Economic Distress and Geopolitical Risks

The economic turmoil roiling world markets right now brings with it plenty of pain. Jobs are being lost, people’s savings decimated, retirement plans/goals thrown out the window, etc. Hard times bring with them harsh consequences. However, it is perhaps useful to be mindful of the geopolitical risks that accompany economic dislocation. Many analysts are eager to compare the difficulties now confronting the global economic system with those of the Great Depression. While I do not believe that the world is facing a second Great Depression, it might be worthwhile to recall from history that the Great Depression spawned geopolitical turmoil that lead to the Second World War. The incoming Obama administration—and Democratic members of Congress who talk of implementing massive defense cutbacks—may want to remember the lessons of the past as they stand on the threshold of power.

The hardship and turmoil which impacted the world during the Great Depression provided fertile ground for the rise of fascist, expansionist regimes in Germany, Italy and Japan. Hard times also precluded the Western democracies from a more muscular response in the face of growing belligerence from these countries. The United States largely turned inward during the difficult years of the 1930s. The end result was a global war of a size and scale never seen by man either before or since. Economic hardship is distracting. It can cause nations to turn their focus inward with little or no regard for rising global threats that inevitably build in tumultuous times. Authoritarian regimes invariably look for scapegoats to blame for the hardship affecting their populace. This enables them to project the anger of their citizenry away from the regime itself and onto another race, country, ideology, etc.

Looking at the world today, one can certainly envision numerous potential flashpoints that could become problematic in a protracted economic downturn. Pakistan, already a hotbed of Islamic extremism and armed with atomic weapons, has been particularly hard hit by the global economic crisis. An increasingly impoverished Pakistan will be harder and harder for its new and shaky democratically-elected government to control. Should Pakistan’s economic troubles cause its political situation—always chaotic—to spin out of control, this would be a major setback in the global war on terror.

Russia, whose economy, stock markets and financial system have literally imploded over the past few months, could become increasingly problematic if faced with a protracted economic downturn. The increasingly authoritarian and aggressive Russian regime is already showing signs of anger projection. Its invasion of Georgia this summer and increasing willingness to confront the West reflect a desire to stoke the pride and anger of its people against foreign powers—particularly the United States. It is no accident that the Russians announced a willingness to deploy tactical missile systems to Kaliningrad the day after Barack Obama’s election in the U.S. This was a clear “shot across the bow” of the new administration and demonstrates Russian willingness to pursue a much more confrontational foreign policy going forward. Furthermore, the collapse in the price of oil augers poorly for Russia’s economy. The Russian budget reputedly needs oil at $70 per barrel or higher in order to be in balance. Russian foreign currency reserves, once huge, have been depleted massively over the past few months by ham-fisted attempts to arrest the slide in both markets and the financial system. Bristling with nuclear weapons and nursing an ego still badly bruised by the collapse of the Soviet Union and loss of superpower status, an impoverished and unstable Russia would be a dangerous thing to behold.

China too is threatened by the global economic downturn. There is no doubt that China has emerged during the past decade as a major economic power. Parts of the country have been transformed by its meteoric growth. However, in truth, only about a quarter of the nation’s billion plus inhabitants—those living in the thriving cities on the coast and in Beijing—have truly felt the impact of the economic boom. Many of these people have now seen a brutal bear market and are adjusting to economic loss and diminished future prospects. However, the vast majority of China’s population did not benefit from the economic boom and could become increasingly restive in an economic slowdown. Enough economic hardship could conceivably threaten the stability of the regime and would more than likely make China more bellicose and unpredictable in its behavior, with dangerous consequences for the U.S. and the world.

Economic hardship invariably has consequences that can dwarf the original impact of those troubles. With the U.S. already at war and facing an increasingly troubled world, it is probably not a good time to make large reductions to the defense budget. With the U.S. government carrying massively greater amounts of debt now as a result of the financial carnage of the past few months, there will be increased pressure to wring savings out of almost every element of government. However, given past experience in tough economic times, it would be wise for our new government to understand the dire need to maintain a strong national defense.

Comments

[investor88:]

Good article that highlights increased geopolitical risks with broad economic declines, something is overlooked by economists. Geopolitical risks could create black swan economic events.

2008 Nov 18 07:39 AM

[Fabien Hug:]

The problem with military budgets is that when you buy all these toys you want to use them. One one side, I don't see a global threat neither from Russia nor from China. There is a effectively a risk that a future Pakistani launches an atomic bomb (let's use the toy) or that Russia gets nostalgic about Ukraine or anything else (Ukraine would not be fun since I think they still have the third atomic arsenal in the world courtesy of former UDSSR). However, a real threat like a Japan/Germany alliance with enough manpower and technology to threaten the States is out of the question.
Now, see how much is spent to control two military small countries like Irak and Afghanistan and you quickly see that it is useless to try to control the world. What will be will be and, in the meantime, keep your money close.

2008 Nov 18 08:51 AM

[lewisabroad:]

Agree with investor 88.
China could use reunification with Taiwan as a distraction from internal problems. Fortunately ties are improving but that could change in three years if a pro-independence party is elected in Taiwan.
The best solution is diplomatic engagement and retrenchment, in my opinion. Retrenchment meaning a major pullout from the Iraq debacle which has been finally successful due to the persistence and intelligence of our troops and military leadership but has been a major drain on our economy. Engagement with Russia and China who should be our partners in turning around an economic catastrophe. Working together to come up with solutions to the economic crisis would build confidence and partnership with these countries that need not be our adversaries. Political transformation happens from within a country and cannot be forced from the outside. It is a cultural phenomenon - if we expect to see democracies in China and Russia in the next 50 years we should do as much as we can to promote cultural exchange and economic ties, and put down the guns (i.e missile defence in Eastern Europe and Japan, weapons sales to Taiwan).

2008 Nov 18 08:52 AM

[ferguson:]

I think Lewisabroad has it right. The challenges facing the world from global warming to food supply, environmental degredation and income inequality make it clear that we can no longer afford war. It should be clear to leaders all over the world that the common good lies in finding ways to work together. The alternative is catastrophe and not just for those who lose. It is catastrophe for everyone as the six year debacle in Iraq clearly illustrates.

Today, we have a gigantic Saudi oil tanker hijacked by a couple of dozen Somali pirates and there doesn't seem to be anything that all the firepower in the world can do about it. This is ridiculous. We need a world of law and order that provides opportunity for all people and limits the degree to which pirates of all stripes from the Red Sea to Wall Street, Red Square and everywhere in between plunder the world for their own benefit.

2008 Nov 18 11:08 AM

[Here's a th...:]

Brief but well put. It's high time someone wrote an article about this. It goes to show the US dollar is signifigantly undervalued.

2008 Nov 18 03:33 PM