An Analysis of US Foreign Policy

A friend writes, "What the end of hegemony looks like..."

In another indication that China is growing increasingly concerned about holding huge dollar reserves, the head of its central bank has called for the eventual creation of a new international currency reserve to replace the dollar.

In a paper released Monday, Zhou Xiaochuan, governor of the People’s Bank of China, said a new currency reserve system controlled by the International Monetary Fund could prove more stable and economically viable.

A new system is necessary, he said, because the global economic crisis has revealed the “inherent vulnerabilities and systemic risks in the existing international monetary system.”

On the one hand, true. China's over $1 trillion in dollar-denominated reserves aren't as safe as they once were, and a devaluation of that asset through inflation would not be good for China. But, where else are they going to go?

While few analysts believe that the dollar will be replaced as the world’s dominant foreign exchange reserve anytime soon, the proposal suggests that China is preparing to assume a more influential role in the world. Russia recently made a similar proposal.

Lets look at this more closely. The Dollar has its privileged position in the world economy because a) many economists believe that the world economy needs some sort of stable reserve currency, b) the US is willing and can afford to maintain such a strong currency, and c) the rest of the world has left this arrangement unchallenged and benefits from it. Much of this is classic Kindleberger--the world economy needs a stabilizer, one stabilizer, to stabilize the global economy as market, currency, and lender of last resort. The US is that stabilizer.

The third of those reasons--acceptance by other world powers--is now under some degree of threat as China starts to fret about its dollar position. However, absent another actor willing and able to play the role of stabilizer, everyone--China included--risks putting themselves in a significantly worse position should the dollar lose its pride of place in the international economic system.

China suggests that the IMF's SDR form a new reserve currency. This indicates they really aren't all that serious about actually doing anything to dislodge the dollar. For one, to have a currency able to act as a reserve currency requires backing of a stable, authoritative, empowered entity that can manipulate fiscal and monetary policy as needed to protect the value of its currency. We call this a sovereign state. To give the IMF such rights would make the IMF a de-facto global economic sovereign. China has no demonstrated desire to create supra-national authority, not at the UN, nor the IMF. Moreover, there is a significant and real cost to maintaining a strong reserve currency. The strength of the dollar makes the US a great destination for products--we can afford to buy others' cheap stuff. A significantly de-valued dollar (coupled with an increased value of other currencies like the Yuan or Yen or Won) would be a disaster to economies that rely on exports. China would need to show that it is willing and able to take on a stabilizing role in the global economy, which just doesn't seem in the cards as of yet.

Perhaps, though, this might be read as an attempt to gain leverage:

The timing of the Chinese announcement, analysts said, could also be aimed at giving Beijing more leverage to negotiate with the United States and other nations in London on trade and on proposals about how to stabilize the global economy.

All that said, it would be foolish for US policy planners to simply ignore China's (and others) growing dissatisfaction with the Bretton Woods legacy system that now constitutes the global economy. The fundamental bargains that made such a hegemonic system possible (cf Ikenberry) have become frayed, and while neither China nor the EU (nor India, for that matter) are poised to overthrow US hegemony in the short term, they can clearly erode US hegemony by driving up the cost of acting as a stabilizer. In the medium term, this imposes a cost on everyone, as the global economy (and security order) falters without a clear stabilizer, but from a realist perspective, the relative gains (or in this case declines) could benefit the challengers to US hegemony--at least that's what they are betting on.

Labels: China, economic crisis, hegemony

One thing that has been bothering me of late in the Presidential debate is how the press and the public are asking the wrong questions of the candidates about the economy. While part of it may be symptomatic of a general lack of understanding as to what is going on, it also betrays an intellectual laziness in those covering and discussing the campaign. Wedded to tired lines of debate, these questions rehash what we think is important and distract from the development of an understanding of the current state of affairs which has very little relationship to the ancien regime.

Two general areas of inquiry really stand out.

The first is the "How are you going to pay for this?" bit. Lehrer asked a version of this in the first debate. The set-up goes something like this: We've spent $300B on Fannie and Freddie, authorized $700B for the TARP bailout/rescue, have 2 wars, and you want to cut taxes. So, clearly something you are promising will have to go. What promise are you going to break?

Here's the problem with that answer: It assumes that the government is going to have the luxury of choosing among its spending programs as this economic crisis deepens. The old-school view is that government debt is part of the problem and steps must be taken toward a balanced budget. But, in a matter of weeks, several decades of economic orthodoxy has fallen by the wayside as the Administration reaches deeper and deeper into the government's interventionist toolbox trying to find something that works. In one day, Paulson spent as much money as the Wars cost in a year on a government take-over of AIG. Former Bush-
Administration officials are calling for faster government action, picking winners and losers from among US financial institutions. As Brad DeLong points out, the pendulum has swung back toward (if not past) Keynes.

What Keynesian economics calls for is counter-cyclical government spending to mitigate the effects of an economic downturn on a society. We're well into the crisis, but have yet to see a real move toward counter-cyclical spending. We've seen all kinds of other ad-hoc government intervention in the economy in the financial sector, but little for "main street."

What this question overlooks is the fact that the government probably ought to be spending on all of the candidate's priorities, and maybe then some. Does it drive up the deficit? Sure. But that's the Keynesian point--increased government debt now to avoid a deeper recession later. Given the potential severity of the economic downturn, all this spending and more might be necessary. Yet, asking the question as posed--what will you cut--frames the discussion in the old and now discredited economic context. It makes it harder for the next President to spend what he'll need to in order to help the nation as a whole.

The second question that bothers me is "What's your plan" to solve the crisis. This question has both a flawed premise and produces a counter-productive discussion.

The flawed premise is to realistically expect these two campaigns to come up with a silver bullet before they have the full resources of the US government at their disposal. Obama and McCain have a team of very smart economic advisers working for them from their current jobs. The Treasury and Fed have full time staff who have spent a career working on issues just such as this. They have legal authority, resources, and expertise to gather information, devise plans, and map out potential consequences. They also have the ability and responsibility to consult and coordinate with allies in the G-7 and international institutions like the IMF. And, despite all these advantages, they still have not come up with anything that seems to work.

This question also produces a counter-productive discussion. This crisis is moving with such velocity that any plan seems outdated days later. The $700 Billion TARP that just had to pass? Already obsolete, as Paulson has moved on to directly injecting capital into banks--something that wasn't even in his original plan. Does anyone think that either a McCain or Obama plan would still be relevant by Election Day, let alone Inauguration Day? Neither candidate can do anything now--what we want is what they will do once they get into office--but no one has any idea what the financial markets will look like in mid-January.

Asking the wrong questions generates tremendous amounts of heat with little light to illuminate any useful understanding of the issue.

Labels: Campaign 2008, economic crisis

The current economic crisis has quickly become a global crisis. Banks around the world are teetering on the edge of failure and governments and central banks are stepping in with as much financial ammunition as they can to bolster the world economy. Despite these actions, and calls for a financial summit by France's President, the world still is looking to the United States Government as the only actor capable of stemming the growing credit crunch and financial panic.

The Washington Post gives a survey of the reaction from bankers and officials around the world. The lede, says it all:

Central bankers and elected leaders around the world acknowledged Tuesday that they lacked a comprehensive strategy to protect their countries from the global financial crisis and were as dependent as ever on Washington to come up with a solution.

Even the EU is sidelined in the current crisis. While the economy of the EU rivals the US and its central bank is strong, it lacks the fiscal tools and policy coordination mechanisms among member states to convincingly act to shore up financial markets. An EU spokesperson said:

"The United States must take its responsibility in this situation, must show statesmanship for the sake of their own country and for the sake of the world," Johannes Laitenberger, a spokesman for the European Commission, told reporters.

Labels: economic crisis, EU, hegemony

Rachel Maddow just asked perhaps the most insightful question of this bailout to date: Is this economic crisis global warming or the Iraq War? Is it a real crisis that builds slowly that people fail to acknowledge, or is it a bunch of hype and hysteria over what is, in the end, nothing.

Laura D'Andrea Tyson says that this credit crunch is real and real bad, and your job is at risk. Its not a bail-out, but a rescue of a broken market.

Therein lies the rub. I think there are two fundamental issues that have doomed the bailout bill earlier today.

First, this is a really complicated mess, and no one understands what is actually going on. Who among you actually understands credit-default swaps, or the leveraging of commercial paper for mortgage-backed securities? Not me. Probably not you. One of the major difficulties here is that there is no story to explain what is happening, leaving no reason to justify the extraordinary actions necessary to save the economic markets. There's a lot of assigning of blame, but there's little explanation of what actually is the problem. I'm not saying that there needs to be a blue-ribbon commission producing a report. Rather, what is needed is a narrative that makes sense of what is going on in such a way that people can actually understand what is happening and that justifies a response. All we have now is a series of bank failures, the biggest drop in the Dow ever, and a back and forth of Presidential politics.

So what has actually happened? Two items have broken through: 1) people can't pay mortgages and 2) wall street bankers made some poor bets. Neither of these really sounds all that drastic, and neither of these really calls out for action. People are annoyed with others who borrowed over their heads when they were responsible, but its hard to blame families for tough economic times. No one really has any sympathy for Wall Street.

The massive problems that remain--the credit crunch, the insolvency of key financial instruments, the potential lack of cash for business operations, this is much more significant but much less of the story. If a rescue operation is going to have any chance of success, its proponents need to develop a narrative on the crisis before they can sell the solution.

Second, this is a "bailout." Of Wall Street, no less. No one likes to bail-out fat cats who make poor decisions. Except that at this point its far beyond a bailout, its rescue of a broken financial system by extensive nationalization, regulation, and government intervention. This intervention needs another frame. FDR, who has re-emerged as everyone's favorite President these days, was an expert at this. The New Deal socialized large parts of the economy. Lend-Lease paved the way for entry into World War II. But Roosevelt was expert in telling the American People that, when your neighbor's house is on fire, you give them the hose now and worry about payment later.

This is more than a bailout, its a rescue of a broken system on the verge of collapse. Except that you wouldn't know that from the event itself. If Congress and the Administration are going to rescue the economy, they need a plausible narrative of what is going on to explain the seriousness of the problem and to form the basis of a political coalition. Then they need to start talking about a government rescue to save the economy, and drop all this Wall Street bailout jargon.

Labels: economic crisis