“End of Empire” by David Roche

Much of the material posted on the FM site serves, I hope, to provide thought and discussion.  Most I agree with to some extent.  Most feature clear expression of original — or extreme thinking (often the latter is the best available substitute for the very scarce former).  In that spirit, here is today’s offering.  I recommend reading it in full.

“Another Empire Bites the Dust“, David Roche (President of Independent Strategy), Far Eastern Economic Review, October 2008 — Excerpt:

Wall Street’s crack-up presages a global tectonic shift: the beginning of the decline of American power. Great empires and great civilizations have a way of cresting that is pretty well set in historical stone. First, the ideology corrupts. Then the economic model does. Then the currency goes. Finally, military power loses its supremacy.

The United States of America, the “great and good” empire, shows many of the symptoms of cresting, and unfortunately the pace of history has accelerated. Rome’s decline from its zenith took over 300 years; America’s will be timed in decades. After the cataclysm that we have seen in financial markets, economics will accelerate the process. Nero was fortunate that Rome had no Bloomberg. Had it, the city might have burned in a day!

The primary reason for the U.S.’s decline mirrors that of other empires at their tipping point into dotage. Unsustainable living standards at the empire’s core, which are enjoyed but not earned, depend upon flows of wealth from the periphery. In the American case, the credit bubble and its collapse are the flip side of a culture of excess consumption, of which the unwinding will be highly destructive of both U.S. economic and military power and intellectual leadership in the world. That “gain without pain” mentality had become generic in a thriftless, credit-addicted society, where the gap between what people wanted and earned was constantly filled by debt. In the end, the level of debt became so unsustainable that it collapsed of its own accord. The upshot may look like a credit crisis, but in reality it is a moral one.

Roche has long held this view.  Perhaps his best-known essay is “End of Empire”, 4 March 2003 (no online link found).  The reasoning was similar, but five years later appears premature.  The world changes slowly, but Roche’s forecasts deserve attention no matter how accurate or inaccurate his timing.

Roche is co-author with Bob McKee of the book New Monetarism, recently re-issued:

After predicting a global credit crisis in the first edition, in this new edition of New Monetarism, one year of the global credit crunch is reviewed and what will happen now.

As an introduction to this view, see his report of 26 April 2006 with the same title.  He sees geopolitics through a monetary prism, the source of his pessimism about America’s future.

The last two decades of global disinflation have been the product of a new monetary order combined with new technology, globalisation and liberalisation of markets. As inflation expectations plummeted, so did real interest rates and the cost of capital. This engendered a massive expansion of liquidity. New-fangled forms of money were invented that were beyond the reach of central bank control. This liquidity drove up the value of financial assets. But prices of goods and services were largely unaffected, because this new money was compartmentalised in its architecture and dedicated to asset markets.

But the era of underpriced capital in constant oversupply is ending. The global cost of capital is rising and risk appetite will diminish. The drivers will be as shown in Inset 1. Then the gearing of money multipliers that drove up asset prices will go into reverse and deflate them.

Lower price increases year after year in the 1980s and 1990s were caused by four factors. First, sane central bankers started to target low inflation as a priority. Second, globalisation empowered producers of cheap things, like China and India, to sell their wares to rich folk as trade barriers were lowered. Third, new technology, including the internet, shattered the mould for corporations, allowing them to produce and market globally and more efficiently. And finally, governments freed up markets and limited their own budget spending and deficits.

… This is where New Monetarism enters the stage. During disinflation, although central bankers practised tighter monetary policy than previously and kept policy interest rates relatively high, financial assets still expanded much more than GDP or the ‘material’ economic activity underpinning asset values (Figure 3).

Part of this phenomenon was due to better mobilisation of capital (i.e. financial market liberalisation). Some was due to the creation of new financial instruments, such as those that spread risk beyond banks and other financial intermediaries.

… But it mostly indicated that some form of liquidity (i.e. money) was being created outside the central bankers’ control. The creation of ‘liquidity’ in excess of real economic needs pumped up asset prices.

… But in all changes there are constants and today nothing in the architecture of the global economy absolves rich, ageing countries of the need to accumulate wealth and achieve fundamental balances that are the foundations of their own future.

And many do. Germany and Japan are old, but still rich and endowed with a cultural gift for the manufacture of some of the world’s best products. They continue to keep ahead of the Chinese learning curve and run large current account surpluses and maintain sufficient domestic savings to prepare for their dotage. Japan is the world’s largest creditor nation in external assets. Germany has by far the largest, most conservatively- invested stock of household wealth in Europe. Both Japan and Germany have adapted to the competitive challenges of globalisation far better than they are given credit for.

It is tempting to view the world’s imbalances as the result of a new economic order whereby the rich economies become shopping malls filled with old age pensioners and the emerging economies produce everything for the malls and invest their economic gains there. But there is a much simpler monetary explanation that can explain all of this in terms of cash flows rather than cosmic architecture. …

Afterword

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To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp relevance to this topic:

• 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
• some Good News about America!

Some posts about the causes of the end of the Post-WWII regime:

1. A brief note on the US Dollar. Is this like August 1914?, 8 November 2007 — How the current situation is as unstable financially as was Europe geopolitically in early 1914.
2. The post-WWII geopolitical regime is dying. Chapter One , 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
3. The US economy at Defcon 2, 11 March 2008 — Pretty self-explanatory.  Where are we in the downcycle?  What might the world look like when it ends?
4. A picture of the post-WWII debt supercycle, 26 September 2008