3 Steps for America To Regain the World's Trust 17 comments
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David Smick contends that “The World Is Curved” because in financial markets people cannot see over the horizon. That is, the future is subject to incomplete information and, hence, risk and uncertainty.
To Smick, a money manager, writer, and public intellectual who founded, edits, and publishes The International Economy, and an adviser to both Republicans and Democrats, this concern with risk and uncertainty has become a worldwide phenomenon that eclipses national governments. And, this loss of control, especially for the United States, is a “new thing”.
American politicians are now struggling against this reality and are attempting to regain the relevance that the United States once held. Smick says it can’t be regained. This is the most important point stressed by Smick in the book and leads to three more specific conclusions.
First, the United States must act as a partner in the world and not an independent, isolated unit. Smick argues “that most U.S. politicians operated as if the global financial system did not exist.” In the last eight years or so the people in the Bush administration, including Alan Greenspan, chairman of the Federal Reserve System, believed that the United States economy was “a closed system.”
In fact, the author contends that the United States is the last world power to experience this reality check. The Mitterrand government in France in the early 1980s serves as an example. Here an avowedly socialist government attempted to ignore international markets and ended up establishing open trade, balanced fiscal budgets and an independent central bank to keep inflation at low levels. The experience of France was repeated in many other countries around the world and now must be adopted by the U.S.
Second, in globalized world markets financial leverage can become excessive and uncontrollable. In a financial bubble, financial leverage always increases. Smick contends that the world has reached the point where, because of all the new and innovative financial products available throughout the world, central banks find themselves relatively powerless. Central banks can create and sustain bubbles, but they can do very little to resolve an economic crisis once the bubble bursts.
But two things can happen when there is excessive leverage. First, if people have little or no equity invested in their projects they can become exceedingly careless — intentionally or unintentionally — because they have little to lose if things go wrong. Second, since modern financial innovations have removed the tie between an initial lender and the risk or fate of the borrower the discipline of the lender can suffer. Both factors, Smick argues, can reduce discipline in financial institutions and markets.
Third, the power of central banks has substantially declined. To support this argument, Smick draws from the Japanese economic collapse of the 1990s to apply to the U. S. situation. He draws three lessons from this review: First, in the creation of a bubble, an economy can become overloaded with debt; second, during the bubble an economy becomes more and more fragile and eventually bursts; and last, central bankers become powerless to rescue the system because of the consequent deleveraging and retrenchment that must take place.
In getting to this point Smick does not present a very pretty picture of Alan Greenspan. Greenspan is painted as an individual who was always looking to “one up” others, who worked diligently to identity arcane bits of information that he could cite and overwhelm “competitors” in order to maintain control of a situation or retain the power of his position. Greenspan is seen as someone who had no coherent, overarching model of the world. He worked from the bottom up, seeing the trees but not the forest.
Without a coherent economic model, Greenspan reacted to the collapse of the stock market bubble of the 1990s by keeping interest rates extraordinarily low and by allowing the value of the United States dollar to fall dramatically. He did not achieve much economic growth for his efforts and he did very little to stimulate employment. What he achieved was another bubble fueled by a massive creation of debt.
The bottom line is that financial leverage can grow almost without limit in times of financial expansion while any attempts to prevent or offset the efforts of financial markets to deleverage and restructure prove to be almost totally ineffective during periods of financial contraction.
To summarize what must be done, Smick argues:
- the United States must accept its role as a partner in the world community and get away from thinking that it can act independently of the rest of the world;
- the United States must continue on the path of open trade with the world and cannot revert to feelings of superiority or of class interest;
- the United States must become disciplined in the conduct of its monetary and fiscal policy so as to avoid financial bubbles and the creation of incentives for firms and people to leverage up their balance sheets. Once discipline is lost it is difficult, in a policy sense, to bring back financial stability. This means that the United States must put more focus upon the value of the dollar so as to cooperate with the world community.
Only in these ways does Smick see the United States creating one of “the most attractive destinations for global investment.” Creating such an environment must be the longer term goal that we should be shooting for.
The World is Curved: Hidden Dangers to the Global Economy, by David Smick (2008: Penguin Portfolio; 280 pp.)
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This article has 17 comments:
Seek out objective, well informed experts and combine their knowledge with long term data, then apply all of that to todays reality and you will have a view over the horizon.
My predictions: a secular bear market that lasts for as long as 20 years (but did it start in 2000?) and the Dow well below 5,000 and possibly as low as 1,500.
--Fred Voetsch 12-13-2008
But as for Dow 1,500, that's just silly.
Not quite. Maybe 15,000, then 25,000, once the inflation that's coming gets here. And it will get ugly and out of control.
Trillions are about to bail from T bills, and knowing the coming dollar devaluation and inflationary campaign underway, equities will be bought.
You will never see your 1,500 on the DOW. Sorry.
dow will not be 1.5k due to the excessive money supply, but it will have to come down more to the real value the listed companies are giving to the public, and they are still overvalued IMO.
China's demographic time-bomb, the opacity of its public companies, its pursuit of negative real interest rates, its stockpiling of commodities... all ominous rumblings behind a facade that is still relentlessly bullish.
Are Japan's housewives finally starting to buy stocks? I saw a NYT article to that effect recently, but who knows.
> jack
-The Federal Reserve should be abolished and an actual Federal Reserve system put into place - You know, one that is owned and controlled by the Federal Government, not private banks.
-Fractional Reserve Lending abolished once and for all. Why should a bank be allowed to lend money it does not have?
-Fixed government spending - balanced budget mandatory (except for war time or emergencies)
-Back the currency with something tangible so they can't print money out of thin air when they see fit - that hurts those of us holding USDs.
-Fixed interest rate that does not move would give stability to the system. Why entice people to take on more debt and spend money they do not have with lowering the interest rates? That just creates more swings up and down in the market...
-Encourage some savings among Americans! I don't know how - maybe change the tax system to a consumption based tax so that families are encouraged to save their money? Who knows.. but there must be some good ways to encourage savings in the future.
Just a few ideas, not all of them are good...
1) Stop thinking, speaking and acting like America is the best.
2) Stop using CIA and war to control the commodities America needs.
3) Get America's own house in order.