Sinking Globalization

Niall Ferguson

From Foreign Affairs, March/April 2005

Summary:  Could globalization collapse? It may seem unlikely today. Yet despite many warnings, people were shocked the last time globalization crumbled, with the onslaught of World War I. Like today, that period was marked by imperial overstretch, great-power rivalry, unstable alliances, rogue regimes, and terrorist organizations. And the world is no better prepared for calamity now.

Niall Ferguson is Professor of History at Harvard University, a Senior Fellow at the Hoover Institution, Stanford University, and a Senior Research Fellow of Jesus College, University of Oxford. Copyright (c)2005 by Niall Ferguson.

There are obvious economic parallels between the first age of globalization and the current one. Today, as in the period before 1914, protectionism periodically challenges the free-trade orthodoxy. By the standards of the pre-1914 United Kingdom, in fact, the major economies are already shamelessly protectionist when it comes to agriculture. Then, the United Kingdom imposed no tariffs on imported agricultural goods, whereas now the United States, the European Union, and Japan all use tariffs and subsidies to protect their farmers from foreign competition.

Today, no one can be sure how stable the international monetary system is, but one thing is certain: it is no more stable than the system that preceded World War I. Although gold is no longer the basis of the monetary system, there are pegged exchange rates, just as there were in 1914. In Europe, there is a monetary union--essentially a deutsche mark zone. In eastern Asia, there is a dollar standard. Both systems, however, are based on fiat currencies. Unlike before 1914, the core central banks in New York and Frankfurt determine the volume of currency produced, and they do so on the basis of an opaque mixture of rules and discretion.

Today, technological innovation shows no sign of slackening. From nanocomputers the size of a pinhead to scramjets that can cross the Atlantic in an hour, there seems no limit to human ingenuity, given sufficient funding of research and development. That is the good news. The bad news is that now technology also helps the enemies of globalization. Before 1914, terrorists had to pursue their bloody trade with Browning revolvers and primitive bombs. These days, an entire city could be obliterated with a single nuclear device.

Today, as before 1914, the U.S. economy is the world's biggest, but it is now much more important as a market for the rest of the world than it was then. Although the United States may enjoy great influence as the "consumer of first resort," this role depends on the willingness of foreigners to fund a widening current account deficit. A rising proportion of Americans may consider themselves to have been "saved" in the Evangelical sense, but they are less good at saving in the economic sense. The personal savings rate among Americans stood at just 0.2 percent of disposable personal income in September 2004, compared with 7.7 percent less than 15 years ago. Whether to finance domestic investment (in the late 1990s) or government borrowing (after 2000), the United States has come to rely increasingly on foreign lending. As the current account deficit has widened (it is now approaching 6 percent of GDP), U.S. net overseas liabilities have risen steeply to around 25 percent of GDP. Half of the publicly held federal debt is now in foreign hands; at the end of August 2004, the combined U.S. Treasury holdings of China, Hong Kong, Japan, Singapore, South Korea, and Taiwan were $1.1 trillion, up by 22 percent from the end of 2003. A large proportion of this increase is a result of immense purchases by eastern Asian monetary authorities, designed to prevent their currencies from appreciating relative to the dollar.

This deficit is the biggest difference between globalization past and globalization present. A hundred years ago, the global hegemon--the United Kingdom--was a net exporter of capital, channeling a high proportion of its savings overseas to finance the construction of infrastructure such as railways and ports in the Americas, Asia, Australasia, and Africa. Today, its successor as an Anglophone empire plays the diametrically opposite role--as the world's debtor rather than the world's creditor, absorbing around three-quarters of the rest of the world's surplus savings.

Does this departure matter? Some claim it does not--that it just reflects the rest of the world's desire to have a piece of the U.S. economic action, whether as owners of low-risk securities or sellers of underpriced exports. This is how Harvard economist Richard Cooper sees it. Assuming that the U.S. economy has a trend rate of growth of 5 percent a year, he argues that a sustained current account deficit of $500 billion per year would translate into external liabilities of 46 percent of GDP after 15 years, but that then U.S. foreign debt would "decline indefinitely."

Well, maybe. But what if those assumptions are wrong? According to the hsbc Group, the current account deficit could reach 8 percent of GDP by the end of the decade. That could push the United States' net external liabilities as high as 90 percent of GDP. When the United Kingdom accumulated net foreign debts of less than half this percentage, it was fighting World War II. In the war's aftermath, the resulting "sterling balances" owned by the rest of the world were one of the reasons the pound declined and lost its reserve currency status.

A sharp depreciation of the dollar relative to Asian currencies might not worry the majority of Americans, whose liabilities are all dollar-denominated. But its effect on Asia would be profound. Asian holders of dollar assets would suffer heavy capital losses in terms of their own currencies, and Asian exporters would lose some of their competitive advantage in the U.S. market. According to Michael Mussa of the Institute for International Economics, lowering the U.S. deficit to 2 percent of GDP over the next few years would require a further 20 percent decline in the dollar. The economists Maurice Obstfeld and Kenneth Rogoff estimate that the fall could be as much as 40 percent. And the University of California at Berkeley's Brad de Long has pointed out that,

[i]f the private market--which knows that with high probability the dollar is going down someday--decides that that someday has come and that the dollar is going down now, then all the Asian central banks in the world cannot stop it [emphasis in original].

That day may be fast approaching. In the words of Federal Reserve Board Chairman Alan Greenspan last November, "the desire of investors to add dollar claims to their portfolios" must have a limit; a "continued financing even of today's current account deficits ... doubtless will, at some future point, increase shares of dollar claims in investor portfolios to levels that imply an unacceptable amount of concentration risk."