The silliest thing that clever people are saying about the world economic crisis is that the United States will lose its position as the dominant world superpower in consequence. On the contrary: the crisis strengthens the relative position of the United States and exposes the far graver weaknesses of all prospective competitors. It makes the debt of the American government the world’s most desirable asset. America may deserve to decline, but as Clint Eastwood said in another context, “deserve’s got nothing to do with it.” President Barack Obama may turn out to be the most egregious unilateralist in American history.
America’s supposed decline dominates the glossy magazines. Last September, Germany’s Finance Minister Peer Steinbruck intoned, “One thing seems probable to me. As a result of the crisis, the United States will lose its status as the superpower of the global financial system.” The German official is quoted by Professor Richard Florida in the March 2009 Atlantic Monthly, who adds, “You don’t have to strain too hard to see the financial crisis as the death knell for a debt-ridden, overconsuming and underproducing American empire – the fall long prophesied by [British historian] Paul Kennedy and others.” (Florida’s views are more nuanced).
And the ubiquitous Professor Niall Ferguson told a Vanity Fair interviewer on January 20 that America would crumble like Great Britain in the 1970s. “It certainly will be extremely painful … Half the federal debt is held by foreigners. And if the US either defaults on debt or allows the dollar to depreciate, the rest of the world is going to say, ‘Wait a second, you just screwed us.’ And that’s, I think, the moment at which the United States experiences the British experience – when, in the dark days of the 60s and 70s, Britain fundamentally lost its credibility and ceased to be a financial great power.”
But is this true? In fact, the rest of the world has queued up to lend America as much money as it might wish to borrow in order to get its consumers to spend again, and buy the manufactures and raw materials of the rest of the world. It won’t work, but that is another matter. As I wrote last October, the world isn’t flat, contrary to New York Times pundit Thomas Friedman’s vision of a level global playing field. It’s flattened. (see The world isn’t flat, it’s flattened, Asia Times Online, October 28, 2008).
Here’s a thought-experiment to gauge the merits of different national markets as a safe haven. Close your eyes and try to imagine what Germany, Japan and China will look like 30 years from now, that is, when a newly issued long-term bond will mature. Citing Pope Benedict XVI’s critique of economics, I argued recently that the market cannot form accurate long-term expectations; it only can imagine future states of the world. (See Benedict XVI is magnificently right, Asia Times Online, December 9, 2008). Let us see what imagination tells us about the world’s largest capital markets. The conclusions of this exercise, I will show later, reinforce the founding premises of “supply-side economics,” the theory that guided America out of the 1979-1983 mini-depression.
Imagination fails in the case of Europe and Japan. One out of every four Germans today is older than 60, and in 30 years the proportion will rise to two-fifths. Japan is even worse: 30% of Japanese today are above 60, and in 30 years the number will be almost half. What does a national economy look like when the demographics are so skewed to pensioners?
We never have seen anything like this before in all of history. Pension and health costs projected forward will crush these economies a generation from now. Taxes will suffocate the dwindling population of young workers. A straight-line projection of present trends takes us to the cusp of national failure. We do not know whether present trends will continue in a straight line, to be sure. The race is not to the swift, nor the battle to the strong, as Damon Runyon said, but that’s the way to bet.
Children are the wealth of nations, provided that their nations can put tools in their hands and the rule of law at their back. Countries that lack children are poor. Aging Germans do not have young people to whom to lend. That is why they lent their savings to Americans, through the subprime market, and why European banks are if anything worse off than American banks.
Imagination also fails in the case of China, not because extrapolation of present trends is so frightening, but rather because economic growth cannot possibly continue at the pace of the past 10 years. China is a different country than it was 30 years ago, and it will be a different country in another 30 years. It is in the midst of the largest migration of peoples in the history of the world, the fastest rate of urbanization and the greatest economic expansion of which we know. Its political system and social structure will change so radically that it is impossible to form a clear picture of the country in 2040.
Great opportunities are attended by enormous dangers. China has more young people than any other country in the world, more than all of Europe put together, but too many of them are trapped in rural poverty, uneducated and untrained.
That is why Chinese save half their income, more than anyone else in the world. Part of China’s steroidal savings rate can be explained by the one-child policy. People whose children will not care for them in old age require financial assets. What economists call precautionary savings, saving for a rainy day, explains a great deal of the Chinese demand for savings. The sun has shone on the Chinese economy for a generation, but when it rains, who is to say how hard it will rain? Extreme uncertainty about the future explains China’s savings rate.
But America’s future is not hard to visualize in 2040. In fact, America in 1979 was not much different from America in 2009. Minor adjustments await Americans over the next generation compared with the great changes affecting its prospective competitors.
China may offer greater prospective returns than America – a billion Chinese will make the transition from a low-productivity rural environment into a high-productivity urban environment during the next generation – but it also requires a greater appetite for risk. Nothing can compete with the United States as a safe-haven investment for the long term. German petulance about America’s domination of world markets rises in inverse proportion to the German birth rate. The German finance minister should know better.
The Chinese have no such illusions. Luo Ping, a director general at the China Bank Regulatory Commission, told an American audience, “We hate you guys. Once you start issuing $1 trillion-$2 trillion … we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.” (Financial Times, December 12, 2008.)
A fearful world is buying trillions of dollars of securities from the US Treasury. Of all the cash flows in the world, nothing is more reliable than the tax revenues of the American state, the longest-lasting government on Earth presiding over the world’s largest economy.
During the 1960s, a young Canadian economist, Robert Mundell, argued that an increase in US government debt might represent a true increase in wealth under certain circumstances. It is relatively easy to capitalize corporate income streams through bonds, Mundell observed, but much harder to capitalize household income streams. If the government cuts taxes and issues bonds to replace the lost revenue, the increase in the float of the government bonds outstanding will represent an increase in wealth, provided that the tax increase stimulates growth, and the resulting growth brings in enough taxes to pay the interest on the bonds.
From this insight emerged the economic program of president Ronald Reagan. Drastic tax cuts, reducing the marginal tax rate from 70% to 40%, vastly increased the US budget deficit during the early 1980s. But the increase in revenues from a recovering economy more than paid the interest on the additional bonds, and the increase in government debt represented an increase in wealth. Mundell went on to win the Nobel Prize for Economics in 1999, for work in a different area.
America’s economic crisis in 2009 bears little resemblance to the mini-depression of 1979. Then, the baby boomers were in their 20s and 30s; now they are in their 50s and 60s. As I wrote in my year-end essay, the Reagan administration made it easier for homeowners and businesses to obtain leverage (see Waking from Lever-Lever Land, Asia Times Online, December 25, 2008). Young people need leverage to start families; old people need savings. The medicine that cured the economy in the early 1980s turned into an addiction during the 2000s.
But there is a perverse parallel between the Treasury market of 1979 and 2009. In both cases, the market is willing to absorb an enormous increase in the float of US government securities. Looking into the future, no cash flows in the world are more secure than the tax revenues of the American Treasury.
The greater the uncertainty attached to all other cash flows, the greater the demand for US Treasury securities. America does not have to throw its political weight around to persuade the world to fund between $1.5 trillion and $2 trillion of new debt issuance; its political weight stems from the fact that the world needs the United States as a safe haven for its money.
The difference, of course, is that the increased issuance of Treasury securities during the Reagan years represented an absolute increase in wealth, capitalizing the recovery prospects of the US economy. All the other economies of the free world benefited. The Obama administration’s multi-trillion dollar borrowing requirement constitutes a shift in relative wealth. Less capital will be available for other economies. The relative position of the United States will strengthen radically, which is to say that the position of many other parts of the world will weaken radically.
Obama isn’t entirely to blame for this sorry state of affairs, to be sure, given that these trends were in place before he took office. Still, it is incongruous that the liberal consensus welcomed the multilateralist Obama and bade good riddance to the unilateralist Republicans. A radical shift in economic power in favor of the United States makes Obama the moral equivalent of a unilateralist, to a degree that Reagan never could have imagined.
To overpay unionized construction workers to build bridges, and bail out the bloated budgets of American states, the Obama administration will flood the world with so much Treasury debt that capital will flow out of the poorest countries to buy it. Rather than protest this outrageously unilateralist action, the rest of the world encourages him to do so, hoping that somehow the Obama stimulus package will get American consumers to buy their goods once again.
During the Reagan years, the rest of the world had the right to grumble about the dominance of the American economy. Now that American policy has become a millstone around the necks of most of the world’s economies, the rest of the world’s leaders flatter Obama while he beats them. No Republican president ever had it so good.