Remarks to the China Renaissance Capital Investment's Annual Meeting
We live in a time of great transitions and confusions. The global distribution of wealth and power is in rapid evolution. In many countries famous for optimism, like the United States, doubt has succeeded confidence about the future, and pessimism prevails. In other countries, like China and India, the opposite is occurring. According to recent polls, this year only 36 percent of Americans are satisfied with the direction our country is taking, and a mere 17 percent see the national economy as in good condition. In Europe, with the notable exception of Germany, the mood is even gloomier. By contrast, 87 percent of Chinese are satisfied with China’s prospects and 88 percent consider its economy to be good. In India, 53 percent think things are going well and 73 percent see the economy as sound.
No doubt the pessimism in the West and the optimism in Asia are both overdone. Still, they are indicators of the profound shifts in the global economic centers of gravity and political influence that are underway. They reflect public perceptions of the competence of leaders and the capability of governmental systems. Internationally, many place their hopes in President Obama, but few have any faith in the United States government. The current effort to fix the notoriously derelict American health insurance system, which costs much more and delivers much less than its counterparts in other industrial democracies, has not helped. To many, it has come to symbolize a system of government so corrupted by special interests that it cannot solve problems even when they are both urgent and obvious.
Political delinquency of this kind matters greatly, not just to Americans but to the world. The Great Recession originated in the United States. To date, however, the underlying causes of the financial crisis that triggered it have not been addressed. Principal among these causes was the self indulgence of fiscal and monetary policies in the United States. Neither the fiscal and monetary stimulus packages nor the bank and insurance company bail-outs that preceded them have cured this self indulgence; they have enabled its continuation with government support.
The result is ever-larger budget deficits and the monetization of mountains of debt by the Federal Reserve. Americans remain in fiscal and monetary denial. The United States continues to base its policies on the presupposition that foreigners will never develop an alternative to lending Americans the money to fund their government and well-being. This complacency produces stimulus programs that rely on tax rebates, consumer giveaways, plus-ups of transfer payments, and other gimmicks to inflate consumer demand. Such programs do next to nothing to repair structural problems in the economy. They make little investment in long-term competitiveness. Instead, in an odd juxtaposition of military Keynesianism with fiscal parsimony, the federal government lavishes funds on the military-industrial sector, even as state governments disinvest in education and physical infrastructure.
All this increases American dependence on foreign borrowing. It also fails to cure the short-sighted greed and financial chicanery that has destroyed Wall Street’s reputation and eroded its global market share. These two factors inadvertently promote the decoupling of the global economy from the American financial sector, including the dollar. The dollar has long been the dominant reserve currency and unit of account for global trade and investment. But the world is now shorting the dollar to buy other things, in the process creating yet another huge asset valuation bubble. Meanwhile, there is a global consensus that U.S. currency’s role is unsustainable and must be reduced. Persistent balance of trade and payments deficits make it clear that the dollar must lose value in relation to other currencies. One way or another these adjustments will take place. They could take place suddenly and at any time.
It matters greatly whether the dollar’s role and value are managed down to sustainable levels in an orderly and gradual way or left to the mercies of currency traders. People’s Bank of China Governor Zhou Xiaochuan proposed a managed reduction in the dollar’s role earlier this year. He was brushed aside. This has left the global monetary reserve system to an uncertain future. Apparently, it’s politically easier to let the dollar head for a crash than to attempt a soft landing for it. This is very risky. The existing political and economic orders were shaped by dollar hegemony. The unmanaged displacement of the dollar from its central role in global trade and finance would be a devastating blow to the world’s prosperity. It would do huge damage to the United States, its largest economy. The resulting dislocations would almost certainly unravel globalization. They would threaten political stability in many nations and regions.
Faith in the free market remains high in every major economy. It is highest in China and the United States. In China 79 percent of the people believe in market economics; in the United States 76 percent do. The global economic disintegration that would accompany a dollar collapse could end this hard-won consensus and reignite ideological struggles most of us thought were behind us.
Despite these dangers, it is not hard to understand why the United States finds it difficult to respond to an invitation to negotiate an orderly reduction in the dollar’s role or value. The perception that such a process is imminent could trigger a massive sell-off in world markets. It could destroy not just the dollar but other currencies as well.
In financial markets the transparent pursuit of change is the enemy of stability. Negotiated change is sometimes necessary to prevent unpredictable and uncontrolled shifts in the value of money. It must, however, be concerted in secrecy. So, one way or another, from the perspective of everyone outside the inner circles of the U.S. Treasury and key ministries of finance, any change in the role of the dollar is likely to appear abrupt. If change is inevitable, so, inevitably, is surprise.
Whether accomplished in stages by design or all at once by neglect, a reduced role for the dollar will disrupt political and, ultimately, in military as well as economic order. The first decade of this century saw the end of political hegemony and the beginning of the end of economic hegemony for the United States. America no longer has automatic followers except on a dwindling number of issues. The resulting leadership vacuum at the global level is reflected in the lengthening list of problems with no one in charge and no solution in sight. Global warming, the Iranian nuclear issue, the Doha Trade Round, the crafting of a stable relationship between Russia and its neighbors, the international response to the financial crisis, and many other examples come to mind.
The past two years have gravely undermined the U.S. role as banker to the world. Dollar hegemony has heretofore enabled the United States government to finance its day-to-day operations, including the wars in Afghanistan and Iraq, through credit rollovers from foreigners. But an end to the American free ride on foreign dollar loans is now clearly just a matter of time. There is widening skepticism about the future value of little green paper portraits of dead presidents.
If American power is not to go into free fall as the dollar props are kicked out from under it, the United States must return to pay-as-you-go government. It must rebalance its economy by keeping growth in consumption below growth in production of goods and services. It must strengthen its international competitiveness. This will demand major improvements in American infrastructure, education, health care, energy efficiency, financial regulation, and fiscal responsibility at all levels of government. In short, the United States must rediscover how to live within its means.
But living within America’s means is incompatible with the basic premise of post-Cold War U.S. national security policy. This is that the American global military dominance created by the collapse of the Soviet Union must be sustained indefinitely against all comers. Since 1991, Americans have come to see the entire globe as a U.S. sphere of influence. In this geopolitical space, Americans have felt entitled to primacy and an effective veto over the interests and actions of all other nations, including otherwise dominant regional powers.
To sustain such hegemony, the United States has been spending more on military power than the entire rest of the world combined. In the absence of foreign loans and subsidies, however, this level of military expenditure cannot be continued unless taxes are raised to politically improbable heights. Nor can the United States continue to pursue absolute military superiority simultaneously in all regions of the world as it now does. When the flow of foreign loans dries up, as it will, the United States will have to trim both its foreign policy objectives and military power to levels that are fiscally feasible.
The end of the American pursuit of military hegemony will not displace the United States from its status as the most powerful military power in the world. The U.S. will still be the only country able to project its armed might to every corner of the globe. More modest American defense objectives and programs will, however, alter the world in fundamental ways.
Most countries will find it easier to live with an America interested in regional balances of power rather than global military dominance and dependent on allies to create and sustain such balances. If absolute military superiority globally and in every region is not the United States’ objective, increases in power by other countries will not be seen by Americans as inherent threats. They will instead be seen as changes to be coped with or accommodated. A less hegemonic stance by the United States could put Sino-American relations, in particular, on a different and more promising footing. Those relations might well develop more productively if the declared American objective were to participate in a regional balance that includes China rather than to seek to retain a monopoly on the management of regional security affairs.
But other implications of a reduced and inevitably more selective, self-interested American role in global security are more problematic. Will the United States still police the global commons, for example, ensuring freedom of navigation for oil exporters and importers alike? If not, how and to whom would the responsibility for these crucial elements of global economic security be apportioned? Who will assume the global lead in dealing with failed states or preventing nuclear proliferation?
Will unilateral American security guarantees – that is, defense commitments that entail no reciprocal commitment to defend the United States on the part of those to whom they are extended – survive the end of America’s aspiration for hegemony? If not, Japan will have to assume a level of responsibility for its own defense that it has not since its defeat in World War II. Japan’s current defense environment is a northeast Asian balance of power that is shifting rapidly toward China. Would a self-reliant Japan accommodate China or oppose it? If the U.S. commitment to Taiwan were constrained, would Japan assert an interest in protecting the island or just write it off? What would be the consequences for Pakistan, India, or militant Islam of a more cautious United States?
Just these few examples illustrate the extent to which a less expansive definition of the national security objectives of the United States would introduce major global and regional uncertainties. In the military sector, like others, there is ample reason to anticipate the need for change rather than to allow events to impose it. We cannot know how the issues I’ve cited or the many others that come to mind will sort out. Clearly, however, in a world in which the United States plays a more restrained military role, regional powers would gain greater influence and freedom for politico-military maneuver in their regions. This would certainly be the case, for example, in East Asia.
China’s stimulus plan focuses on capital investment to enhance the efficiency and competitiveness of the Chinese economy. The fact that China is emerging from the economic doldrums more rapidly than any other large economy is both drawing its neighbors ever more into its economic orbit and actualizing the concept of “Greater China.” The crisis is accelerating China’s rise in relation to both its neighbors and other great economic powers. It is making China the preeminent power in East Asia. The Japanese and Koreans are now joining Southeast Asians in orienting their economies toward China. China’s rise is, however, far from putting it on a par with the United States as a global superpower. China’s political system is too unattractive, its economic system too idiosyncratic, its military power too defensive for it to take on a global leadership role comparable to that of America in the last century. For now at least, we must view China much more in a regional than in a global context.
In that context, will Japan and Korea seek greater cooperation with China, including through newly formed institutions that exclude the United States? Will one or the other of them seek to balance China, for example, by allying with a rising India or demanding more of the United States? Russia remains mired in an identity crisis and under stress from the global recession. It is currently deepening its dependence on China. How far will this go? How would it be affected by an American pullback from military domination of the Western Pacific and the Indian Ocean? Would the end of American global dominance and its replacement by competitive multipolar politics force the great fog factory in Brussels to transform itself into an effective wielder of united European power?
Then there is the question of global economic restructuring. The financial crisis has greatly damaged the credibility of U.S. financial institutions. It has set off a continuing but so far inconclusive search for alternative models of financial regulation as well as alternatives to the U.S. dollar.
The Chinese yuan is being steadily internationalized, moving by degrees to full convertibility. It has already become a vehicle for bond issuance, a unit of account for the pricing of exports and imports, and a currency in which to settle some trade accounts, among other things. It now seems certain that someday – though not as soon as some speculate – the yuan will join the dollar, the euro, yen, and pound as part of the basket of currencies that defines the International Monetary Fund’s Special Drawing Rights. As Governor Zhou suggested last spring, such SDRs have the potential to become an international currency of sorts.
Meanwhile, the G-8 has been superseded by the G-20. “South-South” economic cooperation has gained impetus. Important new capital markets in the Arab Gulf countries and China are emerging. Islamic financial instruments, with their avoidance of leveraging, are becoming commonplace.
Each of these developments is a small, evolutionary step away from global overreliance on the dollar. What would be the international response to a sudden turn away from the dollar or a major drop in its value? No one can say, but neither development is impossible to imagine under circumstances of continuing American fiscal irresponsibility, no real global financial reform, and a growing asset value bubble based on the dollar carry trade. America must get on with the task of putting its fiscal house in order. In its own interest and in that of the world, it must also work with China and other major financial powers to contrive appropriate adjustments in the international financial system. No such adjustments will occur without the full engagement of the United States and China.
Let me conclude. Many nations – even those most skeptical about the United States – seem now to be nostalgic for the bygone era of active American leadership of global politics and economics. The absence of American leadership has been a problem for a world long accustomed to deferring to it. The election of Barack Obama as president renewed hope abroad as well as in the United States that this leadership might be reborn. That hope is now subsiding. The obstacles to effective American responses to the challenges confronting the United States and its allies, friends, and partners overseas are turning out to be structural and systemic. They cannot easily be swept aside by an American leader, no matter how strategic-minded, well-intentioned, or rhetorically gifted President Obama may be.
Washington’s inability to put its fiscal house in order now threatens to undermine the remaining pillar of American global preeminence – the ability of the United States to fund the unchallengeable worldwide hegemony of its armed forces. The consequences of an America that defines its interests more narrowly and selfishly are already apparent in the political and economic spheres. The emergence of a parallel approach by the United States to alliance management and other military security questions would have immense implications for the evolution of world and regional geopolitics. Until now, any significant change in the American global role has been so unthinkable that almost no one has thought about what it might mean. It is past time to begin to do so.
Some in China, India, Russia, and elsewhere have looked forward to the decline of American power. They may find themselves wishing before long that they had acted to prevent it. We must all now think about the consequences of a world order, including a world security order, with no one to manage it, in which the United States is the most powerful and influential country among others, not the global hegemon. The challenge for all of us will be to learn how to survive and prosper amidst the inherent volatilities of such an uncentered world. This challenge will not be easy to meet. If it is ignored until it is upon us, it will be even more daunting. History usually punishes denial and procrastination. It favors foresight and the prudent management of necessary change.
When the second decade of the 21st Century begins, will America have resumed an active role in shaping the world order? More than any other people, Americans created the international institutions and arrangements that restored prosperity following World War II. But today’s challenges demand much more than the ideas and energies of a single great power. They can be met only through innovative collaboration among peoples. Will the United States, China, India, Japan and others now join in crafting new institutions and arrangements that can promote peace and development in the years to come? We can do this if we try. It is by no means too late to begin.