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Regulation and Compliance > State Regulation

If the U.S. No Longer Leads, Who Will?

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These days, American economic leadership is being repeatedly thrust into question.

Surely, the likes of China and Russia have long been complaining about a “uni-polar” world dominated by the United States and demanding some kind of an orderly collective economic and financial system to be put into place. Since the advent of the global economic crisis, even close allies in continental Europe and Canada who share the American belief in the market economy, free trade and private enterprise have raised doubts about the Anglo-Saxon model of unfettered capitalism and highly speculative financial markets. Meetings of the Group of Twenty leading industrialized and emerging economies now regularly moot altering the international economic architecture which has been in place since World War II.

Economic Malaise

The United States is indeed suffering a period of economic drift, but it isn’t a real problem. True, we have been living beyond our means, running enormous budget deficits and getting a free ride on the dollar, buying more abroad than we can afford and letting others support the global reserve currency.

But none of this would have prevented the United States from carrying on as a global leader. In fact, by running budget deficits and sustaining domestic consumption, the United States has provided a market for the rest of the world to develop — which many countries have done successfully, most notably Mexico, India and China. Since the end of World War II, the United States has been consistently running trade deficits, providing dollars which the rest of the world needed in order to invest at home and to stabilize their domestic financial systems.

Finally, even excessive government borrowing is not a major problem over the short term. The U.S. Treasury supplies the global financial system with safe and secure instruments which savers around the world use to keep their savings.

The United States has been getting paid dividends for setting up the global economic and financial system and acting as its guarantor. The system has been working well, and both the United States and its creditors benefit from it. In the 1960s, European central banks — with the notable exception of the Bank of France — held on to their paper dollars even though they could exchange them for gold at the U.S. Federal Reserve. In the 1970s, oil exporters held vast amounts of U.S. debt. Now, Japan, China, Russia and other exporters keep buying U.S. Treasuries because they all have an interest in preserving this system.

Political Instability

Nevertheless, the United States has lost its ability to lead — and did so all of a sudden, seemingly overnight. A decade ago, when the bubble burst and corporate malfeasance came to light, the U.S. government implemented tough measures, notably the Sarbanes-Oxley Act. Even though U.S. regulators were criticized for excessive zeal and unfavorably compared to hands-off regulation in the U.K., the subsequent financial crisis, which hit London-listed shares especially hard, showed which approach was correct.

But in the current crisis, the United States seems unable to provide any useful solutions or models not only for the rest of the world but, most importantly, for its own economy. It has no plausible way to achieve sustainable growth and bring back the 8.4 million domestic jobs lost since the start of 2008. The government is gridlocked. None of the crucial issues dividing society and weighing on the economy — from immigration laws to overhaul of the financial sector to health care reform — have been resolved.

New York Times columnist Thomas Friedman wrote recently that foreign participants of the 2010 World Economic Forum in Davos, Switzerland, kept taking him aside and asking what was going on in Washington. For the first time, he notes, the rest of the world has started to worry about political stability in the U.S. — words that used to be reserved for Third World countries.

Replacing the Leader

With the United States losing its leadership role, a preoccupation with a new leader (or a group of leaders in a collective leadership function) and a new reserve currency is understandable. But it has been a pitiful, unedifying and somewhat comic exercise in circular reasoning. To get away from a U.S.-dominated world you need a leader to rally others and to lead the process. Unfortunately, no such leader has been able to emerge. No nation has been willing or able to assume responsibility or take on the cost of leadership. Nor are there many people in the world who would want to voluntarily entrust their fate to China or Russia — not to mention Germany or Japan.

As to a collective leadership, world bodies such as the United Nations are notoriously fractious and incapable of effective decision-making. Time and time again, in every issue of international politics or economics, we have seen that unless Washington steps in very little gets done.

In addition to political will, the sheer weight of the United States in the global economy ensures that no other nation can step into its shoes. Early on, the International Monetary Fund came up with a synthetic currency, the SDR. However, since the composite currency has to reflect global economic realities, the dollar still dominates the SDR. Its weighting in the currency fell below 40 percent in the 1990s, but it is now up to 44 percent once more.

Leaderless = Rudderless

The United States has a resilient political system and a highly flexible economic system, which is still ahead of the rest of the world in what counts most — science, technology and innovation. The dollar, despite the free ride the United States has been enjoying at its expense over the past two decades, still fluctuates within a fairly narrow corridor. Whenever it falls to the bottom of its historic fluctuation range, U.S. productive and financial assets become cheap from the perspective of foreign investors and they bid up the dollar once more.

Nevertheless, over the near and medium term, the United States will go through a period of inaction while the country remains bitterly divided and unsure as to the kind of economy or even political entity it wants to be. Until it makes up its mind, it will not be able to recover fully from this downturn and to maintain international economic leadership. As a result, the world economy, too, will remain weak and unstable.

Indeed, it is a dangerous illusion to expect the world to grow without a U.S. recovery. China and India avoided a recession, and a number of economies, notably Brazil, bounced back by mid-2009 after an initial slump. However, Chinese leaders have acknowledged that their domestically led recovery is running into problems, as consumer debt becomes unsustainable and real estate and financial bubbles are starting to develop. The Chinese central bank is moving to curb the orgy of lending which Chinese banks enjoyed last year on the urging of the government.

Without a recovery in the export sector — meaning, a rebound in U.S. demand — no sustainable growth in China is likely. On the contrary, China will have to mothball or destroy productive capacities which were created over the past decade to meet U.S. demand. While this happens, we may see a series of price wars which could lead to falling consumer prices in the global economy, collateral damage to other manufacturers in Asia, Latin America and elsewhere and a blow to commodities producers such as Brazil, Australia, South Africa and oil exporters.

Even though some central banks around the world, notably in Australia, Israel and Norway, started to raise their interest rates in the second half of last year, the world economy is not out of the woods yet. Without the United States to lead the world out of a recession, a double-dip downturn remains a distinct possibility.


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