The SECOND Failure of Globalization?

• Fragmentation
• Explaining Failures
• Global Financial Crisis: The Second Test
• Beyond the GFC

Attachment: September 11: The First Test

Summary

As a result of failures to deal with risks to international stability the basis of global order has been at risk - and political and economic disorder like that that followed the collapse of 19th century globalization is not impossible.

Democratic capitalism and communism were rival Western / European styles of political economy in the Cold War. This ended in 1989 when the communist Soviet Union collapsed in the face of the greater economic strength of the US and its allies. A new global order, based on democratic capitalism, seemed likely to emerge.

However there are many competing understandings of the nature of such an order. At the same time the UN, the main institution that could have provided the political framework for a unified world, has been proving ineffectual, while the economic institutions established at the Breton Woods Conference primarily reflected US assumptions.  Both have been subjected to criticism - though there appears to have been inadequate fundamental work on the causes of their problems to have allowed practical alternatives to be devised.

Moreover there are uncorrected defects in dominant democratic capitalist practices, theories and institutions. In recent decades these defects and a universal failure to consider how they interact in practice with non-Western cultural assumptions have been contributing to economic and political distress in rapidly developing East Asia, and to even worst problems in states on the global margins (eg failed, repressive or rogue states, leading in some cases to terrorism as an extremist reaction to political exclusion).

One symptom of this situation, was the launching of a terrorist attack apparently by Islamist extremists against core Western institutions in the US in September 2001. World leaders seemed unable to agree about how to manage the urgent security risk of 'terrorists with weapons of mass-destruction' and what model of political-economy could ease the political and economic malfunctions that give rise to such problems. The global response to this (which featured increasingly unilateral and militaristic action by the US) achieved very little (see Attachment on September 11: the First test).

Another major challenge to the global order arose in October 2008 when a credit crisis, which had first been recognised in the US in mid 2007, threatened to turn into a total failure of the global financial system.

Rescue operations were mounted by governments worldwide and calls emerged for the creation of a new world financial order. However success in creating this is anything but assured - for essentially the same reasons that the response to 911 attacks proved unsatisfactory.

John Craig
March 2003 - and updated from October 2003 and again from October 2008

Fragmentation of the Global Order

Rather than creating a fair and workable global political and economic order based on liberal democratic capitalism, political disorder and economic collapse are a feasible alternative if political leaders do not cope adequately with diverse and related security and economic challenges. Those most likely to suffer would (as always) be the world's poorest [1].

International trade and investment have become more significant to the world economy over the past 30 years [1]. It has been credibly suggested that economic globalization and accelerated rates of economic growth were partly attributable to unilateral US action in 1971 to end the Gold Standard (part of the 1944 Bretton Woods agreement which had required convertibility of currencies into gold). The subsequent emergence a (US) Dollar Standard overcame previous constraints on the creation of credit [1], and complemented the effect of improved transport and communication in 'globalizing' economic activity. Not only was the $US the world's reserve currency, but US monetary policy played an informal, unpublicised but significant role in counter-cyclical management of the global business cycle (eg the US Federal Reserve maintained extremely loose monetary policies at times citing the need to counter the risk of 'deflation' - though this was a problem in Japan not in the US. Thus it is reasonable to conclude that Japan (and perhaps other countries) had behind the scenes influence on US monetary policy).

Moreover since communism was generally discredited as a system of political economy when the Cold War ended in 1989, large additional segments of humanity have been drawn into market economies and democratic capitalism in its various forms has been regarded as the global 'standard' - and likely to become the basis of a world order. 

However globalization has occurred before. At the close of the 19th century, in a global environment dominated by the British Empire international trade and investment were even more relatively significant in the world economy than they are now. Yet this collapsed in the frictions with Germany that led to World War I [1] - frictions that presumably arose from cultural differences in assumptions about the nature and role of power. 

Different styles: German (Teutonic) societies appear to favour general community reliance on the rationality of knowledgeable and experienced 'authorities' whereas Anglo-American (Saxonic) societies emphasize the rational initiative of individuals. Other characteristic styles might include arational / intuitive group consensus in Japanese society, and the rationalized social consensus favoured in French (Gaelic) society (eg see Galtung J. 'Structure, culture and intellectual style: An essay comparing saxonic, teutonic, galic and nipponic approaches', Social Science Information, V 20, No6, 1981).

Needless to say each of these preferred decision styles translates into preferences for different systems of political economy. For example:

• much of the traditional friction (and centuries of conflicts) between France and England may have emerged from a lack of mutual understanding flowing from different ways of thinking. Frenchmen whose group rationality focused on 'the glory of France' as a whole - saw England, with its preference for individual rationality, as a 'nation of shopkeepers';
• the first World War (whose origins no one seems able to explain) was the result of an intense contest for economic control between Germany and the UK. Again the core problem may have been the obscure difference between Anglo and Teutonic assumptions about the ground rules that should apply to a global order (whose origin in that case was likely to be in differences in assumptions about the influence of individuals versus experts / authorities).

Furthermore it may have been the tensions in the 1920s and 1930s associated with attempting to modernize to adapt to the globalization of Western-style society which led Japan to try to achieve independence through aggression in Asia prior to World War II [1].

Moreover, while democratic capitalist models are widespread, they come in quite distinctly different styles [1].

The major styles are:

• the Anglo-American varieties under British Law. The latter makes individuals equal to the state before the law, and expects that states will represent sectional interests. Economic outcomes are highly dependent on the initiative of individuals - which is advantageous because the power of rationality can be used in systems that are simple enough for it to be effective (see Competing Civilizations). This system also facilitates 'breakthrough' political initiatives;
• those in some EU countries that are based in Roman Law - a system where the state is legally superior to individuals, and is expected to be concerned with the culture and functioning of society as a whole and not to reflect partisan interests. States have a significant influence on the framework for economic activities, which tends to ensure that the latter are more socially equitable, but less dynamic;

In the post Cold War environment differences due to such un-stated cultural parameters have become increasingly apparent - and contributed to a breakdown of multilateral institutions.

Europe and the US have been seen to have radically different perspectives on the nature and reliability of global institutions [1]. Similarly differences are perceived in basic values and beliefs in terms of: the value of institutional or military solutions to conflicts; focus on past or future; and the role of religion [1].

The European Union has been developed as a model for building economic and political collaboration amongst various nations based on a preference for collaboration and consensus. While national membership is expanding [1, 2] and an effective economic union has been created, the EU is not untroubled. For example:

• institutional problems exist [1, 2, 3];
• economies tend to be stagnant [1, 2, 3];
• there is difficulty maintaining social [1] and political [1] cohesion. In particular where the state is expected to reflect to culture of society as a whole, the failure in assimilate large Muslim populations is a clear source of tension [1];
• popular support of the EU is weaker than support from elites [1];

And East Asia, which now accounts for about half the world economy, incorporates elements of (neo-Confucian?) models that prefer government by elite bureaucracy (rather than by democracy and a rule of law) and which tend to favour mercantilist / communitarian economic goals, rather than being driven by the return on investors' capital available from meeting consumer demands.

East Asian models tend to be based on epistemologies (ie the frameworks within which people think) that are profoundly different to the rationalism that Western societies inherited from classical Greece - see outline in Competing Civilizations. These differences also appear to have been a significant factor in the Asian financial crisis.

Moreover structural incompatibilities between the mercantilist / communitarian economic goals of major East Asian economic and financial systems and those of the US / Western dominated global economic / financial systems could make global growth unsustainable.

Proposals have been made for the creation of an Asian Monetary Fund to operate on 'Asian values' in competition with the IMF which has operated on (an increasingly US dominated version of) Western traditions. 

Elsewhere the majority of the world's people live in states that have ineffective (or even despotic) regimes and tend to be economically disadvantaged to varying degrees. A substantial minority of this (still third) world involves states dominated by Islamic traditions - from whom also proposals have emerged for the creation of a new monetary system and economic union [1].

Furthermore there is no effective institutional basis for globalization.

Current global institutions were created at the end of the second world war, and involve primarily the United Nations (UN) and economic organizations established as a result of the 1944 Breton Woods agreement (WTO, IMF and World Bank).

However the core institution, the United Nations, is too often of little practical value being apparently:

• inadequately staffed;
• under-funded;
• pursuing ineffectual 'political' formalities eg the Kyoto protocol that could never produce any real environmental gains [1];
• irresponsibly influenced at times by tin-pot despots and single-issue NGOs) [1, 2] and;
•  serviced by 'expert' bodies that can be democratically illegitimate [1].  

Of particular significance is that the UN could suffer the League of Nations' fate due to its inability to enforce its resolutions related to security breaches (eg by despotic regimes).

At the same time, global economic institutions have been heavily influenced by US interests to pursue its preferred liberal democratic capitalist model, and have attracted as much criticism as the UN system (eg see Bretton Woods project).   Worldwide reactions against global economic institutions (on environmental and social grounds) have also arisen, and been conspicuous for the fact that those involved seem to be only interested in 'protest' and have no practical alternatives to suggest.

In September 2003, the WTO's efforts to arrange a new round of multilateral trade liberalization was derailed by a dispute between developed and developing nations about whether improved access to the latter's markets is appropriate [1, 2, 3]. This breakdown in global multilateral trade arrangements may be as significant as the inability of the UN Security Council to resolve concerns about terrorists with WMD that led to unilateral US action in Iraq. It must impede trade, and thus reduce growth.

Furthermore it seemed likely that global economic growth may prove unsustainable because of the financial imbalances created by dependence of recent growth on US demand, and the structural incompatibilities between various economic models which may make it impossible to overcome those imbalances.

Looking for Causes of Economic and Political Failures

While many societies benefited from the global order that emerged after the Cold War, that era has been anything but problem free. For example:

• political and economic failures escalated in the 1990s in many marginal states (especially in Africa, the Middle East and Latin America) perhaps because: (a) outside involvement / support declined following the end of the Cold War; and (b) increasingly intense global economic competition raised the standards required for economic success;
• political failures in individual states have also compounded the difficulties facing the UN - as inept or despotic regimes have gained an increasingly influential 'legitimacy' in its councils;
• financial and economic crises have emerged every few years - of which that affecting East Asia in 1997 was the most significant until 2008;
• concerns have emerged about environmental sustainability.

In the context of the 911 attack in America Competing Civilizations suggested:

• several difficulties that face non-Western societies that may contribute to economic and political failures in marginal states, namely:
  • the effect of historical events such as: European colonization which left an unsound basis for future progress in some states; and the Cold War;
  • un-evaluated side-effects of democratic capitalist systems of political economy and defects in the economic theories promoted by global economic institutions;
  • the unintended adverse consequences of foreign aid; 
  • the lack of attention to the practical implication of cultural assumptions that seem to be a critical determinant of a people's ability to be materially successful (eg the role which authorities play in defining and enforcing the moral basis for interpersonal relationships in societies which lack embedded 'put others first' ethical ideals derived from Christianity seems particularly significant given the important of individual liberty to Western economic and political models);
• an hypothesis about how a 'clash' of civilizations might be defused which referred to:
  • expansion of democratic models;
  • ethical renewal, including a more serious metaphysics;
  • reform of the global order on a basis under which all may reasonably hope to succeed;
  • more effective mechanisms for development in disadvantaged regions;
  • specific attention to problems of cross-cultural communication; and
  • reviewing the economic role of money.

Economic and political failures have been associated with widespread misery, and have also contributed to the risk of terrorism. The latter seems to be an reaction to real or perceived social, economic or political concerns by extremists who feel otherwise powerless. It also has the potential to transmit failure to other states [1]. 

Those who had been economically and politically successful (especially the United States which was geared for Cold War conflicts) were for a long time not directly affected by the economic difficulties and political failures (and political extremism) - so they did not become serious about examining the political and economic development issues.

The attack by Islamist extremists in America in 2001 provided the opportunity to address those broader questions, but in the absence of global agreement about how to address this the US pursued almost unilateral actions with a militarist emphasis that, though enormously costly, did not materially improve the global situation (see September 11: The First Test).

However it is likely that the 2008 global financial crisis will force a different approach.

In the context of the 911 attack, Competing Civilizations had also suggested that defusing a potential 'clash of civilizations' required reviewing the role which money plays because, though though there are advantages in its use as a means of exchange, store of value and measure of economic success:

• the self-reinforcing effect which money flows can have on an economy's performance can lead to bubbles and busts; and
• some societies have cultural difficulties in achieving economic success if this is assessed in terms of a strong balance sheet - a problem to which Western observers tend to be oblivious even though it seemed to be the basis of a 'clash of civilizations' related to differences in financial systems' which was more serious than that with Islamist extremists.

These issues have become critical in 2008 - though the latter continues to be put in the 'too hard' basket.

• Origins
• Causes
• Complications
• Seeking a GFC Solution

Global Financial Crisis: The Second Test of Globalization?

Origins

A global financial crisis (GFC) had become well recognised in late 2008 when:

• governments (especially but not only in the US, UK and Europe) found it necessary to provide financial support to prevent the failure of major banks;
• share markets crashed; and
• serious disruption of the global 'real' economy also seemed probable.

Financial Market Instability: A Many Sided Story presented an account of the emergence of this crisis as a result of financial arrangements that had become foundational to global economic growth and development. The crisis was revealed initially (in mid 2007) when, following falls in US housing prices in 2006, losses on US 'sub-prime' mortgages created large unexpected and non-transparent losses for banks. This then resulted in a 'credit crunch' (ie: it disrupted banks' ability to lend to one another; and made credit less available and more costly for their customers).

The problem quickly spread globally and subsequently escalated, even though traditional remedies were vigorously applied (ie the US Federal Reserve  responded with lower interest rates and made credit available to distressed institutions, while the US Government provided a fiscal stimulus to boost economic activity). 

Causes

There appear to be many factor whose interactions contributed to the GFC including:  prior asset inflation; declining US housing prices; an oil price spike; loss of effective regulation due to globalization; inadequate aggregate global demand as a by-product of 2 decades of globalisation; failure of post-war international financial regime to recognise unsustainable macroeconomic consequences of Asian economic models, and the need which other emerging economies had to export-led development to guard against financial crises; emergence of an unregulated 'shadow' banking system in US;  high levels of household debts which caused consumer spending to fall as financial losses emerged;  innovations in financing and monetary policy; statisticians' adjustments to economic data which may give a misleading impression; decisions by regulators and businesses; government social policies; complex financing arrangements that rendered consequences incomprehensible; possible intrinsic disequilibrium in financial markets that was not perceived by deregulators; community irresponsibility; a lack of top-level US government economic expertise because of the 'war on terror' focus; a 'savings glut' in East Asia that was vital to economic models adopted in the region; Japan's ambitions and 'carry trades'; the way Lehman Brothers failed; very high levels of corporate debt in Europe; risky investments in emerging market economies; and policy actions by governments in reacting to the emerging crisis.

Complications

While the GFC might seem like merely a matter of fixing the financial system (a massive challenge in itself), it is in fact far more difficult because:

• not enough has been done to enable credit markets to function effectively, and it may be impossible to to do enough. For example, in the US about 50% of credit had come to be provided by non-bank institutions selling structured financial assets through financial markets. While banks' capital base (which determines their capacity to lend) was eroded by their exposure to losses from such dealings, simply rescuing banks (which many governments have been attempting) can't allow credit markets to function as they did before the GFC. Pre-GFC levels of credit availability can't be sustained without: (a) development of safe methods of securitized funding; and / or (b) significantly increasing (not just restoring) the capital base of conventional banks to allow a large expansion of balance-sheet-based lending; and / or (c) radical innovations in financing practices. There are many indicators that not enough has been done to prevent a continuing shortfall in credit from crippling global economic activity (eg even in terms of writing off banks bad debts, not enough has been done). It can also be noted that:
  • demand for credit is likely to decline in the face of severe recession. Households / firms may avoid uses which the credit crunch showed to be risky and seek to reduce their debts. This would moderate the perceived shortage of credit, but not reduce the economic effect of reduced provision of credit. It was suggested that there was (in February 2009) a global contraction in non-governmental borrowing of about $5tr [1];
  • reserve banks (especially the US Federal Reserve) have gone beyond reducing interest rates in boosting liquidity (eg through unprecedented 'quantitative' easing - by buying assets from banks or directly funding roll-over of corporate debts that banks are unable to fund). This should make credit more widely available, but whether this can be sufficient or whether this credit could be productively used is uncertain.  There may also be some risk, noting changes in household behaviour, of mainly facilitating speculative investments (which could create a new boom bust cycle);
  • US Fed chairman has argued that [1]:
    • credit markets are more dysfunctional than in the 1930s and Japan in the 1990s;
    • fiscal stimulus plans will achieve little unless financial systems are restored - which requires further efforts to socialize banks' losses;
    • concerns expressed about printing money (which risks Weimar Republic style hyperinflation) are valid but banks are not lending it merely leaving it on deposit with Fed;
    • the problems in September 2008 arose when a major money market reserve fund (which held $785m in Lehman commercial paper) became valueless and caused a run on all such funds ;
  • it has been suggested that the US did not fully remove bad debt problems in its banking system (because doing so would have been too economically damaging) and thus its future growth will be seriously impeded; [Comment: the debate about 'mark to market' accounting practices can be noted in this respect].
  • it has been argued that there are fundamental defects in mainstream economic assumptions about the ability of reserve banks to control money supply - ie that rather than credit creation by banks reflecting a multiplier of the base money created by authorities, than credit creation by financial systems is the primary driver. If this is so, then reserve banks are wasting their time trying to halt a contraction in credit, because this will be driven by a desire to deleverage resulting from a credit bubble. Banks will simply not use any liquidity provided to them under those circumstances [1]
  • Western banks have become so dependent on government guarantees (which supports short term borrowings) that it is hard to see them now operating independently. Lacking an adequate capital base they are are unable to to create credit on the foundation of deposits [1]
• radical policy actions that governments and reserve banks are taking in an attempt to prevent severe recessions could themselves trigger further crises if they are unsuccessful (see above) - or perhaps even if they are party successful. There is some plausibility in the narrative that dominated in early 2009 - ie that a severe global recession in 2009 would be followed by slow recovery in 2010. But there is also a risk that the distortion of fiscal, monetary and economic affairs in stimulating recovery will cause 'the wheels to fall off'. For example:
  • the virtual nationalization of many banks (especially in the US) that has been needed to prevent financial contagion must reduce their ability to support sustainable economic recovery, while government efforts to rescue other major companies to prevent the financial crisis spreading is likely to result in important economic sectors dominated by the 'living dead';
  • the strength that the $US has exhibited in the face of crisis (which has allowed its government to finance rescue operations) reflects a flight to safety, and when / if this is reversed by increased confidence in other investment options, the US (and world) economy could go into deeper recession [1]. It can be noted that:
    • a bond market crash starting in 1931 (after a post-1929 flight to safety) was apparently a significant factor in ongoing financial system problems during the Great Depression;
    • as bonds crashed the benchmark return on 'safe' investments was set to a higher level - thus putting downward pressure on other asset values;
    • there was a similar flight to safety of government bonds after 2007, and yields collapsed;
    • while the factors that caused the 1931 bond market crash were not present in 2009, there were different risks, ie (a) governments (especially the US) incurred huge deficits in an effort to recapitalize banks and stimulate growth; (b) funding its deficit had become difficult (ie by May 2009 it seemed that only the Federal Reserve bought US Treasury bonds - printing money to do so; forcing up yields [1]; and raising concerns (eg by China [1]) about durability of $US);
    • the capacity of the global financial system to provide cash and credit is much less than it was 2007 ; and
    • when investment prospects in equities seem attractive (ie when real economic recovery seems likely) the flight to quality would no longer be attractive - and 'everyone' could be expected to to dump low-yielding government bonds.
  • the US is facing very severe government budgetary problems because of the cost of stimulus measures and pending  retirement of the baby boomers will increase entitlements spending. Negotiating the fiscal stimulus in an environment in which tax rises and cuts to entitlements appear necessary will be difficult [1];
  • government debts in largest 10 rich countries will rise from 78% of GDP to 110% - and this will constrain spending but be difficult to reduce because it arises at just the time that pension and health care costs of an aging population will rise. This represents perhaps the greatest economic mess in history [1]
  • the US will be operating in an environment in which it is much harder to obtain the funds it needs for economic stimulus, because (a) much of this comes from offshore; (b) the role of states in economic affairs has increased; and (c) other governments will face domestic demand for funds and give higher priority to this [1];

  • Keynesian policies (ie a government economic stimulus) have been suggested to be ineffective. In the 1980s, when confidence in UK government finances had collapsed, the Thatcher government restored the situation by a sound money policy, cutting government spending, cutting taxes and allowing failing industries to fail. Throwing government money will simply increase debts while not reviving the economy [1]  ;

  • 'quantitative easing' by central banks and fiscal stimulus measures may be driving a re-run of the speculation that led to a market bust in 2007. Sharemarket rallies in 2009 appear unrelated to economic fundamentals - and there is fear that this could be driven by excess liquidity created by official responses to the crisis [1] ;

  • measures used to protect banks may have left US economy like Japan's in the 1990. Banks were 'rescued' (because failure to do so would have led to economic collapse) but were left with large bad debts (because government could not afford to absorb all toxic assets). Because the system was not really cleaned up there is no solid base for future growth (ie funure income will tend to be diverted to repayment of old debts), so a long period of economic stagnation is likely [1]

  • the US Fed has been seen to be pursuing a policy of promoting asset inflation with its easy money policies that are creating a dollar carry trade flooding money into everything [1]

  • government made huge efforts to save financial institutions (which they had to do) and this was ultimately successful, but (a) this was in some respects at the expense of the rest of economy and (b) the 'saved' institutions are not appropriate to future needs. Those institutions are now resisting regulatory reform; can't be expected to manage risk wisely (as they are too big to fail). There is a need for a credible threat of bankruptcy [1];

  • it takes a great deal of time to effectively spend large amounts of money. Europe's experience is that the huge short-term stimulus efforts by countries such as US and China is mainly likely to generate waste and corruption, and perhaps make the situation worse [1]

  • regulators plans to require an increase in bank capital risk creating another credit crunch [1]

  • efforts by governments and central banks to stimulate recovery seem likely to create nasty side effects (ie asset bubbles in equity markets across Asia, and property markets in China, Singapore and Vietnam) [1]

  • government attempts to reform US banking system have the effect of restricting banks' ability to create credit - and this has the potential to trigger a market crash [1]

• emergency official efforts to cope with the crisis appear to be trying to re-establish economic conditions like those that preceded the GFC (ie by encouraging a resumption of high levels of household spending and borrowing in countries such as US / UK / Australia - which created a 'virtuous' feedback between (a) an asset bubble built on the foundation of unrealistically cheap credit and (b) global financial imbalances). That relationship was intrinsically unstable as the GFC has demonstrated, and will have to be broken eventually and require further economic change. In particular:
  • high levels of household spending and borrowing in countries which have had large current account deficits won't be sustainable. Moreover,  the US in particular needs to reinvent its economy and rebuild infrastructure which has tended to be neglected while reliance on financial engineering had been been an 'easy' way to generate profits [1];
  • the ending of extreme global financial imbalances will have significant repercussions in the long term (as noted below). Also, in the short term;
• increasing debt has apparently been a major component of demand in recent decades (and has been essential to recovery from the previous two recessions), but that this is now unlikely to continue. Rather a process of ongoing debt reduction (de-leveraging) may occur, and this has already been seen in both US and Australia. De-leveraging, from debt levels much lower than now exist, was a feature of both the 1890s and 1930s depressions. This effect (which would lead to future demand well below past income for many years) could swamp the stimulatory efforts of governments and reserve banks (and lead to deflationary depression) [1]. [Note: this doesn't / can't prove what is going to happen in the immediate future - because, if confidence can be restored, the asset / debt bubble can continue to inflate for another few years. However it does suggest that: (a) if disaster is avoided this time that another crisis will erupt in a few years an even bigger potential de-leveraging risk; and (b) there is thus a need to change the way in which asset values are determined so that ever-increasing debt is not a viable basis for investment strategies].  
• 'East Asian' export-driven economic models (which do not yet incorporate well developed financial systems) are likely to impose an inbuilt deflationary demand deficit on the global economy - which may make recovery from the economic impact of the GFC very slow because necessary de-leveraging in other economies, which had previously compensated for those demand deficits, must overwhelm efforts by authorities to stimulate growth in the US, Europe (etc) if the conditions that created the GFC are not to be recreated. It has been suggested that:
  • Japan's financial system is structured so that available capital is focussed on increasing production capacity, so efforts to 'stimulate' its economy have little effect on demand and increase its reliance on demand elsewhere [1];
  • China is constrained from relying on consumer spending by its huge imbalance of wealth. 0.4% of the population have been suggested to control 70% of the wealth, so 99% of the people are poor and can't afford to consume [1] [Comment: This wealth imbalance probably reflects China's focus on focusing all available resources on production capacity, which in China's case is controlled by elites with good connections to government];
  • most of China's economic stimulus package has been devoted to increasing its production capacity and hence their export over-capacity [1]
• the GFC was followed by a dramatic collapse in global trade - though the reasons for this are unclear. Though a shortage of credit for trade did emerge, other possible factors include  declining demand or increasing protectionism [1];
• resolving the GFC requires that countries with large foreign exchange reserves (eg Germany and China) must facilitate adjustment in the global balance of payments - so that debtor countries can export their way out of the crisis. The alternative (which China has asked the US to guarantee will not happen) is that the value of their foreign exchange holdings must be lost [1];
• signs emerged of a potential disruption of international trade because of an apparent inability to resolve concerns about financial imbalances (ie the accumulation of large foreign exchange reserves in some countries and huge debts in others) [1, 2]
• major Western economies (eg US) may be on the point of a demographic transition that will see a substantial decline in the household spending which has been a major source of global final demand.
  • Background: The huge baby boomers cohort is passing from their peak spending years into retirement. A US analyst (Harry Dent) developed an interesting theory about the correlation between the size of the cohort in their peak spending years and general conditions in the US economy (as revealed by stock market trends). That correlation went back to about 1900 (ie it 'predicted' the Great Depression) and in the early 1990s it 'predicted' a massive boom until 2010 - followed by a sustained economic slump. Clearly demographic factors are not the sole determinant of economic outcomes, but their implications should not be ignored either.
• Europe's rapidly aging population contains the seeds of a new financial crisis, because pension arrangements are very generous and heavily indebted governments will soon find it impossible to maintain these [1]
• political risks are likely to constrain financial / economic solutions. For example:
  • geopolitical risks are increasing in 2009 everywhere except Iraq - yet these are not being considered by markets focused on GFC and so will provide negative surprises. [1].
  • politics will increasingly affect the economy because (a) there is been a shift everywhere towards economic reliance on governments because of weakness is financial systems and (b) governments have assumed control over financial institutions and other business entities in the course of rescue efforts. Economic progress is possible where the economic environment is stable and predictable - but this stability will now be less available [1]
  • political risk will be severe in US because of determination of Congress to exert independence from Executive [1];
  • authoritarian regimes that have depended on economic boom conditions for political stability could be in trouble, eg reduced oil prices may expose insolvency of the Russian state, while inability to provide jobs inflames China [1] - though it is also possible that Chinese people simply blame the West for their economic problems, and become increasingly nationalistic [1];
  • with growth collapsing, radical protest and social revolution can now be expected across East Asia  [1]
  • despite motions accepted by G20 about the need to maintain open markets, protectionist pressures are increasing in Europe [1]
  • China is planning to ban exports of rare earths that it alone produces which are vital to some leading edge technologies [1];
  • German finance minister threatened to force a substantial segment of the British finance industry to be shut down - based on perceptions (which were questioned) that: (a) that industry was responsible for the GFC; and (b) the British Government seemed reluctant to introduce tough controls  [1] [Comment: the alternative to blaming banks (and poor regulation in the Anglo-American world) for the GFC is to blame global financial imbalances linked to export-dependent economies (such as Japan, China, Germany). The implication of US pressure for more balanced growth is not only that radical changes are needed in Asia, but that Germany's preference for reliance on external demand spending would have to moderate].
• the GFC affects and undermines the very core of past economic globalization because:
  • the decoupling of the $US from the gold standard in about 1970 was as important for economic globalization as improved transport and communication - because it overcame the limits on credit creation that had previously made it difficult to counter economic booms and busts. This made management of US monetary policy a critical element in sustaining the growth of the global economy as a whole (see above) - but now:
    • the status of the $US is less certain (and no alternatives are obvious);
    • the US monetary policy process has contributed to the emergence of the GFC (because it encouraged asset inflation) and needs to be re-invented;
  • US demand had provided a key economic driving force for the global economy. The US had acted as 'the consumer of last resort' and thus made export-driven growth a feasible method for economic development - and this in turn relied upon (a) asset inflation to support demand by US consumers and governments and (b) the ability of a strong US financial system to attract capital inflow. In future, the US appears most unlikely to be able to sustain this excess demand [1];
  • the development of financial services as an economic growth sector was an important part of the diversification of advanced economies into high wage knowledge intensive industries, as emerging economies with lower wages have tended since the 1970s to take the lead role in capital intensive manufacturing. The viability of complex financial services industries as a growth sector must now be in doubt because this may contribute to the failure of rationality in economic decision making (see above);
  • countries now dependent on capital inflow to finance growth need to reduce this in the face of the GFC - and this requires changing the balance of trade to increase exports [1]. Countries that in the past have been willing to provide the demand to counterbalance the export driven development strategies of Asian (and other) economies may no longer be able to do so. Also:
    • private borrowing in the US has fallen from about 15% of GDP to a net saving around 7% of GDP (and this seems likely to be maintained) [1]. The US government has very limited capacity to continue indefinitely borrowing to sustain US / global growth - though doing so in the short term is unavoidable (op cit);  Similarly,
    • it will be virtually impossible for the US government to stimulate economic recovery (as Japanese analysts have also noted) because (a) the US private sector is now going to be forced to save about 6% of GDP pa - which reduces its spending and thus increases the need for government spending to achieve growth; (b) there is a current account deficit of about 4% of GDP - which adds directly to the amount of spending in US needed to sustain growth; and (c) government (which is already running a large deficit) will face large increases in costs because of the recession. The incoming Obama administration hopes to run large budget deficits to stimulate recovery - but given these constraints recovery can't be achieved quickly. Also huge rates of spending can't be sustained very long. Structural changes in the US and global economies are required - which political leaders have not yet confronted (eg a massive write-off of bad debts to prevent ongoing impediments to economic activity; and ending of structural current account deficit) [1];
  • the export-driven development strategies, which have been the basis of East Asia's rapid economic advancement and also important components of past global economic growth, are now unlikely to be sustainable (see Are East Asia's Economic Models Sustainable?)
  • in the face of economic collapse, China's regime could be at risk - and respond by devaluing its currency, thus setting off a trade war that was a rerun of the Great Depression [1];
  • nationalization of many banks in US and Europe appears likely, and these would be inward looking and completely change the global financial environment [1];
  • emerging market economies generally have been damaged and clearly require that financing techniques be re-invented;
  • very low income developing economies could suffer a serious setback - which creates a humanitarian crisis [1]
  • current crisis is first modern threat to globalization. Even earlier there had been concern that globalization favoured wealthy more than poor. Drivers of globalization (open markets, global supply chains, global companies and private ownerships) are being undermined by protectionism. Companies return to national roots. Public participation has increased significantly. Global companies have been challenged by failure of global banking systems which had supported them. Existing regulatory arrangements had been inadequate for them. National responses to the crisis are leading to economic fragmentation. Companies in emerging counties depend heavily on foreign credit and are in particular trouble. Tariffs have been increased despite G20 resolutions. Once established protectionism takes a log time to dismantle. Also, as well as reforming financial systems, there is a need to ensure that international capital flows are maintained. [1];
  • China (which has benefited most in recent years from trade) imposed bans on the purchase of foreign equipment in investment projects - a more restrictive version of the US's 'Buy America' clause - which threatens to generate reactions elsewhere [1]
• new techniques for macroeconomic management which are less likely to result in unrealistic asset inflation clearly need to be developed - but what these might involve is anything but obvious;
  • there is a need for a new science of macroeconomics which starts from a recognition that individuals have severe limitations on their ability to understand much about the complexity of the world they live in [1]
• it may be that free market economies (such as the US) lack the tools available to economies with significant 'command' features (such as China) to manage the crisis [1]
• the nature of money and financial systems and their role in an economy is dependent on cultural assumptions - and these are viewed differently in various parts of the world (see Obstacles to Effective Regulation). This complication is likely to be well outside the knowledge base of those engaged in political and economic negotiations while specialists in the humanities, who might potentially make more useful progress, never seem to do so apparently because of their idealistic (post-modern) desire for cultural assumptions to have no practical consequences (see Competing Civilizations and Are East Asian Economic Models Sustainable?);
• the methods for seeking to create a new global financial / economic regime will also be fundamentally different. While public debate with a goal of universal benefits is the accepted Western political model, behind-the-scenes doing without public debate will tend to be be the method preferred in East Asia (which is now around 50% of the global economy) and in each society goals will tend to be limited to benefiting a particular ethnic community - see East Asia and comments on the emergence of a virtual Asian Monetary Fund;
• suggestions have emerged about developing an alternative to the $US as the global reserve currency (eg a basket of currencies or IMF SDRs) [1, 2], and it has been suggested that this might contribute to speedier resolution of the GFC by permitting stronger demand growth in emerging economies.

Creating a new reserve currency was advocated by China [1] on the basis that:

• there has long been a search for a global reserve currency that: (a) can be issued in response to demand according to clear rules; (b) is flexible (c) and is disconnected from economic conditions in any country;
• countries issuing a reserve currency are in the (Triffin) dilemma between meeting domestic monetary policy goals, and others' demand for reserve currencies. They may fail to meet liquidly demands of a growing global economy to restrain domestic inflation, or create excess global liquidity by overly-stimulating domestic demand;
• countries issuing reserve currencies can't address economic imbalances by varying exchange rates, because of the demand for their currency;
• Keynes proposed an international reserve currency in the 1940s. Bretton Woods system was implemented instead, and when this failed IMF's SDRs were created by not fully implemented;
• a super-sovereign reserve currency would eliminate the risks inherent in a credit-based sovereign currency - and make it possible to manage global liquidity. This would also allow exchange rate policies to be used to adjust economic imbalances;
• it would take time and political vision to establish such a system. SDRs should be considered as the basis for a new system - and this is being studied by IMF. SDRs' valuation should be based on a basket of currencies;
• entrusting part of member countries' reserved to centralized management by the IMF would enhance international community's ability to manage crisis, Centralized management with a reasonable return will be more effective in deterring speculation and stabilizing financial markets. The IMF's universal membership, mandate to maintain monetary / financial stability, role as international 'supervisor on macroeconomic policies of member countries and expertise provides basis for managing members' reserves. This would in turn significantly strengthen the SDR's role.

China's suggestion about a supranational reserve currency system (which would increase the number of countries responsible for protecting the value of foreign exchange reserves) might:

• provide East Asia (and some others) with a means to protect the value of their reserves from the potential weaknesses of the $US that is now likely as a consequence of the global financial imbalances that have arisen from the demand-deficient export-driven development strategies that Japan spread throughout East Asia (see Structural Incompatibility Puts Economic Growth at Risk);
• provide a possible means to provide desperately-needed credit to East Asian economies with limited regard to return on capital when their reserves have become depleted as would necessarily occur with domestically-driven growth (see below).

However from others' point of view it would be of uncertain merit because:

• monetary policy has become the main basis of macroeconomic management. It is not obvious how global macroeconomic management through control of liquidity would be any easier (eg through the IMF's SDRs) than by the Federal Reserve using $USs. Certainly managing the relationship between domestic and international goals is a problem (as illustrated by the easy money policies the Fed was forced to adopt to maintain global growth in the face of a structural demand deficit in East Asia). However an even bigger constraint is the need for impossible levels of strategic insight into when asset values have become a 'bubble' by whoever the monetary regulators are. The suggestion by a Chinese economist [1] that Keynesian policies by the US Federal Reserve (ie attempts at macroeconomic management through monetary policy were part of the cause of the GFC may be noted);
• problems seem to arise (as demonstrated by the European Monetary Union) where uniform monetary policies are applied (and attempts are made to encourage similar fiscal policies) across regions with vastly different economic characteristics (eg stimulus needed in the majority of regions may trigger bubbles elsewhere, while restraint needed in most regions can lead to severe downturns elsewhere).  Similar problems would apply to IMF SDRs;
• unless the world economy's dependence on high levels of US demand to maintain growth can be quickly reversed, such a step in the midst of a financial / economic crisis would potentially trigger a much more serious global economic collapse (ie it would put at risk the ability of the US to mobilize the resources needed to recapitalize its banking system and stimulate economic growth with government spending - as these had come to depend on the ability of the US Fed to 'print money');
• the use of SDRs would not eliminate the risk that financial imbalances would give rise to crises.  For the world as a whole, there can be no net current account surplus or deficit no matter whether this is valued in $US's or SDRs. So long as East Asian economic models depend on maintaining current account surpluses, someone else must be willing / able to run persistent deficits - a role which the US has been able to fulfil in the past only because of the strength of its financial system and the growth of an asset bubble;
• it is not clear that SDR's would really be backed by much apart from $USs - as this is the main current form of the foreign reserves that would be made available to the IMF for centralized management. A basket of currencies has been suggested in valuing SDRs, but China (which has proposed this change and has (like Japan) had to accumulate large foreign exchange holdings because weaknesses in its financial / monetary systems could only be protected by running large current account surpluses) does not have any freely convertible currency of its own that could be provided to support SDRs;

As noted below (in comments on a A New World Order: Leadership by Emerging Economies?), suggestions that creating a global reserve currency might permit speedier resolution of the GFC by strengthening demand in emerging economies are neither necessarily valid nor optimal.

• practical initiatives have been taken in Asia to reduce dependence on the $US as the global reserve currency - without apparently creating any viable alternative
  • China has taken various initiatives to reduce its exposure to and dependence on $USs (see Doing China's Own Thing?)
  • in May 2009 Japan threatened to buy no more US bonds unless they are dominated in Yen - in parallel with frequent complaints from China that US is using quantitative easing to devalue $US. Because of their export dependence Asia' economies would be in serious difficulties if they 'crater' the US bond market [1]
  • the possibility of redirecting surplus savings (from East Asia and oil exporting nations) into investment in developing countries through international institutions created by the IMF has also been raised [1] [see comments];
• the possibility of a global swine virus pandemic raised fears of a further economic dislocation in April 2009 [1]

• the financial difficulties facing developed countries in winding down, and recovering from, their stimulus measures is complicated by the costs of emissions trading schemes(which would make energy more expensive for their industries), while developing nations expect compensation for doing the same. Citizens want something done about climate change, but developing nations believe that this is their chance to get ahead - by making energy costs in the developed world much greater than in developing nations [1]

Economic growth and globalization has been dependent on complex and dynamic arrangements within the global economy which effectively disintegrated. Efforts to stimulate economic activity through government spending and loose monetary policies can't be sufficient - because the problem is, in effect, to 'put Humpty Dumpty back together again' (see also reference to our inability to 'restart the music' [1]).

• US Leadership?
• G20: Avoiding key Issues
• G20: Peace for our Time'?
• Leadership by Emerging Economies?
• Future

Beyond the GFC

Established machinery for international collaboration (eg G7, EU) made various attempts to promote a coordinated response to the GFC which would not only deal with the crisis but address its systemic causes. A forum of European and Asian leaders agreed in October 2008 on the need for such action, and arrangements were made for an international meeting in the US in November following the 2008 presidential election to find a way forward.

US Leadership?

Much was apparently expected of the renewal of US leadership within global institutions under a new president in developing solutions to the financial and rapidly-escalating economic crises.  However given the complexities of the issues (which currently render them virtually incomprehensible) and dysfunctions in global institutions it is hard to see how 'hope' (for apparently-long-overdue reform of US government programs; 'liberal' values that some cultures believe to be socially damaging; and a vacillating approach to international relations) might translate into world leadership in practical reform of global financial / economic systems.

Why: In November 2008 there were worrying signs concerning the future Obama administration. While he was undoubtedly charismatic and politically skilled, he espoused a VERY conventional Democrat policy agenda (more and better government programs and liberal social policies) combined with a confused approach to international relations which promised both diplomatic collaboration and economic protectionism. While, of mixed race, he seemed to be a cultural Anglo-American (no less than then former US President Bush or former UK PM Blair) - which was presumably the reason that he was widely acceptable to the US electorate.

The international situation his administration faced was the same as faced leaders such as Bush and Blair in 2001 - eg involving dysfunctional global institutions, failing states on the global margins, security risks with potential massive costs (eg from WMD in the hands of extremists) - see September 11: The First Test.

The financial / economic situation his administration inherited was certain to absorb most of the energy that it wanted to apply to other other things - and probably quickly erode its public approval. There was little sign that his administration understood the problem - if it was anything like that outline above.

Parallels might be relevant with the 2007 election of the Rudd Government in Australia where populist rhetoric about solving presenting problems did not actually seem well founded (see Populism Trumps Electoral Victory).

Barack Obama as President also seemed potentially a 'Blair' - ie unsuccessfully seeking modified socialist ways to make the world a better place. Think-tanks in UK continued to develop ideas about Blair's 'third way' - and this would have influenced US Democrats. Feedback the present writer had from contacts in US who gave the impression that they were advising Democrats suggest interest in approaches to reform of government administration which come out of think-tanks that inspire ALP governments in UK and Australia. Those in Australia were be putting forward the argument that Australia's approach to financial system governance (for example) could provide a better model for the US. The latter conclusion arguably reflected a naïve assumption that Australia's system had been effective (rather than lucky that real risks had not yet caused a crisis) - and the Obama administration needed experienced advice to be able to see through such claims.

Whether the Obama administration mobilized or alienated those who could help it was critical to whether the 'hope' that it promised was likely to be realized.

G20: Avoiding Key Issues

A meeting of G20 nations (representing about 80% of the global economy) was arranged for mid-November 2008 to consider a coordinated response to the GFC. Resolutions were passed about (a) developing proposals for a coordinated response for consideration in 2009 and (b) restarting talks about liberalization of international trade under the WTO framework (which had previously failed because of disagreements about agricultural protection in developing countries).

Various published comments on the challenges facing the G20 included:

• the G20 resolved that stiffer regulation of international financial markets is needed because they operate internationally, and consistency is required. Principles adopted were: (a) greater transparency and accountability; (b) strengthening existing regulatory regimes; (c) promotion of 'integrity; (d) more international regulatory consistency; and (e) reform of existing international financial institutions [1];
• G20 resolved to conclude stalled Doha round of world trade talks [1]

There was however concern that: (a) the summit had not actually decided to take coordinated action; (b) the causes of the GFC were not raised in debating solutions; and the incoming US administration was not involved in the summit. There was also fairly clear differences of opinion between 'Europe' (which appeared to favour some sort of EU-style international regulatory regime) and the outgoing US administration's aversion to such arrangements.

An APEC meeting in late November again highlighted fundamental differences in approach - when China also strongly endorsed a 'new international financial order' as an alternative to the 'free markets' approach favoured by the US [1].

While the US administration of Barack Obama was more likely than its predecessor to favour an 'international' solution, this seemed unlikely to be enough. For example, as noted above the Obama administration's approach to international affairs has been internally inconsistent. Moreover the new president gained electoral support by promising to protect jobs in failing industries, though trade protectionism could seriously worsen the economic downturn associated with GFC - and the G20 resolved to pursue the further removal of trade barriers by revitalizing stalled WTO negotiations [1]

In the lead-up to the proposed G20 conference in April 2009 to discuss resolution of the crisis diverse and incompatible approaches to solutions were again very much in evidence.

For example:

• G20 should focus on coordinated fiscal and monetary policies to boost growth and defer action to reform regulatory arrangements. Because the causes of the problem are not yet well understood, early changes could make things worse. Jittery investors need certainty not shifting rules. Moreover a unified regulatory system across the entire world is probably impossible and undesirable, given the quite different governance regimes that exist [1];
• France and Germany want the IMF to act as a global supervisor of regulators as a means to substitute the European model of capitalism for the less heavily regulated US style, though even in the US, regulators' inability to adequately forecast future trends have resulted in significant problems [1];
• the UK Prime Minister (Gordon Brown) issued calls for a global approach to wholesale restructuring of financial regulations in response to the GFC while stressing the dangers of protectionism [1]. [Comment: This seemed reminiscent of efforts by a former UK PM (Tony Blair) to garner support for a global approach to the war against terror - and likely to be unsuccessful for much the same reasons].
• Australia's Prime Minister put forward a package of proposals based on cleaning up distressed financial institutions and better regulation  while a former Australian PM presented a radically different notion based on the view that global financial imbalances were the source of the problem and needed to be corrected. [Comment: The former was likely to be ineffectual for reasons like those applicable to UK proposal, while the latter seemed inadequate because the inability of East Asian economies to develop the type of financial systems this would require);
• as well as proposals by Australia's PM and a former PM, the US government called for more public spending. Europe wanted more financial regulation. China wanted a bigger seat at the table. WTO was concerned about rising protectionism. World Bank warned that funding crisis threatens catastrophe in developing countries, unless developed world supplies capital. Reaching agreement at such conferences is hard - and becomes more so the larger the agenda grows [1];
• China proposed  that IMF SDR's should take the $US's place as the global reserve currency - and others suggested that this would reduce the risks implicit in reliance on a currency that is only backed by one country and would make it possible to manage global liquidity [1] [See comment above, which suggests that such a shift might enable Asia to protect the value of foreign exchange holdings against the likely decline in their value that will result from global financial imbalances that result from 'Asian' economic models - but would be of limited benefit to most others]

Moreover unilateral action by various nations / regions acting independently seemed unlikely to lead to success.

For example:

• neither the US nor the EU seemed likely to be able to provide sufficient funds to recapitalize their banking systems - a step which was widely seen to be vital to providing the ongoing credit facilities needed for economic recovery;
• US Fed chairman suggested that US could emerge from recession in late 2009 if the banking sector stabilized. A reform agenda was suggested involving: supervision of banks that are too big to fail; improving resilience in system; reducing pro-cyclical risks; and creation of authority to identify systemic risks [1]. However:
  • while the Fed expected that resolution of problems in US banks would lead to recovery, the US government (which the Fed expected to restore the banks) appeared to be expecting that economic recovery would come first - and and that it would be economic recovery that would fix the banks [1]; and
  • the risk that the US might (because of a bond market crash) not be able to fund the budget deficits required for its stimulus and bank-rescue efforts appeared real [1]. Quantitative easing (ie printing money) has been started in order to provide funding for government deficit [1], but this poses huge risks [1];
• the US Secretary of State had encouraged China to continue investing in US Government bonds (which would be vital for the US to fund its stimulus packages), while (a) China's premier expressed concerns about the safety of its investments and indicated an intention to diversify into strategic commodities, outbound investment and trade [1]; (b) China's current account surplus collapsed, because of its exports decline [1]  so that it had little new capital to invest; and (c) China sought to diversify perhaps 50% of its $2tr+ foreign exchange holdings away from $US - perhaps into commodities and other assets that are currently undervalued in order to protect against $US collapse [1]
• the US will be unable to provide the high levels of demand required for export-driven growth in East Asia (see Unsustainable economic models?);
• East Asia (China in particular) seemed likely  to be unable to sustain market-oriented economic growth because of structural obstacles to domestically-driven growth (see Are East Asian Economic Model's Sustainable?) - and thus to perhaps shift into nationalistically oriented growth which is likely to be both (a) non-viable in the long term and (b) potentially a threat to regional and global security (see After the Bubble).

In March 2009 a preliminary meeting of G20 finance ministers papered over pre-meeting differences between EU and US on fiscal stimulus and agreed on (a) a common framework for assessing impaired assets and bank recapitalization (b) boosting resources of the IMF and regional development banks to provide capital for emerging and developing economies (c) avoiding protectionism and (d) increase oversight of Credit Rating Agencies, transparency of exposures to off balance sheet vehicles; improvements in accounting standards, including provisioning and valuation uncertainty; greater standardization and resilience of credit derivatives markets [1] .

Despite hopes expressed by some, the prospects of reaching agreement that would be effective appeared dim.

Australia's PM, Kevin Rudd, (a) warned global leaders of the risk of 1930s style depression unless they collaborate to clean up banking sector and stimulate growth; and (b) suggested that the IMF needs more resources to meet a second-round financial-tsunami emerging from Eastern Europe. Other economic concerns are: (a) Japan's export collapse and likely 6% economic contraction; (b) uncertain funding for US / UK budget deficits and stimulus packages; and (c) nervousness about $US when US Treasury Secretary suggested that China's proposal regarding IMF's SDRs as new world currency might be considered. Mr Rudd will press for collaboration in finding solutions to avoid breakdown like that that followed failure of 1933 World Monetary and Economic Conference. Mr Rudd has argued for four part response involving: (a) macroeconomic stimulus; (b) restoring credit markets; (c) supporting developing nations; and (d) reforming international financial regulation. He will ask G20 to put aside self interest in favour of common good. There is concern that (a) US / European banks could withdraw from overseas markets; and (b) protectionism could emerge. [1]

The US delegation to the G20 believes that only an agreement between China and the US can create a sensible new world economic order [1]

[Comment: While no outcome that does not reduce global financial imbalances could result in sustainable growth (a) China is by no means to only East Asian country that would need to be involved and (b) the necessary adjustments to financial / monetary systems in Asia are arguably culturally impossible - see Financial Imbalances]

Though the situation is better than in 1933, there are also similarities. The US is trying to reflate its economy, while Europe hangs back worried about its currency. Prior to 1933 conference both Europe and US had tried to stick to gold standard - a position Roosevelt then abandoned. G20 summit is earlier in this depression, and fiscal and monetary responses are well advanced - except in Europe. Draft communiqué has been published, which is vague. It expresses hopes for growth, commitment to free trade and market (not capitalist) economies, commitment to reform of  financial regulation, concern about inflation and an exit strategy from fiscal expansion. Problem is more urgent than in 1933 because of speed of collapse in manufacturing. G20 needs to rescue globalization and trade as well as fixing financial system [1] 

In the 1930s any country that tried to reflate was punished by its creditors - so most stuck grimly to liquidation. Surplus countries refused to play their part in restoring demand - just as they do today either because they don't want to (Germany and Netherlands with combined $294bn surplus) or can't for structural reasons (China with a $401bn surplus)  [1]

Comment: In terms of resisting reflation, more attention should be paid to East Asia than to Europe. As noted, China has 'structural reasons' for doing so. However China's surplus may well be much less than the $401bn mentioned - as it had shrunk to almost nothing in February 2009 (see China: After the Bubble). Thus, unless there is strong recovery elsewhere, China's 'structural problems' may pose a threat if it seriously attempts to reflate its economy. Moreover, the 'structural reasons' for China's inability to reflate (which are the same as Japan's) requires explicit attention (eg see China: Victor of Victim?), as do apparent attempts to create defence mechanisms in the form of (a) proposals to increase the number of nations who would become responsible for protecting the value of Asia's foreign exchange holdings (see comments on China's proposals for using the IMF's SDRs as a global reserve currency) and (b) the creation of a 'A Virtual Asian Monetary Fund').

French president has threatened to walk out of G20 meeting if his tough globally-managed regulatory reforms to moralize capitalism are not adopted. He opposes stimulatory spending. US / UK argue that global regulator is impractical [1]

G20 seems unlikely to rise to challenge - because there is a need to both boost aggregate demand and shift its distribution away from chronic deficit countries to those with surpluses. No consensus exists on causes of crisis. UK / US argue that problem is not just deregulation - but excess supply in surplus countries (especially China - $379bn, Germany - $253bn, and Japan - $211bn in 2007). But China and Europe argue that problem is fault of deficit countries. German Chancellor points out that Germany is reliant on exports - and expects the rest of the world to adjust to be able to continue buying these sustainably.  But deficit countries have now run out of willing / credit-worthy private borrowers - and will now shift their fiscal balances massively towards surplus. In surplus countries (which relied on irresponsible borrowing by the private sector in deficit countries) the private sector will still run large surpluses, while governments are forced to very large deficits. Because of low fiscal deficit, China clearly expects strong external recovery. As there is no sign of adjustment of underlying structural imbalances, there is no chance of sustainable exit from crisis. [1]

The US wants the world to embark on macroeconomic stimulus programs - and believes that complicated task of reinventing financial supervision and regulation can wait. Many European countries can't afford a stimulus package because of over-stretched public finances - and so want to make progress on regulation of banking [1]  [Comment: It can be noted that under European Monetary Union rules government deficits are strictly controlled, and so even if individual countries wanted to increase spending to stimulate economic activity they may be unable to do so without breaking down the EMU]

Moreover it was what was not being discussed at all that seemed most likely to inhibit effective agreement.

For example:

• there are major unmentioned differences in understanding about what an 'international' solution would involve (eg see Obstacles to Effective Global Regulation). To oversimplify:
• when the current US administration refers to 'free markets' it means that capital should mainly be allocated to uses that produce the greatest financial return. The Obama administration would seriously undermine the US's economic potential if it took a different view;
• when 'Europe' talks about a 'new international financial order' it means that capital should mainly be allocated by institutions which reflect prevailing 'democratic socialist' values as well as considering financial return;
• when 'Asia / China' talks about a 'new international financial order' it means that capital should mainly be allocated by state institutions controlled by non-democratic social elites who tend to give preference to nationalists with good connections to the prevailing regime - and the lack of serious concern for profitability in such uses of capital should be concealed by constraining consumption to ensure a large current account surplus;
• some of the world’s up-and-coming new powers neither embrace nor aspire to the Western model of liberal democracy and authoritarian regimes (eg Russia) are demanding a role in global governance on their own terms which makes the idea of an "alliance of democracies" hard to maintain (Karaganov S., 'Confrontation of cooperation', 14/11/08)

In the absence of commitment to addressing underlying problems, the predictable outcome of international negations related to the GFC could only be:

• some sort of multilateral agreement on a very narrow series of global financial system 'reforms', or
• the creation of several separate (incompatible?) regional regimes - which would retain the problems associated with incompatible national regimes. There seemed to be no mention of the creation of a virtual Asian Monetary fund as a regional alternative to an effective global solution.

Such 'solutions' would imply that another crisis would emerge in a few years.

G20: Announcing 'Peace for our Time'?

Following the G20 summit in London in early April 2009:

• the UK Prime Minister (Gordon Brown) announced the creation of a "new world order". "This is the day that the world came together to fight back against the global recession," he said. "Not with words but with a plan for global recovery and reform." [1]
• US President Obama, hailed the deal as a "turning point" that would put the global economy on the path to recovery; [1]
• France's president also said that a "page has been turned" on the old Anglo-Saxon financial model [1];
• Germany Chancellor Merkel spoke of a 'very, very good, almost historic, compromise' [1]
• Australia's Prime Minister reportedly intended to produce a budget based on the assumption of economic recovery in 2010 [1]

Though Western leaders proclaimed the G20 a success and there were some signs of progress, there is a real possibility that they were merely having a Neville Chamberlain moment because serious underlying problems were not being addressed.

Indicators of Success

Observers noted that:

• the G20 summit: provided an additional $US1.1tr to IMF to support countries facing payments crises, finance trade flows or provide SDRs; agreed to publish a blacklist of tax havens; imposed oversight on large hedge funds and credit rating agencies;  created a supervisory body to flag problems in global financial system; did not accept US calls for new stimulus measures. Australia's PM suggested that this constituted crackdown on 'cowboys' who caused market problems. UK PM said governments had agreed to $5tr in stimulus measures before the summit - though others were unable to see where this figure came from. French president suggested that this reflected a shift away from 'Anglo-Saxon' finance model. Germany welcomed the lack of commitment to further stimulus measures [1];
• at G20 summit, UK PM announced end of 'Washington consensus' because of $1tr injection for global economies. A six point agreement involved: new approach to tax havens; common approach to managing 'toxic assets'; radical banking system reforms; new regulatory arrangements including a 'financial stability body'. A new world order may emerge on the basis of international cooperation. Key pledges involve: publishing a list of tax haven; provision of additional IMF funding ($500bn general funds, $250bn SDRs and $250bn for trade assistance); and international colleges of supervisors for national financial regulation; agreement to promote growth domestically; revamping IMF / World Bank with more influence for China and developing countries; continuation of millennium development goals; $50bn for world's poorest regions  [1] ;
• the G20 took a step towards the creation of a global currency, backed by a global central bank running monetary policy for all humanity - through $US250bn allocation to IMF for SDRs [1]
• the G20 meeting had been a success in terms of boosting confidence [1]. Markets surged as world leaders agree sweeping package of measures to restore the world economy, including $250bn money supply increase [1]
• G20 produced a more ambitious outcome than many thought possible. Rather than focusing on fiscal stimulus by large economies (which Europe's leaders were suspicious of) attention focused on the poorest developing economies and medium-income emerging markets [1]
• the US and China agreed to ongoing dialogue on economic and political issues [1];
• the Anglosphere went to the Summit seeking massive ongoing fiscal stimulus - but didn't get it because of European resistance. Europe wanted global financial regulator that would force US institutions to operate by European rules - but didn't get it because of US resistance. The outcome was 'coordinated unilateralism' (similar to APEC's free trade forums in 1990s) which was better than nothing. G20 also marked world's acceptance of US President as its leader [1]
• all the suspects in the GFC (except the politicians and regulators who oversaw it) have been locked a new interlocking global / national system of regulation (ie hedge funds, institutions too large to fail, credit rating agencies, tax havens, derivatives, excess remuneration for short term risk) while a new Financial Stability Board will monitor the whole system [1]

Moreover there were 'real-economy' indicators that the effect of the GFC could be fading. Stock markets are viewed leading indicators of economic change - and will tend to bottom (say) 9 months before corresponding economic effects. There was a view in early April 2009 that stock-markets (having fallen about 50%) had fully discounted the real-economy downturn that were then unfolding and that there were signs of recovery which the market should thus anticipate. For example:

• recent surveys of manufacturing and service industries show that conditions have stopped getting worse in US, Europe and Asia [1];
• the main sign of progress is that rate of economic decline has slowed. China seems to be keeping its economy ticking over (though data is uncertain). Global contraction of manufacturing has slowed - and new orders are emerging. Low interest rates in US have triggered a wave of refinancing. Building approvals have strengthened in Australia [1]
• new regulations will make global banking systems more healthy. There are also signs of bottoming of US housing market and improved consumer confidence. The US has recognised that it can't be the only consumer driving world growth. China / Japan and Europe will be forced to increase consumption  - which won't be easy and in China's case will require safety nets so savings can reduce. Australia will benefit from commodity prices during recovery, and from a reasonably sound (though not perfect) banking system [1];
• mark to market accounting rules (which had made it hard for banks to sell toxic assets) were eased.[1] Assets could now be held on bank's books at estimated longer term values rather than current market values - so sales of distressed assets would not require that all similar assets on banks' balanced sheets be devalued.

It seemed that the economic dislocation triggered by the GFC could run much longer because: there was obvious confusion about the nature of the problem; nothing was done about the structural causes of the financial imbalances that make global growth unsustainable; correcting those imbalances is both essential and likely to make East Asian economic models unworkable; establishing global institutions to address the problem of economic management and financial regulation merely 'passed the buck'; and there are numerous market-level indicators of ongoing problems

Structural Indicators of Ongoing Recession / Depression

Confusion (ie unrealistically narrow perspectives) regarding the complex causes of the GFC seemed to be widespread.  The 'neo-liberalism-and-greedy-bankers-dun-it' view put forward by Australia's Prime Minister was only one example of this phenomenon. For example:

• UK-French-German leaders and analysts discussed the problem in Eurocentric terms;
• the US president noted that the US could no longer be the primary source of global demand, without suggesting any practical alternative;
• even analysts who recognise the importance of financial imbalances find it too hard to examine the cultural foundations of such problems (eg that China's $2tr foreign exchange reserves and corresponding reserves in Japan are symptoms of systemic weaknesses, not signs of economic strength);
• Asia's ethnic leaders engaged little in the Western artifice of political debate, because of the traditional preference for behind-the-scenes action to boost their communities' positions - just as their financial counterparts prefer 'real economy' outcomes to success in the Western artifice of financial profitability.

Nothing was  done to confront the structural causes of the financial imbalances that have made global economic growth unsustainable - and that were one factor in causing the GFC. The G20 established a Financial Stability Board to provide early warning of problems with systemically important financial institutions, instruments and markets. This totally missed the point that there was a need for early warning about the effect of destabilizing financial / economic / monetary systems.

Thus at best any recovery could only be a short term affair. Pre-GFC global growth depended on (a) excess demand from US consumers, which was maintained because asset inflation created the impression of high household incomes and (b) very high levels of government spending in Europe, which had left public finances over-stretched [1].

This can't continue, and the US (and like) governments can't continue borrowing indefinitely to stimulate economic activity (eg noting the potential for the US to encounter difficulties funding its budget deficits ), while countries like China  and Japan (and others with large demand deficits because of their export-based economic strategies) appear to assume that economic recovery will be driven by external demand.

Of even greater long term concern is that East Asian export-driven economic models (that have been major factors in both global economic growth and global financial imbalances) will almost certainly prove unsustainable in the post-GFC era but be incredibly hard to reform because of cultural constraints (see Are East Asian Economic Models Sustainable?).

Others argued similarly that:

• G20 decided nothing of substance. More money was given to the IMF, but there was nothing new on fiscal stimulus - because German / US disagreement remained. Everyone knows indebted / deficit countries can't continue borrowing to prop up demand. Surplus countries have to provide the demand (especially Germany and China) , but they are waiting for the return of Anglo-Saxon demand in the near future. [1];
• G20 involves contest between France-Germany and the rest of the world. Most others are backing various stimulus measures. While Germany is right that indebted countries can't keep adding more debt, global demand is contracting - and deficit countries should not carry burden. If surplus states don't do more, global demand will collapse. The mercantilist powers (eg Japan) are already being hit hard. Global system can't be rebuilt until countries like Germany and China accept that extreme imbalances are bad.  [1]
• it has been argued by influential insiders that Germany can no longer continue to rely on an export-dependent economy [1];
• the next collapse will only be a matter of time because key issues received no attention - namely the high levels of consumer spending in US (72% of GDP) and the low level in China (36% of GDP). G20 agreements dealt with regulation of financial institutions, but the main problem now is macroeconomic [1];
• in Australia there had been a large element of unreality in government's approach to G20 in expectation that it might tackle the really big issues such as the rotten state of US / European banking, and the need to increase government spending. The G20 went nowhere near these issues [1]

While the G20's creation of a stronger global financial-monetary authority through the IMF reduces some risks to the global economy, this does not in itself solve the operating difficulties facing any such body. For example:

• the step towards creation of a global reserve currency (ie IMF SDRs) and a global central bank to control monetary policy is of uncertain benefit;
• macroeconomic management based on either fiscal or monetary policy now seems unreliable no matter who tries to do it. Working out how to do this effectively seems more important than just asking new institutions to do so;
• IMF has frequently been criticised for its tough-love 'Washington-consensus' approaches (eg requiring fiscal tightening in the face of balance of payments difficulties), while the alternative approaches based on strong government control of the financial system and support from other countries with current account surpluses so domestic financial weaknesses can be ignored depended on the strength of the US as counter-party to such surpluses;
• since the G20 summit the IMF has taken a much more pessimistic, and arguably more realistic, approach to assessing the prospects of the global economy and the challenges of reform (eg [1]) - but has also demonstrated significant deficiencies in the information that it relies on in attempting to do this [1]

At a market level there seem to be ongoing causes for concern that offset the optimistic signs outlined above. For example: 

• the creation of a new regulatory regime for international finance in the absence of real understanding of the causes of the GFC seemed likely to be as destabilizing and vacillating as the US government's early efforts to respond to the credit crunch were widely seen to be. Moreover the proposals adopted seemed to give everyone a bit of what they wanted on the basis of radically different understandings of what was required (see Obstacles to Effective Global Regulation and also above). Coherent operation of this global regulatory machinery thus seems unlikely;
• any stock-market recovery is likely to adversely affect the price of government bonds - which (especially US Treasuries) have had a high 'flight to safety' value in the absence of alternative investment options. Collapse in the value of such bonds: (a) will put the ability of governments to fund their budget deficits at risk and (b) set new (higher) standards for yields on corporate debt and equities;
• US government rescue package for banks has been seen as unlikely to be successful - because of problems in setting prices for 'toxic' assets. If set too high, those enticed to buy them by government guarantees against loss would be unable to make a profit. If set too low, they would reveal the extent of banks' balance sheet problems - and thus banks would be unwilling to sell. Changes to mark-to-market accounting rules will ease this problem (and thus reduce their need for new capital)- but result in a loss of transparency regarding banks' balance sheets (and thus increase their difficulties in obtaining new capital);
• recapitalizing US banks won't restore normalcy to credit markets - because about 50% of credit had been provided through securitization of assets which were then sold through financial markets;
• government rescue operations for financial institutions has resulted in a high level of government control, and thus will reduce their ability to support innovative commercial activity that is vital for real-economy recovery and ongoing growth;
• financial services had become a major growth sector of developed economies under pressure from competitive challenge from developing economies in traditional industries. This sector's future prospects (which were important in terms of both employment and tax revenues) will no longer be such a bright prospect;
• major companies (eg US auto majors such as GM) are hovering on the brink of bankruptcy - and this will give rise to further rounds of derivatives losses via credit default swaps (CDSs);
• it is not clear what has been done resolve the CDS problem. It was clear that (a) the total exposure to derivatives was many (eg 50) times the capital base of major banks - though their net exposure was only roughly equal to their capital base (b) any counter-party failure (such as Lehman Brothers) could amplify these net losses (c) it was thus unacceptable to allow major financial institutions to fail. There is a lack of transparency about what has been done to reduce the potential for losses on derivatives, and what still remains to be done;

And unfortunately indicators of an economic crisis which are recorded elsewhere continued to accumulate despite signs of improvement that were observed from mid 2009. Moreover, as the first phase of  the crisis abated, many analysts started raising concerns about ongoing risks.

The G20 summit was arguably a 'success' mainly in the sense that differences were papered over, no one walked out and a foundation was laid for ongoing negotiation. Many issues that needed attention were hinted at, which is at least a form of progress even though they were not addressed.

In September 2009 a meeting of the G20 decided that fiscal and monetary stimulus measures had been successful but needed to be continued (and great care taken in phasing them out) and the global financial system needed reform in terms of (a) better coordination of monetary and fiscal policies (b) higher capital requirements [1]

However the issues that the the G20 avoided did not go away. Various observers noted the relationship between global financial imbalances and the GFC that was mentioned above. Moreover:

• as noted below, this was highlighted as the major justification for a fundamental re-ordering of the global financial system in June 2009;
• the US and Europe raised the need for systematic efforts to reduce imbalances in the context of a September 2009 G20 meeting - a proposal to which China objected [1];
• in the face of increasing pressure to reduce trade surpluses, Japan and China are resisting. In China state-owned enterprises generate most savings. Better financial markets, social security reforms and a willingness to allow Yuan to appreciate a needed [1];
• by October 2009 it was being suggested that the GFC was only in one small way a failure of markets, but was mainly a necessary market correction to deal with international financial imbalances that had built up during a decade of successful globalization [1];
• by January 2010, the head of Bank of England was (a) suggesting the need for G20 to take control of IMF and (b) highlighting the need for balanced growth - on the grounds that unless imbalances are brought to an end by properly aligning exchange rates, countries might unilaterally impose self-defeating protectionism measures [1].

This issue was also reflected by G20 meeting in Pittsburgh which decided that (a) G20 would be forum for global economic management; (b) tougher bank rules would be in place by 2012. It was argued that responses by governments had stopped decline in global activity and stabilized financial markets - though (a) much more needed to be done to reform financial regulation and reshape global growth; and (b) stimulus measures will still be needed for some time. Other issues addressed included: IMF reform and world trade talks. In return for getting more say emerging economies would be expected to help rebalancing the world economy (by increased savings in deficit countries and more consumption in surplus countries). Some rebalancing was already occurring as US household consumption has shrunk. [1].

However while the G20 was able to get agreement on financial regulation (an issue on which there is wide agreement), it was seen to be likely to have difficulty getting agreement on trade, financial imbalances and reform of Bretton Woods institutions where there are significantly different views [1]

A New World Order: Leadership by Emerging Economies?

In June 2009 various observers noted that growth in emerging economies had remained relatively strong and that this was likely to: (a) drive future global growth; and (b) indicate the emergence of a 'new world order' [1]. For example:

Though there is gloom and doom in US, Europe and Japan, in some other countries growth powers ahead (eg China, India, Indonesia and Brazil). Government has little debt, and citizens are optimistic. It had been believed that emerging economies had grown because of exports to US / Europe. But not all economies and stock markets have gone down with US / Europe. In West / Japan banks are over-leveraged and dysfunctional, governments indebted and consumers rebuilding balance sheets. But in emerging markets banks are healthy / profitable, governments are in good fiscal shape, currencies are appreciating, bonds are rising. US remains powerful, but global powers have always found problems when they become overburdened with debt and stuck in a path of slow growth [1].

Professor Nouriel Roubini (who predicted the GFC) reportedly suggested that: the rise of emerging markets is a fundamental change; China's economy will eventually grow larger than that of the US; emerging economies are some of the US's strongest creditors, and will gradually lose their willingness to fund US budget / current account deficits;  and there will be a move away from international use of the $US - though this will take many years. [1]

In January 2010, it was noted that though emerging economies had been initially badly affected by GFC (because of dependence on trade and capital flows) they had subsequently achieved better growth and become attractive destinations for investment - though this could prove a bubble [1, 2]

However the ability of such economies to continue growth may have been little more than a temporary consequence of the shift towards export-oriented growth and the accumulation of foreign exchange reserves as protection against possible financial crises which had been favoured as a reaction to the Asian crisis of 1997. The ability of major emerging economies (with the probable exception of India) to do this in the past depended on the willingness / ability of the US (mainly) to compensate for the resulting demand deficits.

Though most emerging economies had been protected by strong current account and fiscal balances, the IMF pointed out that many had been severely affected by the GFC because of their dependence on foreign capital inflows (mainly from Europe). [1].

While economic activity could be maintained for a time on the basis of accumulated reserves, long term growth in an environment in which such economies were expected to drive global growth (ie support export-led strategies by others and run current account deficits) would require the development of effective local financial systems. Creating financial systems that could operate without current account surpluses (which requires strong demand elsewhere) may be structurally impractical in emerging East Asian economies (eg China) that have adopted variations on the economic model that was the basis of Japan's pre-1990 economic miracles (see Are East Asian Economic Models Sustainable?)

China may in fact be making determined efforts to create a new international economic and (perhaps) political order because of this constraint (see Creating a New 'Confucian' Economic World?) - though such an initiative  may not be durable.

A fundamental critique of the prevailing global economic and financial system was put forward in June 2009 by André Lara Resende (a Brazilian economist) leading him to conclude that establishing a new world reserve currency might allow emerging economies to increase demand and thus speed the resumption of global growth [1]. This proposal raised complex issues including: (a) the fear of currency crises that led to export-oriented growth in emerging economies; (b) the intractable stagnation probably facing the US economy; (c) the crisis this potentially creates for emerging economies; and (d) the possibility of enabling emerging economies to boost global growth..

Outline: In brief Resende suggested that:  

• first world societies have assumed in recent decades that economic growth was sustainable (because of effective macroeconomic management) - but emerging economies tended to experience currency crises;
• to protect against such crises, it became necessary to adopt export-led economic strategies - and accumulate large foreign exchange reserves;
• world growth has been driven by consumption in leading countries - supported by growing debts. This is no longer sustainable;
• the GFC reflects the complementary problems of regulatory failures and international financial imbalances. It can't be easily resolved because:
  • monetary policy can't provide a solution to the GFC, as the problem is insolvency not a lack of liquidity. Moreover using monetary policy to relieve bad debts of financial institutions won't restore growth when households / firms merely want to save. Similarly, use of fiscal policy must be ineffective because households just want to save any extra income - so multiplier effect of public spending that Keynes relied on will fail;
  • in the 1930s debts were written off and economies collapsed completely - but they were then able to grow from a much weaker base.  In the current crisis, the US is like Japan in the 1990s. Bad debts have not been written off (to prevent total economic collapse) - but now growth will be limited as new income will simply go to repaying old debts.
• the US must thus face a long stagnation - though recovery could be accelerated by export-led growth with emerging economies providing the demand;
• the features that led emerging economies to constrain demand need to be removed, ie their fear of financial crises which results from lack of confidence by those controlling reserve currencies;
• the GFC reveals problems in the political and institutional framework that emerged from Bretton Woods;
• China advocated a world reserve currency which might reverse past imbalances due to unrestricted expansion of spending / debts by central countries and conservative export-led stance of emerging countries.

Assessment:

The argument makes considerable sense in relation to the probably intractable nature of the economic trap that the US has fallen into. This, by implication, demonstrates that global economic recovery is likely to be slow and painful - because of the constraints on domestic demand which emerging economies face because of their reasonable fear about currency crises.

However Resende's proposed solution (ie the creation of a global currency) won't necessarily solve the problem (see above).  For example, whoever issues such a currency would be put in charge of global macroeconomic management - because of the role that monetary policy has come to play in this function. The question is how macroeconomic management should now be conducted - and creating a new currency / institutions does not (in itself) constitute an answer to that question. And, as noted below, manipulation of this for the benefit of particular political factions could have even worse adverse global effects than existing arrangements.

The high levels of consumption and build up of debts in the US in recent decades was not solely to serve US interests. Alan Greenspan, as Fed chairman, frequently referred to the need to prevent deflation as the reason for keeping US interest rates low. However deflation was Japan's problem - not one the US itself faced. This clearly demonstrates that US monetary policies were: (a) designed to promote global growth rather than merely meet US domestic needs (and this necessarily led to excesses in the face of demand deficits elsewhere); and (b) probably being formulated in consultation with Japanese officials.

Concern about currency crises undoubtedly constrained domestic demand  in emerging economies. However this arose as much from a lack of discipline in the operation of financial systems and institutions in emerging economies, as because they were remote from those who issued reserve currencies.

Unless those financial systems and institutions operate on a different basis in future, the only way that creating a global reserve currency would enable emerging economies to boost global growth through liberalizing domestic demand would be if the agency which managed the global currency system was prepared to issue SDRs to insiders without regard to return on capital - which is the way financial and monetary systems have tended to operate in East Asian economies.

Furthermore, the way in which East Asian financial systems operate (ie allocating capital to well-connected nationalistic elites rather than on the basis of concern for profitable use of savings) is not only wasteful, but provides no internal means to balance supply and demand and is thus no more likely to prosper than mercantilist economic practices in earlier eras (see A Fundamental Problem: Balancing Supply and Demand).

While it might seem to be socially desirable to allocate capital preferentially so that emerging economies (necessarily poorer) can increase consumption and environmentally desirable to allow 'informed' elites to direct resources to clean industries, neither social justice nor environmental goals can best be achieved through inefficient resource allocation.

Hidden Agendas?

Resende's analysis noted the long period of economic stagnation which the US faces as a result of the GFC, but did not mention the economic peril now facing emerging economies whose ability to avoid currency crises depends on export led development, and the ability to accumulate foreign exchange reserves (or at least not be forced to rely on foreign capital). Not only is US recovery likely to be weak and uncertain, but its government has indicated an expectation of domestically driven growth elsewhere.

A fundamental and un-stated agenda behind this proposal (which has perhaps been developed in consultation with advocates of Asian-style monetary systems) seems to be to overcome limits implicit in the economic model that Japan originated, used as the basis of pre-1990 economic miracles and spread throughout East Asia. That model, which is quite effective in organising economic production, is virtually incapable of doing so profitably (see Understanding East Asia's Economic Models and A Hidden Clash of Financial Systems in Competing Civilizations)..

Thus one real issue lies in the difference between Western-style democratic capitalism (under which market directions are set by enterprises pursuing the profitable use of savings) and neo-Confucian corporatism (which is based on the perception that market directions are best set by social elites in consultation with, and reliant upon the obligations of, their subordinates). Those issues are explored more broadly in East Asia, China as the Future of the World and Creating a New 'Confucian' Economic World?.

One practical difference would be between current global practices under which individuals with initiative can launch enterprises whose success is determined by meeting customers demand, and an alternative under which connections to nationalistic elites (rather than mere initiative) would be needed to do so.

A global financial system in which economic directions could theoretically be set by social elites, rather than by profit-seeking enterprises, would also seem to be compatible with the ideals underpinning Islamic banking practices. The latter also appear to be based on the assumption that morally-motivated elites can produce better economic judgments than profit sensitive enterprises.

Notes on Islamic banking practices:

• profits and losses are to be shared - and interest is forbidden. Also investments must be acceptable in accordance with Islam. Lenders profit (while not charging interest) by, for example, purchasing an asset, and immediately on-selling it to the person who wants it at a higher price which is paid in instalments [1]  
• as interest is forbidden, loans (eg 'sukuk' bonds) are presumed to involve partnership in a venture; the arrangement is governed by religious (ie sharia) law rather than by Western civil law (and these can be inconsistent); and securities tend to deliver a lower rate of interest and be illiquid (ie hard to sell) [1];
• a focus on developmental and social goals (and a religious connotation) is a distinctive feature. As techniques to avoid appearing to pay interest seemed merely a sham, Islamic banking only made serious gains when financial deregulation made fees more important for banks than interest [1]

Straws in the Wind: It can be noted in passing that:

• a (so called) 'clash of civilizations' has been of concern in relation to international affairs for some years (eg see Competing Civilizations);
• those seeking to promote institutions based on traditional cultures as alternatives to Western-style democratic capitalism would have been aware of each other's interests;
• Islamists also appear to advocate the adoption of alternatives to the $US (though this tends to involve a return to a gold standard);
• Asia (by export-based development) and the Middle East (through oil exports) had the major role in the global financial imbalances whose growth contributed to the GFC (see Financial Imbalances) - though the Middle East tended to direct its surpluses to the Eurozone in the first instance;
• in 2001 the present writer speculated that collaboration amongst extremists favouring traditional styles of socio-political-economy might have had a role in the 911 events (see Attacking the Global Financial System?).

Alternatives

There seem to be other options to improve the situation. For example, advanced economies (such as the US) might increase their productivity / incomes (and thus reduce their period of economic stagnation) by deploying methods for 'strategic market management' along the lines suggested (in relation to the Australian context) in A Case for Innovative Economic Leadership.

The prospects of emerging economies might be improved by recognition of defects that are built into prevailing business practices and economic 'wisdom' (see Problems with Conventional Wisdom which refers, for example to the distortion of local economic leadership by foreign resource investment and the adverse effects of traditional forms of foreign aid)

And rather than 'behind the scenes' manoeuvring designed to panic the world into a financial and economic 'solution' that would favour particular interests, a process might be put in place which explicitly takes account of differences in cultural traditions and capabilities in getting informed agreement about global machinery which might give all people a reasonable prospect of success (see the now somewhat dated proposal, A New 'Manhattan' Project for Global Peace, Prosperity and Security). The sorts of challenges that need to be overcome were speculated in Competing Civilizations). The latter referred, for example to: remaking effective democracy, ethical renewal, more effective development practices, and rethinking the role of money.

A BRIC forum in Russia in June 2009 sought means to ease the GFC while boosting the role of emerging economies. It called for a stronger voice in global forums; a diversified, stable and predictable currency system; and comprehensive reform of UN in dealing with global challenges [1]. 

There is little BRICs can do to change current global financial architecture. They have 15% of global GDP and 40% of foreign exchange reserves. They are united in concern that US's reserve currency status allows it to run budget deficits without fear of budgetary day of reckoning others would face. Excess $s must be reinvested to avoid damaging currency revaluation. There is little short term prospect of $US alternative - but Russia seeks system where particular motives and countries do not dominate. BRIC countries have little in common. China depends on manufactures' exports. Russia exports oil, gas and other resources. Brazil has agricultural exports, while India's growth is mainly domestically driven [1]

The Future?

Various observers have speculated about ways of moving forward, which do not yet appear to have resolved underlying difficulties.

For example:

• one observer argued that the GFC could be explained entirely in terms of commercial irresponsibility and defective regulation in the US, and suggested a way out of the crisis on the basis of that simplifying assumption. However, while doing one thing at a time (ie focusing on US institutions) is one possible approach, it would seem to merely make future global crisis unavoidable (see Avoiding Ongoing Global Crashes);
• after the GFC the world will be different. In particular the level of globalization will have been reduced, and also that development strategies based on diversification into manufactured and other modern goods (which generated and relied upon large international financial imbalances) will no longer be viable. The potential difficulty facing developing countries could be overcome by ensuring that domestic demand for manufactured and modern goods could be increased (eg by allowing currencies to float; targeted infrastructure investment; industry policies other than those applied through exchange rates). [1]
• it was suggested that "the age of a hegemonic model of the market economy is past. Countries will, as they have always done, adapt the market economy to their own traditions. .... A world with many capitalisms will be tricky, but fun." However The future is not necessarily one of many capitalisms - as the East Asian notions of a market economy seems to be based on Confucian social relationships rather than capitalistic search for profits (see Creating a New International 'Confucian Economic Order?).
• the US presented a proposal for uniform regulatory reform of banking that could have global implications. The need for uniformity was stressed in order to prevent international banks exploiting inconsistent rules and the US losing its banking status through tighter government scrutiny [1];
• there was uncertainty at recent Davos meeting whether new model that will emerge will be a radically reformed version of Western democratic capitalism - or some variant of the authoritarian state-led capitalism favoured by China, Russia and some other emerging economies. Developing countries have lost interest in Washington consensus since crisis - and everyone talks about new Beijing consensus. The West needs to reinvent its systems or lose. It is not adequate to claim that Western and Chinese models of capitalism are not radically different. Also they can't peacefully co-exist. China's determination to run huge export surpluses through undervalued currency gives West cheap products, job losses and higher debts. China is growing more sure about its rejection of democracy. Minor banking reforms will not restore the Western system - as GFC reflected failure of whole market-fundamentalist model of capitalism of Thatcher / Reagan period. The challenge for West is to again create a new version of capitalism - eg with reserve banks and governments taking more responsibility for managing economic growth. Western political systems may also need reform to make them faster in consensual decision making. Does government need a heavy involvement in finance, energy, environmental and strategic infrastructure - but less involvement in health, education, pensions [1]

A process to build agreement and facilitate complementary domestic initiatives that the present writer suggested in the context of the need for effective global responses to the underlying problems related to the 'war against terror' might (with modifications) be relevant if there were to be a serious international commitment to addressing the true complexity of the GFC (see Proposal for A New 'Manhattan' Project for Global Peace, Prosperity and Security).

Moreover in parallel with the narrow financial-system reforms arranged through the G20, it might be desirable to assemble some sort of 'coalition of the willing' to address the more fundamental problems.

However, as experience suggests that such initiatives are unlikely, the GFC probably marks the end of an era in many respects. For example:

• the role that the US has sought to play in world affairs since WWII (ie in promoting and defending Western-style democratic capitalism as the dominant system of political economy) will be even less financially feasible than it had been becoming because of large past budget deficits and spending backlogs;
• efforts to develop effective global institutions appear likely to end in failure. Existing weakness in the UN, will be compounded by an inability to reach agreement about any international system for economic and financial regulation because of the lack of agreement on (or even acknowledgement of) the radical culturally-based differences in perceptions about the nature of such a system; 
• virtual nationalization of (or at least extensive government influence over) many banks in the US and Europe appears likely, and this would tend to result in an inward looking, and rather than international, global financial system [1];
• countries such as US and Australia will need a concerted effort to boost the supply side of their economies in order to shift from high consuming capital importers to being high savings capital exporters. Methods to overcome their declining productivity performance have long been available (eg see Defects in Economic Tactics, Strategy and Outcomes, and A Case for Innovative Economic Leadership). The long delays in starting to consider these requirements (while priority is given to trying to stabilize economies on a pre-GFC basis) will clearly make this challenge more difficult;
• export-dependent economic strategies will be much less viable, and it will be difficult to unwind these without a retreat into protectionism;
• past strategies that led to the rise of Asia thus won't be sustainable, because export-oriented industrialization has been foundational. Development based on domestic demand, which would require financial institutions that took profitability seriously, would encounter severe political and cultural obstacles (eg see Are East Asian Economic Models Sustainable?). Whether socially-coordinated economic systems (eg Japan's 'non-capitalist market economy' or China's 'crony capitalism') can be successful as the basis for an entirely different kind of economic regime in which the role of capital / money played a minor role is currently unclear - though it does appear that such an arrangement is being attempted (see Creating a New International 'Confucian' Economic Order?);
• 'Europe' also appears likely to suffer setbacks because of both demographic and economic decline which are long entrenched [1]
• democratic governments may also be under pressure because of difficulties in meeting community expectations. Broadly representative democracy emerged following the industrial revolution in the UK arguably as a means for better sharing the wealth generate from the use of capital in mass production. This has progressively ceased to be available since the 1960s in the face of NIC competition in mature technology capital intensive industries - but was replaced by high value-added knowledge industries - especially those linked to financial services which are likely to be much less productive in future.  
• there appear to be no obvious techniques for future macroeconomic management, as counter-cyclical public spending proved defective in the 1970s (ie it was difficult to get the timing right so initiatives tended to amplify, rather than smooth, business cycles) and monetary policy was effective in the short term because it generated asset bubbles that were dangerous in the longer term.

The future may be one in which political and economic power will be available for the taking, and there will be many contenders perhaps using methods of which Western societies have little  experience or understanding (eg see China as the Future of the World?, Creating a New 'Confucian' Economic World? and Don't Forget Japan).

• Creating Unity
• Diplomacy Failed
• Unilateral Action
• Flaws
• Problems in Iraq
• Global Chaos?
• Governing by Crisis
• A: US Security Strategy

September 11: The First Test

Outline

The 911 attack in America in 2001 initially created the global unity needed to lead overdue reforms to the global order that would eliminate the breeding grounds of terrorism.

However no common basis for this could be arranged by top-level UK diplomacy. Also, because of the growing availability of weapons of mass destruction, the September 11 attack ensured that malfunctioning states on the global margins (who breed or support terrorism, and have often been acquiring WMD) could no longer simply be ignored or 'contained'.

Thus, instead of leading multi-lateral efforts to treat the cultural, economic and political causes of terrorism, the US administration chose to advocate general democratic political reform in the Middle East (perhaps to reverse the adverse perceptions of itself based on its past support of autocratic regimes), and also to pursue (almost unilateral) military action for regime change in the most morally and legally exposed 'rogue' state (Iraq), apparently in the expectation that 'liberation' could create a model showing how the economic and political failures that have bred terrorism might be overcome.

A fair case could be made for such an attempt to 'nip a new Cold War style contest between different systems of political economy in the bud', eg democratic reform to current autocratic regimes in the Middle East, might (a) be very popular (b) pre-empt revolutions by Islamist extremists and (c) result in at most a temporary shift in democratically-gained power to Islamists, as the latter's policies would not be the basis for practical governance. 

There were also many reasons to doubt that it would be an adequate or optimal response to current problems. For example, the 'freedom' that the US leadership rightly sees as the basis of its economic and political strength (and hopes to 'export' to allow others to improve their circumstances) depends on many complementary cultural features - a constraint that has universally been put in the 'too hard' basket. And democratic government requires supporting civil institutions and community attitudes that would take many years to develop. In the longer term, unilateral US action to impose conditions that, contrary to its expectations, would not actually allow all to achieve prosperity risks increasing the political exclusion that leads extremists to resort to terrorism.

In practice the attempt to leverage transformation of the Middle East by changing Iraq regime seemed by late 2003 likely to have only limited impact, and to be being downgraded. And by early  2004 it appeared that the outcome could be a significant deterioration of the situation in the region. Changes in tactics (mainly involving use of military forces to protect communities rather than to attack militants) stabilized the situation but did not make it possible to claim that the initiative had been a success.

Moreover there are real prospects that US influence might be overwhelmed by the attempt to find a unilateral solution, as: the US could never have enough resources; unexpected military, financial or trade retaliations might emerge; or a global economic crisis (that would escalate political extremism) might eventuate from the combined effect of: financial imbalances that may reflect structural incompatibilities between major economic models; or loss of consumer confidence if the 'war against terrorists with WMD' is not resolved; etc. The possibility that the attack in America could have been manufactured in order to justify US involvement in efforts to stabilize the Middle East (though implausible) was widely canvassed.

The power vacuum that could emerge would not be filled quickly or democratically.

The modern world was presented with a perilous and most-urgent three-way choice between (a) following the US administration and trying to make its 'solution' work or (b) creating a successful global multilateral order or perhaps (c) decades of political chaos and economic reversals.

It may be that precipitating a crisis was expected to change global institutions on the basis of a MADness (mutually assured destruction) similar to that which prevented serious conflicts during the Cold War. 

It may also be that China has been attempting to capture the high ground in global institutions on the assumption that its neo-Confucian traditions provide a better (and profoundly different) way to manage a multi-cultural global order than Western-style democratic capitalism does.

The Attack in America created Unity

In this environment, the September 11 2001 attack in America created a massive strategic opportunity for leading nations to achieve constructive change by:

• mobilizing and strengthening the US (eg in terms of: building unity by providing an external threat; raising morale by gaining the moral high ground; transforming self-obsession into a purpose; breeding 'heroes'; and giving key positions and resources to determined people and reducing constraints on their actions);
• allowing the US to assemble an historically unprecedented global coalition with a determination to eliminate terrorists and terrorism. Because terrorists who are capable of mass destruction are a threat to the global economy and to most states, and because only the US has the military capability to rapidly and effectively deploy forces in the most remote locations, the terrorists virtually forced all states to fall in behind US leaders [1, 2]. 
• allowing an asset bubble (whose bursting could have crippled the US economy) to be deflated in an environment in which other issues were more important;  

• encouraging many Muslim communities to improve their relationships with the West - because of concern to avoid a real clash of civilizations [1]

The need for response to terrorism that eliminated the factors that caused it (rather than a primarily military response) was obviously well recognized [1, 2, 3, 4], as was the critical role that nation building played - especially in Asia - in ultimate success in the Cold War [1].

Military options could never be adequate in dealing with Islamist extremism (as outlined in Competing Civilizations) because:

• extremist Islamists may be strongest and most active outside majority Muslim communities - in Western societies in particular;
• extremists are seen by their supporters to be struggling to achieve noble goals - and this will continue until those goals are seriously debated;
• the resentments extremists express are partly justified - including frictions in the Middle East associated with the establishment of the state of Israel to try to solve Europe's 'Jewish problem'. ;
• trying to locate extremists is likely to result in more injustices (especially if they are not members of the mainstream Muslim communities in which others search for them);
• removal of deprivation that contributes to resentment requires economic advancement - and this has cultural implications which hard-line tactics will not remove;

The author put forward preliminary speculations (see Defusing a Clash?) that goals for reform might have included (for example): seeking an environment in which all peoples could reasonably hope to succeed; reducing the incidence of despotic governments that give rise to terrorism; and creating effective mechanisms for global governance based generally on democratic-capitalist principles.  Such goals might be achieved by steps such as:

• strengthening the support institutions that enable democratic governments to be effective, and outlawing 'covert operations';
• ethical renewal - including a more serious metaphysics;
• enhancing cross-cultural communication;
• reform of key global institutions;
• new practices to accelerate development (including attention to the practical consequences of different cultural assumptions); and
• reviewing the economic role of money, and methods used for corporate governance;

The author also speculated that the most effective way to roll-back Islamist extremism might be to ensure that its 'spiritual leaders' gain enough democratic legitimacy to allow their likely lack of practical solutions to become obvious to potential followers (see Discouraging Pointless Extremism).

Diplomacy did not Produce Agreement

Britain's Prime Minister publicly advocated broadly-based global reform as the solution to international terrorism on behalf of the US-led coalition against terror [1].

However, despite travelling for months seeking international agreement, success apparently proved elusive.

While the nature of those discussions are not publicly known (a fact that makes meaningful public discussion of the world's response to terrorism now virtually impossible), it is likely that agreement was elusive because of a combination of:

• friction arising out of the current unsatisfactory global situation, the 'secret histories' of the Cold War [1], or resistance to incipient US unilateralism (which is likely to have been in evidence as it has been suggested that planning for regime change in Iraq predated September 11 [1]; and
• seeking broad agreement based on a 'political-economy package' that corresponded to Western (especially Anglo-American) assumptions - which neglected the practical (political / economic) consequences of different cultural assumptions.

It can be noted that:

• many do not support the Western ideals of democracy and political liberty. In particular:
  • endorsement of democracy is not universal - and in the absence of competent supporting institutions, democracy can be ineffective (see below);
  • there is determined opposition to the dominance of (eg socially-liberal) Western values [1] a resistance which in future could be associated with 'Southern' Christianity [1] even more than with Islam;
• the assumptions that are made under an Anglo-American world-views can lead to powerful economic outcomes, while others have had varying degrees of difficulty (see Competing Civilizations); in particular  
• the source of Islamist extremism is probably a fear for the future of Islam if Western economic and cultural traditions are globalized - a fear that is probably well-founded because the social and political rigidities that Islam prescribes make it very hard for affected communities to achieve the rate of change that a productive economy requires;
• the universalistic ethical systems that imply concern for 'the least, the last and the lost' in Western societies are not shared in East Asia's communitarian world-views - where obligations to consider other's welfare do not extend past those with whom one has a clear relationship;
• a general failure to analyze the practical consequences of different cultural assumptions means that disadvantaged communities have not known how to improve their situation and some have instead listened to conspiracy theories that suggest that their problems are simply due to deliberate oppression by those who are economically successful;
• some just object to 'Europeans' trying to run the world again [1]; and
• even in 'Europe' there are significant differences in outlook - which have contributed to divergence on many policy issues [1]. In particular this applies to the character of a potential global order and to the relevance of military force in solving problems  [1]. One observers suggested that many Europeans viewed the US response to terrorist attacks as 'Bismarchian' [1], a 19th century European approach to diplomacy which was seen as primitive  There are also institutional differences in the roles of the state (see above)

It is likely that in most cases the points of disagreement would be different. Moreover there is no common conceptual framework for debating such issues.

Thus there was probably no alternative proposal that would gain agreement - merely resistance to the suggested proposal.

In this environment, the US administration's ideas about responding to terrorism were outlined in its National Security Strategy: 2002.

In brief the NSS suggested (in effect) that:

• freedom must be the foundation of future models of political economy;
• the US is powerful (and should not allow that power to be challenged), but will not use that power for its own advantage, but to create a world in which free people can make their own lives better;
• defense requirements have been changed by the combination of radicalism with weapons of mass destruction. Threats must now be met before being fully formed;
• the need that all states have for security against such threats provides an unprecedented opportunity to build a stable international order;
• the US will support the spread of freedoms' economic and political benefits;
• weak states can be as dangerous as strong states, because they can breed terrorism and drug cartels; and
• multilateral arrangements are vital - but resulting obligations are serious.

This represented a more assertive policy, because rather than participating in multilateral discussions and complaining that they are going nowhere, the US stated that it had a solution and was going to implement it (and in doing so wanted to encourage multilateral institutions to become more effective).

A Parallel: a story is told of a person appointed to manage a nuclear power station which had a large problem in storing radio-active waste. Solving this problem had defeated his predecessor because numerous complex and contradictory regulatory requirements had to be met. The new manager decided to ignore all the regulations and just solve the problem. Everyone said 'You can't do that'. He said, 'I just did'. So for years afterwards his power station was visited by study groups trying to learn the secret of his success.

However, if everything had not gone well, the manager would have been jailed for breaking the very laws that made practical progress impossible.

Another parallel: might be drawn between this proposal and the Europe 92 process to overcome (so-called) 'euro-sclerosis' (which had blocked the establishment of an integrated European community because every possible step was blocked by some opposing interests). Progress was achieved by initiative outside the political process to develop an integrated vision. If this parallel has any validity then it would be expected that supporting and credible 'sub-visions' building on the NSS proposal will emerge.

And another: might be drawn with the assertive strategies adopted by Microsoft in its dominance of some software systems.

Unilateral Action

In the 1990s as the effectiveness of the UN declined and the effect of disorder and economic failures in marginal states started to spread, some in the US defence establishment became increasingly attracted by the 'neo-con' idea of using its power to create unilateral security solutions.

As a diplomatic search for consensus was not seen to have produced a satisfactory solution in the post 911 era, such influences dominated and the US apparently pursued a multi-dimensional strategy involving:

• general withdrawal of support for autocratic regimes in the Middle East - and an advocacy of democracy. This strategy, Wolfowitz (seen as leading thinker) argued, had been developing since 1986 [1] - and was clearly based on accepting the validity of 'blow-back' theories (ie that past US support of autocratic regimes on the basis of geo-political 'realism' produced problems which rebounded on the US);
• military action to overthrow the most legally and morally exposed 'rogue' regime, that in Iraq;
• a significant recasting of its post WWII security alliances [1].

However, military action in Iraq generated opposition from many sources on the basis of: the perceived humanitarian cost; a lack of coherent rationalization of the plan; concern that it could not be effective; suspected linkages with the Israel / Palestine conflict; the presumed self-interested motives of those developing such plans; and extremists' alternative visions for 'revolution' in the Middle East.

The difficulty of evaluating very complex issues (because of the way human brains are wired) can be noted in considering this debate [1]

Fatal Flaws?

However there seemed to be a critical problem in any unilateral option which focused on replacing Iraq's rogue regime.

The NSS presented 'freedom' as the key ingredient needed to create prosperity and thus inhibit a collapse into political authoritarianism. Other analysts suggested more details of possible institutional requirements that would allow 'freedom' to be effective.

The problem facing Iraq (which was once one of the most successful Middle Eastern societies) was seen to be like that in Europe at the time of the Marshall Plan - where there were already many established economic institutions and only constraint was bad leadership. The main reforms needed were seen as involving: central bank; secular educationists; honest courts; and a road map to independence [1]

The Japanese precedent needs to be considered where victors tinkered with the media, the education system, the textbooks. [Ajami]

Iraq requires unity; free press; end to special militias; and removal of all of old regime [1]

Office of Reconstruction and Humanitarian Aid is focusing on: restarting and increasing oil production; telecommunication; getting civil service working; small business loans; reconstruction of state enterprises; currency; securing foreign investment [1]

The expectation that 'freedom' can lead to prosperity may have been be based on some recent developments in economic growth theory.

Theories of Economic Growth - an unavoidably simplistic view:

Economists have a long tradition of seeking explanations of economic growth (eg see Historical views and website on growth theory).

Until the 1990s, an influential view was that developed by Robert Solow in the 1950s. Under this view, growth was analyzed through a production function whose inputs were labour and capital. Solow showed that most growth was not associated with those inputs but came from a third factor which was ascribed to knowledge or technological change.

In the 1990s economists tired of the 'exogenous' theories under which most economic growth was not explained by their models, and at the suggestion (initially) of Paul Romer many efforts have been made to develop 'endogenous' theories under which knowledge / information could be treated as an input to a production function.

In parallel, there has been debate about why it was that economic growth initially and primarily occurred in Western societies. In this respect two views have been said to dominate [1] - namely the view of radical sociologists that growth is a disease which is the result of particular cultural characteristics, and Robert Lucas's view (derived from 'new' growth theory) which assumes that growth can be achieved in any culture when households begin to envisage the possibility of changing their circumstances.

It may be that there may have been a presumption that 'freedom' can create the perception that change is possible and thus provide the basis for growth.  

Furthermore there seems little doubt that individual freedom has been a major factor in the economic gains made by Western (especially Anglo-American) societies (see Cultural Foundations of Western Dominance).  

None-the-less the short term economic benefits of 'freedom' to others are uncertain:

It has been argued that on several occasions over the last two centuries earlier US administrations have sought to ensure progress in backward states through enforcement of Western standards with little success [1].

Moreover the types of profound problems that Iraq presented were replicated in various ways (though seldom as severely) in dozens of modern states.

Thus, while changing Iraq's murderous regime was desirable, a review of prevailing commercial / economic 'wisdom', the organization of global institutions and the impact of cultural constraints on political and economic systems are even more necessary. Visiting Baghdad in force was not a pre-requisite to achieving this.

The US and its allies can not achieve what is needed to suppress terrorism by making a scapegoat of Iraq's regime, any more than conspiracy theorists achieve when they make scapegoats of the US administration for its allegedly selfish motives in dealing with what are, after all, only symptoms of much more profound problems.

The potential for economic and political weakness to lead to the failure of states in Australia's immediate vicinity and insecurity (a problem that would not be overcome no matter what is achieved in the Middle East) can be noted [1].

In practice 'visiting Baghdad in force' seems to have created the opportunity for extremists (who have no ability to advance their community's welfare, or interest in doing so) to present themselves as relevant by developing a 'resistance' to outside forces [1]. This  plays into the hands of those who (like those involved in the Palestinian Intifada [1]) resort to violence to avoid having to face up to the practical difficulties of developing a modern society and thereby ensure ongoing chaos and that nobody wins.

And in the medium term, a unilateral US attempt to impose 'freedom' everywhere (which even without 'resistance' can not actually lead everyone to prosperity) must increase the numbers of people who find themselves both economically and socially disadvantaged and politically excluded.

Even in Australia, where cultural features were a less serious constraint, 'freedom' (in the form of a liberalized market economy) did not ensure that all regions would prosper - and an extremist political reaction was the result (see Assessing the Implications of Pauline Hanson's One Nation)

In less favoured environments, economic and social disadvantage and political exclusion will allow extremists to see terrorism as a way to force others to care. While it seems that extremists usually have 'rat-bag' ideas, they don't know this. Moreover they will not tend to learn much (except perhaps a self-induced sense of moral virtue and hatred of their 'oppressors') when they are shot at after they have resorted to terrorism.

Practical Problems in Iraq [Added from November 2003]

By late 2003, a successful military campaign had been followed by:

• a process of restoring infrastructure and developing an interim Iraqi administration [1, 2, 3] (for which it seemed that preliminary planning had been poorly advised);
• more open access by Iraqis to information [1]; and
• an inability to locate WMD physically [1] (despite the reported finding of documentary evidence [1] and claims about the reality of such weapons [1]) - which suggested that such items had been (a) destroyed and remained only in the heads of scientists and engineers or (b) relocated. Another view is that such weapons did not exist prior to Iraq invasion - which raised questions about the source of misleading intelligence [1] and the possibility that it related to program of deterrence by Iraq [1]

However serious difficulties were encountered in ensuring security and establishing a viable regime in Iraq [1, 2, 3]. The US sought multilateral support because of the difficulty of the challenge [1, 2] - which the UN apparently wished to provide [1] or encourage [1] though some key states were opposed. In practice the security situation was not stabilized, and attacks on Coalition forces, perceived collaborators, the UN and humanitarian agencies continued.

Rather than establishing a (democratic) constitution for Iraq before elections and a formal transfer of power, it seemed likely that power will be transferred hurriedly to a populist administration [1, 2, 3] - presumably operating under Iraq's partly-satisfactory 1925 constitution [1].  Alternately it might take the form of an Islamic state conforming to the wishes of the Shi-ite majority [1, 2]. The latter's long term prospects would presumably be poor.

The overall outcome seems likely to be:

• partial achievement of the goal of the US administration [1] (which it seems to share with Israel) of defusing terrorism risks originating in the Middle East by making countries in the region more politically and economically successful;
• a clear demonstration of the lack of effectiveness of the naive use of military force - and thus presumably a less-unsophisticated approach to the future use of power by the present US administration in the pursuit of that on-going goal [1];
• eventual transition of the interim Iraqi administration into either (a) a failed state as a result of ongoing instability (b) a 'balkanized' set of smaller states reflecting ethnic divisions [1, 2] or (c) a moderately successful modern state;

However there is also real concern that attempts to transfer power to an Iraqi administration could result in complete failure [1] and a situation in the region far worse than had previously existed [1].

A major source of the problem seems to be that, in the absence of other arrangements, US military forces were left with most responsibility for interim administration. Their focus was on security issues which were real but only a small part of the task that had to be addressed - and they clearly lacked the knowledge and skills to establish constructive rapport with the Iraqi community.

By late 2004, various observers speculated about a complete breakdown in authority [1, 2]. And US president Bush suggested that it seemed that the war against terror could never be won [1]. The loss of security in Iraq through a democratic experiment might actually discourage the region from exploring this option rather than providing a positive example [1]. By early 2005 it was suggested that escalating insurgency could destabilize the attempt to establish democratic government in Iraq, and create a pool of fighters who would extend in the Middle East generally and against the US [1]

It seems likely that the precedence given to implementing a 'free market' Economic Plan for Iraq was a factor in difficulties in establishing a viable new truly-Iraqi administration [1]. It was argued above, that such theories could not generate a viable economic solution because much more is required for a successful market economy than economic 'liberty'. An even more profound problem was that sophisticated political and economic institutions (which are not present in Iraq) are required to even understand the issues involved. It seems it was only belatedly recognized that there must thus be a divergence between the Economic Plan and any democratic consensus of Iraqis, and that this led to dangerous delays in establishing a new truly Iraqi administration.

By late 2006 the outcome was described in terms of: future control of the Middle East by radicals who will cause great harm in region and to the rest of the world; escalation of Sunni-Shia tensions; a new base for terrorists in Iraq; perceptions of democracy as leading to a loss of public order and Sunni control; reinforcement of anti-American sentiment; reduction in US influence worldwide; failure of Middle East peace process; Iran and Israel as the major powers in the region; Islam filling the political and intellectual vacuum and underpinning the politics of the region; and authoritarian and religiously intolerant Arab regimes .[1]

The Risk of Systemic Failure and the Growth of Global Chaos

The current global order is being strained by world leaders' failure to date to agree on how to deal with the immediate threat of terrorists with WMD, and the role which the economic and political failure of weak states plays in breeding terrorism or direct threats.

As noted above, the US administration has seemed to have a plan.

Other nations have been publicly divided between: those who saw the US's strategy as better than nothing; those who distrust the US leadership or the democratic capitalist model that they hope to globalize; and those who recognize a need for broadly-based global reform but do not know what model would actually work and lack the economic and military strength to achieve this without US backing.

The problem has been that:

• though the NSS probably reflected a balanced agenda (eg including the efforts that were made to find political and economic options to eliminate the breeding grounds of terrorism, and the contributions of the US State Department), its strongest visible inputs seem to have had a military bias - reflecting a 'neo-conservative' orientation favouring the humanitarian use of US power [1]. For example,  eg the NSS appears to have have been at least partly founded on the "Rebuilding America's Defenses: Strategy, Forces and Resources For a New Century," (2000 - see Project for a New American Century to whose 1997 principles many influential US officials were signatories). This highlighted the undoubted need for the US to have a vision for building on the achievements of past decades, but dealt only with defense issues without presenting a vision of a better global political and economic context to which such a defense strategy would then be a response. Its primary thrust involved pre-empting any challenges to US hegemony - including inhibiting those who might become allies of such challengers [1]. This proposal in turn seemed linked to:
  • a controversial 1992 Defense Planning Guidance (first disclosed in NY Times, 8/3/92) - which prescribed a military capability to protect US interests but did not appear to have been based on deep consideration of how security problems arose or to consider non-military solutions;
  • planning for possible regime change in Iraq which predated September 11 [1]
• none of the critics have demonstrated a plausible alternative plan for dealing what are now urgent imperatives. For example containment, that some favoured, was clearly inadequate - as 'compliance' by Iraq's regime with weapons inspections in the face of 200,000 heavily armed troops on the border was not really proof that 'the system works' [1]. And if the war against terrorism is to be won, it is vital to eliminate the economic and political weaknesses that breed it. If the US's assumption that this mainly requires 'freedom' is invalid, then it is essential to define the alternative;
• having challenged a dictator with superior military force, if this had not been carried to completion (and no one else did anything that would solve the problem), the attacks from the economically and politically 'failing' world would grow - resulting in material damage, loss of life and injury to the current global order;
• no institutional framework exists to legalize what might really need to be done - thus potentially allowing those who take responsibility to be viewed as 'war' criminals.

Moreover those who could see flaws in what was proposed were not themselves actually doing anything else to solve the problem. It was futile to just oppose others' solutions [1].

And, because it was not hard to envisage the situation deteriorating [1], perhaps catastrophically, it was equally futile to formulate plans for what might be done at some future date after current administrations had failed and been democratically replaced - as there might be too little left for future administrations to work with. 

If the strains in the current global order are not mended, it could fail leaving a huge vacuum of power that would not be filled by liberal democratic states. In particular:

• the European Union, which presents alternative democratic Western models to those which the US and its allies are advocating: has depended on the US military umbrella (as noted above); and has relatively much weaker economic capabilities (and much higher unemployment) than in (say) the US;
• East Asia (dominated by Japan and China), which now comprises about 50% of the global economy, involves many competing interests within broad political and economic traditions that are radically different to those of Western societies - in which liberal democracy is a decoration rather than a foundation;
• amongst numerous smaller states, all that have aspirations to power are autocratically governed.
  

As a result genuine global debate in the public arena is emerging for the first time about what should be done - and this will:

• perhaps force the development of workable global political institutions;
• ensure that attention is given to weaknesses that may currently exist in global economic institutions and assumptions (as speculated above);
• make it harder for nations to act unilaterally. For example:
  • the need to rebuild political capital made it essential for the next major initiative that the US took after Iraq to be diplomatic rather than military (eg noting [1], and that US influence over nation-building in Asia has been supplanted by China - partly due to US unilateralism [1]); and
  • any defects in the US national political process have become a matter for global, rather than purely domestic, debate;
• increase scope for Discouraging Pointless Extremism by exposing the 'solutions' advocated by the spiritual leaders who advocate terrorism to critical review;.

In particular China, which has achieved accelerated economic growth (see China's Development), has started operating within the international system [1], and done so with considerable sophistication.  It seems likely that China's leadership has made a strategic judgment that modernized Confucian traditions (derived from those which have supported a Chinese empire for 4000 years) are likely to prove better able to dominate in a multi-cultural global order than those of Western democratic capitalism.

Needless-to-say this would involve a global order build principles that were vastly different to those Western societies have sought in efforts to develop a global order in recent centuries (eg individualism; individual rights; universal ethics; coordination of economic transactions through financial outcomes; democracy) [eg see China as the Future of the World, The Abduction of Modernity].

This challenge seems likely to ensure that the US also attempts to rejuvenate the multilateral system.

• Beyond MADness

Global Governance by Crisis?

In evaluating what is being achieved by the more-or-less unilateral US action against terrorism, it is relevant to speculate about the possibility of either a simplistic, or a very sophisticated, strategic intent and method.

At the simplest level, the 'war against terror' has led to the emergence of a military-focused US presence in many of the world's trouble spots [1] . And this, which can be viewed as a form of 'imperium', may be all that has been intended and achieved.

However it may be that a 'hidden agenda' behind unilateral US action has been to create a situation which would force the world to take multilateral mechanisms such as the UN more seriously [1].

Indications that US unilateralism might not be designed for the US to 'run the world' imperially but just to worry various despots (and others) enough for them to try to get the UN to act realistically (even if just to put a leash on the US), or to take more practical responsibility for international issues include:

• the US would traditionally advocate establishment of a multilateral global order and was heavily involved in initial development of UN machinery which was supposed to be part of this;
• the US has a traditional ideology that is opposed to 'colonialism' and a community preference for isolationism and self-absorption - and the current President is reputed to be of this mindset. This does not pre-dispose them to want to be responsible for 'hands on' political control of other countries - or suggest that the resources required to do so would gain long-term Legislative approval;
• the US's global dominance has been quite different to that of classical 'empires' [1]. Moreover:
• conventional empires were far more costly because they did not involve multilateral institutions to reduce security and administration costs;
• the US's dominance has depend on a high  level of acceptance that its actions would generally promote a peaceful order to the benefit of all. This whole edifice would fall apart if a different general perception were to emerge;
• the 2002 NSS dramatically increased the US's emphasis on multilateral institutions - and particularly on ensuring that they are actually taken seriously;
• the anti-Americanism that results from the US's global dominance would lead to opposition to reform of the multi-lateral system if the US was seen to be organizing (rather than 'threatening') the process; 

• during the Cold War the strategy of MADness (mutually assured destruction) was used to block serious conflicts. The risk of systemic failure outlined above seems to constitute a new basis for the very familiar concept of MADness;

• the US simply lacks the resources to carry through a unilateralist agenda [1, 2, 3, 4], and faces significant limitations on its power to act alone [1]. Any future economic reversals (eg the bursting of what appears to be an asset 'bubble') could significantly reduce the US's ability to pay huge military bills.

Despite critics' opinions about 'simple-mindedness', it seems likely that the US presidency is gaining advice from strong national strategic machinery. In particular: concepts used in discussing strategy (such as the need for a clear central focus) are sophisticated and show signs of learning from East Asian Art of War methods; the US President himself is a graduate of the Harvard Business School (Bookhiser R 'The mind of George Bush', FR, 28/3/03) and would thus be familiar with the major advances in corporate strategy techniques that were made in the 1990s (see Strategy Development in Business and Government); and 'unilateralism' appears to have a relationship to the concept of 'stretch' as a strategic methodology [1] which was one of those advances. Moreover taking initiatives gives one control over a situation which does not exist if one simply reacts (as the latter can potentially lead to the 'boiling frog' syndrome).  And sponsoring a democratic revolution in the Middle East would drive a wedge between radical Islamists seeking a revolution to establish non-democratic (theocratic) regimes, and Muslim communities who reportedly favour democracy [1] 

People who seems to be aware of such issues will presumably also be aware of:

• what 'imperial over-reach' means [1]; and thus
• the vital importance of effective civil institutions such as a UN to keep the peace - because of the immense cost of reliance on ongoing military action;
• that deception is a valid strategy;
• the success that Afghanistan (for example) has had in evicting invading armies (and at not much else) for the past thousand years;
• the difficulty of hands-on Western administration of a middle eastern country such as Iraq (and presumably the introduction of democracy) [1, 2], and the potential to destabilize other regimes in the region with which the US has had workable relationships [1].
• the futility of being bogged down at the ends of the earth for no purpose - but the vital necessity now to do 'something' about weak / rogue states;
• that smoldering anti-Americanism has never resulted in the formation of an opposing coalition because US power has tended to be used benevolently, and that if the US was seen to have changed (a) cooperation in the war against terror could evaporate and (b) new balance of power resistance would emerge (eg Russia and China; in the Middle East; Europe; the UN);
• the electoral oblivion that would await any administration that generated a 'balance of power' coalition against the US;

Beyond MADness

In practice it can be noted that:

• many people have become immensely concerned about the situation (eg about the need to 'contain the US'), and starting from their individual (narrow) view of the issues involved have been obliged to take an ever broader view and so achieved increased understanding of the requirements for effective global governance;
• an 'exile' option for Hussein emerged from Middle Eastern nations whose autocratic leadership would face problems if the US displaces an autocratic regime in Iraq;
• it seemed at one time that UN Security Council support for the use of force against Iraq's regime could well emerge [1];
• reform of the UN was advocated to a forum of non-aligned nations [1], and great concern was expressed by many of the world's most disaffected nations about respecting the UN Charter [1]
• the Secretary General of the UN re-emphasized the Security Council's determination to disarm Iraq [1]
• Britain's PM sought the reconstruction of key multilateral institutions [1]
• ways in which UN institutions might be reformed have been suggested [1, 2], while others have suggested the need for an entirely new framework [1]
• opposition to a multilateral solution to the regional threats posed by North Korea's nuclear weapons program which the US had sought disappeared after the rapid defeat of the Iraqi regime (Walsh M 'Home run required', Bulletin,  22/4/03)
• the EU is lobbying Australia about participation in the multilateral system [1]. Presumably it is doing the same with the US - and seeking ways to make the multilateral system more effective from the US's viewpoint.
• China's president advocated a strong role for the multilateral system [1];
• Muslim leaders in SE Asia appeared to strongly reject the extremism of some Middle Eastern Muslims - and endorsed an acceptance of modernization [1] ;
• Islamist extremists have included the UN as a claimed enemy (eg because of its role in East Timor) - and UN facilities (and other multilateral institutions such as the Red Cross) have been attacked ;
• the UN Secretary General has called for reform especially of UN security arrangements to be able to deal with problems such as terrorists and WMD - and for comprehensive reform of the UN (and of its relationship with the Bretton Woods institutions) to address the problems that breed terrorism [1];
• there are indications that the international community recognizes the need to succeed in Iraq - and that the US electorate will not tolerate anything but a multilateral approach [1];
• the US president expressed support for multilateral action [1] - a view which was restated strongly by the US Secretary of State [1];
• the need to resist al Qaeda politically (rather than militarily) was advocated by an experienced Australian political operative [1]
• the  Pope called for a more effective global order [1]. His ideal involved 'communitarian' concepts - as a middle way between collectivism and individualism / capitalism. In this (a) the centrality of religion to formation of society would be recognized and (b) the community would mobilize church resources to enable people to help themselves, and resist anti-religious movements (eg Nazism / communism) [1];
• Iraq has been said to be likely to be the first and last US 'pre-emptive' action [1];
• George Soros, in criticizing US efforts to deal with terror by the use of force; developed coherent proposals for global reform [1]
• pressure for UN involvement (including the deployment of Arab / Muslim forces) in the transition to Iraqi self-rule has emerged [1];
• UN proposals for transition to Iraqi self-rule seem likely to be acceptable [1];
• US / UK proposals for transition to self-rule in Iraq gained unanimous Security Council support [1]
• the weakness of 'hard power' when not accompanied by effective 'soft power' has been seen to be demonstrated in Iraq [1]
• when neo-con methods failed in Iraq, US administration turned the problem over to those favouring multilateral solutions [1]
• there has been a substantial extension of democratic government models - especially in the Middle East [1, 2];
• reform proposals put forward for the UN correspond very closely to traditional US views, and would eliminate the features which have led the US to downplay its significance [1, 2];
• US administration has proposed Wolfowitz to head the World Bank [1, 2]. Wolfowitz appears to have been the many architect of the policy of promoting good governance in dysfunctional states (perhaps by democratization) to reduce security threats. Based on the CIA notion of 'blowback' (ie that support for 'bad' governments creates problems) he opposed the traditional view that the US should support whoever in a country seemed favourable to US interests (even if they were brutal dictators). His ideas were apparently a factor in the US invasion of Iraq (which was rationalized by concern about WMD) and in the pressure exerted for the spread of democratic practices. A position in the World Bank (where the effectiveness of aid programs has been disabled often by poor governance) could transform Wolfowitz's agenda from a unilateral US program (through the unsatisfactory agency of the Pentagon) to a multilateral agenda.
• Europe, through the adoption of different methods (perhaps appropriately described as extending a hand of friendship) has been seen to be creating a zone of peace, while US influence declines [1]

However if this hidden agenda was real, then the possibility of an even more deeply hidden source of influence on US policy might need to be considered - because the methods being used would correspond to the role of leaders in Japanese society who traditionally stimulate change by precipitating a crisis (see A New Shogun Scenario).

• Support
• Opposition

ADDENDUM: Précis of US National Security Strategy: 2002

Introduction: The struggles between liberty and totalitarianism ended with victory for freedom—and a single sustainable model for national success: freedom, democracy, and free enterprise. Now only nations committed basic human rights and political and economic freedom will be able to assure future prosperity. The US has unparalleled military strength and great economic and political influence. It does not use its strength for unilateral advantage - but seeks a balance of power that favors freedom. In a safe world people can make their own lives better. The US will defend peace by fighting terrorists and tyrants, building good relations among great powers, and encouraging free and open societies on every continent. Defence requirements have changed. Enemies in the past needed armies and great industrial capabilities. Now, shadowy networks can bring great chaos cheaply - by using the power of modern technologies. Defence requires military power, homeland defenses, law enforcement, intelligence, and cutting terrorist financing - and is a global enterprise of uncertain duration. America will help nations in combating terror, and hold to account nations that support terror. The gravest danger comes from combining radicalism and technology. Enemies are seeking weapons of mass destruction. This will not succeed. Defenses will be built against missiles, and access to dangerous technology denied. The US will act against such emerging threats before they are fully formed - using the best intelligence and careful planning. In future, the only path to peace and security is the path of action. In defending peace, the US will take advantage of an historic opportunity to preserve the peace. The international community has the best chance since the rise of the nation-state in the seventeenth century to build a world where great powers compete in peace rather than preparing for war. The great powers are united by common dangers of terrorist violence and chaos. The US will build on these common interests to promote global security. Nations are also increasingly united by common values. The US will encourage the advancement of democracy and economic openness in Russia and China, as these are the best foundations for domestic stability and international order. Aggression from other great powers will be resisted, as the peaceful pursuit of prosperity, trade, and cultural advancement is welcomed. The US will extend the benefits of freedom across the globe - by working to bring the hope of democracy, development, free markets, and free trade to every corner of the world. 911 showed weak states, like Afghanistan, can pose as great a danger to our national interests as strong states. Poverty does not make poor people into terrorists. Yet poverty, weak institutions, and corruption can make weak states vulnerable to terrorist networks and drug cartels. The US will stand beside any nation determined to build a better future by seeking the rewards of liberty for its people. Free trade and free markets have proven their ability to lift whole societies out of poverty. The US will deliver greater development assistance through the New Millennium Challenge Account to nations that govern justly, and also reduce the toll of infectious diseases. In build a balance of power that favors freedom, the US believes that nations have responsibilities - to enjoy freedom they must fight terror; to have international stability they must prevent the spread of WMD; to have aid they must govern themselves wisely. No nation can build a safer, better world alone. Alliances and multilateral institutions are vital. But international obligations must be taken seriously - and not only symbolically. Freedom is the non-negotiable demand of human dignity. In history, freedom has often been threatened. Now, humanity has the opportunity to further freedom’s triumph. The US is happy to lead in this mission.

Overview of America's International Strategy : The United States possesses unprecedented— and unequaled—strength and influence in the world. Sustained by faith in the principles of liberty, and the value of a free society, this position comes with unparalleled responsibilities, obligations, and opportunity. The great strength of this nation must be used to promote a balance of power that favors freedom. For most of the twentieth century, the world was divided by a great struggle over ideas: destructive totalitarian visions versus freedom and equality. That great struggle is over. The militant visions of class, nation, and race which promised utopia and delivered misery have been defeated and discredited. America is now threatened less by conquering states than we are by failing ones. We are menaced less by fleets and armies than by catastrophic technologies in the hands of the embittered few. We must defeat these threats to our Nation, allies, and friends. This is also a time of opportunity for America. We will work to translate this moment of influence into decades of peace, prosperity, and liberty. The U.S. national security strategy will be based on a distinctly American internationalism that reflects the union of our values and our national interests. The aim of this strategy is to help make the world not just safer but better. Our goals on the path to progress are clear: political and economic freedom, peaceful relations with other states, and respect for human dignity. And this path is not America’s alone. It is open to all. To achieve these goals, the United States will:

• champion aspirations for human dignity;
• strengthen alliances to defeat global terrorism and work to prevent attacks against us and our friends;
• work with others to defuse regional conflicts;
• prevent our enemies from threatening us, our allies, and our friends, with weapons of mass destruction;
• ignite a new era of global economic growth through free markets and free trade;
• expand the circle of development by opening societies and building the infrastructure of democracy;
• develop agendas for cooperative action with other main centers of global power; and
• transform America’s national security institutions to meet the challenges and opportunities of the twenty-first century.

A supportive view

It is only recently in history that nations have commented on their national strategies - as compared with expecting historians to deduce them. Kissinger's State of the World reports had been candid. But it was the DoD Reorganization Act of 1986 that obliged presidents to report regularly on National Security Strategy. Most such reports have restated past practices. However the National Security Strategy: 2002 has stirred controversy. The terrorist attacks have prepared the war for a new strategic approach.  The differences from statements under Clinton are interesting - it refers to defending peace (rather than assuming it); it calls for cooperating amongst great powers. It seeks free and open societies world-wide, where Clinton advocated democracy and human rights. It is more forceful and multilateral than its predecessor. A significant innovation is equating terrorists with tyrants as sources of danger. This is because such persons now have access to WMD. The strategy stresses the legality of nations taking action (before being attacked against forces that threaten attack. This strategy relies on hegemony - which in turn relies upon cooperation amongst the great powers (where Clinton's concern had only been with the weak). It also assumes that others prefer the stability that a hegemon brings, and that the US's universalist values are a better basis for this than many others. Finally the strategy reflects the view that it was not poverty that motivated terrorism, but rather the absence of representative institutions in their own countries that turned political dissidence into religious fanaticism. Thus the goal of US strategy must be to spread democracy everywhere - the job that Woodrow Wilson started. The strategy differs from Clintons in that it is proactive; it is coherent (which Clinton's simultaneous cultivation and humiliation of Russia never achieved); reflects an advanced view of hegemony; and combines power and principles. However it doesn't rationalize Bush's 'axis of evil' comments- which may have been ill-advised. Why go after Hussein? The probably reason is the power of victory. In Afghanistan the US got a taste of being welcomed as liberators, and it is assumed that this would happen again in Iraq (which is the most feasible place to now achieve this). The intent could be to undermine and remove reactionary regimes in the Middle East - thus eliminating the breeding grounds of terrorism. In the process this can save the UN from the irrelevant into which it would descend if its resolutions continue to be neglected. If this is so, then it is a truly grand strategy whose goal is to modernize the entire Middle East. There is no way to tell if this would work. Success requires being able to do many things simultaneously. It is not that authoritarian regimes support terrorism, but that they produce generations of disaffected people from whom terrorists draw recruits. Authoritarians have been relied upon in the past - but this may not continue in future. The strategy also relies on (a)  being welcomed as liberators in Iraq (b) maintaining the high moral ground. The relationship between terrorism and WMD means that authoritarian regimes anywhere can no longer be tolerated.   (Gaddis J., A Grand Strategy of Transformation, Foreign Policy, March April 2003)

Opposing views

Typical opposing views can be identified as links from the above document.