Debt Default: How the U.S. Has Ceded Global Economic Power
Zachary Karabell on how the debt debate has confirmed diminished U.S. economic leadership.
So there you have it. The debt deal is done, and all that remains is for a ritualistic i-dotting and t-crossing, along with the howls of protest from left and right that their bedrock principles were violated in order to save the U.S. credit rating. But make no mistake: While Washington muddled through at the witching hour and avoided sending the global economic system into the vortex, what unfolded over the past few weeks will have repercussions, and they are not good for America.
In the looking-glass world of Washington politics, the debates over fiscal austerity, preserving entitlements, positioning for the 2012 election all made a certain sense. Unless you are of that world, it was nonsense. Americans could—and did—express dismay at the state of politics, as they have done repeatedly over the course of two and a half centuries. But for the rest of the world, as Fareed Zakaria and others have noted, the debt-ceiling impasse was the most pressing and disturbing sign to date that a global economic system that hinges on the United States is a system waiting to crash. And that in turn hastens the urgency of the rest of the world to find a viable alternative to the dollar and to U.S. Treasuries as soon as possible.
The unraveling of American economic leadership began in earnest in 2008, with the financial meltdown occasioned by mortgages, derivatives, and the failure of risk management. The Chinese, who for years had listened to Americans lecture them about the perilous state of Chinese banks, realized that it wasn’t their own banks that should have been the issue. The Europeans, who have more than their own share of problems with the euro, realized that the Americans were not nearly as good at managing matters economic as the Americans thought they were. And in the emerging world, there was a dawning recognition that the way forward might not go through Wall Street and Washington but through new and untested channels.
The global community came together to forestall the worst of the 2008–09 crisis, and "kumbaya" moments came fast and furious. But with the crisis past, the disillusionment with American economic leadership was in stark evidence last fall, when President Obama’s calls to the G20 for more economic balance in the form of Chinese currency reform and surplus nations curtailing their surplus were met by indignation and disbelief by a panoply of officials ranging from China to Germany that an America still so compromised financially and fiscally would have the audacity to lecture the world once again.
But the debt debacle takes the proverbial cake and then smashes it into the collective face of the global community. Yes, the expressions of shock and dismay need to be kept in perspective and discounted somewhat: As the preeminent power for decades, the United States has attracted both envy and animosity, and seeing us at our worst doesn’t necessarily bring out others at their best.
Still, the resounding response globally has been some variant of “What the hell is going on?” From the normally sanguine Canadians: “The power the U.S. exercises on the world stage comes largely from its economic strength. Default would demonstrate the U.S.’s inability to meet its commitments. In addition to the economic consequences, that could lead to a loss of its moral authority in international affairs.” From the Chinese state news agency Xinhua: “Given the United States' status as the world's largest economy and the issuer of the dominant international reserve currency, such political brinkmanship in Washington is dangerously irresponsible.” And from Saudi Arabia: “Saudi Arabia is paid in dollars for its oil. Our currency is tied to the dollar. The Kingdom has approximately 2 trillion invested abroad, the greater part of it in the United States. The value of those investments, the value of our oil earnings and the value of our currency are all under threat as politicians in Washington grandstand for their constituents and argue bitterly from two utterly polarized positions.”
You could find dozens more like these from other parts of the world. Americans may scoff that foreign criticisms of domestic American politics are both beside the point and insulting, but that is missing the larger point: The United States, its dollar, and its Treasury bonds are the current linchpin of a multitrillion-dollar global economic system of trade, capital flows, and commercial transactions large and small. That determines everything from interest rates and, hence, domestic borrowing costs for homes to rates of return in capital markets to the ability to attract and retain jobs and capital. What Congress does about the debt ceiling may be debated in purely American terms of what is good for America, but those decisions have massive ripple effects from Rio to Shanghai, Mumbai to Dubai. And how the world then reacts has equally major ripples from Peoria to Portland.
What the Tea Party misses entirely—as do many others on both the left and right as well—is the degree to which American prosperity is tethered to a global system anchored by the dollar. The Chinese want to untether themselves, but for now, they have no real options, other than making their own currency convertible and inviting economic chaos until the system adjusts. Everyone wants to, but with the Euro deeply troubled and Japan stable but stagnant, the $14 trillion American economy and its still vast and hungry consumer and capital markets makes the United States a fulcrum of a complicated and unstable system.
The advantages for the United States are very low borrowing costs and lower barriers for U.S. businesses abroad, as well as ample room to make mistakes and still attract sufficient capital. All of that is now imperiled.
You could argue—and some Tea Partiers suggested as much—that the best thing for the U.S. would be a terrible crisis occasioned by default and downgrade. At least then, America would have to confront escalating costs and decreasing growth. With the dollar still a reserve currency and funding costs of budget overruns so low, Americans can keep forestalling and hoping that tomorrow it will all magically get better.
But once that genie is out, there is no putting it back, and far from keeping it in, the events of the past weeks even without default may just have loosened the cork for good. The world at large is more sure than ever that the United States is large yet unreliable, powerful yet more capable of harming the global economic balance than maintaining it. That may be the wrong assessment, but our domestic politics are doing nothing to convey otherwise.
Confidence and trust aren’t measurable, but they are vital to economic leadership and prosperity. Yes, as long as the United States is big and its companies dominant, the current system will persist. But unless Washington wakes up to the urgency of the world at large to detach from the dollar and begins to craft policies that keep that from happening, the events of the past weeks will be seen in retrospect as a signal moment hastening the end of American economic hegemony. That may ultimately be good for the world, but in the near term, it will be little but pain for the United States.