PAKISTAN Special

By: JOHN GRAY

Our gaze might be on the markets melting down, but the upheaval we are experiencing is more than a financial crisis, however large. Here is a historic geopolitical shift, in which the balance of power in the world is being altered irrevocably. The era of American global leadership, reaching back to the Second World War, is over.

 

You can see it in the way America's dominion has slipped away in its own backyard, with Venezuelan President Hugo Chavez taunting and ridiculing the superpower with impunity.

 

The setback of America's standing at the global level is even more striking. With the nationalization of crucial parts of the financial system, the American free-market creed has self-destructed while countries that retained overall control of markets have been vindicated. In a change as far-reaching in its implications as the fall of the Soviet Union, an entire model of government and the economy has collapsed.

 

Ever since the end of the Cold War, successive American administrations have lectured other countries on the necessity of sound finance. Indonesia, Thailand, Argentina and several African states endured severe cuts in spending and deep recessions as the price of aid from the International Monetary Fund, which enforced the American orthodoxy.

 

China, in particular, was hectored relentlessly on the weakness of its banking system. But China's success has been based on its consistent contempt for Western advice and it is not Chinese banks that are going bust.

 

Despite incessantly urging other countries to adopt its way of doing business, America has always had one economic policy for itself and another for the rest of the world. Throughout the years in which the US was punishing countries that departed from fiscal prudence, it was borrowing on a colossal scale to finance tax cuts and fund its overstretched military commitments.

 

Now, with federal finances critically dependent on continuing large inflows of foreign capital, it will be the countries that spurned the American model of capitalism that will shape America's economic future. The dire condition of America's financial markets is the result of American banks operating in a free-for-all environment that these same American legislators who have been debating a bail-out created. It is America's political class that, by embracing the dangerously simplistic ideology of deregulation, has responsibility for the mess.

 

In current circumstances, an unprecedented expansion of government is the only means of averting a market catastrophe. The consequence, however, will be that America will be even more starkly dependent on the world's new rising powers. The federal government is racking up even larger borrowings, which its creditors may rightly fear will never be repaid. It may well be tempted to inflate these debts away in a surge of inflation that would leave foreign investors with hefty losses.

 

In these circumstances, will the governments of countries that buy large quantities of American bonds - China, the Gulf states and Russia, for example - be ready to continue supporting the dollar's role as the world's reserve currency? Or will these countries see this as an opportunity to tilt the balance of economic power further in their favour? Either way, the control of events is no longer in American hands.

 

The fate of empires is very often sealed by the interaction of war and debt. That was true of the British Empire, whose finances deteriorated from the First World War onwards, and of the Soviet Union. Defeat in Afghanistan and the economic burden of trying to respond to Reagan's technically flawed but politically effective Star Wars program were vital factors in triggering the Soviet collapse. Despite its insistent exceptionalism, America is no different. The Iraq War and the credit bubble have fatally undermined America's economic primacy.

 

The US will continue to be the world's largest economy for a while longer, but it will be the new rising powers that, once the crisis is over, buy up what remains intact in the wreckage of America's financial system.

 

There has been a good deal of talk in recent weeks about imminent economic armageddon. In fact, this is far from being the end of capitalism. The frantic scrambling in Washington marks the passing of only one type of capitalism - the peculiar and highly unstable variety that has existed in America over the past 20 years. This experiment in financial laissez-faire has imploded. While the impact of the collapse will be felt everywhere, the market economies that resisted American-style deregulation will best weather the storm.

 

The irony of the post-Cold War period is that the fall of communism was followed by the rise of another utopian ideology whereby in America and Britain, and to a lesser extent other Western countries, a type of market fundamentalism became the guiding philosophy. The collapse of American power that is under way is the predictable upshot. Like the Soviet collapse, it will have large geopolitical repercussions. An enfeebled economy cannot support America's over-extended military commitments for much longer. Retrenchment is inevitable and it is unlikely to be gradual or well planned.

 

Meltdowns on the scale we are seeing are not slow-motion events. They are swift and chaotic, with rapidly spreading side effects.

 

Consider Iraq. The success of the surge, which has been achieved by bribing the Sunnis, while acquiescing in ongoing "ethnic cleansing", has produced a condition of relative peace in parts of the country. How long will this last, given that America's current level of expenditure on the war can no longer be sustained?

 

An American retreat from Iraq will leave Iran the regional victor. How will Saudi Arabia respond? Will military action to forestall Iran acquiring nuclear weapons be less or more likely?

 

China's rulers have so far been silent during the unfolding crisis. Will America's weakness embolden them to assert China's power or will China continue its cautious policy of "peaceful rise"?

 

At present, none of these questions can be answered with any confidence. What is evident is that power is leaking from the US at an accelerating rate. Georgia showed Russia redrawing the geopolitical map, with America an impotent spectator.

 

Outside the US, most people have long accepted that the development of new economies that goes with globalisation will undermine America's central position in the world. They imagined that this would be a change in America's comparative standing, taking place incrementally over several decades or generations. Today, that looks an increasingly unrealistic assumption.

 

Having created the conditions that produced history's biggest bubble, America's political leaders appear unable to grasp the magnitude of the dangers the country now faces. Mired in their rancorous culture wars and squabbling among themselves, they seem oblivious to the fact that American global leadership is fast ebbing away. A new world is coming into being almost unnoticed, where America is only one of several great powers, facing an uncertain future it can no longer shape.

BY: NIALL FERGUSON

Future historians will look back on the current decade as a turning point comparable with that of the Seventies. No, not the 1970s. This is not going to be another piece pointing out the coincidence of an unpopular Republican president, soaring oil prices, a sagging dollar and an unwinnable faraway war. I am talking about the 1870s.

At first sight, the resemblances across 130 years may not seem obvious. The 1870s were a time when conservative leaders such as Benjamin Disraeli, British prime minister, were powerful and popular. It was a time of falling commodity prices, after the financial crash of 1873 and the opening up of the American plains to agriculture. And it was an era of currency stability, as one country after another followed the British lead by pegging to gold. Yet, on closer inspection, we are indeed living through a global shift in the balance of power very similar to that which occurred in the 1870s.

This is the story of how an over-extended empire sought to cope with an external debt crisis by selling off revenue streams to foreign investors. The empire that suffered these setbacks in the 1870s was the Ottoman empire . Today it is the US . 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. Between 1855 and 1875, the Ottoman debt increased by a factor of 28. As a percentage of expenditure, interest payments and amortization rose from 15 percent in 1860 to 50 per cent in 1875. The Egyptian case was similar: between 1862and 1876, the total public debt rose from EPounds 3.3m to EPounds 76m. The 1876 budget showed debt charges accounting for more than half of all expenditure.

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. But a dangerously high proportion of the proceeds had been squandered on conspicuous consumption, symbolized by Sultan Abdul Mejid's luxurious Dolmabahce palace and the spectacular world premiere of Aida at the Cairo Opera House in 1871. In the wake of the financial crisis that struck the European and American stock markets in 1873, a Middle Eastern debt crisis was inevitable. In October 1875 the Ottoman government declared bankruptcy.

The crisis had two distinct financial consequences: the sale of the khedive's shares in the Suez canal to the British government (for Pounds 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 dissaving. It is not the public sector that is defaulting but sub prime 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 recognize 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.

In other words, as in the 1870s the balance of financial power is shifting. Then, the move was from the ancient oriental empires (not only the Ottoman but also the Persian and Chinese) to western Europe. Today the shift is from the US-and other western financial centres - to the autocracies of the Middle East and east Asia.

In Disraeli's day, the debt crisis turned out to have political as well as financial implications, presaging a reduction not just in income but also in sovereignty.

In the case of Egypt , what began with asset sales continued with the creation of a foreign commission to manage the public debt, the installation of an "international" government and finally, in 1882, to British military intervention and the country's transformation into a de facto colony. In the case of Turkey , the debt crisis was followed by the sultan's abdication and Russian military intervention, which dealt a lethal blow to the Ottoman position in the Balkans.

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.

The writer is a professor at Harvard University and Harvard Business School and a senior fellow of the Hoover Institution, Stanford.