The United States and the World
- Where Are We Headed?
by Mark Weisbrot, CEPR
www.zcommunications.org/, October
2, 2008
This paper was presented at the Alexandre
de Gusmão Foundation and the International Relations Research
Institute's (IPRI) "Seminar on the United States" hosted
by the Itamaraty Palace (Brazilian Foreign Ministry) in Rio de
Janeiro, Brazil on September 29, 2008.
Introduction
The United States appears to be embarking
on a transition on two major fronts: its own economy, both financial
and real; and its relations with the rest of the world. There
is some relation between these two transitions. Some of these
changes will depend on the outcome of the U.S. national election
in November, and some will not. This paper will present a brief
overview of current trends, with some attention given to U.S.
foreign policy in Latin America, as well as other areas.
US Economic Prospects and Their Implications
At the time of this writing all eyes are
on the financial crisis currently facing the United States and
international financial markets, which is widely considered to
be the worst such crisis since the Great Depression. There is
indeed a serious crisis in the financial sphere, as indicated
by events of the last week, especially the freezing up of credit
markets. The great fear on the down side is that this could lead
to a widespread collapse of parts of the financial system. This
was illustrated most vividly last week when some $224.3 billion
was withdrawn from money market mutual funds, which investors
had previously treated as though they were as safe as a checking
account. There are about $3.4 trillion in these accounts. If
this panic had spread, it could have amounted to something like
a modern-day run on the banking system. Fortunately, however,
the Treasury intervened quickly and announced that it would insure
these funds, which were previously outside its system of federal
deposit insurance.
These and other massive and unorthodox
interventions indicate that the US authorities, including the
Federal Reserve (in conjunction with other central banks such
as the ECB and BOJ) and Treasury Department, are willing to do
whatever is necessary in order to prevent a major breakdown in
the financial sphere. They have engaged in the largest nationalizations
and the largest transfer of debt in world history (the nationalization
of Fannie Mae and Freddie Mac), as well as the nationalization
of the country's largest insurer (AIG), and pumped hundreds of
millions of dollars into the banking system in response to liquidity
crunches.
Given this willingness of the authorities
to do whatever is necessary to prevent a run on deposits (now
including money market mutual funds) and the freezing up of credit,
the threat of a generalized collapse of the financial system appears
to be exaggerated. More likely there will be more strains on the
system as insolvent institutions go under - just as the disorderly
collapse of Lehman Brothers precipitated the current crisis -
and other unexpected events occur, in a process of "de-leveraging"
and shrinking the bloated and over-leveraged financial sector.
The sector has more than tripled as a share of GDP over the post-war
period and before the recent downturn had accounted for more than
30 percent of corporate profits. Much of this profit was illusory
and has since disappeared, as we are now seeing.
The current struggle over the conditions
attached to the Bush Administration's proposed $700 billion bailout
are a more likely indicator of the battles ahead. It will be a
fight over the distribution of losses - taxpayers and homeowners
on the one hand, versus shareholders, CEO's, and investors in
the financial sector on the other hand. The Administration last
week posed the question as one of "give us a blank check
or risk financial collapse." This was rejected by a populist
revolt in both parties, and it appears that there will be at least
some conditions imposed on the bailout. But given the power that
the financial sector wields in the U.S. political system, these
will fall far short of some very feasible and practical reforms
that would protect homeowners, force the investors and executives
who made bad decisions to absorb their share of the losses, and
implement the regulatory reforms necessary to prevent a repeat
in the future. (For an overview of such reforms and guidelines
to a proper bailout, see Dean Baker, Progressive Conditions for
a Bailout).2 Nonetheless these political battles will probably
continue over the next couple of years.
There is a confusion in most of the public
discussion of the state of the U.S. economy. The current economic
problems are seen as overwhelmingly a financial crisis, when in
fact there are major problems in the real economy that are dragging
the economy into a serious recession. In other words, even if
the problems in the financial sector are resolved, it would not
prevent this recession from deepening. We are currently experiencing
a recession that was brought on by the bursting of a massive housing
bubble, one that created some $8 trillion of illusory wealth before
it began to burst in mid-2006.
This bubble is only about 60 percent deflated,
and that assumes that there is no overshoot in the other direction
at the bottom. The arithmetic is fairly straightforward : from
1996 to 2006, U.S. home prices rose by about 70 percent above
the rate of inflation. Prior to this, home prices over the long
term did not rise faster than inflation. This means that home
prices would have to fall about 40 percent to reach trend levels;
in real terms (including inflation), they have so far fallen about
25 percent.
There remains a large oversupply of housing
in the United States, and homeowners are currently receiving foreclosure
notices at the rate of about 3.6 million a year. In addition to
the impact of the shrinking of construction and housing-related
sectors, an even more important impact of the bursting housing
bubble on the economy is through the wealth effect. U.S. households
typically borrow against the equity in their homes, and the expansion
of the U.S. economy from the end of the last recession (November
2001) to last year was largely driven by this borrowing. At the
peak of the bubble in 2006, consumers were cashing out some $780
billion a year from (then rapidly rising) home equity. Much of
this borrowing and spending has come to an end. In the next quarterly
GDP report (3rd quarter) we may see a drop in consumer spending,
which has so far held up despite the collapse of the housing bubble.
Over the last four quarters of data, the
main contributor to economic growth has been an improvement in
the trade balance, as a result of the steep slide of the dollar
(about 25 percent against a trade-weighted basket of currencies)
that began in 2002.4 But trade is only about 26 percent of the
U.S. economy; consumer spending is 70 percent. And the labor market
has weakened to recession levels: unemployment, at 6.1 percent,
is almost at its September 2003 peak from the last recession,
and employment as a percentage of population is near its trough
from the last recession. The economy has shed jobs at a rate of
81,000 per month over the last quarter, and real wages are falling.
All of this will feed back into the housing market and also weaken
consumer spending. In addition, the state and local government
sector, which has so far been adding jobs, will contract in the
near future as these governments begin to cut back spending (most
have to balance their budgets) in response to falling revenues.
The New York City government recently announced $1.5 billion in
spending cuts over the next 15 months.
In other words, the U.S. downturn is just
beginning, and will accelerate even if the problems in the financial
sector were to be resolved in the most efficient manner possible.
More likely, problems in the financial sector as it rids itself
of insolvent institutions and bad debt will contribute to the
downturn through restricting the availability of credit and undermining
investor confidence generally.
This leads to what will be the next major
battle over economic issues, after the financial crisis is resolved:
fiscal policy. An expansionary fiscal policy will be needed to
mitigate the effects of the recession, which is very likely to
be the worst in at least a quarter-century. The Fed has already
cut the Federal Funds rate from 5.25 percent to 2.0 percent, and
so does not have much farther to go. But monetary policy cannot
have even a small fraction of the expansionary effect that it
had on the last recession, when it contributed to the massive
expansion of the housing bubble. It is long-term rates that have
the much larger impact on economic activity in the United States,
and lowering the short-term rate does not necessarily lower long-term
rates; in fact the 10-year Treasury markets have reacted several
times to recent Fed rate cuts with rising yields. Furthermore,
the Fed is much more worried about inflation now, with the CPI
at 7.2% over the last year (core at 3.4%), as compared to 4.0%
at the onset of the last recession (core at 3.5%).
Given the ineffectiveness of further interest
rate cuts, fiscal policy will be the main potential tool for counter-cyclical
policy in the near future. However, the national debt is already
more than 67 percent of GDP; the current bailout will push this
over 72 percent and there will probably be more bailouts (e.g.
the re-funding of the Federal Deposit Insurance Corporation, which
cannot possibly deal with likely bank failures) as well as further
deficit increases due to automatic spending increases and revenue
declines as the economy weakens. These are levels of public debt
that have not been seen since the early 1950s, when the debt was
still winding down from its explosive growth during World War
II. Of course it would still be best policy during a recession
to ignore these debt levels and proceed with a large fiscal stimulus
package - especially since the bailouts, while adding to the debt,
do not have the same effect on demand as other forms of deficit
spending would. However, there remains a strong prejudice in the
U.S. political system, in both political parties and in the media,
against doing so. The size and growth of the national debt is
a major issue in political campaigns, including the presidential
campaign, and many Democrats in recent years have often been more
conservative than Republicans on this issue.
Therefore, the depth and destructiveness
of the current recession may well depend on how much the next
government is willing to ignore this economic dogma and stimulate
the economy. During the last recession the federal government
went from a 2.4 percent of GDP fiscal surplus to a 3.5 percent
deficit (2000-2003); and this was in conjunction with the interest
rate cuts (from 6 percent in May 2000 to 1 percent in June 2003)
and massive growth of the housing bubble. Currently, the Federal
Funds rate is already at 2 percent and the federal budget deficit
(using the unified budget that is customarily reported) is at
3.3 percent of GDP, not including the current bailouts.
While the authorities have so far proven
quite flexible in response to the financial crisis - massive nationalizations,
debt accumulation, and even a tolerance for higher inflation and
inflation risks that are unusual for the Federal Reserve - it
is not at all clear that the next government, regardless of who
wins the election, will be willing to abandon fiscal conservatism
as needed to help pull the economy out of recession. Most likely
they will not make the kinds of mistakes that the Japanese government
made after their stock market and real estate bubble burst in
1989; and the U.S. has other advantages, especially with regard
to the dollar as the key currency in the international economy,
that will make it easier for the United States to avoid falling
into a prolonged period of stagnation. Nonetheless there is plenty
of room for this recession to be much longer than necessary if
there are policy failures.
Leaving aside for the moment the depth
and length of the recession, and its dependence on policy responses,
the current economic juncture is likely to leave lasting effects
on the U.S. economic system, and because of U.S. influence, much
of the world. Some of this has already taken place. The five top
U.S. investment banks are no more: Bear Stearns collapsed earlier
this year, Lehman went bankrupt, Merrill Lynch agreed to be bought
by Bank of America; Morgan Stanley and Goldman Sachs gave up investment
bank status. This brings them all within the Federal Reserve's
regulatory system.
What lasting impact can we expect, after
the economy has recovered? We can expect some regulatory reform
in the U.S. financial system to reduce at least some of the abuses
that led to the collapse. It remains to be seen whether such progressive
reforms as a financial transactions tax, which could reduce speculation
and raise upwards of $100 billion annually in revenue, will have
a chance.
Since this is the second recession in
seven years that was caused by the bursting of an asset bubble,
it is possible that the Fed will change its view of such speculative
bubbles and begin to monitor them and try to counteract them.
The position until now of Alan Greenspan and Ben Bernanke has
been that the Fed should not try to do anything about asset bubbles
until after the fact. However this does not make sense; the stock
market bubble was identifiable and identified in the late 1990s,
and the same is true for the housing bubble beginning in 2002.7
Also, the Fed does not necessarily have to raise interest rates
in order to counter-act a growing asset bubble; much can be done
to rein in speculation through informing investors and the public
of the dangers of investing in bubble-inflated assets, as well
as other regulatory measures. This is important because although
it is now recognized that there were regulatory failures, e.g.
in the case of the sub-prime mortgage market, that contributed
to the current crisis, it is not widely known that failure to
contain the bubble itself - which could have been done - is the
single largest cause of the damage that we are seeing today.
The shrinking of the U.S. trade deficit
during this recession will adjust, at least to some extent, one
of the biggest imbalances in the global economy. For the United
States, it may help to restore the conditions for sustainable
growth. Since the 1990s U.S. economic growth has been largely
dependent on bubble-driven consumption, first from the stock market
bubble and then the housing bubble. One reason for this is the
United States' large and - until last year - growing trade deficit,
which is a result of an overvalued dollar. Since the trade deficit,
as a matter of accounting, reduces growth, the economy needs another
source of demand to compensate. Bubble-driven consumption has
played that role until now, but will no longer be necessary if
the dollar's decline - plus the effect of the recession in shrinking
demand for imports - reduces the trade deficit to a sustainable
level.
After this recession, the influence of
neoliberal ideas, which have their strongest base internationally
in the United States, will emerge somewhat weaker. The libertarian
variant espoused by the late Milton Friedman has already declined
precipitously in recent years, and it will be increasingly difficult
to make a serious argument for this kind of "free market"
fundamentalism in the coming years. But what of the more mainstream
neoliberal ideas, often inaccurately labeled as "free market,"
or "free trade?" In reality, these policies have dismantled
market barriers when such changes would drive down wages or redistribute
income upward (e.g. international trade in manufacturing), while
supporting protectionism and non-market solutions when this redistributed
income upward (e.g. increased patent protection for pharmaceuticals,
restricted competition in professional employment, CEO pay).9
These ideas too will be weakened somewhat in the years ahead.
In some respects it may be similar to what happened after Japan's
collapse in 1989, although a milder version. Prior to 1989, Japan's
industrial policy and export led growth were widely admired as
successful economic policies; after the collapse of Japan's stock
market and real estate bubble and the ensuing stagnation in the
1990s, Japan was no longer seen as an example to be emulated.
There has been a powerful effort in recent
years, in the most important European political and media circles,
to push Europe in the direction of emulating the United States,
which is portrayed as a more dynamic and successful form of capitalism.
It is widely believed that the Eurozone countries cannot afford
their welfare state in the new global economy, and that labor
market regulation and unions have increased unemployment and undermined
productivity growth. The economic evidence for these arguments
has been entirely lacking, but they helped elect French President
Nicolas Sarkozy in 2007, and the German Social Democratic Party
leadership has repeatedly defied its own voters by trying to move
in this direction. These ideas are likely to lose some steam as
the reality of the current crisis and U.S. recession are presented
to the European public. Neoliberal ideas are likely to lose some
credibility in developing countries as well; they have already
fallen sharply in popularity in Latin America over the last decade.
The U.S. recession will also reduce its
influence in the world more generally, which has been falling
rapidly under the Bush Administration.
US Foreign Policy in Years Ahead
It is generally agreed that Washington
has lost considerable influence and prestige in the world in recent
years, most importantly due to most of the world's rejection of
Washington's invasion of Iraq, but also other international scandals
and human rights abuses (secret detention centers, Abu Ghraib,
Guantánamo, extra-ordinary rendition and torture), as well
as a generally unilateralist and "with us or against us"
posture espoused by the Bush Administration.
There are other reasons for the decline
of U.S. influence that are in some cases greater contributing
factors but have received very little attention. The most important
of these is the collapse of the International Monetary Fund (IMF).
This was the most important avenue of U.S. influence in developing
countries for the past three decades. The IMF was positioned,
by informal arrangement, at the top of a creditors' cartel. Governments
who did not reach agreements with the Fund on various economic
policies were in most cases denied credit not only from the IMF,
but from the larger World Bank, other multi-lateral lenders such
as the Inter-American Development Bank, the governments of rich
countries, and sometimes even the private sector. This gave Washington,
which has dominated the IMF since its inception in 1944, a powerful
lever to promote a whole series of economic reforms in developing
countries.
Over the last decade this leverage has
virtually collapsed in middle-income countries. Although some
poor countries, especially in Africa, are still subject to IMF
conditions, almost all of the middle-income countries are not.
In the last four years the IMF's total loan portfolio has shrunk
from $105 billion to less than $10 billion. The organization itself
is currently running a $400 million annual deficit and has been
forced to downsize.
The collapse of the IMF has greatly contributed
to Washington's loss of influence in Latin America. Most of the
governments in the region are now more independent of Washington
than Europe is. This is also because left-of-center governments
have been elected in the last decade in Argentina, Brazil, Bolivia,
Chile, Ecuador, Guatemala, Honduras, Nicaragua, Paraguay, Uruguay,
and Venezuela. A major reason for this revolt at the ballot box
has been the economic failure of neoliberal policies that were
actively promoted by Washington and the multilateral institutions
where it holds sway, including the IMF, World Bank, and IADB.
From 1960-1980 the region's per capita income grew by 82 percent.
From 1980-2000 it grew by only 9 percent, and despite a few good
years recently, it has grown by only 14 percent in the current
decade. Even ignoring the distribution of income, which is the
most unequal of any in the world and has worsened in some countries,
Latin America's long-term economic growth and development failure
in the neoliberal era is unprecedented in its modern history.
Washington's response to Latin America's
leftward shift has accelerated its loss of influence in the region.
The Bush Administration supported the military coup against the
elected government of Venezuela in 2002, and then continued to
fund and support opposition groups and tacitly support serious
destabilization efforts (including the 2002-2003 oil strike) after
the coup. Teodoro Petkoff, currently one of the most prominent
and respected leaders of the Venezuelan opposition in international
circles, recently described the opposition "strategy that
overtly sought a military takeover" from 1999-2003, and its
use of the oil industry for purposes of overthrowing the government.
Washington's support for this strategy,
and continued support for the Venezuelan opposition to this day
has created a serious rift with Venezuela. Instead of trying to
re-establish normal relations with Venezuela, for example through
direct talks, it has engaged in a continuing series of hostile
actions that seemed designed to provoke enmity - most recently
threatening to put Venezuela on a list of nations designated as
"state sponsors of terrorism."
In addition, Washington has pursued a
strategy of trying to isolate Venezuela from its neighbors. This
has also backfired and served more to isolate the United States
rather than Venezuela in the region. The Bush Administration's
support for opposition groups in Bolivia, including funding from
USAID, led to the expulsion on September 10 of the US Ambassador
there; Venezuela expelled the U.S. ambassador as a gesture of
support, and Washington then expelled the Venezuelan and Bolivian
ambassadors.
In another sign of the United States'
declining influence in Latin America and especially South America,
UNASUR met on September 15 and issued a statement strongly supporting
the government of Evo Morales. Among the signers were Colombia,
Washington's closest ally in the region, as well as Peru, and
Chile, the convener of the summit. This demonstrates the importance
of structural changes that are solidifying Latin America's independence
as well as its pursuit of economic and political integration,
through such institutions as UNASUR and the Bank of the South.
There are a number of factors that would
tend to support current trends in the coming years. First, the
United States' market for Latin America's exports, which expanded
very rapidly from 1994-2006, as the U.S. trade deficit reached
a peak of 6.2 percent of GDP in 2006, will not do so in the years
ahead. This is because of the reduction of the U.S. trade deficit
(see above). The impact will be most felt by countries that have
"free trade" agreements with the United States, especially
Mexico, Canada, Central America, and the Caribbean. Countries
such as Brazil and Argentina, which export less than one percent
of GDP to the United States, will not be significantly affected.
This differential impact will in turn reinforce the movement toward
diversification away from over-dependence on trade with the United
States, including Latin American economic integration. It would
not be surprising if even Washington's strongest allies, such
as Colombia, end up joining such institutions as the Bank of the
South.
Declining support for "free trade"
agreements, both in Latin America and in the United States, will
also reduce the relative importance of U.S. commercial relations
with Latin America. The proposed "Free Trade Area of the
Americas," negotiated between 1994 and 2005 is dead, and
the proposed agreement between the U.S. and Colombia does not
look likely. The economic success of the left governments that
have been elected over the last decade will also encourage countries
to seek more policy space than was allowed during the neoliberal
era. Venezuela and Argentina, for example, have pursued heterodox
macroeconomic policies and have had the fastest growing economies
in the hemisphere over the last six years.
As the world becomes increasingly multi-polar,
U.S. influence will continue to decline not only in Latin America
but in the rest of the world. The breakdown of negotiations in
the World Trade Organization this past July, for example, is another
manifestation of this process. Developing countries, including
India and China, are much bigger and more influential than they
were when the WTO was created - with rules stacked against the
developing world - in 1995. Going forward, they will no longer
sign off on deals that benefit the rich countries at their expense,
such as the Non-Agricultural Market Access (NAMA) proposals that
would force steeper proportionate tariff reductions on developing
countries than on high-income countries in manufacturing - this
contributed to the current impasse.
What are we to expect in the realm of
changes to U.S. foreign policy if Barack Obama were to win the
presidency in November? While more moderate than McCain, Obama
has adopted some of the same hostile rhetoric toward Venezuela,
pledged to maintain the embargo on Cuba, and even showed support
for Colombia's March 1 raid into Ecuador. This was a violation
of sovereignty and a dangerous regionalization of Colombia's conflict
- supported by the Bush Administration - that was publicly rejected
by nearly every government in the hemisphere.
On the other hand, Obama has said he would
meet with President Hugo Chavez of Venezuela and Raul Castro of
Cuba. Also, it is difficult to assess the meaning of statements
from either candidate as they compete for the votes of hundreds
of thousands of right-wing Cuban-Americans in Florida, a state
with 27 electoral votes that swung the last two presidential elections.
But the problem is much deeper than the
candidates or their beliefs or strategies. There is an influential
foreign policy establishment based in Washington, which includes
the major media and biggest policy institutes, as well as key
members of Congress and the State Department. This foreign policy
establishment - ignoring the neoconservatives who are among McCain's
top advisors but would have no role in an Obama administration
- have a deep-seated world view that is decidedly unsympathetic
to the political changes that have taken place in Latin America
over the last decade. Obama's advisors are very much part of
that consensus; their main difference with the Bush Administration's
handling of U.S.-Latin American relations is that the Administration
did not pay sufficient attention to the region.
If Obama wins, the most likely scenario
is that President Chavez will welcome the new administration and
offer an olive branch. If Obama listens to his advisors, he will
reject these overtures in a way that reinforces the status quo
ante. There is, of course, the possibility that Obama will go
against his advisors and abandon Washington's campaign against
Venezuela. But that is not the most likely outcome.
Nonetheless, over some years there is
likely to be some significant change in U.S. policy toward Latin
America and the rest of the world under a Democratic congress
and president. That is because the bases of the two parties are
vastly different. This is not noticeable in presidential politics,
for a number of reasons. Every Democratic U.S. Senator with presidential
ambitions voted for the Iraq war. The calculation in such decisions
is simple: they know that if they vote for the war and it is a
disaster, their base will forgive them; but if they vote against
it and it is a "success," they will lose some support
from the center-right (including the media).
But over time, the difference in the base
of the two parties exerts a significant influence on foreign policy.
This is even more true today than it was 20 years ago, when the
Democratic Congress cut off funding to the Nicaraguan contras
as a result of grass roots pressure. President Reagan was forced
to run the war from the basement of the White House, with illegal
funds, which almost cost him his presidency in the Iran-Contra
scandal. Among the base of the Democratic party today are millions
of people, including activists, that see the whole "war on
terror" as a farce and do not believe that the United States
has either the right or need to impose its will on other countries.
The candidates already have some significant
differences over other key foreign policy issues. Obama says he
is willing to negotiate with Iran without preconditions. The present
policy towards Iran, which McCain would continue if not exacerbate,
insists that Iran must suspend the enrichment of uranium before
negotiations can take place. This is a recipe for military conflict,
since Iranians themselves, and not just the government, strongly
support the idea that they have the right (which they do under
international agreements) to enrich uranium for peaceful uses.
So Obama's difference with current policy on Iran is significant.
This has implications for the rest of the region. For example,
Iran's co-operation with regard to Afghanistan might facilitate
a withdrawal from that war.
With regard to Iraq, there are also significant
differences. McCain is much more committed to the war being a
"success," and thus likely to stay longer and try to
maintain a bigger troop presence indefinitely. He is more committed
to confrontation with Iran, whereas the Iraqi government is likely
to pursue close relations with Iran. These commitments, plus his
own neoconservative world view, would make McCain more likely
to remain in Iraq for a longer time and with more permanent military
bases there. The Iraqi government has increasingly been pushing
back against the United States; they have forced agreement on
a timetable for a withdrawal of foreign troops from Iraqi cities
and are likely to get an agreement for a timetable on overall
withdrawal. They have also increasingly confronted Washington
with regard to the role of foreign oil companies. Obama is more
likely than McCain to accept these realities sooner.
On Afghanistan, Pakistan, and Israel/Palestine
there are less obvious differences between the two candidates.
Both want to increase troop levels in Afghanistan, and pursue
a more aggressive posture towards Pakistan. These policies, as
well the failure to even oppose the expansion of Israeli settlements
in the occupied territories, are counter-productive and dangerous.
Both candidates also want to expand the number of troops in the
U.S. military.
On the latter question, the level of national
debt that is likely to emerge at the end of this recession and
bailouts may prove to be a constraint on expanding the military.
Although the United States is capable of sustaining higher levels
of public debt without damage to the economy, there are political
constraints that come into play, as noted above. At the height
of the Vietnam war, when Martin Luther King Jr. warned that the
War on Poverty was being abandoned because of military spending,
the national debt was about 43 percent of GDP and falling; as
compared to the 67 percent of GDP and rapidly rising debt/GDP
ratio today. Eventually, Americans may finally begin to see themselves
as having to choose between fighting to defend an empire in decline,
and enjoying the quality of life - including such amenities as
universal health care - that their counterparts in other rich
countries have.
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