Standpoint
24.06.09

THE BEAR'S LAIR. The perils of multipolarity.

One of the things that has protected us from a re-run of the Great Depression - until now - has been the unipolarity of the global economy, its domination by the United States. Since 1945, the United States has played a generally benign role in pushing for free trade and free capital movements, because it has not felt very threatened by the other major economic powers. Ideologically, the one major alternative to the United States was mired in socialist autarky, which both prevented it from achieving great economic success and made it essentially absent in the economic councils of the world. Thus we got freer trade than in either the 1930s or the supposedly halcyon days before World War I (when Britain operated on a free trade system unilaterally, while every other major country was protectionist).

This has now changed. The US economy has been declining in strength relative to its competitors since the turn of the millennium, a decline that was masked until 2007 by the explosive growth in financial services and real estate. The huge budget deficits and excessive money creation of the last six months seem likely to leave it debilitated for a considerable period. Now, the four "BRIC" economies (Brazil, Russia, India and China) have met for the first time to coordinate their responses to US economic policy moves.

The BRIC meeting is not in itself a conspiracy against the United States, except on the subject of the dollar, where large dollar holders such as the BRICs and Japan are rightly concerned about the value of their holdings in the age of US President Barack Obama. While Russia is pathologically anti-US, and China regards the US with considerable suspicion, India and Brazil are both basically pro-US, with Brazil's president, Luis Inacio Lula da Silva, likely to find President Obama something of a twin soul.

The BRIC group is also not particularly homogenous. Brazil, having been on everybody's list of growth economies for the last century, is finally beginning to make the most of its potential. Not only are its natural resources huge, but it has shown considerable sophistication in exploiting them. The market position achieved by the iron ore manufacturer Vale, the technical mastery of Petrobras' offshore drilling operations in the Tupi basin and the sound economic sense in the country's ethanol program, at a $70 oil price once again economically very attractive, are all evidence of Brazil's capabilities.

China also is a major growth economy, possibly the world's greatest source of growth in the next 20 years. There's no question its banking system is a mess, and its state-directed investment policies could run into trouble at any time. However, the resilience of the Chinese economy has so far proved sufficient to overcome its difficulties - rather as was the case for Japan for several decades until 1990. As China gets richer, the dangers of its misallocation of resources are likely to increase.

India is a more difficult case. The growth achieved since 1991, after four decades of stagnation, has been remarkably impressive. However, the Indian electorate has persisted in re-electing the political party responsible for the stagnation. There is currently little chance of "reform" in a free-market direction since Prime Minister Manmohan Singh has appointed Pranab Mukhergee as finance minister. Mukhergee is an old Congress Party warhorse who was finance minister in some of the worst days of the "permit raj" in the early 1980s, under the notably anti-reformist Indira Gandhi. Since the budget deficit, India's principal problem throttling off growth in past cycles, is already around 10% of Gross Domestic Product, it seems unlikely that rapid Indian growth will continue and more likely that the economy will revert to its past sluggishness.

Russia, the host of the BRIC meeting, is nothing more than a random beneficiary of clever Goldman Sachs acronym creation. Unlike the other three countries, its population is modest and declining, while the bankruptcy of its resources policies becomes obvious when they are compared to Brazil's. Expropriation of both foreign and domestic resource producers and use of the resources as a political weapon against neighboring countries are not characteristic of sound long-term resources management, to say the least. It's likely that the primitive and kleptocratic Russian economic system will show its defects increasingly in future years, and while oil prices may remain high, they are unlikely to remain high enough to allow Russia to continue rapid economic growth.

In the long term, therefore, the United States should worry about economic competition from a "BIC" group rather than from the full BRIC. Russia will remain a substantial strategic threat, with an aggressive foreign policy and a huge remaining collection of nuclear missiles, but economically, it is likely to remain considerably less significant than Canada, let alone Brazil.

The more interesting question is what the return to multipolarity means for the world economy. By and large, the BRIC countries are not proponents of free trade - even China, free trade's greatest beneficiary, is operating a "Buy China" plan for expenditures from its stimulus program. While all four are theoretically believers in free markets, in practice in all four countries, the government has a pretty heavy thumb on the scales. Thus even if the US wished to push a former president Ronald Reaganite agenda of free trade and free markets, it would not get very far.

This situation has occurred before; it is analogous to that of the late 19th century, in which Britain unilaterally reduced its tariffs almost to zero, and then watched its trading partners Germany, France and the United States build up formidable industrial capabilities behind a high tariff barrier. Unlike Adolf Hitler, Kaiser Wilhelm II was no monster, but he was an ardent nationalist who held the free-trade theories of economists in pretty low repute. Hence like the Kaiser's, the BRIC policy will be one of nationalism rather than globalization, of government-directed protectionism rather than free-market free trade.

Probably the first area of conflict between the surging BRICs and the United States will be that of currency. Two of the four BRIC nations have foreign reserves that are very large in the context of their own economies; currently the great majority of those reserves are invested in dollar securities. Given the Federal Reserve's expansive monetary policies and the Obama administration's insouciance about budget deficits, the BRIC asset holders are naturally concerned about the vulnerability of their holdings to dollar declines and interest rate rises.

The BRIC nations' problem is that they have few alternatives available. The euro's monetary policy is more sensible than the dollar's, and the European Union's economies have (with one or two exceptions) been less over-expansive than the US, so their budget deficits are under better control. However, the currency is considerably less liquid than the dollar, and the BRIC countries mostly believe Europe to be a slow-growth area with little long-term future, destined to be uncompetitive with their own industries (this is in fact wrong; Germany runs a large balance of payments surplus, and is likely to continue doing so - one of the BRICs' problems is a tendency to believe their own propaganda). The BRICs also have little time for Japan, while Britain has the same problems as the US, mostly in a more acute form.

China is attempting to internationalize the renminbi, making it a reserve currency and trading currency for its neighbors and selected allies. That is a perfectly laudable ambition, except that China does not allow its own citizens to take assets out of the country, so the renminbi is of necessity a one-way market. The free-market solution to this would be to remove exchange controls from the Chinese people; my guess is that China will choose the protectionist route, and force its trading partners to pay increasingly in renminbi, thus of necessity increasing the volume of renminbi held abroad.

The final solution to the BRICs' currency problem is gold. Russia and China might welcome a move towards a gold exchange system. China has immense foreign currency reserves, which if invested in gold would be protected against inflation. Russia is one of the world's largest gold producers, with output of 163 tonnes in 2007 and reserves totaling 85 years of production. Brazil is also a substantial gold producer; as with other minerals much of its output is controlled by international companies. The odd country out is India, with foreign exchange reserves that are modest in comparison to the size of its economy. Nevertheless, while it would not be in the interests of the United States or the EU to move towards a gold standard, it might very well be in the interests of three of the four BRICs.

A multipolar world will thus be more protectionist and more nationalist than the US-dominated global economy we have grown used to. On the plus side, it might move towards the establishment of a global currency system that provided a true store of value, without the incessant inflation that has bedeviled the dollar's reign. On the minus side, the move towards protectionism will decrease global output below what might otherwise be available, although it seems unlikely that even the BRICs would wish to move to the full protectionism of the 1930s.

Finally, a cautionary note. A multipolar world economy by definition is more liable to conflict than a unipolar one; there is more to fight about and no hegemon to keep the peace. 1914 did not happen by accident.

By Martin Hutchinson


Post-Crisis World Institute