The U.S. global financial crisis has gone global, which illustrates the still potent impact of the U.S. economy on the rest of the world. It also highlights the fact that central banks and other financial institutions in other parts of the world were too highly leveraged, or too highly exposed to investments whose risks had not been properly assessed, and that corrections were necessary. The danger, already apparent in the manic response of U.S. government officials and the widespread failure to understand that the stock market is not coterminous with the real economy, is that instead of the crisis leading to more sensible policies it will lead to foolish policies that not only don’t address underlying problems but assure future crises.
I am not one to decry what most people call globalization – the increase of trade, international investment, and even outsourcing – as a malignant development. The record is pretty clear that the countries that have participated most in international trade and opened themselves up to foreign investment have tended to prosper most – though not without temporarily troubling displacements – and that more people around the world have been lifted out of grinding poverty than in world history, largely because of increased trade.
The present crisis offers opportunities as well as dangers – opportunities to develop a more peaceful and prosperous world with fewer people living hand-to-mouth. But the temptation is likely to be for various countries, possibly including the United States, to crawl into a nationalist shell, perhaps increasing trade barriers and seeking the chimera of national self-sufficiency. To avoid such a fate, it is important to understand how the world has changed, even since the advent of the ill-fated Bush II administration, and to construct intelligent post-imperial policies.
Interconnected, for Good and Ill
For starters, if anyone doubted that we live in an interconnected and globalized world, the swiftness with which the financial crisis in the United States spread to the rest of the developed world should eliminate those doubts. In ordinary times, a globalized world economy has more benefits than costs. When things start to go sour, however, and especially when a panic psychology takes over and buyers of financial instruments retreat to the sidelines, financial interconnectedness becomes a curse.
Thus we have seen severe downturns not just in the United States, but in the stock markets in England, France, Germany, Belgium, China, Japan, India, and elsewhere. Many Europeans want to blame it all on the United States, and insofar as banks and investment houses held bonds and financial instruments from the United States that were declining in value or for which there was no effective market – this is especially true of China – American financial instruments have caused some of the problems in the rest of the world.
At the same time as the global nature of the financial crisis demonstrates the still outsized influence of the U.S. on economies worldwide, however, it is important to recognize how significantly the world has changed. Since 2001, the U.S. share of world gross domestic product has been reduced from 34 percent to 28 percent, according to a recent article by Robert Hormats and Jim O’Neill of Goldman Sachs. One of the major reasons for this is the growth of emerging economies, including Brazil, Russia, India, and China. The share of what some international analysts call "the BRICs" of world GDP has increased from 8 percent to 16 percent.
At the same time, these emerging economies, along with the oil-exporting countries, have dramatically increased their holdings of currency reserves. According to Hormats and O’Neill, since 2001, "China’s reserves have rocketed from $200 bn [billion] to $1,800bn, Brazil’s from $35bn to $200bn, Russia’s from $35bn to $500bn, and India’s from $50bn to $300bn. World oil consumers have transferred more than $3,000bn to exporters."
One result of all that money transferred is that Gulf countries have built some of the most modern and cosmopolitan cities in the world in a very short time. Another is that most of these countries have established what are called "Sovereign Wealth Funds," huge pools of money available for investment in other parts of the world. The U.S. political class has been inordinately suspicious of having these funds invest in the United States. However, if it could be made clear to those who run these funds that they are welcome to invest here, a great deal of liquidity could be created rather quickly, in a much more constructive way than simply having the Fed print more money that is certain to be worth less in the near future.
Not that there won’t be pain along the way. As Esmael Adibi, who heads the Anderson Center for Economic Studies [.pdf] at Chapman University, told me last week, prices for assets that have been overvalued will eventually have to stabilize, and in the process those who took unwise risks – builders, financial institutions, homebuyers who bought more house than they could really afford – will suffer. The more quickly this is allowed to happen the shorter the period of pain, but pain there will be.
The response of U.S. officials to the crisis, however, offers yet another illustration of how ill-suited the United States is to running a global empire. There’s little doubt that the subprime mortgage crisis, created in large part by government policies instituted with the purpose of making home ownership more available to low-income and minority Americans, was going to create pain and require a shakeout. However, even if John McCain, who readily acknowledges that he doesn’t know much about economics, said so, many of the fundamentals of the economy remain relatively sound, even including available consumer credit.
The sky didn’t start falling until Treasury Secretary Paulson and Fed chairman Ben Bernanke started going on television to announce that the sky was falling and the only solution was to give them lots more money and power right away, no questions asked. That began to create real doubt about the soundness of the underlying economy beyond the financial markets. This shortsighted action showed a parochialism and proneness to panic that demonstrate – beyond the fact that the U.S. share of global economic activity is shrinking, which is not necessarily a bad thing – that the U.S. lacked the judgment and maturity to be a proper imperial power. The sooner we draw back from imperial ambitions, both military and financial, the better.
Lee E. Ohanian, who teaches international economics at UCLA, told me his major worry is that the current panic will lead to bad policies. When the government announces a new action every day, and the stock market goes down the next day, the uncertainty already present growing from the subprime mortgage crisis is compounded, and ever more intrusive interventions are contemplated – which can delay and distort the necessary corrections.
Instead of injecting more funny money into an economy already overburdened with fiat currency that has created the impression among all too many Americans that they can continue to borrow to sustain lifestyles beyond their real incomes, it would be wiser to institute policies that encourage savings, the only solid source of capital for future growth. The U.S. has among the lowest savings rates in the world. Beyond the consumerist ethic that pervades this country however, incredibly, interest on savings is taxed, which doesn’t exactly encourage savings. One healthy step would be to eliminate taxation on interest.
Beyond that, the next president needs to understand that the current crisis has seriously undermined the confidence of foreign investors who have helped to sustain the U.S. economy despite a lack of capital-creating domestic savings. That means serious steps to reduce chronic large budget deficits, such as putting Social Security and Medicare, which loom as crises in the near future, on a sounder basis or developing alternative forms of retirement and health-care security. It also means developing domestic sources of energy, including whatever aspects of "green" energy turn out to be economically feasible.
An important aspect of this necessary domestic reform will be reassessing the extent of U.S. political and military intervention in the rest of the world. Maintaining military bases in more than 100 countries overseas is not only expensive, it also creates hostility and suspicion, which undermine willingness to engage in mutually beneficial trade and investment.
Every crisis carries opportunity as well as danger. The way out of the current crisis should involve giving up our foolish dreams of empire and vowing to create productive economic partnerships that work because they benefit both sides, not because the U.S. has the power to enforce its will. As we are seeing, that will is more often foolish and self-destructive than productive.
