Postwar economic booms triggered by military buildups have been the underlying cause of every major episode of financial and monetary instability the United States has experienced since World War II. The United States has suffered two major system-wide banking crises since 1945. The first struck hardest in 1988. Yet, the crisis, which was centered in savings and loan (S&L) institutions, evolved over a longer period. Between 1985 and 1992 approximately half of the existing S&Ls – more than 1,500 in number – were closed due to insolvency. At the time, the S&L crisis was the largest systemic banking crisis to occur in the American economy since the Great Depression. The second systemic banking crisis occurred in 2008. In this episode, five of the largest U.S. investment banks were closed or restructured, commercial banks that collectively held more than 15 percent of all commercial bank assets failed, and the major U.S. banking groups that didn't fail survived only by virtue of a massive injection of public funds. The United States has also suffered one episode of monetary instability. Beginning in early 1968, the United States experienced a run on the dollar, characterized by speculative attacks on the dollar's peg to gold of varying intensity, that persisted through early 1973 and forced the U.S. government to end the convertibility of the dollar into gold and destroyed the international monetary system as a consequence. As is evident, each of these three episodes occurred late in the economic boom, triggered by a major military buildup.

These episodes of financial and monetary instability arose from the booms generated by deficit-financed military buildups. The two banking crises occurred as the last step in a three-stage process. In the first stage, pro-cyclical fiscal policy imparted by the military buildup and the resulting economic boom combined with extremely large capital inflows to spark a credit boom.

Budget politics since 1965, with perhaps a brief reprieve during the mid-1970s, have been dominated by efforts to rein in budget deficits. The federal government has recorded deficits in just about every year of this almost half century, managing to keep expenditures below revenues only in 1969 and then forty years later in 1998–2001. Across this period, postwar budget deficits averaged 2.6 percent of gross domestic product (GDP), climbing to as large as 6 percent of GDP during the 1980s. In spite of the apparent permanence of budget deficits, American politicians have refused to embrace them as an ordinary element of America's post-war political economy. Instead, deficit reduction has become the focus of intense bargaining between key players in the executive branch and Congress. Efforts to reduce deficits usually entail negotiating agreements that provide some combination of higher taxes and reduced spending on social welfare programs.

Although large cuts to military spending have rarely occupied a prominent role in the deficit reduction negotiations, military buildups have nevertheless pushed deficit reduction to the fore of American budget politics for two reasons. First, postwar military buildups have created the large and persistent budget imbalances that generate the pressure for deficit reduction in the first place. Second, the nature of the security shock that sparks the increase in military spending that generates the budget imbalance means that the single largest discretionary spending program is removed from the set of programs that can be adjusted to reduce the budget deficit. Thus, military buildups undertaken in response to security shocks have forced policymakers to reduce a large deficit by negotiating mutually acceptable packages of higher taxes and reduced social welfare spending.

The ability of the administration and Congress to agree on deficit reduction packages has been delayed by many years in every instance since 1960.

America's deficit-financed military buildups have had a powerful impact on its postwar macroeconomic performance. Three of the American economy's four longest postwar economic expansions have occurred in the midst of, and were triggered by, the three post–Korean War military buildups, all of which, as we have seen, were paid for by running large budget deficits. These postwar booms have been responsible for a considerable share of the increased prosperity the American economy has generated since World War II. In each instance, the unemployment rate has been cut in half over the course of the boom. And each boom has raised per capita income by about 22 percent, on average, although since the 1980s these income gains have been unevenly distributed. Deficit-financed military buildups have thus ushered in extended periods of exceptional prosperity. These booms have also carried less welcome consequences. They have been associated with an overvalued dollar, which in trade-adjusted terms has appreciated by about 30 percent during each boom. Buildups have been accompanied by deteriorating current account balances.

America's deficit-financed military buildups have generated economic booms because of America's global financial power. American financial power is generally seen to derive from the dollar's position at the center of the international monetary system as a reserve and vehicle currency. As Cohen (2006: 45) notes, the dollar's international centrality creates a sustained global demand for dollar denominated assets. The United States' position at the center of the international financial system enables American residents to attract foreign capital in large volumes at low interest rates for extended periods. As a result, when the American demand for capital rises, the United States simply attracts a larger share of total cross-border capital flows. Because the United States can import large volumes of capital from the rest of the world for extended periods, the persistent budget deficits that result from military buildups do not crowd out private investment.

What drives changes in U.S. military spending? Answering this question is the critical first step toward a deeper understanding of how the military dimension of American hegemony has shaped postwar economic performance. It is such a critical first step because military spending constitutes one of only a handful of government programs with the ability to impart a powerful stimulus to the American economy. Two simple statistics illustrate this point. First, throughout the postwar period, the defense budget has constituted the largest single category of U.S. federal government discretionary spending. In fiscal year 2012, for instance, the Department of Defense accounted for just over half of total discretionary federal government expenditures. Moreover, the gap between first and second place is huge. The Department of Education received $79.1 billion, roughly 12 percent of the amount allocated to the Department of Defense. Second, because the military accounts for such a large share of the federal budget, it constitutes a substantial share of national expenditures. As a share of total national income, military expenditures have averaged roughly 6 percent across the postwar period. Because military spending occupies so much of federal discretionary spending, and because these expenditures constitute an important share of national income, government decisions about military spending have potential consequences for macroeconomic activity that are unparalleled by any other single private or public activity.

In spite of the economic importance of postwar military spending, we know relatively little about the political dynamics that have driven its variation. This limited insight is not for lack of attention. Research on U.S. defense spending has focused on two models: a threat-driven approach and a bureaucratic politics approach. Throughout the Cold War era, researchers sought to explain U.S. military spending in terms of an arms race between the United States and the Soviet Union (see, e.g., Lambelet 1973; Mintz 1992; Moll and Luebbert 1980; Ostrom and Marra 1986; Richardson 1960).

The fall of 2008 was momentous for the United States. Financial instability that had been simmering just beneath the crust of a deflating property bubble since the summer of 2007 erupted with full force in September. In a short span of time, the U.S. government took over Fannie Mae and Freddie Mac, the two government-sponsored entities that guaranteed half of all outstanding mortgage debt. Lehman Brothers was allowed to enter bankruptcy, Merrill Lynch was acquired by Bank of America, Washington Mutual was rendered insolvent and sold to JP Morgan, and Wells Fargo acquired Wachovia. Many of the banks that survived did so only because the federal government enacted an emergency $750 billion Toxic Asset Relief Program (TARP) that enabled rapid recapitalization, and the Federal Reserve Bank purchased mortgage-backed securities in unlimited amounts. As investors panicked in the face of the apparent meltdown of the American financial system, normally liquid credit markets froze and the crisis expanded into Europe. In all, some twenty-eight countries experienced systemic banking crises in 2008 and 2009. The financial crisis thus clearly marked the end of the credit boom that had driven the housing bubble through much of the previous five years.

In mid-November of that same year, the U.S. and Iraqi governments signed a Status of Forces Agreement by which the United States committed to remove its combat troops from Iraqi cities by June 30, 2009 and to withdraw all U.S. forces from Iraq by the end of 2011. The U.S. ambassador to Iraq and the Iraqi foreign minister signed the agreement in mid-November, and then President George W. Bush traveled to Baghdad in December for a formal signing ceremony.

The Obama administration inherited a mess when it entered office in January 2009. The country remained on a war footing, with more than 160,000 troops in Iraq and 38,000 more stationed in Afghanistan (Belasco 2009). The financial system remained weak, with memories of the collapse of 2008 strong. The national economy had contracted at the annual rate of 8.3 percent in the last quarter of 2008 and continued to shrink at an annual rate of 5.4 percent in the first quarter of 2009. As economic activity collapsed, the budget deficit swelled to almost 10 percent of gross domestic product (GDP). Consequently, much of the administration's energy and attention have been directed at cleaning up this mess, at financial reform and retrenchment – reducing America's overseas commitments.

Regulatory reform was enacted in 2010 via the Dodd–Frank Wall Street Reform and Consumer Protection Act. Among other things, the Dodd–Frank Act consolidated existing regulatory agencies and created the Financial Stability Oversight Council and Office of Financial Research. In addition, the Act established new regulations as well as a new resolution regime with responsibility to step in to liquidate insolvent institutions not covered by the FDIC. Global retrenchment has progressed more slowly. The administration withdrew all U.S. forces from Iraq, and began withdrawing troops from Afghanistan in 2012. Moreover, adherence to the “don't do stupid sh*t” principle has led the Obama administration to resist pressure to accept new and potentially costly obligations, such as its non-intervention in the Syrian civil conflict. It is not unreasonable to suggest that the Obama presidency has been characterized by financial system reform and global retrenchment.

Obama is not the first to be forced to repair the damage imparted by the administration that preceded him. Indeed, retrenchment and reform have been the typical final stage of the political economic of imbalance.

Buildup-driven booms have had a powerful impact on American foreign economic policy. In particular, they have caused the United States to use trade and exchange rate policy to try to pressure its largest trade partners to adjust their policies in order to narrow global imbalances. The United States has sought to deflect the costs of adjusting current account deficits the boom generates by manipulating its trade partner's economic and security dependence. The United States has pressured its partners to eliminate trade barriers, purchase more American products, revalue their currencies, and embrace more expansive monetary and fiscal policies. It has applied this pressure through bilateral talks and through multilateral negotiations in which it threatens to withdraw American security commitments and restrict access to the U.S. market unless governments agree to change policy. And though clearly all governments would always prefer that other states bear the costs associated with reducing global imbalances, the intensity of American pressure on its trade partners has been greatest in the midst of its economic booms.

American policymakers' efforts to deflect adjustment costs have occurred as a response to rising protectionism among manufacturing and in the halls of Congress that the boom generates. The strong dollar and rising imports generated by the buildup-induced boom place the American manufacturing industry under greater strain. As foreign competition intensifies at home and overseas, individual firms and the business associations that represent them begin to pressure Congress. The House and Senate hold hearings on America's declining competitiveness. Legislators hear testimony about how America's trade partners are cheating, using trade and exchange rate policy to give their producers an unfair advantage in global markets. Legislators introduce bills that threaten to restrict foreign access to the American market unless such cheating stops. Somewhat paradoxically, therefore, economic booms generate substantial protectionist activity within Congress.