part due to something larger, a historical trend in which yet another pillar of traditional government control over a society—monetary and financial control—had been undermined thanks to the systematic and very long-term efforts of the business community’s acting in its narrow self-interest—abetted, as ever, by philosophers and opinion makers who had for one inducement or another come to share their views. The evidence, consistent with Summers’s conclusion, was that the profound changes that have occurred were, at least to some degree, irreversible. This implies not, however, that government’s role must continue to shrink, but that it must adapt to new market realities in which the balance of power lies with big private players and the scope and sophistication of instruments is vastly beyond the grasp of most government regulators and policymakers.

Clearly, we had come a great long way from that first document commemorating the stock transaction of Bishop Peter of Vasteras, or, for that matter, from the days when in an effort to fund its empire, Sweden went on the copper standard and forged coins made from the metal found in the depths of the mines at Falun. Copper, of course, was not seen as being as valuable as gold or silver, and to be worth enough to be useful in most transactions, many of the coins, imprinted with royal likenesses certifying their officially sanctioned status, ended up being 9.5 inches in diameter, so they were not really an efficient form of pocket change. And even though the royal seal was affixed to the stock transfer agreement, there was no organized open market on which shares could trade, so its value was hard to determine. But these were not the only reasons these links to the distant past seem deeply outmoded. Much had transpired, including events that drew on the rise of corporations like Stora Kopparberg, the British East India Company, and the other ancient antecedents of modern enterprises such as the Goldman Sachses and Morgan Stanleys of this world, companies that seem to have, if anything, even more clout than their giant, state-sponsored forebears.

The Philosophies of Money and the Uneasy Reality of Financial Sovereignty

In their excellent book Money, Markets and Sovereignty, Benn Steil and Manuel Hinds note that monetary sovereignty—the ability of states to set the value of and manage their national currency and by extension many important dimensions of their state’s fiscal life—“is incompatible with globalization, understood as integration into the global marketplace for goods and capital. It has always been thus, but it has become blindingly apparent over the past three decades of human history.”

The middle part of that statement—that “it has always been thus”—may seem odd to the casual observer. To undertake a study of money, however, is to embark on what often seems like an examination of unfounded beliefs wrapped in perceptions shrouded in mythologies. That any nation ever truly could control its money supply is one of those myths. This is because the underpinnings of the idea of money are dependent on public perception of what is valuable, and thus on a wide range of external variables ranging from the value of commodities to factors that affect that value such as the weather and wars and other conditions influencing the health of national economies.

Monetary sovereignty was therefore a kind of aspiration. It is the idea that states could exert meaningful influence over the value of the monies exchanged within their societies, which was important to the states because it meant tax revenues would have value, wars could be paid for, and economic activity could take place that would ensure more tax revenues to pay for more wars. Even so, a quick look at history shows that even this more qualified view of states’ control over their financial destinies has seen the public sector’s influence compromised from the start and waning ever since, until, as Steil and Hinds suggest, it has shriveled to a nubbin of its former self during the last thirty years.

Perhaps perversely, the less the means of exchange in a society is actually worth, the more perceived influence on its value a government has. Most early societies started out with “commodity” money, units of exchange that were seen to have intrinsic value—gold pieces, shells, a predetermined amount of grain. For example, the word “shekel” refers to a unit of weight that in its monetary sense referred to a specified amount of barley. But over time, states switched to “representative” currencies, types of money that were deemed to have value based on the word of the government that they would be backed up or redeemable in some way by the state. Later, they would switch to “fiat” currencies, which do not imply convertibility to the commodity in question but are seen to have a value primarily because either the state or the market asserts they do (we shall soon see how the balance of power shifted in this instance very recently).

Because banks emerged as repositories of precious commodity-based currencies and often it was more convenient to conduct transactions with some portable, easily transferred representative currency, paper money came into use. It first appeared in China during the Song dynasty around the year 1100. This was a very economically advanced society that, among other things, saw the widespread creation of joint-stock companies and used copper coins—minting as many as six billion in the year 1085. Given the weight of copper, a large industry grew up in the printing of jiaozi, or paper banknotes.

Sweden had, as noted, during the period of its greatest expansion in the early seventeenth century, turned to a currency system that was based on dalers minted from silver or copper. The silver dalers were, because of the perceived intrinsic value of silver, much smaller, and as a consequence they tended to be hoarded. The copper coins were the size of dinner plates. The problems associated with this system were further compounded by the fact that banks were taking short-term deposits in these coins but making long-term loans. Demand for the coins was high and only grew higher as Falun’s copper became in such high demand by 1660 that the copper content of the coins was reduced by almost a fifth, creating a greater desire on the part of depositors to get their old coins back.

The solution was arrived at by the predecessor of Sweden’s national bank, which was founded in 1656 by two royal charters from King Karl Gustav. The bank was called Stockholms Banco, and it was operated by an entrepreneurial character named Johan Palmstruch. Palmstruch solved the problem of the heavy coins and the uneven demand flows by creating Europe’s first paper money. The notes, backed by a promise of redemption from the bank, were called kreditivsedlar, and they were an immediate hit. Transactions that once required a wagonload of coins could be handled with a few notes in standard quantities. The denominations of Europe’s first paper money were therefore 5, 25, 100, and 1,000 copper dalers (koppermynt).

Unfortunately, Palmstruch’s innovations didn’t stop with introducing the first paper banknotes in Europe. Demand for the notes was so high that Palmstruch gave in to the temptation to print more than he had hard currency to cover. By late 1663, the value of the banknotes was falling; by the next year, the bank failed and, setting another precedent, the Swedish government had to take over its operations.

Palmstruch was in jail by 1667. A successor bank, operated by the parliament, called Riksens Standers Bank, was established. The bank, which later changed its named to the Sveriges Riksbank, became Sweden’s central bank and remains so to this day.

The experience was so traumatic for the Swedes, however, that despite the fact that they led the West into the world of banknotes, they did not resume their use of them until well into the next century. As noted, states have always required money to support their functions, and in fact it was the concentration of reserves in a treasury that was one of the founding sources of a state’s power, because those funds could be applied to build fortifications, hire armies, and create the coercive power needed to enforce the law, including the collection of taxes, which completed the circle of power, feeding into treasuries.

As military expenditures grew, the amounts of money needed grew commensurately. The Swedish experiments with copper and paper currencies came in the midst of a larger trend in this area. The nature of conflict in Europe before, during, and after the Thirty Years’ War demanded large standing armies for the first time. The tiny Dutch Republic, for example, already had an army of 60,000 by 1606. The Spanish army grew to 300,000 by the 1630s, fifteen times as large as it had been two hundred years earlier when Columbus led the first explorations in search of gold in the New World. The French army grew threefold in a century, reaching over 150,000 by 1630. Changes in military technologies, the move to firearms, the cost of lengthy sieges, and other factors also made the cost of maintaining each soldier or military unit increase significantly. According to one calculation, during the reign of Elizabeth I, the cost of outfitting an infantry company rose 150 percent. These costs were such that commercial or financial failure meant defeat, as illustrated by the case of Spain during the Thirty Years’ War. The situation grew so extreme that by the late seventeenth century, almost three-quarters of French government revenue was being spent on land warfare, with an additional 16 percent being spent on France’s navy.

Of course, part of this buildup of military capabilities and expenses was due to the reality that maintaining and expanding control over land or sea lanes was the only way nations could enhance or protect their economic well-being. Armies were economic tools that demanded economic strategies, and the period of the sixteenth and seventeenth centuries saw European states develop much more organized approaches to budgeting, taxation, borrowing, and money policies. The Bank of England, for example, was established in 1694 to help manage finances associated with the latest round of fighting with France.

States had always had to borrow in a pinch, but when a sovereign borrowed and thereby became beholden to another party, sovereignty suffered. If capital grew more concentrated in cities, as it did in the sixteenth and seventeenth centuries, urban elites became more influential. If monarchs depended on the mines of Falun or the fleets of the British East India Company to finance their operations, the operators of those enterprises gained influence. If they borrowed, lenders gained influence. Part of the battle between church and state had been about competing claims for financial resources from the people and the land. In fact, it has been argued that the shifting economics of war and the concurrent requirements for more evolved commercial and banking systems of this period are what drove the creation of the nation-state, organized as it was to support and manage such activities.

This focus on finance and the need for the organized underpinnings to help fuel required wealth creation accelerated the development of capitalism, which actually started during the twelfth and thirteenth centuries as an alternative to the comparatively disorganized, intensively rural, inefficient economics of feudalism. Initial theories about economics during this period were, not surprisingly, rooted in the views of the church, which was still the dominant pan-European power of the era. Thomas Aquinas was the principal author of many of the most influential economic views associated with that period, offering theories on a “just price” and a “just wage” that guided merchants toward deriving what was needed to support their families and the church and nothing more. View this as being spiritually motivated or as a self-serving argument advancing the church’s economic interest; an ethos developed in which material wealth was disdained and commerce and trade were distrusted, seen as evidence of sinful impulses such as greed, selfishness, and covetousness.

With movement to the cities accelerating during the Renaissance and then the onset of the Reformation, and with the diminution of the influence of the church, not only did manufacturing expand and a market system take hold, but philosophies also began to change. Part of the change was associated with what Max Weber later addressed in his essay “The Protestant Ethic and the Spirit of Capitalism,” in which he argued that the Calvinist approach to life, which emphasized both hard work and doing well as a way of pleasing God, meant that prosperity could be more acceptable if sought for the right motives and by the right kind of people. Or, to draw from another source close to the momentous changes that were taking place, Christopher Columbus observed, “one who has the gold does as he wills in the world, and it even sends souls to Paradise.” This is a view that helped underpin the mercantilist economies that would emerge in the sixteenth and seventeenth centuries and would lead to the establishment of many of the great trading companies of the era.

Competing economic views are associated with this period, including those of the “bullionists” of sixteenth-century England, whose thinking focused on how best to ensure that the precious metals were efficiently collected into the coffers of the state. Their views, echoing Machiavelli’s admonition that “in a well-organized government, the state should be rich and the citizens poor,” supported policies that would promote a healthy tax base, such as having a wide circulation of money within a country’s borders, as well as those that would keep precious metals for the use of the sovereign, such as discouraging export of gold and silver. (In Spain, the punishment for illegally exporting gold and silver was death.) Policies of the time also included deliberately seeking to increase the purchasing power of foreign currencies so as to encourage their flow into the borders of a nation.

Although bullionism began to fade during the sixteenth century, it was not until the birth of the big trading companies that an alternative, more trade-based set of theories emerged—largely because companies such as the East India Company needed to export gold and silver in order to purchase the goods in which they were trading. A political debate emerged around whether this was actually good for England, and one of the directors of the Company produced a series of influential writings including a 1621 pamphlet called “A Discourse of Trade from England unto the East Indies” and, more important, a treatise published after his death called “England’s Treasure by Foreign Trade,” which enumerated the benefits that trade brought to England, from sales of locally produced goods to savings on goods made overseas. The author of these works, Thomas Mun, argued that the problems England faced could better be addressed by a policy of promoting exports and limiting foreign imports to the country—except for those brought in by English charter companies, naturally.

While Mun’s work was resisted at first, it ultimately became a basis for England’s expansion during the period in which England was indisputably the world’s greatest power. Adam Smith, referring to “England’s Treasure,” would write, “the title of Mun’s book became a fundamental maxim in the political economy, not of England only, but of all other commercial economies.”

The era during which Smith began to write—the Enlightenment—also saw a broader desire to strip religious pieties out of economic theory once and for all. A leader in this effort was Smith’s French contemporary, Voltaire. Reacting against what he saw as too strong a lingering Christian ideological influence on commercial behavior, Voltaire made the case—later echoed by Smith—that the pursuit of wealth through market activity and the consumption of wealth were both politically and morally desirable. In words that would be echoed through the centuries that followed, in the writings of those from Hayek to Friedman, he wrote that “the individual’s self-regarding propensities were the basis of social order, rather than the threat to it that Christian and civic moralists have imagined.”

In his Philosophical Letters, Voltaire argued that market activity should be valued not because it made society wealthier but because it was a more reliable motivator than religious zeal. For Voltaire, intent was paramount. “The whole difference,” he wrote in his essay “On the Pensées of Pascal” (Blaise Pascal advanced opposing moralist views), “lies in the occupations being gentle or fierce, dangerous or useful.” Seeking personal gain was a rational motivator in the eyes of this ultimate rationalist, whereas the real danger lay with religion.

Voltaire also did much to promote the standing of the financial community, which was viewed with much skepticism at the time (not entirely surprising in the wake of the South Sea Bubble and related perturbations that resonated across the European marketplace). In his Philosophical Letters, he describes the Royal Exchange in London, the forebear of the London Stock Exchange, and sketches out the broader benefits of the exchange as a social as well as a financial engine producing considerable and diverse benefits:

Go into the Exchange in London, that place more venerable than many a court, and you will see representatives of all the nations assembled there for the profit of mankind. There the Jew, the Mahometan, and the Christian deal with one another as if they were of the same religion, and reserve the name of infidel for those who go bankrupt. There the Presbyterian trusts the Anabaptist, and the Church of England man accepts the promise of the Quaker. On leaving these peaceable and free assemblies, some go to the synagogue, others in search of a drink, this man is on the way to be baptized in a great tub in the name of the Father, by the Son, to the Holy Ghost; that man is having the foreskin of his son cut off, and a Hebraic formula mumbled over the child that he himself can make nothing of; these others are going to their church to await the inspiration of God with their hats on; and all are satisfied.

Rueful contempt for religious posturing and ritual aside, Voltaire saw commerce as a natural antidote for much of what ailed contemporary society. He went so far as to suggest that material consumption by the rich is what drove the employment of the poor, which in turn enabled them to consume. He also noted that the pursuit of wealth had driven intercontinental exploration and commerce, thus knitting the world more closely together.

Smith’s views, discussed earlier, certainly echo Voltaire’s spirit. It is important to note, however, that many of Smith’s and Voltaire’s views were based on an idealized view of commerce among small enterprises, none of which had the power to distort pricing or market dynamics as giant corporations might. In Smith’s eye, the potential distorter was the state. That is the reason he focused on encouraging the state not to meddle in the marketplace (a view that has since been often taken out of context). As Dowd writes in Capitalism and Economics: A Critical History: “He did not anticipate the baronial power that would be sought and gained by the enormous companies industrialization facilitated—and that a compliant state allowed.”

As Smith himself acknowledged, he was heavily influenced by David Hume, a contemporary and fellow Scotsman, who wrote that “commerce itself … gives rise to the notions of justice between peoples.” Hume also offered a view of trade that suggested it could trigger a virtuous cycle of growth among participating nations—an argument contrary to zero-sum notions of trade and, as such, a foundational notion behind the ideal of free trade. He also shaped views on postmercantile monetary policy that not only embraced the self-correcting consequences of inflows of foreign gold and silver but would suggest ideas like “beneficial inflation,” monetary policies that would lead to some of the thinking of John Maynard Keynes a century and a half later.

This chorus of Enlightenment voices set the stage for a new view of industry and finance that could not have been timelier, given that it helped set the stage and provide the intellectual framework to embrace and rationalize the developments associated with the Industrial Revolution just stirring. As was noted earlier, 1776 not only produced Smith’s Wealth of Nations and the American Revolution, it also saw the first commercial introduction of the steam engine designs of yet another influential Scotsman of the period, James Watt.

The First Movers of Globalization: The Rise of the Banking Elite

The nature of early banking was based in part on the weight and value of gold, silver, and other treasures that needed to be stored safely and were risky to transport (although not as burdensome perhaps as wagonloads of pie-sized copper coins). To facilitate commerce, banks would establish branches that allowed deposits in one place to be withdrawn in another or that allowed those with deposits to issue checks (the first of which are reported to have been used among Arab merchants) that were essentially IOUs for the treasure that was safely stored in the banks’ vaults.

Because of the branch structure, early banks became important globalizing forces. The Medici Bank, for example, the most important of Europe’s banks throughout the fifteenth century, had branches stretching up and down the Italian peninsula and across France, Switzerland, and what today would be Belgium all the way to London. Through its accumulation of riches it became a vitally important lender to popes and kings. This was a double-edged sword. The Medici became rich and powerful, and ultimately they produced two popes. They also won important trading concessions that added to their wealth. However, because everyone loves their banker when they are lending but no one loves them when they come collecting, the relationship was precarious. Periodically the Medici would be put in the position of seeking repayment from monarchs and other nobles at just the time that the monarchs were least able to pay and, not surprisingly, not in the best of spirits.

In good times, the Medici played an essential role in supporting rulers from Charles the Bold to Edward IV of England. But when these rulers fell on rough times, they would play rough, resisting repayment, threatening to withdraw special concessions on which the Medici depended, coercing them into not lending to their enemies, and, as a consequence of all such measures, undoing the banks in London and Bruges and ultimately the Medici banking empire.

But, as history has also shown, where one banking empire leaves off, another picks up, because the demand for lending and facilitating commerce is essential to the functioning of both states and economies as a whole. So where the Medici banking story ends, the Fugger story begins.

The Fuggers were a German banking family that, like the Medici, became the richest in the world during the period of their greatest dominance, the sixteenth century. They opened bank branches throughout Europe and financed the rise of kings, notably Charles V, who owed his election as Holy Roman Emperor to their collection of over 850,000 florins (almost 100,000 ounces of gold). Their lending enabled Charles and countless nobles to rule, and in exchange they were granted not only religious but commercial indulgences, including a series of silver and copper mines in central Europe. In fact, they sought to compound their power by actually mining the precious metals that states could mint into the coins that would be stored in their vault, and this led them into competition with and deals linked to the mining ventures in Falun. The Fuggers’ vision and ambitions were great, and through their linkages with Charles and the Spanish they also underwrote and profited from mining ventures in the Americas.

Of the banking figures who did the most to shape the rise of the modern era, perhaps the most influential was Mayer Amschel Rothschild. Rothschild was born in a Jewish ghetto in Frankfurt, Germany. His father had been a money changer, and Mayer built upon his family’s business by installing each of his five sons at the head of a branch of the family banking business in different capitals of Europe, thereby creating an independent, confidential, resilient, and fully family-controlled network.

While the influence and business of the family grew during the eighteenth century through the support of many ventures taking part in the expansion of the early industrial economy, the most striking example of how a private financial enterprise could influence a state is illustrated in the events surrounding the Napoleonic Wars, which fueled the rise of the Rothschild family to the point that its members ultimately ended up holding aristocratic titles from England to the Austro-Hungarian empire. Again, the leverage of the bankers was linked to the ambitions of the state. To assert public power required money beyond that controlled by public authorities. Thus, they had to reach out to and thereby grant enormous leverage to private lenders. Thanks to the legal and political developments of the seventeenth and eighteenth centuries that made it more difficult for monarchs to simply rebuff bankers as they might have done in the past, the power of the lenders was further amplified. Techniques and markets developed by the Rothschilds, notably those associated with the issuance of government debt instruments, amplified that power even further.

The trigger for this escalation of private influence was the most audacious grab for public-sector power Europe had seen since Charlemagne: that of Napoleon Bonaparte. Napoleon was bringing an industrial-era efficiency to conquest, pioneering the art of “total war.” His onslaught, with reverberations from Spain to the frontiers of Russia, remade Europe and set his neighbors on edge as they desperately sought ways to contain him. While the strategies considered were numerous, the prerequisite for all of them was money.

On England’s behalf, Lieutenant General Sir Arthur Wellesley, later known as the Duke of Wellington, pursued Napoleon on a campaign so costly that it resulted in a ballooning of the national debt to £745 million, twice the country’s GDP. (By comparison, America’s debt in 2011 raised alarms because it reached 100 percent of GDP.) The problem was that the government needed not only money but hard currency as well, since merchants on the Iberian Peninsula where Wellesley was fighting refused to accept British bills of exchange.

Knowing of the Rothschilds’ reputed abilities, the English chancellor of the exchequer instructed his representatives to “employ that gentleman [Nathan Rothschild, head of the British branch of the clan] in the most secret and confidential manner to collect in Germany, France and Holland the largest quantity of French gold and silver coins, not exceeding in value 600,000 pounds, which he may be able to procure within two months of the present time.” The objective was to get the coins to Wellesley to support his efforts.

Using the network to gain advantage—selling gold for bills of exchange in countries where its price was high and using the proceeds to purchase even more gold in countries where the price was lower—by May 1814, the Rothschilds had raised twice the amount the British government required. According to the excellent account of this period in Niall Ferguson’s The Ascent of Money, the response of a grateful British government in the wake of Napoleon’s subsequent exile to Elba was encapsulated by the comment of Lord Liverpool, then the prime minister, who said, “Mr. Rothschild [has become] a very useful friend … I do not know what we should have done without him.” Metternich’s secretary called Rothschild the Finanzbonaparten, the Bonaparte of finance. His competitors, such as the Baring family of bankers, used a similar analogy to refer to him. Others were less charitable and resorted to predictable anti-Semitic slurs. (One of the reasons leaders had, through the ages, chosen to use Jewish banking networks was that, merits aside, the low regard in which Jews were held helped keep the bankers in check.)

Nathan and his family continued to profit from the war when Napoleon resumed his quest for empire. They concluded that another war would push up the price for gold, and they bought it up in large quantities, making significant sums available to the British for shipment to Wellington. And while they made significant profits on these transactions, the short war caused the demand for their gold to be more limited than they expected, and they ended up with a substantial quantity of the precious metal on their hands.

Cannily, Nathan estimated that with the war over, despite Britain’s enormous debts, the country’s bonds would soon rise in price. He and his family were developing a great expertise in bond markets—one that would in some respects help to permanently remake the relationship between private finance and governments—and he showed it here, reaping a profit of 40 percent by buying up the bonds when they were still cheap and selling them two years later when they peaked in price.

As Ferguson lucidly explains, the Rothschilds were early masters of networks, blending their capital-raising connections with superior information-gathering capabilities to make markets and stay a step ahead of other players within those markets. In this way, they became the architects and the masters of European bond markets, working from London, the region’s leading center of debt trading. They would charge governments significant commissions for distributing bonds throughout the Continent, and they were careful never to remit the bonds until payment for them had cleared. They made markets not only in British bonds but also in French, Prussian, Russian, Austrian, Neapolitan, and even Brazilian debt instruments. They monopolized bond insurance markets. They pioneered innovations such as promoting the denomination of most bonds in a single currency, sterling, to eliminate transactional inefficiencies. They also developed the then unique capability of issuing bonds from one country in branches across Europe. This gave them a competitive advantage, as did their track record. They dealt only in investment-grade securities, and even during periods when defaults were common, such as some of the early Latin American debt crises of the era, none of their bonds issued during the period (the 1820s) defaulted.

A sense of the Rothschilds’ power over governments as well as an indication of the impunity with which modern bankers could now act was illustrated by a letter from Nathan to the director of the Prussian treasury pertaining to a recently negotiated sale of Prussian debt:

Dearest friend, I have now done my duty by God, your king, and the Finance Minister von Rother, my money has all gone to you in Berlin … now it is your turn and duty to yours to keep your word and not to come up with new things, and everything must remain as it was agreed between men like us, and that is what I expected, as you can see from my deliveries of my money. The cabal there can do nothing against N. M. Rothschild, he has the money, the strength and the power, the cabal has only impotence and the king of Prussia, my Prince Hardebenberg and the Minister Rother should be well pleased and thank Rothschild, who is sending you so much money raising Prussia’s credit.

By dominating the market that countries had to depend on for funds, Rothschild had gained leverage over the courts of Europe that endured long after Bonaparte’s similar but less successful efforts had failed. In part this was due to the skill of the Rothschild family bank; in part it was due to the ambitions and follies of states that locked them into this dependent relationship; in part it was due to the spread of capitalism and its enablement by new communications and transport technologies that were linking markets together in ways that required practiced global intermediaries (a role states could not play). And in part it was due to the fact that the idea underlying the rule of law had evolved to the point that heads of state were increasingly less likely to be seen as above the law but rather as servants to it.

J. P. Morgan Bails Out America

When Nathan Rothschild died in 1836, his net worth was equivalent to 1 percent of Britain’s GDP. When America’s richest man died twelve years later—in that eventful year of 1848—John Jacob Astor, the son of a village butcher from Waldorf, Germany, was worth $20 million, also approaching 1 percent of the GDP of his new country. Astor’s wealth, built from an adventurous fur trading business, was very much of the preindustrial variety. His company employed only a few people and engaged in material commerce. He used his influence to push initiatives that banned foreigners from participation in the fur trade and eliminated government trading posts. Both had the direct effect of reducing government influence over the U.S. economy.

But Astor was a vestige of the eighteenth century. The great fortunes of the nineteenth and twentieth centuries in the United States would be made by harnessing the leveraging power and scale of the new industries and markets of the industrial era. We have considered briefly one example. Another illustrates the massive power that can be wielded by a private actor who has the foresight to harness several of these transformational forces at once.

While we have noted the role that railroads played in breaking down the “island communities” of early America, a parallel and related development was the explosion of interest and activity in American stock markets. When Astor was at his pinnacle, a day of trading on the New York Stock Exchange might involve the transfer of ownership of a few hundred shares, a tiny subset of the value of the rapidly growing European debt markets in which the Rothschilds plied their trade. By the 1850s, hundreds of thousands of shares would trade each day. In 1886, the number hit one million. Many of the enterprises that garnered the greatest interest by investors were railroads, or companies whose fortunes were tied to the expansion of the railroads. Building the infrastructure for a rail-linked national economy demanded constant inflows of capital, and given the small size of the U.S. government at the time, there was no alternative to do the heaviest lifting than private securities markets.

During this period, insider trading was rampant, and robber barons like Jay Gould freely used the markets to advance predatory commercial interests and to influence officeholders whose support they needed for favorable treatment on rights of way, declarations of eminent domain, taxes, and other regulatory matters. Referring to these executives, Charles Francis Adams and Henry Adams wrote:

Pirates are not extinct; they have only transferred their operations to the land, and conducted them in more or less accordance with the law; until, at last, so great a proficiency have they attained, that the commerce of the world is more equally but far more heavily taxed in their behalf; than would ever have entered into their wildest hopes while, outside the law, they simply made all comers stand and deliver.

*   *   *

Such periods of boom are inevitably followed by consolidation, and John Pierpont Morgan was one actor who stepped up to use the postboom troubles of the railroad business to his advantage by acquiring shares in failing firms and rolling them together to create great economies of scale. Morgan, who came to banking naturally through working for his father’s firm, eventually established a firm of his own, J. P. Morgan & Co. The firm was prosperous from the outset, but its power and reach truly began to grow as Morgan used his stock-market skills to accumulate shares in a series of railroad companies. Through reorganization and consolidation, he built these—including what were to become the New York Central Railroad, the Chesapeake and Ohio Railroad, and the Great Northern Railroad—into dominant forces that, even after the passage of the Interstate Commerce Act of 1887, led the remaking of the industry into a prosperous national enterprise that was to remain the backbone of U.S. commerce for three-quarters of a century.

Morgan’s first collaboration with the U.S. government in which he revealed the kind of influence that led his colleagues to call him the Jupiter of the markets came during the Gold Crisis of 1893–95. Fresh from his railroad triumphs, helping to oversee the cleanup and consolidation that brought bankruptcy to almost two hundred railroads and from having bailed out the Rothschilds’ rivals, the Baring Brothers bank in Britain, he was a natural choice for the government to reach out to. The crisis came through a series of spiraling problems—a Wall Street panic in 1893 led European investors to start selling gold-based U.S. bonds, which led to the hoarding of gold and the dwindling of U.S. gold reserves to minimal levels ($100 million). Government efforts—which amounted to selling gold bonds to itself with the Treasury acting as the purchaser—not only didn’t work but made matters worse, and gold reserves spiraled downward, signaling a crisis.

Realizing the problem, Morgan offered a proposal to the Treasury. He would team up with the Rothschilds to lend the United States $100 million, a loan that would certainly end the crisis if half of it were placed abroad as intended, and as the clout of the Rothschild name promised. No other institutions could pull off a deal of such scale. But initially the Grover Cleveland administration balked. It was not until a year after the offer was made that Cleveland realized his policies were in shambles and he turned to Morgan and the Rothschilds for help. Morgan hammered out his terms and cabled London that he had made the deal. Almost immediately, the U.S. Treasury backtracked and said it would manage the deal on its own. Morgan was furious and stormed back to Washington to take matters into his own hands. Despite the president’s refusal to see him, Morgan cajoled his way into the president’s office at the White House. As a meeting on the crisis progressed, it became apparent that the United States was on its last legs. Only $9 million in reserves remained. Morgan then observed that he had a $10 million gold draft coming due that day. In short, he had the ability to pull the trigger on the ultimate calamity: the emptying of the government’s coffers. Cleveland recognized he had no choice, and the deal was done.

Morgan walked out of the meeting with government powers. He would essentially perform the tasks that were usually the purview of a central bank, such as managing the dollar-sterling exchange rate. Since the British currency was the world reserve currency at the time, this meant that Morgan was given responsibility for setting the value of the dollar, and thus for many dimensions of the entire U.S. economy. Manage the problem he did, and by 1896, the U.S. Treasury had been saved from bankruptcy—and his bank was commanding astronomical premiums on gold securities.

Ironically, his call to recap his remarkable feat came after Morgan had been targeted by the Roosevelt administration as the operator of one of the trusts the president sought to “bust.” In that case, it was the Great Northern Railroad trust—although it should also be noted that, in the intervening years, Morgan engineered the creation of enterprises that would later become among the most important multinationals of their era, General Electric and U.S. Steel. Nonetheless, Roosevelt had enough admiration for Morgan that when Wall Street suffered yet another crash, on March 25, 1907, it was the aging banker who was seen as the natural savior of the system he sat at the middle of. Panicked selling—a hallmark of markets throughout time, though not one that is regularly cited by the “leave it to the markets” champions—resulted in many financial houses teetering on the brink of collapse. Trusts, once the enemy but still a bulwark of the economy, also lurched toward bankruptcy. The stock market ceased to be able to make markets in even widely held securities.

By October, the situation had grown so dire that Morgan finally gave in to the entreaties that had been coming to him since the beginning of the downturn and convened an impromptu, informal committee of bankers. On the twenty-second of that month, Morgan and the bankers met with the Treasury secretary, George Cortelyou, an experienced public servant who was rapidly coming to the conclusion that the U.S. government lacked the tools it needed to protect the U.S. economy from crashes such as the one then being experienced. Cortelyou made $25 million available to the Morgan group, and the next day Morgan led an intervention that helped put a stop to the run on the trusts.

However, the next morning, trading on the New York Stock Exchange halted. The president of the exchange, Ransom Thomas, made his way to Morgan’s 23 Wall Street offices to plead for a cash infusion. Ron Chernow describes the scene in his biography of Morgan:

Thomas wanted to shut the Exchange. “At what time do you usually close it?” Morgan asked—though the Stock Exchange was twenty paces from his office, Pierpont didn’t know its hours; stock trading was vulgar. “Why, at three o’clock,” said Thomas. Pierpont wagged an admonitory finger, “It must not close one minute before that hour today.” At two o’clock, Morgan summoned the bank presidents and warned that dozens of brokerage houses might fail unless they mustered $25 million within ten or twelve minutes. By 2:16 the money was pledged. Morgan then dispatched a team to the Stock Exchange floor to announce that call money would be available as low as 10 percent. One team member, Anthony Hodges, had his waistcoat torn off in the violent tumult. Then a blessed moment occurred in Morgan annals: as news of the rescue circulated through the Exchange, Pierpont heard a mighty roar across the street. Looking up, he asked the cause: he was being given an ovation by the jubilant stock traders.

Later the same week, Morgan put together $30 million to bail out the City of New York, extracting from the mayor a promise to allow a banking committee to monitor the city’s bookkeeping practices.

Morgan was able to extract some benefit from the crisis when he purchased the Tennessee Coal and Iron Company from a faltering brokerage house. Such a purchase would require the president to agree not to invoke the Sherman Antitrust Act, which a grateful Roosevelt did. But Morgan was seventy, and it was clear to all who witnessed the crash of 1907 that a country as increasingly dependent as the United States was on its burgeoning financial markets could not rely on a single individual to preserve the health of the nation’s economy. Finally, a century and a half after Alexander Hamilton had made the initial case for a U.S. central bank and after several politically controversial false starts, the crash triggered moves that resulted six years later in the creation of the United States Federal Reserve Bank. Its first president was Benjamin Strong, one of the young bankers who had been on Morgan’s rescue committee.

While the creation of the Federal Reserve was seen as a significant strengthening of federal power and was part of an undeniable broadening of federal authority that spanned the first half of the twentieth century—including everything from the creation of a federal income tax to the economic restoration measures (after yet another crash) that came to be known as the New Deal—the question that hung in the air was: Could government authority and resources grow fast enough to keep up with financial markets? Or would other factors ultimately compromise the influence of government authorities and enhance that of private actors so that future committees of bankers might wield great influence over their government again, albeit under different circumstances?

Efficient Markets and the End for All but a Few Currencies

As we have seen, stock market crashes are regular drivers of political reform and adaptation by financial players that lead to even greater market growth. The stock market crash of 1929 was no exception. Despite every new measure created to increase government scrutiny over market activity, including the Securities and Exchange Commission, within a couple of decades there was a major expansion in U.S. and international securities markets that corresponded with the demand to finance post–World War II expansion. The fact that in this postwar era there loomed a threat from a Communist rival that was employing an all-government ideology to build a global bloc challenging that of the United States made such expansion practically a patriotic duty. In the 1950s and 1960s, Wall Street returned to great favor and prominence and drove a series of changes that would ultimately negate the temporary gains in influence the government may have acquired in the first half of the twentieth century relative to private actors.

One by one, from the 1970s onward, an evolving series of policy decisions and related market innovations fueled a profound shift away from the comparatively simple “old world” of money and finance that had existed for four centuries. Several factors drove these changes: the practical realities of competing in an ever more integrated global economy; ideological frustrations with the inefficiencies and missteps of New Deal–era big government in the United States; welfare-state government in Europe and even Communist government elsewhere in the world; the increasing starkness and political salience of the ideological gap between Western bloc market policies and Eastern bloc socialist policies; and new technologies that linked markets, accelerated them, amplified their volatility, and enabled the creation of new instruments, strategies, and scale.

The effect of these changes on the relative role of public and private influence over global financial flows was so profound that it led many to signal that government was on the verge of being permanently marginalized, forced into the role (for which advocates of the change felt it was especially well suited) of part-time referee, part-time coach, and part-time helper of markets, and little else. One of the first moves hinting at the scale, impact, and radical nature of the changes to come took place in the early 1970s, a decade whose influence on international economic policy was so profound that it ranks with the other pivot points in history. This first change was foreshadowed when, on an August Friday the thirteenth in 1971, U.S. president Nixon and his top advisers slipped out of Washington for a secret retreat at Camp David, the presidential mountaintop escape in nearby Maryland. Joining the president were his secretary of the Treasury, John Connally; his budget director, George Shultz; his Federal Reserve chairman, Arthur Burns; and his top economic adviser, Paul McCracken, plus a coterie of political aides and his speechwriter.

At issue was whether the United States should step away from a hard linkage between the U.S. dollar and gold, the promise that had existed since the end of the Second World War that the government would offer to redeem dollars for gold at the rate of $35 an ounce. This promise, the latest manifestation of the idea of representative currency, was the foundation of the international financial system of which the dollar was now the anchor. The problem was that in the several years preceding, the U.S. balance-of-payments deficit had ballooned, foreign countries were holding vastly increased dollar reserves, and the pressure to revalue the greenback downward was growing to potential crisis levels. Early in 1971, the German Central Bank said it would no longer support the dollar, speculators anticipated a revaluing upward of the deutschmark, and in May of that year, foreign exchange market pressures became so great on the dollar that the Germans, the Swiss, the Dutch, the Belgians, and the Austrians all shut their markets in unison. In one week, billions of dollars had flowed into these European currencies, and several nations—the Germans, the Swiss, and the Dutch—felt they had no choice but to let their currencies float, which is to say the markets had sent them a signal that they had to revalue upward versus the dollar. The Europeans saw this as a dollar crisis. The United States denied it.

The Europeans, feeling the U.S. leadership had their heads in the sand, began to seek their conversion rights, asking for gold to stabilize exchange rates. In the months before the Camp David retreat, France asked the United States to convert $282 million into gold, Belgium asked for $80 million, Switzerland for $75 million, the Netherlands for $55 million, and then the British came in with a request for $3 billion. By early August, the U.S. Treasury had only $10 billion in gold left, the lowest amount since 1936. The problem, as in bygone crises, was that more than $18 billion was held by foreign banks. A few more big requests for gold and the United States would be unable to meet demand, a run on gold could start, and the international monetary system would be undermined.

Nixon asked his team to forget their old positions on the issue of the dollar and think in terms of the new reality. According to William Safire, the speechwriter who was present, Nixon “was not about to stick his thumb in the dike and wait for another hole to appear elsewhere. He wanted a whole new dike.” Connally led the charge in this direction by proposing to close the gold window. Fed chairman Burns resisted. But the tide turned as other senior officials went along with Connally’s arguments that they had no choice but to get out of the gold business, including future Fed chairman Paul Volcker, a man Safire described as “schooled in the international monetary system, almost bred to defend it; the Bretton Woods Agreement [the 1947 deal that pegged the dollar to gold at $35 an ounce and set up the postwar monetary system] was sacrosanct to him.”

On the night of Sunday, August 15, 1971, Nixon made an address to the American people that preempted an episode of one of the country’s most popular television shows, Bonanza. In it, the president explained his moves as being responses to “crises” that had been created by “international money speculators”:

We must protect the position of the American dollar as the pillar of monetary stability around the world. In the past seven years, there has been an average of one international monetary crisis every year. Now, who gains from these crises? Not the working man, not the investor, not the producers of real wealth. The gainers are the international money speculators. Because they thrive on crises, they help to create them. In recent weeks, the speculators have been waging an all-out war on the American dollar. The strength of a nation’s currency is based on the strength of that nation’s economy—and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators. I have directed Secretary Connally to suspend temporarily the convertibility of the American dollar except in amounts and conditions to be in the interest of monetary stability and in the best interests of the United States.

The argument ignored the fact that it was foreign governments who were putting the pressure on gold and that it was the U.S. government’s management of its own affairs that had helped put it into the account hole in which it found itself and which had so unsettled foreign-exchange markets. It also neglected to note that by delinking the dollar from gold, the president had effectively although unintentionally amplified the power of speculators, who would henceforth play an even greater role in setting the price of any currency. In so doing, he would set in motion the creation of modern foreign exchange markets that would have little room for any but a handful of large currencies and would therefore essentially strip all but a few countries of what had once been a fundamental sovereign right—the right to print their own currencies or mint their own money. In a world where ever fewer underlying factors influence the price of money, more power accrues to the markets, and the greatest power goes to those who move the greatest sums of money.

The “Nixon shocks” that killed the Bretton Woods Agreement, while they effectively triggered the move of most of the world to fiat currencies in which the illusory value of money was more illusory than ever, did enable the United States to push through deals with its international economic partners that let the value of the dollar slip and its debt decrease. At a meeting of the Group of Ten in London in September, Connally explained what America expected of the world in trying to turn its deficit around: “We had a problem and we’re sharing it with the world—just like we shared our prosperity. That’s what friends are for.” The deficit at the time was $13 billion. Today it is more than a thousand times that.

Plans to manage the float of the dollar were not long-lived. In 1972, the British followed suit and let the pound float. A year later, the Europeans let the Americans know that they would all let their currencies float together. What this meant was that markets now ruled, as never before, the setting of the value of money. Today, global foreign exchange volumes are approximately $4 trillion a day. While governments may attempt to influence currency values through market interventions, they have only the reserves in their central banks, and whatever loans they seek to draw against those reserves, to work with. Currently, the country with the world’s largest reserves is China, with reserves in the range of $2.85 trillion. However, of this amount, it is estimated that China applies perhaps only $2 billion a day to market trading, one two-thousandth of the total trading volume on a given day. Japan, with the next highest reserves, is the only other country exceeding $1 trillion, which it does by just about $100 billion. Only twenty of the world’s countries have more than $100 billion in reserves, with the United States weighing in near the bottom of that list with only $129 billion. Thus, governments’ power to intervene in these markets is smaller than at any time in history.

Furthermore, the amount of trading that is actually conducted by speculators, hedge funds, and other investment companies that specialize in foreign exchange trading is estimated to be three-quarters of all volume or more. In addition, of the volumes being traded, only about $1.5 trillion a day is in actual foreign exchange “spot” transactions, with the remainder in various derivative instruments that are often highly complex and whose risk factors are very difficult to assess because they are neither well regulated nor well understood by any but those who specialize in them—and, as we have learned, even the specialists often do not fully understand the scope or consequences of what they are doing. The top ten companies trading currency range from Deutsche Bank, which is responsible for almost one-fifth of market share, through UBS, Barclays, Citi, Royal Bank of Scotland, J.P. Morgan, HSBC, Credit Suisse, Goldman Sachs, and Morgan Stanley.

Nonetheless, as Joseph Stiglitz has suggested, largely for reasons of ideology, economists from Milton Friedman onward have argued that letting market speculation play the kind of dominant role it does in setting modern monetary values is actually healthy. This despite the unprecedented size, complexity, volatility, opacity, and unknown risks associated with such markets. The influence of governments over the pricing of currency was further diminished by the consolidation of many of the world’s leading currencies, those of Europe, into the euro at the turn of this century. Governments gave up their control over historic currencies in order to facilitate easier trade within a single European market (as of this writing, the Eurozone is embroiled in a crisis that has raised questions about the future of the euro and how it may be managed in years to come). Just ten currencies account for virtually all of foreign exchange trading today. The dollar is involved in 85 percent of all trades, the euro in 39 percent, the yen in 19 percent, and the pound in 12.9 percent. The remainder of the ten biggest currencies are all in the single digits. For all intents and purposes there are really only four meaningful currencies traded in the world today, with the possibility looming that sometime soon the Chinese renminbi may join the list.

While the economic merits of monetary union in Europe are undeniable, they create new risks and delimit government prerogatives further. The risks have become apparent in the context of the Eurozone crisis of 2010 and 2011, in which fiscally weak countries like Greece, Spain, and Portugal have had to depend on their stronger neighboring countries to maintain their responsibilities within the European Union. Indeed, at the time of this writing, it is uncertain whether the euro experiment will succeed or whether the unwillingness of the German and other more prosperous peoples of Northern Europe to pay for the excesses of their southern neighbors may set back not only monetary union but the seemingly irreversible move toward regionalization, an important corollary to globalization and a critical driver in determining the future role of the state. Alternatively, the crisis may have the opposite effect, should European nations conclude that the costs of breaking up the Eurozone are too high. In that circumstance, the crisis may lead to the embrace of ideas such as that proposed by European Central Bank president Jean-Claude Trichet, that to achieve successful monetary union, fiscal union is also necessary, and that the European Union’s power over individual states should be strengthened through the creation of a single pan-European finance ministry to work alongside the European Central Bank.

The fact that there are only a few different currencies of note left in the world suggests that monetary policy is in the hands of just a few central bank officials, principally those in the United States, the European Union, Japan, and the United Kingdom. But we know even this to be misleading, because those central bank governors have comparatively limited resources at their disposal. Given the enormous trading volumes, it is now market forces, dominated by a handful of major private foreign exchange traders and hedge funds, that really set prices for the world’s money.

Of course, physical money itself is a very nearly an obsolete concept. Not only is there virtually no currency in circulation today that is backed by real assets, but currency itself holds a diminishing place among the tangible and virtual instruments that are swirling around the world and serving as repositories for value. Today, there are 1,655 billion physical dollars in existence, with some rough estimates of the world’s total physical currencies at over eight trillion dollars. On the other hand, the total value of the world’s derivatives is estimated at approximately $791 trillion. That’s not only almost a hundred times the currencies, it is also about fourteen times the global GDP. Derivative instruments are by far the world’s largest pool of instruments of value. Few people understand them, they are not regulated in any meaningful way, and it is impossible to know what they are truly worth, not only because their value is contingent on future conditions but also because factors such as the risks associated with the counterparties of each instrument are utterly opaque.

Other than derivatives, the total value of securities in the world today includes approximately $82.2 trillion in worldwide debt securities and $36.6 trillion in equity value (the total value of all the world’s stock markets combined). Not only does the total value of these securities dwarf all the currencies of the world, but all these securities have something in common. They were conceived, issued, and valued by the market, and they will be settled, or undone, by the market. The lifeblood of the world’s markets, the repositories of all the world’s value, are financial instruments—often complex, certainly stateless, constantly swirling above and beyond the reach and comprehension of virtually all government officials, all created, controlled, and influenced by a comparatively small group of private actors.

First Church versus State, Then State versus Market; Next … the Church of the Marketplace

In The Commanding Heights, Dan Yergin and Joe Stanislaw describe the pivotal moment during the 1970s when pro-market forces started to gain the philosophical upper hand over prior ideologies that had espoused a bigger role for government, from Marx to Keynes. “The message of the 1970s,” they write, “was that government could fail, too. Perhaps markets were not so dumb after all.” They quote the former Nixon economic adviser Herb Stein as saying:

We were at the end of two decades in which government spending, government taxes, government deficits, government regulation, and government expansion of the money supply had all increased rapidly, and at the end of those two decades the inflation rate was high, real economic growth was slow and our “normal” unemployment rate was probably higher than ever. Nothing was more natural than the conclusion that the problems were caused by all these government increases and would be cured by reversing or stopping them.

A contemporary reader can’t help but be struck by the fact that in the United States today, many of the same conditions apply after a period of protracted government disengagement from the market. In the United States and in England, the disaffection with old policies grew and ushered in a new ideological bent. Martin Feldstein, one of the most influential economists of the era, described several dimensions of it:

The intellectual roots of tax reform went beyond the technical concepts of public finance specialists. They reflect a very fundamental retreat from the general Keynesian economic philosophy that had shaped economic policy throughout the post-War period. There were four interrelated aspects of this shift in thinking: attention to the effects of incentives on behavior; a concern with capital formation; an emphasis on the efficiency of resource use; and a negative attitude about budget deficits. None of these represented new ideas in economics; they were in fact a return to the earlier views that had dominated economics from the time of Adam Smith until the Depression of the 1930s ushered in the Keynesian revolution.

As Feldstein observed in his own reflections on the period, the elections of Ronald Reagan and Margaret Thatcher in the United States and the United Kingdom respectively reflected this shift and led to a focus on policies that were intended to shrink the role of government through deregulation, cutting taxes, privatization (in Britain), and eliminating government activities wherever possible. The results were uneven. In the United States, taxes were cut dramatically, with the top rate falling by half, but government spending went up and consequently so did deficits, making government both less inclined to regulate markets and more dependent on them at the same time. During the 1980s, the number of lawyers in the Justice Department’s antitrust division was cut in half and its appropriations were slashed by a third. The Federal Trade Commission was also slashed. More business-friendly judges were appointed. An “extreme position against antitrust enforcement” not only prevailed, but the indoctrination of Justice Department lawyers went so far as to include a requirement that they take an economics course.

In Britain the coal industry was privatized. In the United States, the airline industry gained more autonomy and the private sector gained true control. British Gas and British Steel were restructured to enhance profitability and reduce government influence. The British government’s share in its North Sea oil and gas reserves was privatized—so too were airports and ports, and the country’s share in British Petroleum was similarly passed along to the people. In the United States, the telecom sector was also deregulated, and other tightly controlled industries such as the energy sector saw significant deregulation.

The former Reagan official turned Wall Street banker David Stockman asserted that “the Reagan administration believed that economic regulation was wrong as a matter of first principles.” The view was closely supported by the business establishment for obviously self-interested as well as ideological reasons. Because Reagan and Thatcher were both politically successful and their countries enjoyed periods of economic growth during their terms of office, their views and those of their philosophical guides like Milton Friedman and Feldstein were more broadly embraced. In the United States, centrist Democratic Party politicians such as Bill Clinton led this movement, later to be followed by “third way” candidates such as Labor’s Tony Blair in the United Kingdom. This not only closed the ideological gap between them and their opponents, it also made fund-raising much easier.

Too Small to Succeed: Governments in an Era of Crisis

Among the most important fund-raisers for Bill Clinton was the CEO of the company that had assumed the role Morgan once played as the clear leader of the financial community. That company was Goldman Sachs, and the fund-raiser was Bob Rubin, who would later become both the first director of Clinton’s National Economic Council and later the Treasury secretary. Rubin was one of a significant number of former Goldman officials who made his way into the U.S. government during the period. Indeed, each of his three successors at Goldman also had senior roles—Steve Friedman ran the National Economic Council for President George W. Bush, Hank Paulson served as Bush’s Treasury secretary, and Jon Corzine was both a senator and the governor of New Jersey. Others with Goldman ties took top jobs in the State Department, in the Treasury Department, at the Export-Import Bank, and in the White House. But Goldman was not alone: senior Wall Street executives became the indispensable men and women in modern American government and in governments worldwide. Goldman alone produced dozens of ministers, central bank governors, and subcabinet officials in countries around the world. Citigroup, JPMorgan Chase, and other leading financial institutions added more. But other industries, including aerospace and defense, with companies such as Lockheed Martin and Boeing, also have strong government ties. In all these cases, the revolving doors tend to swing both ways: not only do Wall Street execs snatch up White House positions, but many government employees move on to lucrative private sector jobs (a great reward for those who promote corporate-friendly policies). As a result, there is frequent movement in both directions. For instance, prior to becoming White House chief of staff in 2011, William Daley served on the board of directors of Boeing, Abbott Laboratories, Merck & Co., and JPMorgan Chase. It was not the first time he had made the transition between the public and private sectors, having previously served as secretary of commerce under Clinton. Nor was he the only such example in the Obama administration, with former Goldman employees and contractors found in top jobs from the White House to the Treasury to the State Department.

Selling themselves as the best and the brightest, top financial executives offered to political leaders from both American political parties and to governments around the world not only financial support during campaign seasons but also the ability to understand and communicate with markets that were increasingly seen as vital to the economic success or failure of governments. The more that markets usurped the governments’ traditional roles within the economy, and the more entirely new economic mechanisms and markets they created impacted global and national economies, the more vital it became for governments to work with market players who could decipher trends and serve as interlocutors to the financial power brokers. Even foreign leaders would have one campaign at home and another on Wall Street to ensure that markets would not send a signal that might damage them politically.

Furthermore, of course, the increasing dependence of governments on financing their deficits put them in precisely the same position that everyone from Charles the Bold to Lord Liverpool to Grover Cleveland had been in. Except that by the time governments came to deal with financiers in the 1990s and the first years of the twenty-first century, the deregulation, technological revolutions, and globalizations of the preceding decades had made financial actors far, far more influential, put much more money at their disposal, and let them operate, especially in global markets, with far less scrutiny or government regulation than at any time in the preceding century.

Robert Rubin led the Clinton administration to promote an aggressively pro-market agenda, ranging from the free-trade advancement on which I worked while at the Commerce Department to a systematic effort, conducted in conjunction with Larry Summers and a team that included the likes of Timothy Geithner, Gene Sperling, and others who went on to senior positions in the Obama administration, to continue the process of deregulating the American financial community. As the market in financial instruments such as derivatives exploded, Rubin resisted efforts to tighten their oversight, battling even other top Clinton appointees such as Commodity and Futures Trading Commission chief Brooksley Born. Born had urged greater bank disclosure regarding derivatives exposure, but Rubin, Summers, Fed chairman Alan Greenspan, and SEC chairman Arthur Levitt all pushed back, suggesting it was best if markets could “regulate themselves.” In June 1998, Rubin publicly denounced Born’s regulatory policies and positions and even recommended that Congress strip the CFTC of its regulatory authority. The ultimate result of his effort was an act passed by Congress on the last day of Clinton’s last year in office, 2000, called the Commodity Futures Modernization Act, which enabled banks to trade derivatives like default swaps without any government interference to speak of.

At the same time, for all the impetus toward reduced government intervention in the markets, in one area that intervention was embraced. The federal government was actually encouraged by Wall Street broadly to continue supporting low-rate lending for housing. Turning Americans into homeowners not only had the benefit of creating a big market in mortgages and mortgage-backed securities, but the more home buyers there were, the more homes were thought to be worth, and the more people felt they could borrow or invest—a boon to finance at every turn. In 1997, the total value of real estate owned by U.S. households was $8.8 trillion; by 2006, the figure was almost $22 trillion. During most of the 1980s and 1990s, the ratio of the average American home price to the median household income had hovered around 3 to 1. By 2006 it was almost 5 to 1. In San Francisco’s Bay Area and in Los Angeles it was around 10 to 1. While this should have looked like a bubble to anyone familiar with bubbles, government observers like the Fed chairman Alan Greenspan argued that it couldn’t be one because houses were illiquid and thus unlikely to attract speculators. Quite aside from the fact that this probably meant Greenspan didn’t get out enough to have the experience I did of having waiters touting their condo-flipping strategies to my family while we were on vacation, it ignored the fact that the Clinton administration’s liberalizations had fueled the explosive growth of the mortgage-backed securities market, and those securities were quite liquid enough to attract reckless investment.

Knowing Bob Rubin and his colleagues in the Clinton administration and many of their successors during the Bush years, I know that in a very sincere way they felt that they were promoting growth by promoting market efficiency. I don’t believe that they were acting in a calculated protection of their interests as former or future bankers or investors. They had internalized predominant contemporary views. But clearly, a miscalculation was made. The Commodity Futures Modernization Act, like the pushback on Born’s initiatives and the repeal of the Glass-Steagall Act—a Depression-era regulation designed to keep commercial banks and investment banks separate—all helped enable and thus fuel conditions that led to the housing bubble and to the crash that was precipitated by its bursting.

What is interesting about this latest crisis, however, is the subtle twists in the usual script that actually demonstrate the even greater power and impunity financial giants have in today’s world. (These in turn triggered the international backlash against many of the ideologies that led both to the crash and to the erroneous 1990s- and 2000-vintage assumption that American cowboy capitalism was the inevitable future for markets everywhere.) The crisis had the usual elements—the bubble, the government incompetence, the cadres of government officials co-opted by too-close relationships with those they were supposed to regulate, the lack of understanding of the nature of changing market dynamics, and the panic selling that led observers to fear catastrophe. It even included the meetings of committees of senior bankers with government officials to work through the crisis, officials who recognized (as Tim Geithner acknowledged) that they had to rely on such informal groups—as Roosevelt had done—because they lacked the proper tools to control the markets.

Whereas some might observe that today’s banks must be less powerful because they are not the ones bailing out government as Morgan did, the reality is the reverse. These institutions—by virtue of lobbying, of the influence bought by donations, of the influence bought by having their people in senior positions—pushed through a series of regulatory reforms that promoted an idea that would be laughable in any other industry: that they could self-regulate. (Imagine one of those same bankers getting into a self-regulating taxicab or brushing his or her teeth with toothpaste produced by a self-regulated pharmaceutical company.) Then, when that consequence of their exercised power put them in a tough position, they were able to go back to the government and argue that they—champions of free markets and reduced government intervention—were “too big to fail” and that the government had to bail them out. And when the crisis began to pass and they no longer needed the government’s funds, they returned them and demanded that the government get out of their hair again. When the government sought to tighten regulations on them, they pushed back hard and managed to influence reform efforts so that the core issues on which the crisis turned—such as the opacity of derivatives markets—were not addressed. The fact that global finance put many of those markets beyond the reach of national regulators was even raised by some heads of state and top government officials, notably France’s president Nicolas Sarkozy and Germany’s chancellor and finance minister, but reform was blocked by the United States under the argument that we had to protect our sovereignty. That not having any international regulatory mechanisms at all actually ensures zero sovereign influence rather than having at least some through an effective multilateral mechanism was an argument that fell on deaf administration ears.

Companies like Goldman Sachs profited in the run-up to the crisis, were bailed out during the crisis, and have returned to great profitability and rich executive bonuses sooner after the crisis than any other businesses. Goldman may be the most prominent example of a financial firm that distinguished itself before, during, and after the 2008–2009 financial crisis by its apparent excess and its seeming sense of entitlement to a government that served its needs but did not cramp its style. But it is clearly not the only such company. Among other financial firms, Morgan Stanley, Citigroup, Bank of America, and dozens of European firms were all prime beneficiaries of the cozy relationship between big business and government at the time of the crisis; all those companies each received billions of dollars in emergency loans from the Federal Reserve in order to continue operating throughout the crisis. Those loans were not only received on favorable terms but they were dispensed in a fashion that was so far from transparent that their details were not even fully revealed until years afterward.

That said, the roots of contemporary America’s discontent with a business culture of excess, abuse, and taking advantage of prolonged periods of lax oversight extends back at least a decade before 2008 (every generation, in fact, has examples of such cases). The Enron and WorldCom scandals are two prominent cases that came to symbolize the apex of a long trend of accounting fraud that shook Americans’ faith in the corporate and financial worlds years ago. Both Enron and WorldCom had fraudulently booked millions of dollars in profit over the course of several years, which fooled investors into thinking the companies were performing better than they actually were. Both spiraled into bankruptcy when the extent of their fraud was revealed, doing damage to the public in the form of investors’ empty wallets and the thousands of innocent employees who lost their jobs.

Another way in which big corporations have, in recent years, stoked public resentment is through their ability to largely avoid taxes and their ongoing lobbying of the financially strapped U.S. federal government for favorable tax breaks. For example, one of America’s oldest and most successful companies, General Electric, has a decades-long history of paying shockingly small percentages of its earnings to the U.S. Treasury through creative tax-avoidance strategies. In a New York Times article titled “G.E.’s Strategies Let It Avoid Taxes Altogether,” David Kocieniewski describes how the company has systematically slashed the percentage of U.S. profits it pays to the federal government through the use of “innovative accounting techniques” and aggressive lobbying for lower tax rates. In 2010, G.E.’s total tax burden was 7 percent of its profits—less than a third of what even the average multinational corporation pays in total taxes. The article notes that G.E.’s tax department is known as the “world’s best tax law firm,” and over the course of the last decade the company spent $200 million lobbying to push for changes in U.S. tax law. This approach—as well as G.E.’s track record of years of relocating major manufacturing facilities overseas—has proved an embarrassment to the Obama administration after it appointed G.E.’s chairman, Jeffrey Immelt, as the chairman of its efforts to stimulate U.S. competitiveness and job creation.

It is therefore not any one of these stories but rather the seemingly endless parade of them—of instances of the (often overly) aggressive pursuit of profits and lax standards or the lack of shared interests with the communities within which certain companies operate—that has contributed to the gradual but steady erosion of public support for the relaxed regulatory regimes and special treatment to which many companies have grown accustomed. In the wake of the crisis, we have also discovered that Goldman and other Wall Street firms had extraordinary influence over even government decisions pertaining to Goldman. In one instance, they argued to the CFTC that their commodities trading division J. Aron should be able to place big bets on oil price fluctuations without government intervention because they had every incentive to be careful enough, since they stood to lose a lot of money if they were wrong. When a congressional staffer later learned of the letter from Goldman to the CFTC and requested a copy, the CFTC didn’t release it to Congress until Goldman had given it the okay to do so. On another occasion, I sat in the office of the former AIG CEO Maurice “Hank” Greenberg listening as he described how, as AIG and Lehman Brothers were allowed to fail, the former Goldman CEO and Treasury secretary Hank Paulson was in close consultation throughout with the current Goldman CEO, Lloyd Blankfein. Greenberg was practically spluttering when he described how Paulson determined to direct AIG to accept billions from the government only to pass the funds along to counterparties in order to preserve the counterparties rather than AIG—with the largest of those counterparties and fund recipients being Goldman, and the only financial institution represented in the room with Paulson at the time being Goldman (represented by Blankfein). During that AIG bailout, Paulson called Blankfein twenty-four times.

This last transaction was essentially a direct cash payment from the taxpayers of the United States to the shareholders of Goldman Sachs, formerly prominent champions of small government and leaving it to the markets. Whom did the government put in charge of the TARP program to provide bailout funds to Wall Street? Neel Kashkari, a thirty-five-year-old Goldman man.

The Rolling Stone reporter Matt Taibbi, who did groundbreaking work covering this crisis, wrote in his searing article “The Great American Bubble Machine” that

The collective message of all this—the AIG bailout, the swift approval for its bankholding conversion, the TARP funds—is that when it comes to Goldman Sachs, there isn’t a free market at all. The government might let other players on the market die, but it simply will not allow Goldman to fail under any circumstances. Its edge in the market has suddenly become an open declaration of supreme privilege.

That sense of privilege was on display to the world when Goldman executives rudely shrugged off the questions of Congress during hearings and again when soon after the crisis they resumed awarding themselves enormous bonuses, bonuses they could not have enjoyed without the intervention of taxpayers. During 2008, however, the company paid only $14 million in taxes on $1.4 billion in earnings, a 1-percent rate. Part of the reason for this was its “geographic earnings mix,” a tool many multinationals use to move earnings offshore where taxes are low. In other words, Goldman was a U.S. company when it needed U.S. funds but less so when it came to paying taxes.

The experience has not been chastening for Goldman. Blankfein argues that the company did not need the bailout—a claim that even the former Goldmanite Kashkari finds absurd. Further, Blankfein asserts, “We’re very important. We help companies grow by helping them to raise capital. Companies that grow create wealth. This in turn, allows people to have jobs that create more growth and more wealth. It’s a virtuous cycle.” As Mae West might have said, “Virtue had nothing to do with it.” Still, there is a certain practical reality that does come into play when considering whether to rein in these giant financial organizations. Perhaps not surprisingly, it comes up in conversation with men like Robert Rubin.

I sat with him in his office at the Council on Foreign Relations in New York, a modest room filled with half-packed crates, before he headed off to his next venture. He is a quiet, very thoughtful man to begin with, and when the conversation turned to whether he had any regrets about the liberalizations of the 1990s, he came out in roughly the same place as had his protégé Summers. He felt that they had advocated the right policies and that he would argue the same things today. He wondered aloud whether we had not taken enough account of the dislocations associated with free trade. And he certainly recognized that more could have been done to anticipate the upheaval in the housing market. But when asked about whether the biggest and most influential financial organizations ought to be broken up, whether being “too big to fail” really was a problem to be addressed, he immediately shook his head.

“No,” he said, “don’t you see? Too big to fail isn’t a problem with the system. It is the system. You can’t be a competitive global financial institution serving global corporations of scale without having a certain scale yourself. The bigger multinationals get, the bigger financial institutions will have to get.”

Another Euro-Anomaly: A Banking Crisis in Sweden

There is logic to what Rubin says. Moreover, there is a certain inevitability to it if the scales of power continue to tip in the direction of the markets and their biggest players. But the crisis of 2008 and 2009 was also a turning point, a wake-up call. In other parts of the world, the American capitalist system, while it was still widely regarded as the world’s most effective engine of growth, was seen to be flawed in substantial ways. Those offering other models saw their systems as having a revitalized appeal, from European governments that had long held that the public sector must partner with business, to those in Asia to whom that partnership was something even closer, more symbiotic, and who still saw companies as serving a national as well as a narrow shareholder-focused purpose.

One senior Asian government official with whom I met said that throughout his life, whatever his colleagues from throughout the region may have thought of America, after a meeting with Americans at which differences might be aired he always had the sense that everyone in the room felt that in order to succeed, his country must become more like America. In the wake of the crisis, he argued, “That’s no longer the case. Irreparable damage has been done to American capitalism.”

Even in little Sweden, Par Nuder made the case that not only did Sweden handle the threat to their automakers and the challenges of globalization better because of the centrality of the social contract to their vision of how markets should work, but when they faced their own banking crisis in the early 1990s, also caused by a burst real estate bubble, “We stepped in and where a bank needed help, we gave it. But if the people of Sweden bailed out the bank, the government made sure the people of Sweden got something in return and not just the token repayments you got in America. We realize that our country and our companies are in a kind of partnership, but unlike what you have developed in America, we don’t see that partnership as a one-way street.”