by Naomi Klein
CHAPTER 8
CRISIS WORKS
THE PACKAGING OF SHOCK THERAPY
Well, what is the sense of ruining my head and erasing my memory, which is my capital, and putting me out of business? It was a brilliant cure but we lost the patient.
—Ernest Hemingway on his electroshock therapy, shortly before committing suicide, 19611
For Jeffrey Sachs, the lesson of his first international adventure was that hyperinflation could indeed be stopped in its tracks, with the right tough and drastic measures. He had gone to Bolivia to slay inflation and he had done it. Case closed.
John Williamson, one of the most influential right-wing economists in Washington and a key adviser to the IMF and the World Bank, was watching Sachs’s experiment closely, and he saw something of far greater significance in Bolivia. He described the shock therapy program as “the big bang” moment—a breakthrough in the campaign to bring the Chicago School doctrine to the entire globe.2 The reason had little to do with economics and everything to do with tactics.
It may not have been his intention, but in quite spectacular fashion Sachs had proven that Friedman’s theory about crisis was absolutely correct. Bolivia’s hyperinflation meltdown was the excuse that was needed to push through a program that would have been politically impossible under normal circumstances. Here was a country with a strong, militant labor movement and a powerful left tradition, site of Che Guevara’s last stand. Yet it had been forced to accept draconian shock therapy in the name of stabilizing its out-of-control currency.
By the mid-eighties, several economists had observed that a true hyperinflation crisis simulates the effects of a military war—spreading fear and confusion, creating refugees and causing large loss of life.3 It was strikingly clear that in Bolivia, hyperinflation had played the same role as had Pinochet’s “war” in Chile and the Falklands War for Margaret Thatcher—it had created the context for emergency measures, a state of exception during which the rules of democracy could be suspended and economic control could be temporarily handed over to the team of experts in Goni’s living room. For hard-core Chicago School ideologues like Williamson, that meant that hyperinflation was not a problem to be solved, as Sachs believed, but a golden opportunity to be seized.
There was no shortage of such opportunities in the eighties. In fact, much of the developing world, but particularly Latin America, was at that very moment spiraling into hyperinflation. The crisis was the result of two main factors, both with roots in Washington financial institutions. The first was their insistence on passing on illegitimate debts accumulated under dictatorships to new democracies. The second was the Friedman-inspired decision at the U.S. Federal Reserve to allow interest rates to soar, which massively increased the size of those debts overnight.
Passing on Odious Debts
Argentina was a textbook case. In 1983, when the junta collapsed after the Falklands War, Argentines elected Raúl Alfonsín as their new president. The newly liberated country was rigged to detonate, thanks to the planting of a so-called debt bomb. As part of what the outgoing junta had termed a “dignified transition” to democracy, Washington insisted that the new government agree to pay off the debts amassed by the generals. During junta rule, Argentina’s external debt had ballooned from $7.9 billion the year before the coup to $45 billion at the time of the handover—debts owed to the International Monetary Fund, the World Bank, the U.S. Export-Import Bank and private banks based in the U.S. It was much the same across the region. In Uruguay, the junta took a debt of half a billion dollars when it seized power and expanded it to $5 billion, a huge load in a country of only 3 million people. In Brazil, the most dramatic case, the generals, who came to power in 1964 promising financial order, managed to take the debt from $3 billion to $103 billion in 1985.4
At the time of the transitions to democracy, powerful arguments were made, both moral and legal, that these debts were “odious” and that newly liberated people should not be forced to pay the bills of their oppressors and tormentors. The case was especially strong in the Southern Cone because so much of the foreign credit had gone straight to the military and police during the dictatorship years—to pay for guns, water cannons and state-of-theart torture camps. In Chile, for instance, the loans bankrolled a tripling in military spending, enlarging Chile’s army from forty-seven thousand in 1973 to eighty-five thousand in 1980. In Argentina, the World Bank estimates that roughly $10 billion of the money borrowed by the generals went to military purchases.5
Much of what wasn’t spent on weapons simply vanished. A culture of corruption permeated junta rule—a glimpse of the debauched future to come when the same free-wheeling economic policies spread to Russia, China and the “free fraud zone” of occupied Iraq (to borrow a phrase from a disaffected U.S. adviser).6 According to a 2005 U.S. Senate report, Pinochet maintained a byzantine web of at least 125 secret foreign bank accounts listed under the names of various family members and combinations of his own name. The accounts, the most notorious of which were at the Washington, D.C.–based Riggs Bank, hid an estimated $27 million.7
In Argentina, the junta has been accused of being even more acquisitive. In 1984, José Martínez de Hoz, architect of the economic program, was arrested on fraud charges relating to a massive state subsidy to one of the companies he used to head (the case was later dismissed).8 The World Bank, meanwhile, later tracked what happened to $35 billion in foreign loans borrowed by the junta and found that $19 billion—46 percent of the total—was moved offshore. Swiss officials have confirmed that much of it ended up in numbered accounts.9 The U.S. Federal Reserve observed that in 1980 alone, Argentina’s debt expanded by $9 billion; in that same year, the amount of money deposited abroad by Argentine citizens increased by $6.7 billion.10 Larry Sjaastad, a famed University of Chicago professor who personally trained many of Argentina’s Chicago Boys, has described these missing billions (stolen under the noses of his students) as “the greatest fraud of the twentieth century.”*11
The junta embezzlers even enlisted their victims in these crimes. At the ESMA torture center in Buenos Aires, prisoners with strong language skills or university educations were regularly pulled out of their cells to perform clerical tasks for their captors. One survivor, Graciela Daleo, was instructed to type a document advising officers on offshore tax havens for the money they were embezzling.12
The remainder of the national debt was mostly spent on interest payments, as well as shady bailouts for private firms. In 1982, just before Argentina’s dictatorship collapsed, the junta did one last favor for the corporate sector. Domingo Cavallo, president of Argentina’s central bank, announced that the state would absorb the debts of large multinational and domestic firms that had, like Chile’s piranhas, borrowed themselves to the verge of bankruptcy. The tidy arrangement meant that these companies continued to own their assests and profits, but the public had to pay off between $15 and $20 billion of their debts; among the companies to receive this generous treatment were Ford Motor Argentina, Chase Manhattan, Citibank, IBM and Mercedes-Benz.13
Those who favored defaulting on these illegitimately accumulated debts argued that the lenders knew, or ought to have known, that the money was being spent on repression and corruption. This case was bolstered recently when the State Department declassified the transcript of a meeting held on October 7, 1976, between Henry Kissinger, then secretary of state, and Argentina’s foreign minister under the military dictatorship, the admiral César Augusto Guzzetti. After discussing the international human rights outcry following the coup, Kissinger said, “Look, our basic attitude is that we would like you to succeed. I have an old-fashioned view that friends ought to be supported…. The quicker you succeed, the better.” Kissinger then moved on to the topic of loans, encouraging Guzzetti to apply for as much foreign assistance as possible and fast, before Argentina’s “human rights problem” tied the hands of the U.S. administration. “There are two loans in the bank,” Kissinger said, referring to the Inter-Ameri
can Development Bank. “We have no intention of voting against them.” He also instructed the minister, “Proceed with your Export-Import Bank requests. We would like your economic program to succeed and we will do our best to help you.”14
The transcript proves that the U.S. government approved loans to the junta knowing they were being used in the midst of a campaign of terror. In the early eighties, it was these odious debts that Washington insisted Argentina’s new democratic government had to repay.
The Debt Shock
On their own, the debts would have been an enormous burden on the new democracies, but that burden was about to get much heavier. A new kind of shock was in the news: the Volcker Shock. Economists used this term to describe the impact of the decision made by Federal Reserve chairman Paul Volcker when he dramatically increased interest rates in the United States, letting them rise as high as 21 percent, reaching a peak in 1981 and lasting through the mid-eighties.15 In the U.S., rising interest rates led to a wave of bankruptcies, and in 1983 the number of people who defaulted on their mortgages tripled.16
The deepest pain, however, was felt outside the U.S. In developing countries carrying heavy debt loads, the Volcker Shock—also known as the “debt shock” or the “debt crisis”—was like a giant Taser gun fired from Washington, sending the developing world into convulsions. Soaring interest rates meant higher interest payments on foreign debts, and often the higher payments could only be met by taking on more loans. The debt spiral was born. In Argentina, the already huge debt of $45 billion passed on by the junta grew rapidly until it reached $65 billion in 1989, a situation reproduced in poor countries around the world.17 It was after the Volcker Shock that Brazil’s debt exploded, doubling from $50 billion to $100 billion in six years. Many African countries, having borrowed heavily in the seventies, found themselves in similar straits: Nigeria’s debt in the same short time period went from $9 billion to $29 billion.18
These were not the only economic shocks zapping the developing world in the eighties. A “price shock” occurs every time the price of an export commodity like coffee or tin drops by 10 percent or more. According to the IMF, developing countries experienced 25 such shocks between 1981 and 1983; between 1984 and 1987, the height of the debt crisis, they experienced 140 such shocks, pushing them deeper into debt.19 One hit Bolivia in 1986, the year after it had swallowed Jeffrey Sachs’s bitter medicine and submitted to a capitalist makeover. The price of tin, Bolivia’s major export other than coca, dropped by 55 percent, devastating the country’s economy through no fault of its own. (This was precisely the kind of dependence on raw resource exports that developmentalist economics had been trying to transcend in the fifties and sixties—an idea dismissed as “fuzzy” by the Northern economic establishment.)
This is where Friedman’s crisis theory became self-reinforcing. The more the global economy followed his prescriptions, with floating interest rates, deregulated prices and export-oriented economies, the more crisis-prone the system became, producing more and more of precisely the type of meltdowns he had identified as the only circumstances under which governments would take more of his radical advice.
In this way, crisis is built into the Chicago School model. When limitless sums of money are free to travel the globe at great speed, and speculators are able to bet on the value of everything from cocoa to currencies, the result is enormous volatility. And, since free-trade policies encourage poor countries to continue to rely on the export of raw resources such as coffee, copper, oil or wheat, they are particularly vulnerable to getting trapped in a vicious circle of continuing crisis. A sudden drop in the price of coffee sends entire economies into depression, which is then deepened by currency traders who, seeing a country’s financial downturn, respond by betting against its currency, causing its value to plummet. When soaring interest rates are added, and national debts balloon overnight, you have a recipe for potential economic mayhem.
Chicago School believers tend to portray the mid-eighties onward as a smooth and triumphant victory march for their ideology: at the same time that countries were joining the democratic wave, they had the collective epiphany that free people and unfettered free markets go hand in hand. That epiphany was always fictional. What actually happened is that just as citizens were finally winning their long-denied freedoms, escaping the shock of the torture chambers under the likes of the Philippines’ Ferdinand Marcos and Uruguay’s Juan María Bordaberry, they were hit with a perfect storm of financial shocks—debt shocks, price shocks and currency shocks—created by the increasingly volatile, deregulated global economy.
Argentina’s experience of how the debt crisis was compounded by these other shocks was, unfortunately, typical. Raúl Alfonsín took office in 1983, in the midst of the Volcker Shock, which placed the new government in crisis mode from day one. In 1985, inflation was so bad that Alfonsín was forced to unveil a brand-new currency, the austral, gambling that a fresh start would allow him to regain control. Within four years, prices had soared so high that massive food riots broke out, and Argentine restaurants were using the currency as wallpaper because it was cheaper than paper. In June 1989, with inflation up 203 percent that month alone, and five months before his term was set to expire, Alfonsín gave up: he resigned and called early elections.20
Other options were available to politicians in Alfonsín’s position. He could have defaulted on Argentina’s huge debts. He could have joined with neighboring governments in the same crisis and formed a debtors’ cartel. These governments could have created a common market based on developmentalist principles, a process that had begun when the region was torn apart by sadistic military regimes. But part of the challenge at the time had to do with the legacy of state terror faced by new democracies. In the eighties and nineties, much of the developing world was in the grip of a kind of terror hangover, free on paper but still cautious and wary. Having finally escaped the darkness of dictatorship, few elected politicians were willing to risk inviting another round of U.S.-supported coups d’état by pushing the very policies that had provoked the coups of the seventies—especially when the military officials who had staged them were, for the most part, not in prison but, having negotiated immunity, in their barracks, watching.
Understandably unwilling to go to war with the Washington institutions that owned their debts, crisis-struck new democracies had little choice but to play by Washington’s rules. And then, in the early eighties, Washington’s rules got a great deal stricter. That’s because the debt shock coincided precisely, and not coincidentally, with a new era in North-South relations, one that would make military dictatorships largely unnecessary. It was the dawn of the era of “structural adjustment”—otherwise known as the dictatorship of debt.
Philosophically, Milton Friedman did not believe in the IMF or the World Bank: they were classic examples of big government interfering with the delicate signals of the free market. So it was ironic that there was a virtual conveyor belt delivering Chicago Boys to the two institutions’ hulking headquarters on Nineteenth Street in Washington, D.C., where they took up many of the top positions.
Arnold Harberger, who headed the University of Chicago’s Latin America program, often brags about how many of his graduates landed powerful jobs at the World Bank and the IMF. “There was one moment in time when four regional chief economists at the World Bank had been my students in Chicago. One of them, Marcelo Selowsky, went off to be the chief economist for the newly minted ex-Soviet empire area, which is the biggest such job in the whole Bank. And guess what? He was replaced by yet another former student, Sebastian Edwards. So it’s very nice to see these people moving up, and I’m proud to have played a part in their development as economists.”21 Another star was Claudio Loser, an Argentine who graduated from the University of Chicago in 1971 and went on to become director of the Western Hemisphere Department of the IMF, the most senior post dealing with Latin America.* Chicagoans occupied many other senior IMF posts as well, including the second-highest po
sition, first deputy managing director, as well as chief economist, director of research and senior economist of the African Department.22
Friedman may have opposed the institutions on philosophical grounds, but practically, there were no institutions better positioned to implement his crisis theory. When countries were sent spiraling into crisis in the eighties, they had nowhere else to turn but the World Bank and the IMF. When they did, they hit a wall of orthodox Chicago Boys, trained to see their economic catastrophes not as problems to solve but as precious opportunities to leverage in order to secure a new free-market frontier. Crisis opportunism was now the guiding logic of the world’s most powerful financial institutions. It was also a fundamental betrayal of their founding principles.
Like the UN, the World Bank and the IMF were created in direct response to the horror of the Second World War. With the goal of never again repeating the mistakes that had allowed fascism to rise in the heart of Europe, the world powers came together in 1944 in Bretton Woods, New Hampshire, to create a new economic architecture. The World Bank and the IMF, financed through contributions by their initial forty-three member countries, were given the explicit mandate to prevent future economic shocks and crashes like the ones that had so destabilized Weimar Germany. The World Bank would make long-term investments in development to pull countries out of poverty, while the IMF would act as a kind of global shock absorber, promoting economic policies that reduced financial speculation and market volatility. When a country looked as though it was falling into crisis, the IMF would leap in with stabilizing grants and loans, thereby preventing crises before they occurred.23 The two institutions, located across the street from each other in Washington, would coordinate their responses.
