Glad confident mornings

THE DEBATE ABOUT America’s special role in the world economy and China’s troubled rise is haunted by the work of Charles Kindleberger, who studied the Depression of the 1930s. A lost decade of trade skirmishes, unemployment and devaluations eventually led to an arms race and a world war, the worst there had ever been. Kindleberger concluded that one country had to be in charge to keep the world safe in future. “The international economic system was rendered unstable by British inability and the United States’ unwillingness to assume responsibility for stabilising it…When every country turned to protect its national private interest, the world public interest went down the drain, and with it the private interests of all.”

Writing in 1973, Kindleberger worried that America was no longer able to play that role—although, oddly, in those days the challenger he saw emerging was Europe. In time it was replaced by another supposed rival, Japan, but by 1991 that had burned out. A reasonable person might conclude that gurus have been fretting about America’s ability to hold on to its dominant economic position for decades. China, too, might crash and burn. The reasonable person might add that in the 2007-08 crisis America more or less did what Kindleberger said a hegemon should, maintaining an open market for goods and providing short-term liquidity (though it was less good at providing long-term loans, another thing he had demanded).

But false alarms do not preclude a real one. A lot has changed since the 1970s and 1980s. America’s share of global output has fallen from 36% in 1970 to 22% today, measured at market prices. For all its flaws, China is a far more credible competitor than Japan. Its share of world output is close to where Japan’s was at its peak, even though it is relatively still much poorer than Japan was then, so it has plenty of headroom. Global capital flows have vastly increased since the 1970s and 1980s, making the world’s financial system more unstable, and the number of financial crises is rising.

A last hurrah?

America’s response to the financial crisis of 2007-08 can also be seen as a last hurrah. Officials, as always, did all they could to bail out the banks and refloat the world, but at the cost of shattering the American public’s trust in policymakers and causing a populist backlash that is still reverberating today. The way America saved the world in 2007-08 may make it impossible for it to do so again. All this points in a bitterly pessimistic direction. In Kindleberger’s words: “Stalemate, and depression.”

^{Imagine a fantasy American administration and Congress set to act in its own enlightened self-interest and to the benefit of the world}

Yet just as circumstances have changed since the 1970s, so the world’s response to a power vacuum need not be the same as in the 1930s. The 75% of the planet’s population who do not live in either America or China may well come up with their own answers to some of these problems.

The need for rules to govern trade can be partly dealt with by a patchwork of regional trade deals, of which there are 450 in the works. If the dollar remains dominant but neither America nor the IMF is able to act as a lender of last resort to the system, there are other solutions. Just as English has transcended Britain to become a world language, the greenback could pass into global ownership. Foreign central banks could use their dollar reserves to guarantee liquidity to the offshore dollar system and club together to create a dollar payments system that bypasses America entirely. They could try to reform the IMF by excluding America from it or create new regional bodies to compete with it. In the past such attempts have not been successful—an Asian club called the Chiang Mai Initiative, for instance, has had little impact—but they could be cranked up. In response to the waves of capital gushing around the world, mainly to the rhythm of financial conditions in America, emerging economies could impose capital controls and restrictions on global banks and fund managers, and continue to build up dollar reserves.

A fiddly alternative

Such a world would have its downsides for participants. It would be fiddly. A patchwork of medium-sized trade deals is likely to be much harder to enforce than a few near-universal deals. It would be inefficient, too, as poor countries’ hard-earned savings would be sitting idly as reserves invested in Treasury bonds. Attracting capital might become harder, too, although China’s experience suggests that, given the right conditions on the ground, long-term investment might keep coming even when short-term portfolio flows are strictly ruled out. Restrictions on global banks might keep a lid on capital flows, too, and there would be no way to control competitive devaluations.

All this would still be safer than no organisation at all. But from an American perspective the cost of its neglect in recent years would end up being a world that looks a little less like America and rather more like China: less open, more guarded, keen to engage but on its own terms. It is far from clear that this would be in America’s interest.

The world need not be a prisoner of the 1930s; but neither is it safe to assume that America’s mood will always be as angry as it has been since the financial crisis, or that China will be paralysed by its many paradoxes. The Jacksonian tradition in American politics comes and goes. Perhaps if the economy continues to grow handsomely and more jobs are created, wages will rise at last and America’s middle class will breathe a great sigh of relief that will be heard around the world. Americans’ belief in their country’s exceptional mission has already recovered a little from the depths of the 2009 crisis, opinion polls suggest. Perhaps it can recover a little more. A new president and House of Representatives in 2016 could clear the rancour in the air. Or the election after that might.

Imagine, for a moment, a fantasy American administration and Congress set to act in its own enlightened self-interest and to the benefit of the world. It would tackle the global paranoia about the lack of a lender of last resort. It would triple the funding available to the IMF, to $3 trillion, and prepare a plan to cede the American veto. It would allow the Federal Reserve to extend liquidity to foreign central banks without a cap and require it to start talks with big central banks with which it does not have swap arrangements, not least China and India.

A big and credible safety net should reduce the build-up of the vast dollar reserves that in aggregate may have a destabilising effect. But to meet long-term concerns about a shortage of safe assets, America would set up a sovereign-wealth fund that would be able to issue Treasury bonds and invest the proceeds abroad for a profit, leaving America’s solvency enhanced.

To strengthen the link between America and the world’s banking system, America would encourage big foreign banks in the emerging world to open or expand their presence in New York, transfer all powers of supervision from local governments to less politicised and more competent bodies, strictly limit extraterritorial judgments over their operations and take the resulting howls of protest in its stride.

Having revived and legitimised the IMF, America would resuscitate or replace the other two pillars of the global economic architecture, the World Bank and the World Trade Organisation. It could try to use its hoped-for regional trade deals, such as TPP, to create a new platform that takes in rival and duplicative trade deals, and get China and India to join.

This fantasy America would join China’s institutions such as the AIIB. It would support China’s ambitions to elevate the yuan as a reserve currency, by helping to get it into the IMF’s SDR basket, and by establishing New York as a hub for yuan trading. For now the Big Apple is the only financial centre in the world that has no plans or arrangements to support the redback. A big effort would be made to raise Chinese investment in America. Today for every dollar of Chinese direct investment in America there are two dollars of Chinese investment in Europe and up to five dollars of American investment in China.

What would China have to do in return for that support? Most outsiders point to a long list of reforms that they believe to be important. There is no guarantee that any of them will happen. Even so, America seems to have nothing to lose by being more confident and composed. Making the world economy more stable will win it friends everywhere. It will also save it money in the long run.

Take a chance

If China’s economy turns out to be a house of cards, the country’s claim to global economic superpower status will soon be exposed as hollow. If it becomes ever more autocratic, it will need to become ever more closed to guard against capital flight and foreign influences, which will limit its capacity to affect the world economy beyond its borders. But if it manages to keep growing, to open up and reform, then America will have to reach an accommodation with it some day. Why not start now?