Ricardo Hausmann: "The crisis gives the US new financial power" - Mercedes-Benz Forum

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Ricardo Hausmann: "The crisis gives the US new financial power"

FT.com / Comment / Opinion - The crisis gives the US new financial power

The crisis gives the US new financial power

By Ricardo Hausmann

Published: December 15 2008 19:19 | Last updated: December 15 2008 19:19

The economic crisis in the US signals the end of American global hegemony. Or does it? Pundits from different camps, some with fear and others with glee, contemplate a future where the US will have a much diminished weight in global affairs. But if the US plays its hand well, things will turn out to be just the opposite.

It is useful to remember that power is a relative, not an absolute concept. True, the US has been hurt by the current turmoil but so have many others. The Dow Jones is down by almost 40 per cent so far this year but this makes it pretty much the best performing stock market in the world.

More importantly, as far as power is concerned, unfriendly states such as Russia, Iran and Venezuela are suffering from a dual collapse in the price of their oil exports and the value of their sovereign bonds.

Remember the dangerous scenario this past summer with Russia intervening in Georgia and threatening Europe with the energy card?

Now, Russian policymakers perform daily prayers just to be able to open the stock market for regular business.

More broadly, the financial meltdown has translated into a sudden stop in capital flows to emerging and developing countries, which threatens to destabilise their growth, their financial systems and their government accounts.

Contrary to popular opinion, the current crisis has very little to do with the Armageddon that Nouriel Roubini, professor of economics at New York University, predicted over the past few years. In his mind, the widening US current account deficit would eventually top the willingness of the rest of the world to fund it, causing the US dollar to crash while long term interest rates on US Treasury bonds would soar.

That has little to do with this crisis: the US has become the only remaining super-borrower, able to issue thousands of billions of dollars in debt at record low rates while the dollar strengthens. People are unwilling to lend to almost anybody except for the US Treasury. This has allowed the US to provide – at record low cost – about $5,000bn (£3,325bn, €3,700bn) to bail out its financial system and organise a Keynesian reflation of its economy.

At the same time, fairly well behaved countries such as Brazil, Colombia, Mexico, Peru, South Africa and Turkey have essentially lost access to external finance.

What should the US do with its newfound financial power? While it is tempting to use this power only for domestic policy purposes, it would be a mistake to do so.

First, the US is already running a large current account deficit, a reflection of the fact that domestic spending is well above output. Using the capacity to borrow just to spend it domestically is going to aggravate this deficit and leave the US with a worsened external balance that will limit growth down the line.

Second, net public debt is rising sharply just as baby boomers will begin to collect their social security cheques, worsening long-run fiscal solvency.

Third, many countries across the world are going to suffer the consequences of the lack of access to finance at a time where the decline in their export earnings would have warranted more borrowing to smooth things out. If unchecked, this will cause their economies to shrink and their imports to decline, hurting US exports just when they are most needed. Under these conditions, there is the risk that countries will shut themselves off from the global economy and impose the financial equivalent of the protectionist Smoot-Hawley Act of 1930 . This can lead to an unravelling of the consensus for globalisation that has characterised the post-cold war era.

Fourth, if the US re-circulates financial resources, by on-lending to well behaved countries that have lost access because of the financial crisis, it would not increase its net debt but instead would make money for the US taxpayer while helping increase demand for US exports.

Fifth, re-exporting capital to the rest of the world would prevent the inconvenient strengthening of the dollar.

Finally, exercising this function would give the US enormous soft power in the world. Countries would have to decide whether they want to play ball with market democracy and benefit from access to the financial resources that the US and others can mobilise, or try to form a separate camp with Russia, Iran or Venezuela just as the rug has been pulled from under them.

Re-circulating the money in the needed scale will require more than business as usual at the International Monetary Fund, the World Bank and regional development banks. These institutions have been lending well below $100bn a year but the collapse of financial markets represents some $700bn in lost access.

Moreover, countries are afraid to ask for assistance for fear of scaring the markets. The US Federal Reserve has already broken new ground by offering $120bn in swap agreements with Brazil, Korea, Mexico and Singapore but this is geographically limited and unilateral. Intervening directly by creating a fund to purchase globally public and private securities, as is being done at home, and the Latin American Financial Regulation Shadow Committee – of which I am a member – has recently recommended, may be a promising way forward.

The author is the director of Harvard’s Center for International Development and a member of the Latin American Financial Regulation Shadow Committee

Copyright The Financial Times Limited 2008
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