From the October 2011 issue of Research Magazine • Subscribe!

Fading Superpowers

The U.S. and Russia have surprisingly similar economic problems.

After the Cold War’s end, the paths of the two former enemies should have diverged dramatically. No longer locked in a nuclear rivalry known as Mutually Assured Destruction, or MAD for short, each should have been going its own way: the United States to enjoy the fruits of victory and its status as the world’s only superpower, and Russia to learn the democracy and free-market capitalism it had newly embraced.

But ever since, the two countries have followed a remarkably similar downward spiral.

America’s victory in the Cold War was unprecedented. Without firing a shot, it brought about the collapse of the Soviet Union, liberating its vast empire. It got Russia to acknowledge its errors, junk its Communist creed and join the capitalist economic system. The U.S. should have seen its own economy strengthen and its prosperity increase, since the dollar-based economic system which it had created after World War II now extended into the former Eastern Bloc as well as China. Russia, too, after a period of tough reforms and adjustment in the 1990s, should have been entering a new era of economic success on the model of Poland or the Czech Republic.

Commodity Exporters

Instead, Russia chose a different path. The Soviet industrial base was never reformed or modernized, since factories and plants remained in the hands of Communist-era managers, who were more interested in stripping assets than building viable private enterprises. While it became de-industrialized, Russia also became addicted to easy petrodollars flowing in as a result of steady price increases in world markets for its oil, gas and other natural resources.

Russia has overtaken Saudi Arabia as the world’s largest producer of crude, pumping 10.3 million barrels per day. Its output is at a post-Soviet high, with some 60 percent going to export. Russia has been constrained to pump crude flat out to satisfy rapidly growing domestic demand and earn petrodollars. However, unlike in Soviet times, the main source of domestic consumption is not heavy industry, but motorists. Russia is wealthier than it has ever been, but its wealth comes from oil and non-oil commodity exports.

The U.S. has a world-leading technology sector and its business management is still beyond compare: American companies continue to expand their global footprint, successfully penetrating new markets, introducing new goods and services and beating out competitors. Despite a sluggish economic recovery since 2009, the U.S. corporate sector has maintained spectacular earnings growth. The $2 trillion-plus cash pile on the balance sheet of top 500 American multinationals is a measure of their success.

But in many ways the American economy has become eviscerated. Industrial jobs have disappeared, while service sector jobs have proved fickle, disappearing the minute the financial bubble popped. The problem is that over the past two decades, the U.S., too, has become a commodity exporter. Our largest export today is Treasury paper. In the past year, China for example purchased some $300 billion of new Treasuries, raising its holdings to $1.3 trillion.

For China, U.S. Treasuries are raw materials much like oil, metals or soybeans. It uses metals and oil to make products, soybeans to feed its workers and U.S. Treasuries to beef up exports to the United States. Had China’s central bank not bought U.S. government paper, the dollar would have plunged, making Chinese exports prohibitively expensive at WalMarts across the United States. Meanwhile, without China lending to the U.S., we wouldn’t have had the ability to finance our budget deficit and aggregate demand in the U.S. would have shrunk by as much as 8 percent in each of the past three fiscal years.

Bureaucrats at the Trough

Commodities that come out of the ground are often considered a national asset, belonging to the entire nation. All citizens are supposedly entitled to a portion of profits from the extraction and sale of such commodities. Of course, in order to collect and distribute the rent on this national asset you need an army of bureaucrats. Commodity-producing countries tend to have a highly bureaucratized political system, where government officials and politicians invariably turn out to be the true — and only — winners. Russia has become notorious during Vladimir Putin’s rule both for its populist rhetoric about controlling its own national wealth and for the blatant thievery by corrupt government officials.

Much of Russia’s commodities production has been renationalized or heavily taxed. But little of the huge earnings the commodities sector provides goes to alleviate poverty, develop the economy or rebuild Russia’s terrible social and industrial infrastructure. Most tend to find their way into numbered accounts offshore and choice properties in resort areas around the world.

But don’t rush to criticize Russia. The U.S. is moving toward a similar economic model, except its commodity exports are not oil but Treasuries. Printing Treasury bills is even easier than pumping oil out of the ground. As in other commodity-producing nations, the money is distributed through politicians and government officials. This explains why the District of Columbia has grown so much over the past quarter of a century. Its expansion closely parallels the structural widening of the Federal budget deficit and the expansion of our national debt. American public servants are less likely to steal than their colleagues in Russia, and their enrichment involves legally acceptable, if somewhat convoluted, schemes, such as becoming lobbyists. But the end result is similar.

After the 2008 financial debacle, which hit Russia especially hard, Russian leaders declared that they would rid the economy of its dependence on oil and diversify the industrial base. But diversification was entrusted to Russian bureaucrats. Not surprisingly, Russia is entering what may become the second dip in a double-dip global economic crisis while being even more dependent on oil exports than before.

In a very similar fashion, political Washington spent weeks over the summer debating the budget deficit, national debt and the size of the government only to come up with a putative $2 trillion deficit cut over the next decade, or about the same as the projected federal deficit in fiscal 2011. After Standard & Poor’s downgraded its sovereign debt rating on the U.S., prompting severe criticism from the White House, Russia’s Prime Minister Vladimir Putin also lashed out against the credit agency. He too believes that his country’s credit rating is too low. 

Poisoning the Well

It is an old truth that you’ve got to use your faculties in order not to lose them. Since making money for Russian and American bureaucrats has been such a no-brainer, they seem to be losing their ability to use their brains. They are starting to undermine demand for their countries’ respective commodities.

Several times in recent years Russia has tried to use its oil and gas exports as a political weapon. It has attempted to blackmail leaders in neighboring ex-Soviet republics Ukraine and Belarus and has even brandished this economic weapon before its customers in Western Europe. The result has been predictable. While falling into line in the short term and placating the angry Russian bear, Western Europeans began exploring alternative sources of natural gas, including the North Sea, North Africa and Israel.

Russia is building several pipelines to supply Western Europe, but it may find itself with a lot of spare capacity when those multibillion dollar projects are completed.

Americans, too, are playing with fire as far as their own commodity exports are concerned. The world seems to have an insatiable appetite for Treasuries, as evidenced by historically low yields on U.S. government paper going into mid-August. This means that the U.S. remains the global safe haven. However, unlike Russia’s oil — which people still need to power their cars and to produce chemical products — Treasuries have value only as long as investors don’t doubt the full faith and credit of the U.S. government that backs them. Trust is something that you can lose only once.

The spectacle in Washington over the summer has chipped into the trust for the U.S. over the long term. Treasuries may one day become an unexportable commodity — but, paradoxically, it may do the country a world of good to stop being a commodity-exporting nation.

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