January 03, 2008

A 'Sick Man of Europe' Reprise?

Niall Ferguson had an interesting op-ed recently in the FT, drawing comparisons between the 70s (that is, the 1870's) and present, more particularly, credit crises impacting the Ottoman Empire then, and the U.S. now. Some key passages:

In the aftermath of the Crimean war, both the sultan in Constantinople and his Egyptian vassal, the khedive, had begun to accumulate huge domestic and foreign debts...The loans had been made for both military and economic reasons: to support the Ottoman military position during and after the Crimean war and to finance railway and canal construction, including the building of the Suez canal, which had opened in 1869...The crisis had two distinct financial consequences: the sale of the khedive’s shares in the Suez canal to the British government (for £4m, famously ad­vanced to Disraeli by the Rothschilds) and the hypothecation of certain Ottoman tax revenues for debt service under the auspices of an international Administration of the Ottoman Public Debt, on which European bondholders were represented. The critical point is that the debt crisis necessitated the sale or transfer of Middle Eastern revenue streams to Eur­opeans.

The US debt crisis has taken a different form, to be sure. External liabilities have been run up by a combination of government and household dis-saving. It is not the public sector that is defaulting but subprime mortgage borrowers.

As in the 1870s, though, the upshot of this debt crisis is the sale of assets and revenue streams to foreign creditors. This time, however, creditors are buying bank shares not canal shares. And the resulting shift of power is from west to east.

Since September, Middle Eastern and east Asian sovereign wealth funds have made a succession of investments in four US banks: Bear Stearns, Citigroup, Morgan Stanley and Merrill Lynch. Most commentators have been inclined to welcome this global bail-out : better to bring in foreign capital than to shrink balance sheets by reducing lending. Yet we need to recognise that these “capital injections” represent a transfer of the revenues from the US financial services industry into the hands of foreign governments. This is happening at a time when the gap between eastern and western incomes is narrowing at an unprecedented pace. [my emphasis]

The perils of such historical analogizing are clear, and I'm typically dubious of drawing such broad parallels so easily (in fairness to Ferguson, he does point out commodity prices were trending down back then, not up, that major reserve currencies were reasonably stable, not steadily losing value as is the greenback now, etc--so he is conscious the analogy is imperfect at very least on those points) . And many Wall Streeters would remind markets go up, and they go down (to take one example, was it just the late 80's when the Japanese were scooping up Manhattan real-estate willy-nilly, including trophy properties like Rock Center?). So the position of U.S. financial institutions could be very different indeed within a few years, and perhaps for the better. Put differently, is there really some epochal shift at play here--simply because several foreign government affiliated funds are taking large positions in a handful of bulge bracket U.S. banks--given the U.S. economy's tremendous size, it's potent (well, to a fashion) military power, and other factors pointing to its overall resilience?

Still, I think the emergence of sovereign wealth funds of mammoth size (see China, Singapore, the Gulf States, Russia) is a phenomenon worthy of closer scrutiny going forward, with significant implications for the global economy (not to mention political anti-liberalization trends, with the growth of 'capitalist' autocracies) that have yet to be sufficiently understood. Nor should the historical irony that our forces are bogged down in Afghanistan and Iraq--at tremendous cost to this nation's blood and treasure--while Gulf States take major positions in some of our 'crown jewel' financials, go unnoticed. And with the dollar ailing, gold at historic highs, and oil pushing up near $100, certainly market participants (even with geopolitical risk premium having been lowered given the Iran NIE, though then countervailed much by the turbulence in Pakistan) are smelling dangerous spillage still from the subprime-fallout, credit/banking crisis, declining housing sector, and even chance of a recession in the world's biggest economy this year (not least if the American consumer finally surrenders to burgeoning inflationary pressures, the depression-like housing sector, and other financial strains).

Ferguson closes:

It remains to be seen how quickly today’s financial shift will be followed by a comparable geopolitical shift in favour of the new export and energy empires of the east. Suffice to say that the historical analogy does not bode well for America’s quasi-imperial network of bases and allies across the Middle East and Asia. Debtor empires sooner or later have to do more than just sell shares to satisfy their creditors.

Little matter, Rudy wants to surge into Afghanistan! Thank God his electoral prospects have taken a walloping these past months. But this type of 'I'm tougher than the next guy' crapola has permeated most of the Republican field (Mitt 'double Gitmo' Romney, Fred Thompson's primitive appeal to the 'Jack Bauer caucus', McCain's incredible singing of 'bomb Iran' in a display of ribald unseriousness). The American people, I think--and even after close to a decade of demagoging--can nonetheless espy that these wannabe emperors have no clothes, and that their proposed policies would only serve to damage even more our political, economic (see here for more on the possible implications of the weakening dollar) and moral standing around the world.

P.S. On related topics, don't miss Cunning on a newly identified form of BDS, as well as his take on varied inflationary pressures here. It's going to be an interesting year friends--and not just because of a Presidential election. Don your seatbelts...

Posted by Gregory at January 3, 2008 08:40 AM