Geopolitical implications of the current economic downturn

Summary:  How will this recession end?  My guess:  with re-balancing of the global economy and a decline of the US dollar so that the our goods and services are again competitive.  No more trade deficit, we can pay our debts, and there will be no serious outflow of jobs.

There are several schools of economic thinking about the current down cycle of the US economy.

1. The mainstream consensus of neo-Keynesian economics:  this is just another business cycle, to be treated with the usual tools.  To see this analysis, read today’s op-ed in the New York Times by Joseph E. Stiglitz.
2. There are a few heretics, even some apostates.  The first question if the standard remedies of fiscal and monetary policy, plus devaluing the currency, will work this time.  The latter question the Keynesian paradigm itself.  Does it adequately consider the effect of rising debt levels?  Might the insights of Hyman Minsky show the limts to the operating boundaries of Keynesian theories?  Perhaps we need a fusion of Keynesian and Austrian economics?
3. The members of the small Austrian school of economists, vocal but powerless to affect public policy.

What if the heretics and apostates — perhaps even the Austrians — are right, and this cycle is different?  Let us explore this scenario and see what it says about America’s geopolitical (esp. military) strength…

1. The current economic downturn takes us beyond the envelope in which mainstream economic theory works.
2. This marks the end of the post-WWII economic regime, during the last 25 years of which American public policy allowed massive growth of debt — to both foreign and domestic creditors — and deterioration of the competitiveness of US goods and services on world markets (i.e., decreased ability to pay our foreign debtors).

The key source of disharmony in the global economy is our foreign borrowing and weakening competitiveness.  Either would be bad; having both is deadly.

1. These US policies have resulted in great distortions in global flows of capital and trade.  For example, a funneling of a large fraction of world savings to the US (we do not invest, but spend it), including the oddity of savers in the world’s poorest nations funding consumption by the world’s richest nation.
2. The current economic slowdown marks the begging of the long-predicted “re-balancing” of the global economy, in which these oddities disappear and more normal patterns return.
3. The global dominance of the US depends on massive borrowing at low interest rates from a small number of governments, most Asians and oil-exporters, with no thought as to how or when we will repay these loans.

The restoration of normal economic relations probably requires the value of the US dollar to decline far below levels seen since President Nixon took us off the gold standard in 1971 (sparking the great inflation of the 1970’s).  The greatest adjustment might be vs. the Chinese currency (the RMB or yuan), devaluing the USD/RMB by 1/3 to 1/2 (expert estimates vary widely).  

1. That will make our exports of goods and services far more competitive, allowing us to earn the foreign currency needed to repay our creditors.
2. That will make imports of raw materials (e.g., oil) and goods (e.g., toys and TV’s from China) far more expensive.
3. The net result will be a greatly reduced US trade deficit, and less foreign borrowings.  The “outsourcing” of jobs to emerging nations will slow, as our workers become relatively more attractive for employers.  (Wages here would not crash to those of the 3rd world, as American workers and facilities are far more productive).

The UK went through a similar process starting after WWI and ending with the election of Margaret Thatcher as Prime Minister in 1979.  This is the decline and fall of the British Empire.  In 1900 their web of military bases encircled the globe.  As they grew poorer and the value of the pound fell, these bases became too expensive — an unaffordable luxury.  Since the locals were unwilling to pay for the police services provided by the UK, the bases closed and the troops went home. 

Now it is our turn.  

Geopolitical Implications

This adjustment in the US economy might have consequences other than reducing our ability to buy overseas bases and fund wars.  The stress on the economy might force reallocation — or even reductions — in federal spending.  Increased military spending — new generation of stealth aircraft and capital warships, a larger armies, permanent occupation of Iraq and Afghanistan, a “star wars” missile defense shield — might become a fantasy.  We could afford to spend 14% of GDP on defense during the Korean War, when our industries dominated the global economy.  We could almost afford to spend 10% on defense during the Vietnam War.  By massive government borrowing President Reagan could spend 7% on defense.  In the coming decade we might find spending 3% of GDP too much to bear.

The dreams of so many brilliant thinkers, from neocons like William Kristol to visionaries like Thomas Barnett, will become moot.  However desirable or feasible, we will no longer have the money to fund them.  They will find themselves trumped by the bleak forecasts of Paul Kennedy, author of Rise and Fall of the Great Powers (1987).

Conclusions

This does not mean the end of America.  America will outlast its empire. 

We were a benign hegemon, perhaps the greatest hegemon in world history.  We gave much and asked little.  After victory in war we asked for no reparations; our enemies became our friends.  Our soldiers return from overseas duty with neither tribute nor loot.  The international order we created after WWII, both economic and geopolitical, saw the fastest growth in global wealth and income since the invention of agriculture.   Our dreams of global peace brought forth the United Nations.  Our dreams of exploration landed men on the moon.  We can look back in pride at our half-century of dominance.

Afterword

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For more information about this topic

To see all posts about the new era now being born:

• About America – how can we reform it?
• About the Financial crisis – what’s happening? how will this end? 
• About the End of the post-WWII geopolitical regime

Posts with speculation about the future, about structural changes to America and the world:

Speculation about the future, about structural changes to America and the world

1. Treasury Secretary Paulson leads us across the Rubicon, 9 September 2008
2. Say good-bye to the old America. Welcome to our new socialist paradise!, 17 September 2008
3. Another voice warning about the nationalization of AIG, 18 September 2008
4. Another step away from our Constitutional system, with applause, 19 September 2008
5. America appoints a Magister Populi to deal with the financial crisis, 21 September 2008
6. Legal experts discuss if the Paulson Plan is legal, 21 September 2008
7. German Finance Minister Peer Steinbrück explains how the world is changing, 30 September 2008
8. America has changed. Why do so many foreigners see this, but so few Americans?, 1 October 2008
9. America is changing. Read some chillling words from a liberal economist, 2 October 2008
10. Does this economic crisis make the State stronger – or is it another step in the decline of the state?, 16 January 2009
11. This financial crisis is the transition to a new world; like birth, it is painful, 11 February 2009
12. Everything written about the economic crisis overlooks its true nature, 24 February 2009
13. A look at the new world – after the downturn, 19 March 2009