In 2009 I wrote some papers for the department of social sciences at the University of Florence. Among these, the main study was on the Sovereign Wealth Funds “phenomenon”. The field I was approaching was History of International Economic Relations. Rereading my work, I realized that I still think the same about the possible answers to the questions posed by the (supposed?) new world order. Here’s what.
A new world order
Towards the end of the nineteenth century, the borders of Britain’s financial empire went well beyond politics. The dependence of a country from English economic power was ahead, more or less formally, to the submission to political power. When the Egyptian Khedive had the need to raise cash to cover his personal debt in respect of some British private banks, he could do nothing but sell its shareholding in the Suez Canal Company. The Khedive certainly did not act better when it came to managing the Egyptian public debt: the difficulty in honouring it brought England and France to take control of the Egyptian Treasury, and finally, in 1882, Egypt was put under military occupation. [click for reference]
In 1956, the decision of Egyptian President Gamal Abdel Nasser to nationalize the Suez Canal Company (owned by an Anglo-French coalition) provided to UK and France a justification for organizing a joint military operation against Egypt, which led to the occupation of the Channel from England (along with France and Israel, with the latter having joined the conflict on the side of the European powers). The financial status of the UK, however, was no longer that of the previous century: Britain had indeed a small current account surplus, but in 1956-57 the pound sterling had become subject to speculative pressures. The Bank of England made extensive use of its dollar reserves to support the exchange rate existing between the pound and the dollar, but came to a point where the threat of a forced devaluation or a change to a flexible exchange rate system was real. The United States, then the largest single creditor of Great Britain, declared that their intention to continue to provide direct financial support to England and to participate in an IMF loan for the United Kingdom, would depend to the compliance by British government with a UN General Assembly resolution calling on the United Kingdom, France and Israel to withdraw from the Suez Canal. [click for reference]
The American ultimatum forced Britain to reconsider its position. Anthony Eden, then British prime minister, explained that:
We were therefore faced with the alternatives, a run on sterling and the loss of gold and dollar reserves till they fell well below the safety margin […] or make the best we could of UN takeover and salvage what we could. [click for reference]
The lesson which follows from the the Suez crisis should be, especially for the United States, rather obvious: political strength is (almost always) related to financial strength. For example, the capabilities of a debtor country to carry out military actions depend largely on the support provided by creditor countries. Militarily, the United States are stronger today than it was Great Britain in the ’50s and are also not obliged to keep the dollar exchange rate to a predetermined level. However, in other respects, US financial position is more precarious than English one at the time of the Suez crisis. Indeed, while in 1956 the English had even a small current account surplus, the United States, at the end of 2010, had a current account deficit of about $ 120 billion, i.e. -3.2% of their GDP. Furthermore, Britain’s main creditors were British political and military allies (the United States on all) while, on the other side, U.S. debt, is not funded by “allies”: without investments in U.S. government securities made by China, Russia and the Gulf countries, the dollar would suffer a substantial depreciation, boosting U.S. interest rates. This would be difficult to sustain for the United States, because it would put entirely on the shoulders of the domestic economy the cost of maintaining their international role.
After all, it seems that the U.S. have the ability to borrow huge amounts of money at very favourable rates. Their dependence on foreign financing could be considered not as vulnerability, but as a sign of strength on the international scene: simply, the American economy could be too big to fail.
Actually, one could suggest the opposite, namely that the growing U.S. current account deficit represents a strategic (read: political) understated vulnerability. The willingness of central banks in emerging countries to accumulate dollar reserves has provided a stable source of debt financing. The problem is that these central banks already hold far more reserves than they need, so that they can also be used to finance new investment vehicles (Sovereign Wealth Funds, in fact). True, central banks still have an interest in maintaining the dollar relatively strong, but the U.S. may have more to lose than to gain from a possible “showdown” with the monetary authorities in creditor countries. In a nutshell: the more the U.S. will continue to base their economy on deficit financed by the investment vehicles in emerging countries (central banks and sovereign wealth funds), the more they will reduce their strength on the international stage.
In addition to that, it can be observed that the economic weight of China, India, Russia, Brazil, Arab States of the Gulf and other emerging economies will increase in the twenty-first century. Also if China’s growth were to grow at a slower pace than the current, it is likely that China, over the next twenty-five years, will displace the U.S. as the largest economy in the world. [click for reference]
This step alone would involve substantial changes to the world economy and to institutions which are responsible for the global governance. At the moment, however, the increase in the relative economic importance of these new actors is accompanied by another dramatic change: the emerging economies have become creditors of the industrialized countries.
This flow of state capital appears more and more as the consequence of political choices rather than the natural evolution of the global economy. Indeed, the size of Chinese population suggests that China should be the first economy in the world and not the largest creditor of the West! Moreover, the weight of the U.S. foreign debt, concentrated in a limited number of counterparties – many of which do not share the Western democratic values – undeniably represents a strategic vulnerability. This certainly does not mean that these creditors will improperly use their “bargaining power”, but the United States should act to avoid the possibility that a foreign country, for example, could suddenly reduce its dollar investments as a response to a foreign policy dispute. Given the magnitude of the american debt position, this could cause a shock to the U.S. economy no less severe than that following the subprime credit crisis. (… here is the second part)