ECONOMIC CRISIS AND DIPLOMACY - PART ONE: ORIGINS
"THE ROARING OF THE CATARACT"
"The world economy is enjoying a glorious run. In 2003, 2004 and 2005, it had its best years since the early 1970s. Yet that is no encouraging parallel. The torrid expansion of the early 1970s led to a period of inflationary turmoil. We must ask whether the extraordinary growth of recent years also hides dangers – different, perhaps, but still significant. The answer, alas, is yes....
What we are discussing then is the possibility of a disorderly unwinding of the external deficits, the trigger being a sharp slowdown in US household demand that would stimulate domestic pressure for both a currency realignment and protection. If, as is likely, this also weakened foreign demand for US assets, US long-term interest rates would rise, threatening the Federal Reserve’s ability to loosen monetary policy while also retaining credibility....
In short, the world economy confronts not just a risk, but a test: that of managing a decline in the huge excess of US household spending over incomes. Will it be able to manage this easily? The answer is: only if others are able and willing to expand demand substantially, in their turn. What are the chances of that? It is hard to feel optimistic".
"A Slowing US Could Brake the World", 26 September 2006 in http://www.ft.com/.
With the rejection by the American House of Representatives today of President Bush's plan for a 700 Billion Dollar fund to purchase the debt held by American financial institutions, in order to re-liquefy the American financial system, the description of the current situation as one of 'crisis', appears to be on the mark. And, yet this 'crisis', is not one which has emerged full-blown like Athena from Zeus's head. Indeed, some farsighted observers, such as Martin Wolf, in the column quoted above, were warning that the growth spurt in the American economy, dominated as it was by an extremely unhealthy combination of: extremely low interest rates (negative when taking inflation into account) since 2001, a series of housing booms, in the USA, UK, Ireland, and most other parts of Europe, resulting in both the aforementioned variable as well as the massive lending by surplus countries of the world (PRC, Japan, the other BRIC countries, some members of the EU) to the USA and the other debtor countries just mentioned, coupled with a massive expansion of financial services industry debt, wherein by anno domini 2007, the same had liabilities of approximately almost 120% of the entire American Gross Domestic Product. The upshot was an archetypal boom (2002-2005, followed by a bubble (2006), and, now of course a bust. With so many seemingly impregnable American, and, now West European financial firms falling like bowling pins. One after the other in quick succession.
Whether or not the today's rejection and the fall the American stock market (the worst in the last ten years), as well as the secular decline in both American and world share prices in the past year or so, means that we are going to be subject to another recession on the scale of 1973-1974, 1980-1982, has yet to be seen. It could well be the the current economic and financial spasm , is just that: more of a momentary hiccup, rather than something more serious. Alternatively, it could very well be, that what the prescient Martin Wolf described more than two years ago, as a process of "unwinding" of external deficits, aka massive amounts of debt, which was equally massively leveraged will have the end result of a prolonged economic slowdown. Not only in the USA, but, indeed worldwide. In short a repeat of the Japanese experience of the 1990's, but over the entire globe, rather than in just in one country.
What the diplomatic consequences both short and long-term to the latter outcome, is something that I would like to discuss in my next entry. In which I explore both the precedents from the past as well as what I believe to be the likely end-results of the current financial debacle.