Thursday, March 26, 2009

Icarus and the Death of Nations

In the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen orso panics and recessions; virulent inflation that led to a 211⁄2% prime rate in 1980; and the Great Depression ofthe 1930s, when unemployment ranged between 15% and 25% for many years. America has had no shortage of challenges.

Without fail, however, we’ve overcome them. In the face of those obstacles – and many others – thereal standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow JonesIndustrials rose from 66 to 11,497. Compare the record of this period with the dozens of centuries during whichhumans secured only tiny gains, if any, in how they lived. Though the path has not been smooth, our economicsystem has worked extraordinarily well over time. It has unleashed human potential as no other system has, and itwill continue to do so. America’s best days lie ahead
. Warren Buffett

Of late I've been encountering quite a few declarations similar to that from Warren Buffett above- our economic system works well, is the best ever devised, etc. Yet I take no comfort from such declarations, which seem to me, increasingly with the frequency of repetition, like whistling past the graveyard. The question I would pose to anyone making such a statement is simple- what system?

While I don't dispute Buffett's facts, I think there are additional causal factors behind the rapid rise in Americans' standard of living than the choice of industrial capitalism (which was imposed on the South during the Civil War) or the adoption of the Federal Reserve System- winning a few wars springs to mind. Victories against the British and Spanish Empires and the Native Americans gave us much of our land. Victory in WWII led to our role as monetary sovereign for much of the world.

Less than desirable outcomes in Vietnam and now Iraq increased our debt with little to show, in an economic sense, for the effort. If one considers military conflict as an element of economic policy, the return on investment of these relatively recent losses is extremely negative.

Yet, I suspect war as tool for economic gain was not what Buffett had in mind when writing his letter to shareholders. However, as Bertrand Russell argued in Icarus, a polemic on scientism, written in 1924, Economists have underestimated the part played by military prowess in the acquisition of wealth. The economic effect of the spoils of war, such as becoming the issuer of the world's reserve currency, a status neither Bernanke nor Geithner, according to recent comments, wish to lose, is the dirty secret of the Wealth of Nations.

Over the past few days the world has come to what can either be seen as the edge of a precipice or a golden road to another generation of economic growth- true globalization. For decades, commercial and financial corporations have organized themselves to take advantage of such a transition. Yet, two key issues need to be resolved before further gains can be generated from globalization- 1) the creation of a multi-national court to resolve disputes 2) a global currency.

After the implosion of the Soviet Union, the US$ was assumed by many to become that global currency. Unfortunately, a quarter century of expanding external deficits, accelerating since the Soviet collapse, has reduced US bargaining power. Neither Russia nor China seem keen to globalize so long as the US continues to abuse its position as issuer of the global reserve currency.

The emergence of a stumbling block on the road to globalization would not be a surprise to Bertrand Russell. In the aforenoted Icarus, Russell argues: Rivalry is, with most well-to-do energetic people, a stronger motive than love of money..... This rivalry has attached itself to nationalism, and enlisted the support of the ordinary citizens of the countries concerned; they seldom know what it is that they are supporting, but, like the spectators at a football-match, they grow enthusiastic for their own side. The harm that is being done by science and industrialism is almost wholly due to the fact that, while they have proved strong enough to produce a national organization of economic forces, they have not proved strong enough to produce an international organization.

After pondering Russell's views, I've come to think the quantum in Smith's Wealth of Nations needs to be expanded- the issue in a globalized economy is the Wealth of the World, and consequently the Death of Nations.

This perspective is a radical break from the past in that, inter alia, the virtues of war shrink dramatically. From a nationalist perspective, new territory gained comes ex nihilo, foreign destruction of capital infrastructure is not a loss but an opportunity to profit during rebuilding.

From a global perspective nothing comes ex nihilo. There are no spoils of war, just potential productivity gains arising from what is assumed to be a more efficient organizational form. From a global perspective, channeling the benefits of seigniorage to a single (or small group of) nation(s) is absurd.

Economics has come to a fork in the road. I believe a decision to take Frost's road less travelled by and expand the quantum of economics offers the potential for another generation of growth. If Nationalist concerns are not overcome, resource wars seem almost certain.

According to Politico, US Treasury Secretary Geithner, in response to China's call for a new global currency said, The continued use of the dollar as a reserve currency, depends..on how effective we are in the United getting our fiscal system back to the point where people judge it as sustainable over time.

In an update to the story, Politico reports, Evidently sensing a gaffe, moderator Roger Altman told Geithner that it would be "useful" to return to the question, and asked if he foresaw a change in the dollar's centrality.

"I do not," Geithner said, adding several forceful promises, including, "We will do what's necessary to say we're sustaining confidence in our financial markets."

Mr. Geithner, it seems to me, is caught in a Catch-22. The only thing standing between further substantial deterioration of US financial markets is the US$'s position as global reserve- any normal currency under similar conditions would long ago have lost much of its value. Yet, US finances are such that the US$ shouldn't be that global reserve. Heck, if one applied the Maastricht criteria, the US couldn't even get into EMU.

The idea that the Wealth of the World requires the Death of Nations has been depressing me for weeks. Perhaps I'm wrong (it certainly wouldn't be the first time) but it seems to me that current conditions are similar to those of a century ago. Then, as now, the commercial world was about to globalize but satisfactory agreements could not be reached, Nationalism ruled the day and two World Wars followed.

A line from the movie, The Matrix comes to mind, You've been down there, Neo. You already know that road. You know exactly where it ends. And I know that's not where you want to be.


Hombre said...

Dude, I'm a bit confused by your post. You argue that the key to prosperity is a global currency or at least monetary regime ("a golden road to another generation of economic growth- true globalization"). If that means the UN and IMF becoming a stronger global government and a global central bank, respectively, then I strongly disagree. I'd argue that we've gotten to this point precisely because we've centralized the monetary system more and more since the creation of the Federal Reserve, have encouraged the buildup of debt, and have bailed out the system at each sign of trouble which has furthered the growth of debt and leverage. Taking the final step towards a global central bank would, "at best," allow for one more epic bubble which would then destroy the global fiat monetary system (not a bad thing, but I shudder to think at the social consequences if we do this round trip one more time).

The market is telling us that it can't handle the current regime and is trying to restore the system to health. And what are the institutions most in trouble? The biggest, the most indebted, and the most centralized (the biggest of the big multinational investment and commercial banks, GE, the EU, the US, and California within the US). The answer is not to centralize these problem children even further, it's to break them up or shrink them so that no one piece of the system is too big to fail.

To me seeing bank failures, large scale bankruptcies and foreclosures, and even government failures and secession movements with their concomitant debt reductions is precisely what the system needs. Yes, it will create a tremendous amount of upheaval in the short-run, but continuing on this path of more and more debt growth and centralization will only lead to an even bigger systemic failure the next time around.

Of course, if the global central bank would issue a currency linked to gold (fat chance), then that'd be another matter entirely.

Dude said...

My view is a bit more nuanced, I think I used the word "potential".

In order, I believe, to reap the full benefits of the "economies of scale" that industrialized capitalism can generate, the world should become one economic unit.

However, the system cannot just be imposed, it must be agreed upon.

The current experiment with monetary union in Europe is instructive. They are still reluctant, not without valid reasons, to think of themselves as one, and thus the benefits of union are much less than they could, theoretically, be.

Whether the world is ready for this kind of leap is, in my view, doubtful. As you note, the idea of a "beefed up" UN/IMF/World Bank system is absurd.

I suspect that the fears of a global central bank are a bit overdone in that once there is no external account the effects of monetization and other financial games are quickly felt. Had the US not been able to externally finance the US$ would long ago have crashed.

You might well be correct in the view that the first thing a global CB would do is try to inflate and thus crash the system as they faced the awful truth, once there is no external account you must borrow from yourself.

Then they might get serious.

Hombre said...

"No external account" is a good point and I'll have to think over the dynamics of how that would play out. Without the ability of a China-US virtuous cycle (US buys goods from China, China buys US govt bonds to keep rates low enabling the cycle to continue, while at the same time amassing a huge USD position), I suppose authorities would have to resort to FDR-style currency depreciation that much faster to accelerate the cycle.

You've mentioned in the past how you found Tolkien to have a great understanding of human nature with the "ring of power" story being a great analogy for what happens to those who inherit it. I have no doubt that should we ever end up with a one-unit fiat global monetary system we'd see those effects in short order.

I guess the question is how do we transition to a system with fewer "too big to fail" elements and full of redundancies (as Taleb has argued for), while at the same time making it efficient enough to handle global trade in a way that maximizes standards of living?

STS said...

Dude, thanks for the link to Russell's "Icarus" essay. Russell was quite far sighted, perhaps this is not unrelated to the fact that he is still remembered.

"Economists have underestimated the part played by military prowess in the acquisition of wealth."

More generally, economists since WWII have done their level best to pretend that political power (and the military power which often underpins it) has no bearing on economic matters. A particular symptom of this is our blindness to the role of WWII in establishing our mid-twentieth century prosperity. Not just the 'sovereignty' in the currency realm to which you alluded. But as well the destruction of our industrial competitors' manufacturing capacity. We became global monopolists and were able to extract 'rents' (in econ parlance) which funded the "50's" single-family housing vision of American domestic bliss.

Another particularly hilarious quotation from Russell:

"Some people think that we keep our rooms too hot for health, others that we keep them too cold. If this were a political question, one party would maintain that the best temperature is the absolute zero, the other that it is the melting point of iron. Those who maintained any intermediate position would be abused as timorous time-servers, concealed agents of the other side, men who ruined the enthusiasm of a sacred cause by tepid appeals to mere reason. Any man who had the courage to say that our rooms ought to be neither very hot nor very cold would be abused by both parties, and probably shot in No Man's Land."

This comic vision perfectly captures the toddler-level content of our arguments about "regulation" in recent years.

STS said...

Actually, on second thought, we've only had arguments for "absolute zero" on regulation. The other side politically (the Dems) have ranged between 'bipartisan' echos of the "zero" argument and vague plaintive hints -- invariably ignored -- that "didn't we sort this out back in the 30's"?

For the latter, see Dorgan, Byron. Video here.