The post-WWII geopolitical regime is dying

After fifty years, the post-WWII geopolitical regime has become frail. Chapter One of this series considers the US economy, and what lies ahead for America — the hegemon of the current global order.

Our friend, Smokey the Bear

In the late 19th Century the goal of preventing forest fires gained wide support in the US. The Forest Service was established in 1905, becoming the lead agency in this program. After a century of successful fire prevention much of the western US consists of dense forest with layers of dead wood. Tinderboxes across the West, ready for the next drought to spark uncontrollable fires.

What can be done? Not much. Nature delayed must take its course. Logging permits are difficult to get and logging itself often uneconomic. Thinning and removal of ground cover is prohibitively expense over large areas. Controlled burns often work well. Unfortunately they occasionally become uncontrolled burns. Instead landowners clear the land around their buildings and wait for the inevitable.  Eventually, over years, this process will work itself to a new equilibrium.

We have managed our economy like our forests. The US Federal Reserve has successfully prevented a severe recession for a quarter-century. The early 1990’s saw a slight downturn in GDP; the early 2000’s an even slighter one. The government responded to each slowdown with aggressive monetary policy (easy credit, low rates), aggressive fiscal policy (government spending), and often exchange rate action (devaluing the US dollar to stimulate exports). The Fed has declared war on the business cycle. As Mao said, protracted struggle.

Consequences

“Sooner or later, everyone sits down to a banquet of consequences.”
— Robert Louis Stevenson, perhaps apocryphal

As a result of the Fed’s success the US economy has evolved in an unbalanced manner since 1982. Large, growing trade deficits. Accelerating growth in household debt. Decreased savings. National consumption in excess of national income, financed by foreign borrowing (current account deficits) — resulting in large foreign debts.

We have been warned. Comptroller General Walker. The IMF. High government officials, like former Treasury Secretary Robert Rubin. The major credit ratings agencies. Wall Street. Academia. It is not all boring jargon; here is a paper with an usually catchy title for a Fed publication: Is the United States Bankrupt?

A long list of alarms, ringing for many years. We ignored them as obviously false, since they warned of threats not yet here.

“On September 28 the {Norman invasion} fleet came safely to anchor in Pevensey Bay. There was no opposition to the landing. The local “fyrd” has been called out this year four times already to watch the coast. Having , in true English style, come to the conclusion that the danger was past because it had not year arrived, they had gone back to their homes.”
— Churchill, The History of the English Speaking Peoples

Now we have (perhaps) passed the point at which corrective action is possible, such as the 1980-82 recession Fed Chairman Volker induced to break the inflationary fever that gripped the US. Today the danger of a recession burning out of control is too great.

Exhausted defenses of the US economy

Much research, like that of the Levy Institute, suggests that with the current record-high levels of household debt a recession like 1980-82 would create foreclosures and bankruptcies at levels not seen since the 1930’s. The lower middle class (aka “blue collar” households) are especially vulnerable. Worse, our counter-cyclical economic stabilizers are largely burnt out from overuse.

• Even at the peak of the expansion in 2006 the Federal government still ran a deficit of aprox $250 billion ($4.6 trillion using real accounting, as corporations must do — including the growth in liabilities). The deficit always increases during recessions, as expenses rise and income fades. This might make massive spending difficult during the next one — without collapsing the US dollar or risking hyperinflation.
• Monetary policy has become less effective with each cycle, as US debt (government, business, households) approaches our maximum carrying capacity. As debt grows, each dollar of new debt provides less stimulus. That is, the elasticity of GDP with respect to debt approaches zero. Eventually we hit the limit on our national VISA card, and new debt does nothing. That marks the end of the Debt Supercycle, and the start of a new era.
• Devaluing the US dollar to stimulate exports has become extremely hazardous, risking currency flight and hyperinflation.

The exhaustion of our stabilizers — which provide negative feedback — means that positive feedback might dominate the downcycle. For example, home prices decline => mortgage default increase => consumer spending declines (wealth effect) and housing-related jobs disappear => more home price declines. And so it goes.

Conclusions

How will this play out? The end of the post-WWII geopolitical regime is like a singularity in astrophysics. We cannot see beyond it, because we do not understand the choices that will determine our fate — or how we will choose. It also resembles a singularity in that what lies on the other side is unimportant until one survives the passage through it.

Economic regimes come, and they leave. As do Empires. The post-WWII regime has brought incredible prosperity to most of the world, but that does not make it eternal. As Queen Gertrude says to Hamlet (Act I, scene 2):

Good Hamlet, cast thy nighted colour off,
And let thine eye look like a friend on Denmark.
Do not for ever with thy vailed lids
Seek for thy noble father in the dust:
Thou know’st ’tis common;
all that lives must die,
Passing through nature to eternity.

** The movie “The Matrix” prominently featured a version of this, “All that lives must die.”

A closing note

The next recession will stress our economic and social fabric like nothing we have seen since WWII. Will we rise to these challenges as have our forefathers before us?

I believe that we need not fear the future. America’s strength lies not in our wealth or power. We are strong because of our ability to act together, to produce and follow good leaders. We are strong due to our openness to other cultures and ability to assimilate their best aspects. We are strong due to our ability to adapt to new circumstances, to roll with defeat and carry on.

We will be whatever we want to be. The choices we make in the next few years may reveal what that is.

Afterword

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For more information from the FM site

To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp interest are:

• About Financial crisis – what’s happening? how will this end?
• About America – how can we reform it?

Key posts about the crisis:

1. Diagnosing the eagle, chapter I — the housing bust, 6 December 2007
2. Death of the post-WWII geopolitical regime – death by debt, 8 January 2008 – Origins of the 1982 – 2006 economic expansion; why the down cycle will be so severe.
3. A picture of the post-WWII debt supercycle, 26 September 2008
4. Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
5. Causes of the financial crisis (no, its not the usual list), 29 October 2008
6. Government policy errors and the Great Depession, 1 November 2008

About solutions:

1. A happy ending to the current economic recession, 12 February 2008 – The political actions which might end this downturn, and their long-term implications.
2. Slow steps to nationalizing the US financial sector, 7 April 2008 — How this will change our society.
3. A solution to our financial crisis, 25 September 2008
4. The last opportunity for effective action before disaster strikes, 3 October 2008 — How to stabilize the financial system.
5. Effective treatment for this crisis will come with “The Master Settlement of 2009″, 5 October 2008
6. Dr. Bush, stabilize the economy – stat!, 7 October 2008
7. The new President will need new solutions for the economic crisis, 9 October 2008
8. Everything you need to know about government stimulus programs (read this – it’s about your money), 30 January 2009