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.

The domestic effects of a dollar crash would be felt most sharply by the growing numbers of Americans with large mortgage debts who would suddenly face a rise in interest rates. The growth in the share of variable-rate mortgages in the volume of total household debt is seen by some as a sign that the U.S. mortgage market is growing more sophisticated. But it also increases the sensitivity of many American families to rises in the rates. The federal government has a pretty large variable-rate debt, too, given the very short maturities of a large proportion of federal bonds and notes. That fact means that higher rates could quickly affect the deficit itself, creating a dangerous feedback loop. And, of course, higher rates would be likely to lower growth and hence reduce tax revenues. In short, today's international fiat-money system is significantly, and dangerously, crisis-prone.

Another cause for concern is the fragility of China's financial system. This Asian miracle is unlikely to avoid the kind of crisis that marked the Asian miracles of the past. To get a sense of the dangers, consider China's Soviet-style domestic banking system and its puny domestic stock market: how can such rapid growth in manufacturing possibly be sustained with such inadequate financial institutions?

Pre-1914 globalization was remarkably susceptible to the international transmission of crises--what economists call "contagion." So is globalization nowadays. As Andrew Large of the Bank of England pointed out last November, the "search for yield" in an environment of low interest rates is encouraging investors, banks, and hedge funds to converge on similar trading strategies, raising "the prospect of one-way markets developing and market liquidity evaporating in response to a shock."

GHOSTS FROM THE PAST

As the economic parallels with 1914 suggest, today's globalization shows at least some signs of reversibility. The risks increase when one considers the present political situation, which has the same five flaws as the pre-1914 international order: imperial overstretch, great-power rivalry, an unstable alliance system, rogue regimes sponsoring terror, and the rise of a revolutionary terrorist organization hostile to capitalism.

The United States--an empire in all but name--is manifestly overstretched. Not only is its current account deficit large and growing larger, but the fiscal deficit that lurks behind it also is set to surge as the baby boomers retire and start to claim Social Security and Medicare benefits. The Congressional Budget Office (cbo) projects that over the next four decades, Social Security, Medicaid, and Medicare spending will rise to consume at least an additional 12 percent of GDP per year. The cbo also estimates that the transition costs of President George W. Bush's planned Social Security reform, if enacted, could create a budget shortfall of up to two percent of GDP a year for ten years. Add that to the fiscal consequences of making the president's first-term tax cuts permanent, and it becomes hard to imagine how the country will manage to stem the rising tide of red ink.

The U.S. empire also suffers from a personnel deficit: 500,000 troops is the maximum number that Washington can deploy overseas, and this number is simply not sufficient to win all the small wars the United States currently has (or might have) to wage. Of the 137,000 American troops currently in Iraq, 43 percent are drawn from the reserves or the National Guard. Even just to maintain the U.S. presence in Iraq, the Army is extending tours of duty and retaining personnel due to be discharged. Such measures seem certain to hurt re-enlistment rates.

Above all, the U.S. empire suffers from an attention deficit. Iraq is not a very big war. As one Marine told his parents in a letter home,

compared to the wars of the past, this is nothing. We're not standing on line in the open--facing German machine guns like the Marines at Belleau Wood or trying to wade ashore in chest-deep water at Tarawa. We're not facing hordes of screaming men at the frozen Chosun Reservoir in Korea or the clever ambushes of Vietcong. We deal with potshots and I.E.D.'s [improvised explosive devices].