By Martijn Konings
For some time, it appeared that the severity of the global financial crisis had created a compelling 'learning moment' that promised to return the world to a more civilised form of capitalism.
Insufficient regulation was widely seen to have created an over-leveraged financial system that did more to reward speculation than to enable productive economic activity, and post-crisis reforms were expected to address this problem.
Fast-forward to the present: the idea that banks' market freedoms should be curtailed has all but disappeared from mainstream public discourse. Government is once again seen as the problem rather than the solution.
Instead, 'austerity' is the new political mantra: threats to economic prosperity are seen to stem from over-generous social programs, bargaining rights of unions and the job security of public sector workers.
In the US, this reversal has triggered some particularly curious political dynamics.
In order for the US Treasury to be able to meet its financial obligations, Congress needs to raise the limit on the national debt by August 2.
As a condition for their agreement to this, Republicans insist on drastic austerity measures through major cuts in social programs.
They have a truly awesome blackmail weapon: were the US to default on even a small part of its financial commitments, it would not only deal a major blow to the American economy but likely also trigger a massive implosion of the world economy at large.
US Treasury bills function as the pivot of the global economy and a downgrading of Treasury debt by the rating agencies would be a more catastrophic event than the world's gold stocks turning into lead overnight.
Of course, the advocates of debt reduction argue that the US national debt is unsustainable as it is; they see their demands for public austerity precisely as an attempt to reverse course before the US hits the iceberg it is heading for.
This seemed to be the argument made by James Gorman, the Australian CEO of Morgan Stanley, who last week identified the American national debt as the key problem facing the world economy.
But it is important to appreciate that the image of the US economy crumbling under the weight of its debt and dragging the rest of the world down with it has been a consistent theme over the past decades.
Time and again, it has turned out that the limits to the American government's ability to fund debts are highly stretchable.
Precisely because the dollar is the pivot of the global economy, the world has an interest in keeping it afloat.
America's ability to borrow is of course not without limits, but that the issue should have become so explosive now – that is, after a decade where the US has experienced no problems financing the stupendous increases in national debt resulting from wars, tax breaks and bailouts – certainly has much more to do with politics than economics.
The emphasis on American debt as the key problem facing the American and global economy might seem especially odd in the light of growing awareness that the pace of recovery is too slow and that unemployment remains at staggering levels.
But the problem is not so much that the recovery is sluggish, but rather that it is highly uneven: as ordinary people are faced with levels of unemployment not seen since the Great Depression, the financial sector is embarking on a new boom.
Assurances that the banks have mended their ways ring hollow: the reasons that banks are doing so well have very little to do with an ability to contribute to economic growth and employment, and everything with an abundance of new opportunities for speculation and the kind of creative financing solutions that were at the root of the crisis.
Moreover, the banks owe their good fortune in significant measure to support from the American government. The recovery of the financial sector has to do not only with the massive bailouts of several years ago, but also leans heavily on the ongoing presence of the American central bank at the heart of the financial markets.
As Perry Mehrling argues in his book The New Lombard Street, in the wake of the GFC the Federal Reserve has become a market-maker: it owns large parts of America's financial system, trades in an extraordinary range of financial assets, and provides banks with virtually free money to take advantage of the market opportunities it has created.
The market for US government debt has been an especially hospitable corner of the financial system, allowing financial firms to profit from trading the debt that was issued to bail them out. Underneath the austerity story hides a reality of massive, ongoing government support for financial firms.
America's financial elites are of course well aware that they are among the government's primary beneficiaries, and that their firms would be the first to go down if the US Treasury were to default on its debts.
So I imagine that their willingness to fuel the austerity fire is at least in part motivated by an expectation that there is no real danger of an American default.
This assessment is probably correct: as Timothy Geithner put it, a default is just not an option and that is why it probably won't happen.
Certainly the Democrats are quite reliable when it comes to giving in to blackmail, and in the unlikely event that an agreement is not reached, it wouldn't be the first time that the US executive branch finds ways to do what is necessary without Congressional approval.
In the meantime, demands for austerity conveniently fuel a public debate that shifts further and further away from serious consideration of public constraints on the financial sector and depicts the world's economic problems as stemming from the extravagance of social programs and the absurd privileges of teachers' unions.
The US will find a way to make sure that it maintains payments on its debt; financial sector profits will continue to grow; the rest of the economy will continue on its path of sluggish recovery; and in about five years from now, there will be another financial crisis requiring the American government to step in and bail out the same firms that are now calling for austerity measures.