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The Multipolar Financial World

by Heidi Crebo-Rediker, Co-Director GSFI, New America Foundation
October 7, 2008

To Sebastian’s original forum question: is there a relationship between the financial turmoil and US power. The answer has to be yes – for both internal and external reasons.

The internal reasons are more obvious: a strong economy is critical to the ability of the US to lead, to fund national security needs, and to generate public support for any truly necessary engagement abroad to protect national security interests. This crisis has a ways to play out with consequences to the US economy ranging from bad to catastrophic (with other countries now facing similar prophesies). A home-first bias will temper foreign aid programs, just at a time when a cash rich beneficiaries of this decade’s wealth transfer out of the US are able to use financial clout for foreign aid programs or even as outright foreign policy tools. Heading deeper into debt (increasing dependence on Chinese, Japanese, Russian… reserves) could potentially limit our foreign objectives as well (see Brad’s excellent Sovereign Wealth piece).

The external impact of this crisis on US power has yet to play out, but early warning signals are not good. Over the past few years, one could count on Putin to rave about revising the world’s financial architecture (US at the center) to benefit the emerging world economic powers. We counted on a rising China buying into a legacy system it benefited from and not rocking the boat. Now we hear from friends and foes that the time to rebuild the entire financial and monetary system of the world has come. Today we focus on saving the global banking system, but after the dust settles, real questions will emerge about free-market capitalism and the role of the state (not least of which will be because the UST will rival ADIA in assets under management). It would be naïve to write this one off as a bubble born of a perfectly fine free market system – back to business as usual in a year – in the eyes of the rest of the world.

I’ve heard the combination of Iraq and the current meltdown described as the one-two punch for American military and economic power. I’d say there was one further blow delivered – to democracy in action.

In the school of lead by example – the eyes of the world watched US leadership flail while the global free-market ship was sinking: a powerless US President, a Treasury Secretary down on his knees to make his case for saving the system (with not the perfect, but at least some plan), a bickering, divided, Congress perilously dragging out the crisis for two weeks over ideology and local politics. While Rome was burning around the globe, Congress finally came together when earmarks were dished out to pass the Bill. Autocracy gained big points here. Research analysts and foreign press buzzed about Russia handling this crisis better than the US because it took decisive action. We have yet to recognize the profound impact this, combined with loss of faith in the US financial and free-market system, made on every country deciding whether our way was is the right way to go. The US spent decades selling (and shedding blood) for democracy and capitalism. We’ve lost legitimacy in this crisis – there will be consequences for US power.

On the dollar question – I am in the camp that believes that for now, the US dollar’s reserve currency role will be maintained, for lack of a credible alternative. Hopefully so, in any case, as Moody’s made clear that the US AAA rating depends on “the ability of the US to maintain confidence in the dollar as a global reserve and transaction currency.” As for the EUR, the Eurozone is proving itself a fair-weather arrangement – even less up to the task of stabilizing the financial system than the US. China is years away from taking a leadership role re: currency and the Asian Currency Unit looks highly unrealistic. Stephen Jen of Morgan Stanley writes most convincingly of why the USD will remain dominant hegemonic reserve currency and Brad Setser described above why reasons of absolute reserve growth needing an investment home support the dollar’s position. But reserve currencies don’t last forever, such that it becomes a matter of time (5, 10, 25 years?) before we see another currency (or financial product representing either a currency basket or commodity basket) either replace the dollar, or at least become its equal. I think the crisis accelerated that time line: major government holders of dollars will unlikely see dollar hegemony as (relatively) benign, and US global financial leadership as something they can depend on and healthy for the home team. On the flip side, the dollar as a store of value has clearly benefited dollar holders short-term in the flight to quality.

As to Peer Steinbrueck’s warning – the financial world went multi-polar several years ago. Of course the US will remain one of the central poles of global finance (one of several superpowers), but before the crisis, NY and London were neck and neck for number one. Roger Kubarych makes some good points about US financial markets competitiveness in addressing the Steinbrueck question, but I’m sure he knows that London completely trounced the US in OTC derivatives and FX most of this decade (we trounced London in securitization – oh well) and we’re losing rapid market share in public equity markets (2008 saw 0 of the top 20 IPOs listed in the US). As for English language and ability to work with counterparts, firms and individuals from different cultures, London wins. Sebastian’s cluster argument holds for London too – financial innovation was booming pre-crisis, driven in part because the foreign quant population was unable to get US visas and/or work permits. In any case, we were well on the multi-polar path in finance pre-crisis. Give Singapore or HK a decade and they might be in the running for equal footing with London and NY. Complacency is our worst enemy here and the crisis certainly doesn’t help the US (or London for that matter).

As we (and the world) move on from this financial storm, we’ll find America is in a different place than we began in this century.


  • Posted by aposen

    None of this suggests a real argument why having a financial center or pole is of real importance to the economy’s well-being. It is difficult to even make the case that finance is a strategic industry in the traditional (trade, high-wages, barrier to entry, strategic externalities) sense, and certainly not investment banking and underwriting.

    As with all broad innovations, such as IT, the issue for productivity growth – and thus economic leadership – is how the innovations get picked up and used by the economy at large. So just as the advantage for the US in the 1990s wasn’t the production of hardware or even software in California, but that UPS and Wal-Mart, et al, utilized that IT to transform their businesses.

    Similarly, it doesn’t really matter all that much whether financial innovation and services are produced offshore, so long as the financial discipline and funding for US non-financial companies is well-utilized. As with IT, that is ultimately about willingness of companies to adapt, and shareholders demanding decent returns via corporate governance, where the US still is ahead.

    In any event, I do not worry about the US losing cluster or whatever financial center advantages abruptly. As Roger K articulates elsewhere on this forum, he has nine solid reasons why US markets remain preferable, even if (in my interpretation) US financial firms do not.

  • Posted by Sebastian Mallaby, Director, Center for Geoeconomic Studies

    One can agree with Adam’s point–that the adoption of IT in the US mattered more than the production of IT in the US–without going so far as to say that we are indifferent if Microsoft or Google move their operations to Vancouver. Surely both IT production and IT adoption were valuable to US jobs and growth? By extension, it may be that US corporate governance is more of a strategic advantage than having Goldman in New York. But Goldman creates a lot of good jobs, and the financial sector in aggregate accounted for a large share of output and tax revenues in the New York-Greenwich corridor.

    How much does that matter? Well, it one asks what the source of US economic performance in the 1990s was, surely these creative clusters (Silicon Valley, Hollywood, NJ for pharma, etc) account for quite a bit? It wasn’t necessarily that US regulation was more rational, that corporate taxes were lower, that the US school system was better. It was that the US attracted and enabled a lot of innovative people, first through its world-beating higher education and second through these innovation clusters (with the clusters often connected to the universities).

    I’m not suggesting these clusters are anything like the whole story, but aren’t they a significant part of any explanation for national economic performance in a post-industrial economy?