Thursday, May 28, 2009

What If America Was No Longer A Dominant Force?

Ed Morrissey at American Issues Project:

The End of the American Economic Era?
By: Edward Morrissey

What comes after the United States ceases to be the central point of free-market economic power? We may shortly get the answer to that question. As the United States increases its borrowing for greater government spending, willing buyers of American bonds increasingly grow more scarce, and the “full faith and credit” of the United States will soon lose its cachet as the rock-solid foundation of the international market.

Warning signs abound. Earlier this month, the Treasury discovered that demand had significantly decreased for its long-term bonds. In order to get buyers at its regular auction – the device by which the United States runs on deficit spending – it had to hike the interest rates it pays the bondholders. It signaled a lack of confidence in America's ability to sustain its debt expansion, which has the effect of worsening it through heavier debt service payments on the bonds they managed to sell.

That reinforcing cycle of cascading debt has analysts worried enough to openly discuss downgrading U.S. debt. Financial Times reported this week that Standard and Poor has already done that for Great Britain's foreign debt, issuing a “negative” rating that will require more generous interest terms in order to sell bonds in international markets. The same kind of deficit spending in the United States will eventually trigger a re-evaluation of the U.S. credit, as the United States and United Kingdom face similar debt spirals with no end in sight. John Tyler spells it out:
Under President Barack Obama’s budget plan, the federal debt is exploding. To be
precise, it is rising – and will continue to rise – much faster than gross
domestic product, a measure of America’s ability to service it. The federal debt
was equivalent to 41 per cent of GDP at the end of 2008; the Congressional
Budget Office projects it will increase to 82 per cent of GDP in 10 years. With
no change in policy, it could hit 100 per cent of GDP in just another five

“A government debt burden of that [100 per cent] level, if sustained, would in Standard & Poor’s view be incompatible with a triple A rating,” as the risk rating agency stated last week.

Right now, the United States has responded to a lack of demand for its Treasuries through a questionable and disturbing method: we're buying our own debt. That allows the yields to remain low, but buying our own debt is somewhat akin to creating your own credit card.

Eventually, you have to acknowledge that the money you create on the books never really existed, unless the United States plans to simply print money to pay off all the bonds. That would create a level of inflation not seen in the West since the Weimar Republic, and will effectively force the rest of the world to avoid U.S. currency and investments as unsound. It would, for the first time in decades, put the United States on the financial sideline.

What would a world with the United States in the second financial tier of nations mean? We would have significantly less foreign investment, to start, and that has other implications besides just the impact to our economy. We rely on economic engagement with other nations as a not-inconsequential portion of our national security and foreign policies.

If China, for instance, decided to end its reliance on U.S. Treasuries and chose to look inward to Asia, it would remove a big deterrent against hostilities between the two nations. That's not merely theory. The European Union formed originally as a trading commonwealth in part as a means to keep the various nations from invading each other. Countries that trade extensively and invest in each other do not want to lose the fortunes that war would destroy. Our engagement with China gives both nations a healthy investment in peace.

Certainly our military prowess would act as a deterrent, too, but we would have trouble maintaining that with an economy severely damaged by a loss of confidence in our currency and our inability to attract investors. Investment flight would reduce the wealth created in the United States, as would the damage that rampant inflation would cause without an adequate means to pay down the debt. And without wealth creation, the nation would not have the means to maintain its military infrastructure.

Without a strong military presence around the world, which would almost certainly disappear just as Great Britain's did after World War I, the world would be a much different – and more dangerous – place. No nation could guarantee trade security to the extent the American Navy does. Piracy has already become a problem, and without either a massive British or American Navy to suppress it, it would expand enormously. That will aggravate the problems an American return to second-tier status would create in the global economy.

Perhaps another nation could fill the vacuum left by an American collapse, but which nation? What kind of world would global dominance by China, India, or Russia bring, assuming any of these could take that role? How about a coalition of oil producers like OPEC, who have the means to fund it?

Don't look anywhere outside of Asia. The EU doesn't have the military resources to secure its own continent, let alone project economic power around the world. The Southern Hemisphere, save for Australia, comprises nations more accustomed to being client nations and aid recipients rather than generating any kind of economic power of their own – and those nations would lose a powerful source of financial support in an American collapse anyway.

We need to demonstrate responsibility for investors to retain their confidence in the United States as a guarantor of stability, economic and otherwise. The downgrade in the United Kingdom's bond rating is a signal flare to the United States that we will be next – and that our ready source of bondholders will look elsewhere for that stability. Will we wake up before the United States gets sidelined?

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