On G-20 and GM: Economics, Politics and Social Stability

November 17, 2008

By George Friedman

The G-20 met last Saturday. Afterward, the group issued a meaningless statement and decided to meet again in March 2009, or perhaps later. Clearly, the urgency of October is gone. First, the perception of imminent collapse is past. Politicians are superb seismographs for detecting impending disaster, and these politicians did not act as if they were running out of time. Second, the United States will have a new president in March, and nothing can be done until he defines his policy.

Given the sense in Europe that this financial crisis marked the end of U.S. economic supremacy, it is ironic that the Europeans are waiting on the Americans. One would think they would be using their newfound ascendancy to define the new international system. But the fact is that for all the shouting, little has changed in the international order. The crisis has receded sufficiently that nothing more needs to be done immediately beyond “cooperation,” and nothing can be done until the United States defines what will be done. We feel that our view that the international system received fatal blows Aug. 8, when Russia and Georgia went to war, and Oct. 11, when the G-7 meeting ended without a single integrated solution, remains unchallenged. Now, it is every country for itself.

From Financial Crisis to Cyclical Recession

The financial crisis has been mitigated, if not solved. The problem now is that we are in a cyclical recession, and that every country is trying to figure out how to cope with the recession. Unlike the past two recessions, this one is more global than local. But unlike the 1970s, when recession was global, this one is not accompanied by soaring inflation and interest rates.

All recessions have different dynamics, but all have one thing in common: They impose punishment and discipline on economies run wild. This is happening around the world.

China, for example, faces a serious problem. China is an export-oriented economy whose primary market is the United States. As the United States goes into recession, demand for Chinese goods declines. Chinese businesses have always operated on very tight — sometimes invisible — profit margins designed to emphasize cash flow and to pay off debts to banks. As U.S. demand contracts, many Chinese firms find themselves in untenable positions, without room to decrease prices, lacking operating reserves and insufficiently capitalized. Recessions are designed to cull the weak from the herd, and a huge swath of the Chinese economy is ripe for the culling.

If the world were all about economics, culling is what the Chinese would do. But the world is more complex than that. A culling would lead to massive unemployment. Many Chinese employees live on Third World wages; indeed, the vast majority of Chinese have incomes of less than $1,000 a year. To them, unemployment doesn’t mean problems with their 401k. It means malnutrition and desperation — neither of which is unknown in 20th century Chinese history, including the Communist period. The Chinese government is rightly worried about the social and political consequences of rational economic policies: They might work in the long run, but only if you live that long.

Economic Restructuring vs. Stability

The Chinese have therefore prepared a massive stimulus package that is more of a development program to make up for declining U.S. demand. It aims to keep businesses from failing and spilling millions of angry and hungry workers into the street. For the Chinese, the economic problem creates a much larger and more serious issue. It is also an issue that must be solved quickly, and the amount of time needed outstrips the amount of time available.

This is not only a Chinese problem. Wherever there is an economic downturn, politicians must decide whether society — and their own political futures — can withstand the rigors recessions impose. Recessions occur when, as is inevitable, inefficiencies and irrationalities build up in the financial and economic system. The resulting economic downturn imposes a harsh discipline that destroys the inefficient, encourages everyone to become more efficient, and opens the doors to new businesses using new technologies and business models. The year 2001 smashed the technology sector in the United States, opening the door for Google Inc.

The business cycle works well, but the human costs can be daunting. The collapse of inefficient businesses leaves workers without jobs, investors without money and society less stable than before. The pain needed to rectify China’s economy would be enormous, with devastating consequences for hundreds of millions of Chinese, and probably would lead to social chaos. Beijing is prepared to accept a high degree of economic inefficiency to avoid, or at least postpone, the reckoning. The reckoning always comes, but for most of us, later is better than sooner. Economic rationality takes a back seat to social necessity and political common sense.

Every country in the world is looking inward at the impact of the recession on its economy and measuring its resources. Countries are deciding whether they have the ability to prop up business that should fail, what the social consequences of business failure would be, and whether they should try to use their resources to avoid the immediate pain of recession. This is why the G-20 ended in meaningless platitudes.

Each country is also trying to answer the question of how much pain it — and its regime — can endure. The more pain imposed, the healthier countries will emerge economically — unless of course the pain kills them. Ultimately, the rationality of economics and the reality of society frequently diverge.

Recession and the U.S. Auto Industry

For the United States, this choice has been posed in stark terms with regard to the dilemma of whether the U.S. government should use its resources to rescue the American auto industry. The American auto industry was once the centerpiece of the U.S. economy. That hasn’t been true for a generation, as other industries and services have supplanted it and other countries’ auto industries have surpassed it. Nevertheless, the U.S. auto industry remains important. It might drain the U.S. economy by losing vast amounts of money and destroying the equity held by its investors, but it employs large numbers of people. Perhaps more important, it purchases supplies from literally thousands of U.S. companies.

There can be endless discussions of why the U.S. auto industry is in such trouble. The answer lies not in one place but in many, from the decisions and makeup of management to the unions that control much of the workforce, and from the cost structure inherent in producing cars in the American economy to a simple systemic inability to produce outstanding vehicles. There might be varying degrees of truth to all or some of this, but the fact remains that each of the U.S. carmakers is on the verge of financial collapse.

This is what recessions are supposed to do. As in China and everywhere else, recessions reveal weak businesses and destroy them, freeing up resources for new enterprises. This recession has hit the auto industry hard, and it is unlikely that it is going to survive. The ultimate reason is the same one that destroyed the U.S. steel industry a generation ago: Given U.S. cost structures, producing commodity products is best left to countries with lower wage rates, while more expensive U.S. labor is deployed in more specialized products requiring greater expertise. Thus, there is still steel production in the United States, but it is specialty steel production, not commodity steel. Similarly, there will be specialty auto production in the United States, but commodity auto production will come from other countries.

That sounds easy, but the transition actually will be a bloodletting. Current employees of both the automakers and suppliers will be devastated. Institutions that have lent money to the automakers will suffer massive or total losses. Pensioners might lose pensions and health care benefits, and an entire region of the United States — the industrial Midwest — will be devastated. Something stronger will grow eventually, but not in time for many of the current employees, shareholders and creditors.

Here the economic answer, cull, meets the social answer, stabilize. Policymakers have a decision to make. If the automakers fail now, their drain on the economy will end; the pain will be shorter, if more intense; and new industries would emerge more quickly. But though their drain on the economy would end, the impact of the automakers’ failure on the economy would be seismic. Unemployment would surge, as would bankruptcies of many auto suppliers. Defaults on loans would hit the credit markets. In the Midwest, home prices would plummet and foreclosures would skyrocket. And heaven only knows what the impact on equity markets would be.

In the U.S. case, the healthful purgative of a recession could potentially put the patient in a coma. Few if any believe the U.S. auto industry can survive in its current form. But there is an emerging consensus in Washington that the auto industry must not be allowed to fail now. The argument for spending money on the auto industry is not to save it, but to postpone its failure until a less devastating and inconvenient time. In other words, fearing the social and political consequences of a recession working itself through to its logical conclusion, Washington — like Beijing — wants to spend money it probably won’t recover to postpone the failure. Indeed, governments around the world are considering what failures to tolerate, what failures to postpone, and how much to spend on the latter. General Motors is merely the American case in point.

The Recession in Context

The people arguing for postponement aren’t foolish. The financial system is still working its way through a massive crisis that had little to do with the auto industry. Some traction appears to be occurring; certainly there was no crisis atmosphere at the G-20 meeting. The economy is in recession, but in spite of the inevitable claims that we have never seen anything like this one before, we have. There is always some variable that swings to an extreme — this time, it is consumer spending — but we are still well within the framework of recent recessions.

Consider the equity markets, which we regard as a long-term measure of the market’s evaluation of the state of the economy. In January 2000, the S&P 500 peaked at 1,455. This was the top of the market. In July 2002, 18 months later, the S&P bottomed out at 935. Over the next five years it rose to 1,519 in July 2007, the height for this cycle. It fell from this point until Nov. 12, 2008, when it closed at 852.30. This past Friday, it was at 873.29.

We do not know what the market will do in the future. There are people much smarter than we are who claim to know that. What we do know is what it has done. And what it has done this time — so far — is almost exactly what it did last time, except that in 2000-2002 it took 18 months to do it, while this time it was done in about 16 and a half months (assuming it bottomed out Nov. 12). But even if the market didn’t bottom out then, and it falls to 775, for example, it will have lost 50 percent of its value from the peak. This would be more than in 2000-2002, but not unprecedented.

The point we are making here is that if we regard the equity markets as a long-term seismograph of the economy, then so far, despite all the storm and stress, the markets — and therefore the economy — remain within the general pattern of the 2000-2002 market at the 2001 recession. That recession certainly was unpleasant, what with the devastation of the tech sector, but the economy survived. At the same time, however, it is clear that things are balanced on a knife’s edge. Another hundred points’ fall on the S&P, and the markets will be telling us that the world is in a very different place indeed.

A massive bankruptcy in the automotive sector could certainly set the stage for an economic renaissance in the next generation. But at this particular moment in time (it’s no coincidence that the crisis in the U.S. automotive industry comes as we enter a recession), a wave of bankruptcies would dramatically deepen the recession. This probably would be reflected by the destruction of trillions more in net worth in the equity markets.

There is a powerful counterargument to bailing out the U.S. auto industry. This argument holds that the auto industry is a drain on the U.S. economy, that it will never be globally competitive, and that if it is dragged back from the edge, no one will then say it is time to push it to the edge and over. The next time it will be on the brink will be during the next recession, and the same argument to save it will be used. In due course, the United States, like China, will be so terrified of the social and political consequences of business failure that it will maintain Chinese-like state owned enterprises, full of employees and generation-old plants and business models. Clearly, short-run solutions can easily become long-term albatrosses.

The only possible solution would be a bailout followed by a Washington-administered restructuring of the auto industry. This causes us to imagine a collaboration between the auto industry’s current management and Washington administrators that would finally put Detroit on a path to where it can compete with Toyota. Frankly, the mind boggles at this. But boggle though we might, hitting the economy with another massive financial default, a wave of bankruptcies, massive unemployment surges and another blow to housing prices boggles our mind even more.

The geopolitical problem confronting the world at the moment is that it has been forced to offer massive support to the global financial system with sovereign wealth — e.g., via taxes and currency printing presses. The world might just have squeaked through that crisis. Now, the world is in an inevitable recession and businesses are on the brink of failure. A wave of massive business failures on top of the financial crisis might well move the global system to a very different place. Therefore, each nation, by itself and indifferent to others, is in the process of figuring out how to postpone these failures to a more opportune time — or to never. This will build in long-term inefficiencies to the global economy, but right now everyone will be quite content with that.

Thus the financial crisis became a recession, and the recession triggered bankruptcies. And because no one wants bankruptcies right now, everyone who can is using taxpayer dollars to protect the taxpayer from the consequences of mismanagement. And the last thing any one cared about was the G-20 concept for the future of the economic system.

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Sarkozy wants new EU-US-Russia security accord

VALENTINA POP

14.11.2008 @ 18:04 CET

With Russia's backing for the G20 summit, French President Nicolas Sarkozy proposed a new security and defence arrangement between the EU, Russia and the US to be agreed at a summit mid-2009, calling both on Moscow and Washington to refrain from deploying missiles until that date.

Mr Sarkozy was speaking at a press conference on Friday (14 November) following the EU-Russia summit held in Nice, alongside his Russian counterpart Dmitry Medvedev.

President Dmitri Medvedev got French support on security and defence matters, despite not having fully complied with the ceasefire agreement in Georgia (Photo: Kremlin.ru)

"As acting EU council president I propose that mid-2009 we gather for instance within the OSCE [Organisation for Security and Cooperation in Europe] to lay the basis of what might be a future EU security arrangement ...which would of course involve the Russians and the Americans," Mr Sarkozy said, backing an idea originally proposed by his Russian counterpart.

He also expressed his "preoccupation" with Mr Medvedev's threat to deploy short-range missiles in the Russian enclave of Kaliningrad, on the shores of the Baltic Sea, bordering Poland and Lithuania.

"There shouldn't be any deployment in any enclave until we have not discussed the new geopolitical conditions of a pan-European security arrangement," he told Russia, while also calling on the US to "stop talking" about the missile defence shield which "only complicates things."

Mr Sarkozy seemed to be offering his role "as a potential mediator in Russian-American relations," AFP commented.

Mr Medvedev had threatened on 5 November to deploy short-range Iskander missiles in Kaliningrad if the Americans install their anti-ballistic missile shield in Poland and the Czech Republic.

Russian-EU entente for G20 summit

Mr Medvedev backed EU proposals for the G20 summit to be held in Washington on Saturday (15 November), calling them "almost identical" with his. The Russian president said he was backing a deep reform of the international financial system, as well as a second financial summit at end of February, after the new US president Barack Obama takes office.

Mr Sarkozy called the Russian financial and economic proposals "of very good quality" and "very close to the EU proposals."

"And I'm very satisfied to see that there is a will on the part of the Russian federation for strong decisions to come out of the Washington summit," he added.

Georgia hardly mentioned

The Russian-Georgian war was portrayed as a somewhat closed affair, with Mr Sarkozy congratulating himself and his team for having brokered the ceasefire agreement, calling for "diplomatic solutions" in the region through negotiations in Geneva and criticising "some prominent leaders" who were against him going to Moscow in August and were now against resuming EU-Russia partnership treaty talks.

He asked the Russians "to make progress" in their withdrawal from Georgia, especially the Akhalgori region within the South Ossetia region and the Perevi village, located just outside in Georgia proper. But he estimated that the Russians fulfilled "the essential part of their agreements."

For his part, Mr Medvedev rejected the idea of not having fully complied with the cease fire agreements, pointing that "the recognition of South Ossetia and Abkhazia is our final decision. It is irrevocable."

Mr Medvedev also rejected the EU's accusation that the Russian use of force in Georgia was disproportionate. He said Moscow's military intervention was "limited, necessary and in accordance with international law."

EU-Russia talks to resume on 2 December

The negotiations between Russia and the EU on a strategic partnership agreement, suspended after the Georgian crisis will be resumed on 2 December, a spokeswoman for the European commission told AFP.

The EU and Russian leaders gathered in Nice "agreed to retake negotiations on 2 December," said Christianne Hohman, spokeswoman for external relations.

She added that the December meeting would be at a technical level, between the heads of the negotiating teams.

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G20 leaders to discuss ways out of the crisis

MOSCOW. (RIA Novosti economic commentator Oleg Mityayev) - On November 15, the Group of 20, representing the world's largest economies, will meet in Washington to discuss ways to overcome the global financial crisis, the worst since the 1930s.

The G20 includes the G7 and the BRIC (Brazil, Russia, India and China) countries, plus other significant economies such as Australia, Indonesia and Turkey.

The leading emerging economies said at the 10th meeting of the G20 finance ministers and central bank governors in Sao Paulo, Brazil, on November 8-9, held to prepare proposals for the Washington meeting, that the financial system must be restructured to take into account their combined economic strength, which is expected to surpass that of the world's richest nations in coming decades.

G8 no longer sufficient

Initially, the global powers planned to convene an emergency G8 summit to discuss cures for the ailing global economy. But it soon became clear that such a meeting would not be of much use without the BRIC countries.

The best option is the Group of 20, founded in 1999 as an informal arena to facilitate dialogue between major industrial and emerging economies. The G20 accounts for 85% of the world's economy and about two-thirds of the world's population.

The emerging countries said in Sao Paolo that the system put in place by the 1944 Bretton Woods agreement, with the IMF and the World Bank as its core institutions, was outdated and needed to be changed to take into account the greater economic importance of emerging nations.

They said they were ready to take urgent measures to stimulate economic growth. Following in the footsteps of the advanced countries, the emerging economies pledged to slash interest rates and increase state investment in the economy.

China, whose development pace is the fastest among the emerging economies, has announced a crisis management plan worth about 20% of its GDP.

Russia has promised to spend 15% of its GDP on assistance to the financial sector and the industry. On November 7, the Russian government presented a plan specifying the allocation of 5.4 trillion rubles ($197.5 billion) for the purpose.

The emerging countries' leaders agreed in Brazil to coordinate their actions to stimulate the development of trade and capital flow between them.

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China announces $585 billion economic stimulus plan

 

China's government announced plans today for an estimated $585 billion in spending and stimulus measures to shore up its weakening economy and counter the effects of the global financial crisis.
The massive stimulus plan would include tax cuts, a loosening of credit and government spending on a wide range of projects, including construction of low-income housing, transportation systems and the development of rural infrastructure, the official new China News Agency said.

 

Analysts welcomed the larger-than-expected stimulus package, which represents about one-sixth of China's overall annual economic output. They said the spending would help businesses, bolster demand for commodities and lift consumption -- which would, in turn, give a boost to a world economy that is faltering.
With the U.S., Japan and much of Europe in a deep downturn, China's role looms ever larger as it has been a major driver of global economic growth in recent years.
In the last five years, China's economy has expanded by double digits, but the annual growth rate slowed sharply to 9% in the third quarter amid weakening exports and a sagging real estate market. Some analysts have predicted that growth would fall much lower next year, a prospect that worries Chinese officials because of the threat of rising joblessness and the risk of social instability.

"This broad-based fiscal stimulus program will emerge as the government's front line of defense against an excessive economic slowdown," said Jing Ulrich, managing director of China equities at JP Morgan in Hong Kong. Ulrich called Beijing's efforts to upgrade infrastructure, develop the countryside and undertake social welfare projects as China's version of a New Deal.
With $2 trillion in foreign reserves and a healthy budget surplus, China has the ability to adopt an aggressive fiscal policy.
"This pro-growth policy response will help translate the balance-sheet strength of the economy into economic growth resilience," said Qing Wang, an analyst at Morgan Stanley in Beijing.
The stimulus package comes as China's president, Hu Jintao, prepares to travel to Washington for a Nov. 15 economic summit with world leaders, including President Bush. Over the weekend, Hu talked with President-elect Barack Obama by telephone about the global financial crisis, among other issues, the New China News Agency said.
In recent weeks, Beijing has announced a number of measures aimed at boosting economic growth, including interest-rate cuts, tax rebates for exporters and reduced reserve requirements for banks so more money could be made available for lending. China also indicated plans to use substantial funds for various infrastructure and rural-development projects.
It wasn't clear how much of the previously budgeted monies were included in the latest stimulus package. The announcement today said China would spend about $58.6 billion in the current quarter, with additional funds to be used over the next two years to finance programs in 10 major areas, including projects related to water, electricity, technological innovation and rebuilding from disasters such as the May 12 earthquake.
Ulrich said Beijing has huge infrastructure projects planned to 2020.
"Despite the weakening economy and slowing tax revenue in recent months," she said, "the government has every political incentive to boost spending in priority programs."

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Obama's Challenge

By George Friedman

The 2008 U.S. Presidential Race

Barack Obama has been elected president of the United States by a large majority in the Electoral College. The Democrats have dramatically increased their control of Congress, increasing the number of seats they hold in the House of Representatives and moving close to the point where — with a few Republican defections — they can have veto-proof control of the Senate. Given the age of some Supreme Court justices, Obama might well have the opportunity to appoint at least one and possibly two new justices. He will begin as one of the most powerful presidents in a long while.

Truly extraordinary were the celebrations held around the world upon Obama’s victory. They affirm the global expectations Obama has raised — and reveal that the United States must be more important to Europeans than the latter like to admit. (We can’t imagine late-night vigils in the United States over a French election.)

Obama is an extraordinary rhetorician, and as Aristotle pointed out, rhetoric is one of the foundations of political power. Rhetoric has raised him to the presidency, along with the tremendous unpopularity of his predecessor and a financial crisis that took a tied campaign and gave Obama a lead he carefully nurtured to victory. So, as with all politicians, his victory was a matter of rhetoric and, according to Machiavelli, luck. Obama had both, but now the question is whether he has Machiavelli’s virtue in full by possessing the ability to exercise power. This last element is what governing is about, and it is what will determine if his presidency succeeds.

Embedded in his tremendous victory is a single weakness: Obama won the popular vote by a fairly narrow margin, about 52 percent of the vote. That means that almost as many people voted against him as voted for him.

Obama’s Agenda vs. Expanding His Base

U.S. President George W. Bush demonstrated that the inability to understand the uses and limits of power can crush a presidency very quickly. The enormous enthusiasm of Obama’s followers could conceal how he — like Bush — is governing a deeply, and nearly evenly, divided country. Obama’s first test will be simple: Can he maintain the devotion of his followers while increasing his political base? Or will he believe, as Bush and Cheney did, that he can govern without concern for the other half of the country because he controls the presidency and Congress, as Bush and Cheney did in 2001? Presidents are elected by electoral votes, but they govern through public support.

Obama and his supporters will say there is no danger of a repeat of Bush — who believed he could carry out his agenda and build his political base at the same time, but couldn’t. Building a political base requires modifying one’s agenda. But when you start modifying your agenda, when you become pragmatic, you start to lose your supporters. If Obama had won with 60 percent of the popular vote, this would not be as pressing a question. But he barely won by more than Bush in 2004. Now, we will find out if Obama is as skillful a president as he was a candidate.

Obama will soon face the problem of beginning to disappoint people all over the world, a problem built into his job. The first disappointments will be minor. There are thousands of people hoping for appointments, some to Cabinet positions, others to the White House, others to federal agencies. Many will get something, but few will get as much as they hoped for. Some will feel betrayed and become bitter. During the transition process, the disappointed office seeker — an institution in American politics — will start leaking on background to whatever reporters are available. This will strike a small, discordant note; creating no serious problems, but serving as a harbinger of things to come.

Later, Obama will be sworn in. He will give a memorable, perhaps historic speech at his inauguration. There will be great expectations about him in the country and around the world. He will enjoy the traditional presidential honeymoon, during which all but his bitterest enemies will give him the benefit of the doubt. The press initially will adore him, but will begin writing stories about all the positions he hasn’t filled, the mistakes he made in the vetting process and so on. And then, sometime in March or April, things will get interesting.

Iran and a U.S. Withdrawal From Iraq

Obama has promised to withdraw U.S. forces from Iraq, where he does not intend to leave any residual force. If he follows that course, he will open the door for the Iranians. Iran’s primary national security interest is containing or dominating Iraq, with which Iran fought a long war. If the United States remains in Iraq, the Iranians will be forced to accept a neutral government in Iraq. A U.S. withdrawal will pave the way for the Iranians to use Iraqi proxies to create, at a minimum, an Iraqi government more heavily influenced by Iran.

Apart from upsetting Sunni and Kurdish allies of the United States in Iraq, the Iranian ascendancy in Iraq will disturb some major American allies — particularly the Saudis, who fear Iranian power. The United States can’t afford a scenario under which Iranian power is projected into the Saudi oil fields. While that might be an unlikely scenario, it carries catastrophic consequences. The Jordanians and possibly the Turks, also American allies, will pressure Obama not simply to withdraw. And, of course, the Israelis will want the United States to remain in place to block Iranian expansion. Resisting a coalition of Saudis and Israelis will not be easy.

This will be the point where Obama’s pledge to talk to the Iranians will become crucial. If he simply withdraws from Iraq without a solid understanding with Iran, the entire American coalition in the region will come apart. Obama has pledged to build coalitions, something that will be difficult in the Middle East if he withdraws from Iraq without ironclad Iranian guarantees. He therefore will talk to the Iranians. But what can Obama offer the Iranians that would induce them to forego their primary national security interest? It is difficult to imagine a U.S.-Iranian deal that is both mutually beneficial and enforceable.

Obama will then be forced to make a decision. He can withdraw from Iraq and suffer the geopolitical consequences while coming under fire from the substantial political right in the United States that he needs at least in part to bring into his coalition. Or, he can retain some force in Iraq, thereby disappointing his supporters. If he is clumsy, he could wind up under attack from the right for negotiating with the Iranians and from his own supporters for not withdrawing all U.S. forces from Iraq. His skills in foreign policy and domestic politics will be tested on this core question, and he undoubtedly will disappoint many.

The Afghan Dilemma

Obama will need to address Afghanistan next. He has said that this is the real war, and that he will ask U.S. allies to join him in the effort. This means he will go to the Europeans and NATO, as he has said he will do. The Europeans are delighted with Obama’s victory because they feel Obama will consult them and stop making demands of them. But demands are precisely what he will bring the Europeans. In particular, he will want the Europeans to provide more forces for Afghanistan.

Many European countries will be inclined to provide some support, if for no other reason than to show that they are prepared to work with Obama. But European public opinion is not about to support a major deployment in Afghanistan, and the Europeans don’t have the force to deploy there anyway. In fact, as the global financial crisis begins to have a more dire impact in Europe than in the United States, many European countries are actively reducing their deployments in Afghanistan to save money. Expanding operations is the last thing on European minds.

Obama’s Afghan solution of building a coalition centered on the Europeans will thus meet a divided Europe with little inclination to send troops and with few troops to send in any event. That will force him into a confrontation with the Europeans in spring 2009, and then into a decision. The United States and its allies collectively lack the force to stabilize Afghanistan and defeat the Taliban. They certainly lack the force to make a significant move into Pakistan — something Obama has floated on several occasions that might be a good idea if force were in fact available.

He will have to make a hard decision on Afghanistan. Obama can continue the war as it is currently being fought, without hope of anything but a long holding action, but this risks defining his presidency around a hopeless war. He can choose to withdraw, in effect reinstating the Taliban, going back on his commitment and drawing heavy fire from the right. Or he can do what we have suggested is the inevitable outcome, namely, negotiate — and reach a political accord — with the Taliban. Unlike Bush, however, withdrawal or negotiation with the Taliban will increase the pressure on Obama from the right. And if this is coupled with a decision to delay withdrawal from Iraq, Obama’s own supporters will become restive. His 52 percent Election Day support could deteriorate with remarkable speed.

The Russian Question

At the same time, Obama will face the Russian question. The morning after Obama’s election, Russian President Dmitri Medvedev announced that Russia was deploying missiles in its European exclave of Kaliningrad in response to the U.S. deployment of ballistic missile defense systems in Poland. Obama opposed the Russians on their August intervention in Georgia, but he has never enunciated a clear Russia policy. We expect Ukraine will have shifted its political alignment toward Russia, and Moscow will be rapidly moving to create a sphere of influence before Obama can bring his attention — and U.S. power — to bear.

Obama will again turn to the Europeans to create a coalition to resist the Russians. But the Europeans will again be divided. The Germans can’t afford to alienate the Russians because of German energy dependence on Russia and because Germany does not want to fight another Cold War. The British and French may be more inclined to address the question, but certainly not to the point of resurrecting NATO as a major military force. The Russians will be prepared to talk, and will want to talk a great deal, all the while pursuing their own national interest of increasing their power in what they call their “near abroad.”

Obama will have many options on domestic policy given his majorities in Congress. But his Achilles’ heel, as it was for Bush and for many presidents, will be foreign policy. He has made what appear to be three guarantees. First, he will withdraw from Iraq. Second, he will focus on Afghanistan. Third, he will oppose Russian expansionism. To deliver on the first promise, he must deal with the Iranians. To deliver on the second, he must deal with the Taliban. To deliver on the third, he must deal with the Europeans.

Global Finance and the European Problem

The Europeans will pose another critical problem, as they want a second Bretton Woods agreement. Some European states appear to desire a set of international regulations for the financial system. There are three problems with this.

First, unless Obama wants to change course dramatically, the U.S. and European positions differ over the degree to which governments will regulate interbank transactions. The Europeans want much more intrusion than the Americans. They are far less averse to direct government controls than the Americans have been. Obama has the power to shift American policy, but doing that will make it harder to expand his base.

Second, the creation of an international regulatory body that has authority over American banks would create a system where U.S. financial management was subordinated to European financial management.

And third, the Europeans themselves have no common understanding of things. Obama could thus quickly be drawn into complex EU policy issues that could tie his hands in the United States. These could quickly turn into painful negotiations, in which Obama’s allure to the Europeans will evaporate.

One of the foundations of Obama’s foreign policy — and one of the reasons the Europeans have celebrated his election — was the perception that Obama is prepared to work closely with the Europeans. He is in fact prepared to do so, but his problem will be the same one Bush had: The Europeans are in no position to give the things that Obama will need from them — namely, troops, a revived NATO to confront the Russians and a global financial system that doesn’t subordinate American financial authority to an international bureaucracy.

The Hard Road Ahead

Like any politician, Obama will face the challenge of having made a set of promises that are not mutually supportive. Much of his challenge boils down to problems that he needs to solve and that he wants European help on, but the Europeans are not prepared to provide the type and amount of help he needs. This, plus the fact that a U.S. withdrawal from Iraq requires an agreement with Iran — something hard to imagine without a continued U.S. presence in Iraq — gives Obama a difficult road to move on.

As with all American presidents (who face midterm elections with astonishing speed), Obama’s foreign policy moves will be framed by his political support. Institutionally, he will be powerful. In terms of popular support, he begins knowing that almost half the country voted against him, and that he must increase his base. He must exploit the honeymoon period, when his support will expand, to bring another 5 percent or 10 percent of the public into his coalition. These people voted against him; now he needs to convince them to support him. But these are precisely the people who would regard talks with the Taliban or Iran with deep distrust. And if negotiations with the Iranians cause him to keep forces in Iraq, he will alienate his base without necessarily winning over his opponents.

And there is always the unknown. There could be a terrorist attack, the Russians could start pressuring the Baltic states, the Mexican situation could deteriorate. The unknown by definition cannot be anticipated. And many foreign leaders know it takes an administration months to settle in, something some will try to take advantage of. On top of that, there is now nearly a three-month window in which the old president is not yet out and the new president not yet in.

Obama must deal with extraordinarily difficult foreign policy issues in the context of an alliance failing not because of rough behavior among friends but because the allies’ interests have diverged. He must deal with this in the context of foreign policy positions difficult to sustain and reconcile, all against the backdrop of almost half an electorate that voted against him versus supporters who have enormous hopes vested in him. Obama knows all of this, of course, as he indicated in his victory speech.

We will now find out if Obama understands the exercise of political power as well as he understands the pursuit of that power. You really can’t know that until after the fact. There is no reason to think he can’t finesse these problems. Doing so will take cunning, trickery and the ability to make his supporters forget the promises he made while keeping their support. It will also require the ability to make some of his opponents embrace him despite the path he will have to take. In other words, he will have to be cunning and ruthless without appearing to be cunning and ruthless. That’s what successful presidents do.

In the meantime, he should enjoy the transition. It’s frequently the best part of a presidency.

A Specter Is Haunting Europe… the Specter of ...

                                 

            Free market is dead - long live the free market

                             (Don’t pull the Devil by the tail)

The current financial crisis has provoked a multitude of problems and fierce discussions over the reasons, consequences and the prospects of the attempted bail-outs, reaching even the fundamental values of capitalism - the free market and democracy. After all, Government regulation in the form of a temporary cash bail-out via partial or total nationalization is an unprecedented intervention. Whether associated with “socialism” or not, the fact is that someone else in a bureaucratic entity, possibly an ordinary non-elected poor employee, is going to gain control over a private person’s assets, money and actions. It also means that taxpayers and future generations will bear the burden of someone else’s debts.

Is it not an irony of history that those who proclaimed collective state ownership the worst evil and worshipped privatization now plead for nationalization and turn to the state to bail them out of bankruptcy? What does this portend in the long run – an end to privatization or a complex reform of the free market system, or its collapse, especially when the inevitable international consequences are taken into account?

One thing is already clear: economic changes of such a gravity cannot but lead to very deep and far-reaching political and social effects transforming our societies and the world at large.

Apologists for capitalism all over the world who are aware of these long-term prospects are fearful of the return of Marx's specter.

Z. Brzezinski sees this specter in US self-complacency: “We had a strong alternative in the face of the Soviet block which stimulated us to move forward, to be an example of humanism for the whole world and to achieve results that were approved and envied by the oppressed all over the world. Now this has disappeared, we have relaxed and fallen back into our own self-complacency that we had achieved a victory over communism.”

George Soros – one of the richest self-made men in the world - sees the specter in the form of the anarchy of finance capital. A long time ago he claimed that the global finance system was out of control and needed to be regulated. His calls for a return to an "international regulator" like Bretton Woods, or some body attached to the IMF, have been repeatedly disregarded. He feared that the casino of finance capital would bring an end to the new world order and provoke a return to anarchy and social revolution. Have his warnings been heeded? Not until recently.

Anthony Giddens – another prominent apologist for capitalism - sees the specter in the rise of left or right fundamentalist ideologies and social upheavals.

A famous New York humor columnist ridiculed the harsh language on workers, class struggle and revolution as the midwife of history of Marxists as being out of zinc with today’s realities.

                                

“I know you want to help the workers, guys, but with language like that, how many actual workers are going to read this thing? And, FYI, we don't like to be called "workers" or "laborers" or even "employees" - we prefer to be called "consumers." As consumers, we are not "forced" to do anything. As consumers, we are empowered to make important daily decisions about whether we will consume the GAP or Old Navy; Iraq or Venezuela; salmonella or E. coli; unaffordable health insurance or no health insurance.”

However, both the professional and less serious apologists for capitalism have hopes or plans to avoid a global collapse like the Great Depression during the 30’s of the 20th Century leading to the rise of fascism and the Second World War. In fact all of us hope to avoid such a global catastrophe.

However, the current financial crisis has brought us down to earth and re-opened the gate for a some open rethinking of what is going on in today’s world, for discussions of capitalism and democracy as a system, for criticisms against it, for ideas and proposals of alternatives, and, of course, for practical actions.

Some critically minded authors versed in the Marxist tradition have already sarcastically noted that apologists for capitalism have posed the current problem in terms long time familiar to them: the contradiction between dead and living labor and the rise of the dead reclaimed by the living.

Others have remarked that any analogy with 19 Century conditions and social recipes based on those conditions are ridiculous and not the best approach to today’s problems.

There is one thing in common though with the above vastly different view-points. This is the big question: is there a way out for capitalism from the dead-end created by itself?

The leaders of USA and Europe have pinned their hopes and actions on a number of attempts to bail-out the banking sector. More or less this strategy is clear to all. The keyword is nationalization. Its implementation has already started. But is it going to work? Is it possible to implement solutions of a large array of particular problems related to the financial crisis or underlying it like rising unemployment, global competition for scarce resources, product quality, environment deterioration, supra-national regulation and so on without a radical change in the basic institutions of society and the present world order?

The most obvious thing to do is to look back into the recent past and see how similar policies have worked. Bail-outs in the form of nationalization are not new. There are plenty of examples of successful and unsuccessful bail-outs, both inside and outside the financial sector. The BBC has already presented a number of cases, namely:

- the successful bail out by the US Government of the airline industry after September 11^th;

- the unsuccessful bail-out of Leyland Co. by the British Government via a cash injection in 1975;

- the nationalization of Rolls-Royce in 1971.

The diagram below borrowed from BBC’s website shows in figures the current banking sector bail-out:

                

                      Source: BBC News, 6 October 2008

Another possible check of the volatile prospects of this endeavor is to monitor the performance

of the stock markets. Fortunately enough, there is abundant information on the immediate reaction and downturn trend of investors whose behavior is often compared to that of a rein-deer sensing an upcoming storm. Take a look at the diagrams below of a few of the major indexes:

Stock markets: FTSE 100 index

                   

Dow Jones:

                    

Based on these facts and volatile data, it is too early to predict the final outcome of the corrective measures undertaken at the moment. We still have to see the positions of the new large international players. Therefore, at this stage we can engage primarily in futuristic speculations and historic analogies.

A few words on the skeptically minded. They have their arguments based also on hard facts.

The first argument is that the current financial crisis cannot be solved by the USA and the EU alone – a fact acknowledged by political leaders and reflected in the decision to convene a global meeting with the participation of new economic powers like China, Russia, India, Brazil, Mexico, etc.

The second argument is based on the convergence of a number of other crises beyond human control - the global energy crisis (depletion of crude oil resources and end of hydro-carbon era), the climate changes, the food and drinking water crises – all of which are pre-determined in the final analysis by natural factors.

The third argument is proverbially simple but no less convincing: “you cannot cook an omelet without breaking the egg” which is obviously an ideological cliche.

For this reason no scenarios for the development of the current financial-economic crisis can be excluded, especially the worst one – a global depression, social upheavals or even a series of regional wars (for energy resources).

Whatever the outcome of the pending international negotiations on the solution of the current global financial crisis, there is still another important political question that cannot be avoided: Should the ruling classes be trembling at the prospect of a social upheaval?

Obviously, the specter of social revolution is a far-fetched and unpopular idea today, especially having in mind the notion of previous “classic revolutions” like the French or Russian ones.

However, violence has many faces – for instance terrorism, and it might become a part of a worst case scenario that should not be underestimated.

As a minimum this prospect reminds us that classes, class struggle and revolutions have taken place and are facts of our history. Matter of fact speaking, they were not invented by K. Marx but by A. Smith – the father of political economy. Marx only deepened the study of these facts and commented on history: “History likes to repeat itself – the first time as a tragedy, after that as a farce”.

David Singer wrote an article “Dancing on the Grave of Revolution: 1789 and All That” that was published by the American magazine The Nation back in 1989. I am tempted to quote, in conclusion, a thought provoking piece from it:

“It is our duty, when the occasion arises, to remind them that revolutions are not just the handiwork of active minorities but the combined result of accumulated discontent and the inability of a system to offer solutions. To remind them, too, borrowing the words of Bertolt Brecht, about the violence not just of the current but of "the riverbanks that squeeze the current between them." Yet in the present Western context, the danger is not remotely of shortcuts or premature action. As higher productivity in the West produces great unemployment, revealing the contrast between our technological genius and the absurdity of our social and political organization, the image that springs to mind is not one of premature birth but of the monsters that result from an overextended, unending pregnancy.

"Pregnancy" leads to "midwife," which opens up a potentially dangerous metaphor: Marx's reference to revolutionary violence as the midwife of history has sometimes been taken too literally, reducing the historical process to its most spectacular outbursts. In practice, 1789 and 1917 were very different in nature. Whereas the French bourgeoisie gained its ascendancy within the feudal order, the Russian proletariat did nothing of the sort. Yet can one envisage a socialist revolution that would gain power at all levels before it seized power at the top-that is to say, winning cultural hegemony in the Gramscian sense as part of its conquest of power?

In any case, the historians who dismiss revolution as the curse of the Third World or merely a historical feature are not maintaining that the next social upheaval will inevitably be different from the storming of the Bastille or the seizure of the Winter Palace. They are really arguing that there will be no such upheaval at all. Clearly they are too clever, and too keen on their profession, to proclaim openly the end of history. Yet like all faithful servants of an established order, they treat that order as something filled in perpetuity. By denying its class nature, by dismissing the possibility of radically altering property and other social relations, they allow for quantitative but not qualitative change. Precluding an alternative, they limit their own vision, and that of their readers, to the capitalist horizon.

Europe's deep freeze may be drawing to an end… Who knows when a new climate will take hold in Paris, London or Berlin? ….If they stand by the ornate column that now graces the vast square where the symbolic prison fortress of the Bastille once stood and listen carefully, they may hear the rising echo of Rosa Luxemburg's parting words: "You stupid lackeys, your order is built on sand. Tomorrow the Revolution will raise its head again and proclaim to your sorrow amid a brass of trumpets: I was, I am, I shall always be...."

Author:

Petar Mitov

http://infopreneur.dum-spiro-spero.info

 

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The United States, Europe and Bretton Woods II

October 20, 2008

By George Friedman and Peter Zeihan

French President Nicolas Sarkozy and U.S. President George W. Bush met Oct. 18 to discuss the possibility of a global financial summit. The meeting ended with an American offer to host a global summit in December modeled on the 1944 Bretton Woods system that founded the modern economic system.

Related Special Topic Page

• Political Economy and the Financial Crisis

The Bretton Woods framework is one of the more misunderstood developments in human history. The conventional wisdom is that Bretton Woods crafted the modern international economic architecture, lashing the trading and currency systems to the gold standard to achieve global stability. To a certain degree, that is true. But the form that Bretton Woods took in the public mind is only a veneer. The real implications and meaning of Bretton Woods are a different story altogether.

Conventional Wisdom: The Depression and Bretton Woods

The origin of Bretton Woods lies in the Great Depression. As economic output dropped in the 1930s, governments worldwide adopted a swathe of protectionist, populist policies — import tariffs were particularly in vogue — that enervated international trade. In order to maintain employment, governments and firms alike encouraged ongoing production of goods even though mutual tariff walls prevented the sale of those goods abroad. As a result, prices for these goods dropped and deflation set in. Soon firms found that the prices they could reasonably charge for their goods had dropped below the costs of producing them.

The reduction in profitability led to layoffs, which reduced demand for products in general, further reducing prices. Firms went out of business en masse, workers in the millions lost their jobs, demand withered, and prices followed suit. An effort designed originally to protect jobs (the tariffs) resulted in a deep, self-reinforcing deflationary spiral, and the variety of measures adopted to combat it — the New Deal included — could not seem to right the system.

Economically, World War II was a godsend. The military effort generated demand for goods and labor. The goods part is pretty straightforward, but the labor issue is what really allowed the global economy to turn the corner. Obviously, the war effort required more workers to craft goods, whether bars of soap or aircraft carriers, but “workers” were also called upon to serve as soldiers. The war removed tens of millions of men from the labor force, shipping them off to — economically speaking — nonproductive endeavors. Sustained demand for goods combined with labor shortages raised prices, and as expectations for inflation rather than deflation set in, consumers became more willing to spend their money for fear it would be worth less in the future. The deflationary spiral was broken; supply and demand came back into balance.

Policymakers of the time realized that the prosecution of the war had suspended the depression, but few were confident that the war had actually ended the conditions that made the depression possible. So in July 1944, 730 representatives from 44 different countries converged on a small ski village in New Hampshire to cobble together a system that would prevent additional depressions and — were one to occur — come up with a means of ending it shy of depending upon a world war.

When all was said and done, the delegates agreed to a system of exchangeable currencies and broadly open rules of trade. The system would be based on the gold standard to prevent currency fluctuations, and a pair of institutions — what would become known as the International Monetary Fund (IMF) and the World Bank — would serve as guardians of the system’s financial and fiduciary particulars.

The conventional wisdom is that Bretton Woods worked for a time, but that since the entire system was linked to gold, the limited availability of gold put an upper limit on what the new system could handle. As postwar economic activity expanded — but the supply of gold did not — that problem became so mammoth that the United States abandoned the gold standard in 1971. Most point to that period as the end of the Bretton Woods system. In fact, we are still using Bretton Woods, and while nothing that has been discussed to this point is wrong exactly, it is only part of the story.

A Deeper Understanding: World War II and Bretton Woods

Think back to July 1944. The Normandy invasion was in its first month. The United Kingdom served as the staging ground, but with London exhausted, its military commitment to the operation was modest. While the tide of the war had clearly turned, there was much slogging ahead. It had become apparent that launching the invasion of Europe — much less sustaining it — was impossible without large-scale U.S. involvement. Similarly, the balance of forces on the Eastern Front radically favored the Soviets. While the particulars were, of course, open to debate, no one was so idealistic to think that after suffering at Nazi hands, the Soviets were simply going to withdraw from territory captured on their way to Berlin.

The shape of the Cold War was already beginning to unfold. Between the United States and the Soviet Union, the rest of the modern world — namely, Europe — was going to either experience Soviet occupation or become a U.S. protectorate.

At the core of that realization were twin challenges. For the Europeans, any hope they had of rebuilding was totally dependent upon U.S. willingness to remain engaged. Issues of Soviet attack aside, the war had decimated Europe, and the damage was only becoming worse with each inch of Nazi territory the Americans or Soviets conquered. The Continental states — and even the United Kingdom — were not simply economically spent and indebted but were, to be perfectly blunt, destitute. This was not World War I, where most of the fighting had occurred along a single series of trenches. This was blitzkrieg and saturation bombings, which left the Continent in ruins, and there was almost nothing left from which to rebuild. Simply avoiding mass starvation would be a challenge, and any rebuilding effort would be utterly dependent upon U.S. financing. The Europeans were willing to accept nearly whatever was on offer.

For the United States, the issue was one of seizing a historic opportunity. Historically, the United States thought of the United Kingdom and France — with their maritime traditions — as more of a threat to U.S. interests than the largely land-based Soviet Union and Germany. Even World War I did not fully dispel this concern. (Japan, for its part, was always viewed as a hostile power.) The United States entered World War II late and the war did not occur on U.S. soil. So — uniquely among all the world’s major powers of the day — U.S. infrastructure and industrial capacity would emerge from the war larger (far, far larger) than when it entered. With its traditional rivals either already greatly weakened or well on their way to being so, the United States had the opportunity to set itself up as the core of the new order.

In this, the United States faced the challenges of defending against the Soviet Union. The United States could not occupy Western Europe as it expected the Soviets to occupy Eastern Europe; it lacked the troops and was on the wrong side of the ocean. The United States had to have not just the participation of the Western Europeans in holding back the Soviet tide, it needed the Europeans to defer to American political and military demands — and to do so willingly. Considering the desperation and destitution of the Europeans, and the unprecedented and unparalleled U.S. economic strength, economic carrots were the obvious way to go.

Put another way, Bretton Woods was part of a broader American effort to extend the wartime alliance — sans the Soviets — beyond Germany’s surrender. After all wars, there is the hope that alliances that have defeated a common enemy will continue to function to administer and maintain the peace. This happened at the Congress of Vienna and Versailles as well. Bretton Woods was more than an attempt to shape the global economic system, it was an effort to grow a military alliance into a broader U.S.-led and -dominated bloc to counter the Soviets.

At Bretton Woods, the United States made itself the core of the new system, agreeing to become the trading partner of first and last resort. The United States would allow Europe near tariff-free access to its markets, and turn a blind eye to Europe’s own tariffs so long as they did not become too egregious — something that at least in part flew in the face of the Great Depression’s lessons. The sale of European goods in the United States would help Europe develop economically, and, in exchange, the United States would receive deference on political and military matters: NATO — the ultimate hedge against Soviet invasion — was born.

The “free world” alliance would not consist of a series of equal states. Instead, it would consist of the United States and everyone else. The “everyone else” included shattered European economies, their impoverished colonies, independent successor states and so on. The truth was that Bretton Woods was less a compact of equals than a framework for economic relations within an unequal alliance against the Soviet Union. The foundation of Bretton Woods was American economic power — and the American interest in strengthening the economies of the rest of the world to immunize them from communism and build the containment of the Soviet Union.

Almost immediately after the war, the United States began acting in ways that indicated that Bretton Woods was not — for itself at least — an economic program. When loans to fund Western Europe’s redevelopment failed to stimulate growth, those loans became grants, aka the Marshall Plan. Shortly thereafter, the United States — certainly to its economic loss — almost absentmindedly extended the benefits of Bretton Woods to any state involved on the American side of the Cold War, with Japan, South Korea and Taiwan signing up as its most enthusiastic participants.

And fast-forwarding to when the world went off of the gold standard and Bretton Woods supposedly died, gold was actually replaced by the U.S. dollar. Far from dying, the political/military understanding that underpinned Bretton Woods had only become more entrenched. Whereas before, the greatest limiter was on the availability of gold, now it became — and remains — the whim of the U.S. government’s monetary authorities.

Toward Bretton Woods II

For many of the states that will be attending what is already being dubbed Bretton Woods II, having this American centrality as such a key pillar of the system is the core of the problem.

The fundamental principle of Bretton Woods was national sovereignty within a framework of relationships, ultimately guaranteed not just by American political power but by American economic power. Bretton Woods was not so much a system as a reality. American economic power dwarfed the rest of the noncommunist world, and guaranteed the stability of the international financial system.

What the September financial crisis has shown is not that the basic financial system has changed, but what happens when the guarantor of the financial system itself undergoes a crisis. When the economic bubble in Japan — the world’s second-largest economy — burst in 1990-1991, it did not infect the rest of the world. Neither did the East Asian crisis in 1997, nor the ruble crisis of 1998. A crisis in France or the United Kingdom would similarly remain a local one. But a crisis in the U.S. economy becomes global. The fundamental reality of Bretton Woods remains unchanged: The U.S. economy remains the largest, and dysfunctions there affect the world. That is the reality of the international system, and that is ultimately what the French call for a new Bretton Woods is about.

There has been talk of a meeting at which the United States gives up its place as the world’s reserve currency and primacy of the economic system. That is not what this meeting will be about, and certainly not what the French are after. The use of the dollar as world reserve currency is not based on an aggrandizing fiat, but the reality that the dollar alone has a global presence and trust. The euro, after all, is only a decade old, and is not backed either by sovereign taxing powers or by a central bank with vast authority. The European Central Bank (ECB) certainly steadies the European financial system, but it is the sovereign countries that define economic policies. As we have seen in the recent crisis, the ECB actually lacks the authority to regulate Europe’s banks. Relying on a currency that is not in the hands of a sovereign taxing power, but dependent on the political will of (so far) 15 countries with very different interests, does not make for a reliable reserve currency.

The Europeans are not looking to challenge the reality of American power, they are looking to increase the degree to which the rest of the world can influence the dynamics of the American economy, with an eye toward limiting the ability of the Americans to accidentally destabilize the international financial system again. The French in particular look at the current crisis as the result of a failure in the U.S. regulatory system.

And the Europeans certainly have a point. If fault is to be pinned, it is on the United States for letting the problem grow and grow until it triggered a liquidity crisis. The Bretton Woods institutions — specifically the IMF, which is supposed to serve the role of financial lighthouse and crisis manager — proved irrelevant to the problems the world is currently passing through. Indeed, all multinational institutions failed or, more precisely, have little to do with the financial system that was operating in 2008. The 64-year-old Bretton Woods agreement simply didn’t have anything to do with the current reality.

Ultimately, the Europeans would like to see a shift in focus in the world of international economic interactions from strengthening the international trading system to controlling the international financial system. In practical terms, they want an oversight body that can guarantee that there won’t be a repeat of the current crisis. This would involve everything from regulations on accounting methods, to restrictions on what can and cannot be traded and by whom (offshore financial havens and hedge funds would definitely find their worlds circumscribed), to frameworks for global interventions. The net effect would be to create an international bureaucracy to oversee global financial markets.

Fundamentally, the Europeans are not simply hoping to modernize Bretton Woods, but instead to Europeanize the American financial markets. This is ultimately not a financial question, but a political one. The French are trying to flip Bretton Woods from a system where the United States is the buttress of the international system to a situation where the United States remains the buttress but is more constrained by the broader international system. The European view is that this will help everybody. The American position is not yet framed and won’t be until the new president is in office.

But it will be a very tough sell. For one, at its core the American problem is “simply” a liquidity freeze and one that is already thawing. Europe’s and East Asia’s recessions are bound to be deeper and longer lasting. So the United States is sure — no matter who takes over in January — to be less than keen about revamps of international processes in general. Far more important, any international system that oversees aspects of American finance would, by definition, not be under full American control, but under some sort of quasi-Brussels-like organization. And no American president is going to engage gleefully on that sort of topic.

Unless something else is on offer.

Bretton Woods was ultimately about the United States trading access to its economic might for political and military deference. The reality of American economic might remains. The question, then, is simple: What will the Europeans bring to the table with which to bargain?

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The Global Financial Crisis and China

BBC News is running a series of commentaries this week by economists on the challenges facing the global financial system. Today, Linda Yueh considers the implications for China.

The economic crisis of 2008 is rooted in the so-called "global imbalances", whereby the West borrowed too much, funded by Asian savings.

Globalised financial markets then transmitted the American led crisis around the world.

Resolving this crisis, in the least painful manner, will require rebalancing the global economy.

China is a significant source of global savings and certainly is not immune to the economic crisis which will slow its economic growth, though it is likely to weather it well.

With nearly $2 trillion in foreign exchange reserves, it is in a position to help with the credit crunch in the West as well as serve as an engine of growth as the other engine, the United States, slows to a halt.

Western governments must borrow to fund the rescue plans since raising taxes is not advisable in a downturn.

Borrowing of these magnitudes will result in future tax rises and higher interest rates which could stymie economic growth.

Instead of selling debt to China and other emerging economies, the sovereign wealth funds of these countries could invest directly in western markets.

China, and emerging economies, contributed to this crisis and are suffering the consequences
Commercial investments from emerging economies would be more palatable.

But would China, and others, permit their firms to invest freely overseas?

They will be concerned about loosening their capital controls which makes it harder to peg their currencies if capital moved freely and eroded the pegs.

By recapitalising the West, China and other emerging economies can preserve their export markets by helping the world's richest economies weather the storm and prevent a drawn out recession, or even depression.

Belt tightening by western consumers is still necessary and will happen but a long period of austerity can be avoided.

China, and emerging economies, contributed to this crisis and are suffering the consequences as their financial markets and export sectors decline. They can also help resolve it.

Linda Yueh is Fellow in Economics at St Edmund Hall, University of Oxford. She is an Associate of the Globalisation Programme of the Centre for Economic Performance at the London School of Economics and Political Science (LSE).

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