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.)
