In the midst of the current economic and financial crisis the world is radically changing. Comparisons are constantly being made between the collapse of the global economy that is now being experienced and the collapse the world went through in the 1930s. Whereas most of the discussion has limited itself to the extent of the downturn and the methods being used by policymakers to avoid a repeat of the severity of the earlier depression, I would like to focus on another area in which comparisons can be made. The specific area I would like to focus upon is the relative shifts that are taking place in economic and financial power in the world.
At the start of World War I there was no question that Great Britain was the number one economic and financial power in the world. The 1920s and the 1930s represented a turning point in the economic structure of the world and a change in the location of the center of financial power. The change in economic structure related to the final triumph of the industrial sector over the agricultural sector in the most advanced countries in the world. This movement favored the United States over Europe. The center of financial power in the world shifted from London to the United States. The changes in industrial structure helped to explain parts of the economic dislocations of the Great Depression that were not fully absorbed until World War II. The shift in financial power was not really recognized until after the war.
An important and interesting history of this period can be found in the book “Lords of Finance” by Liaquat Ahamed. I have written a review of this book for Seeking Alpha and this can be found at http://seekingalpha.com/article/121616-financial-collapse-a-lesson-from-the-20s.
I am bringing up this history because I believe there is a similar shift in economic structure and financial power that is going on in the world at the present time. It is important to understand these changes because they are going to influence what is going on in the world for a long time.
Like the 1920s and 1930s there is an economic restructuring going on. To me, the emerging dislocations in the world are related to advances in information technology and the global changes in energy needs. I have no idea how these dislocations are going to work themselves out but there are huge changes coming. The innovation in financial instruments markets over the past forty years or so are the result of the new information technology and the intense study of what are now called “Information Markets” is going to lead to transactions and trading opportunities that have not fully been realized yet. I believe that the collapse of the auto industry is just one part of the mammoth changes that are coming in the area of energy sources and uses.
The other shift that is taking place is in the location of financial power within the global marketplace. Yesterday it was announced that Russia and Brazil will each acquire $10 billion of bonds from the International Monetary Fund (See Brazil, Russia Trade T-Bills for IMF Clout, http://online.wsj.com/article/SB124463884266502011.html). China is planning to purchase $50 billion in IMF bonds and it is said that India will also make a similar purchase. The BRIC countries are on the move!
The reason given for the purchase of the IMF bonds is to increase the clout that these emerging nations have on world economic and financial affairs. The BRIC nations believe that they have earned and therefore deserve to play a bigger role in what is going on globally. Hence, the movements of these countries are not surprising and are not uncoordinated. The leaders of the BRIC nations have been meeting regularly and communicating frequently. Their next group meeting begins June 16 in Russia.
The important thing for the leadership in the United States to realize is that they must take the world into consideration when making decisions relating to U. S. fiscal and monetary policy. I have gotten comments on my recent posts about the dollar that question the need for policy makers to be concerned about the value of the dollar in their decision making. I agree with Paul Volcker that the most important price in a country is the price of its currency. The United States, even more than in the past, will not be able to afford to ignore what the rest of the world is saying about the direction its budget policy and monetary policy are going. All too often in the past, and especially in the past eight years, American leadership has thumbed its nose at world opinion. The rise of the BRICs indicates that this time is over and real attention needs to be paid to what others are saying and doing. Although the United States will continue, in the near term to be the major financial power in the world, the times are changing and will continue to move in the current direction over the next ten to twenty years.
There are two reasons for saying this. First, Brazil, Russia, India, and China are going to continue to become more powerful economically and financially. Whereas there may not be an absolute shift in world power in these areas, there will be a relative shift with the BRIC nations becoming relatively more powerful. This, in my mind, is not going to stop.
Second, some form of international organization is going to evolve that will oversee global financial institutions and financial markets. The IMF is a natural place to look for such leadership. In the past it has not quite lived up to its possibilities. Now, however, it looks as if there is a new focus on the possibilities it presents. The BRIC nations seem to be eying the IMF as a place where they might be able to exert their growing economic and financial clout to attain the recognition and influence they want and believe they deserve. The IMF is certainly not an unwilling recipient of such attention and is actively seeking more funding.
What does all this mean for investors? I would like to focus on just two points related to the financial issues. First, the United States seems headed for a clash with the rest of the world in terms of monetary and fiscal policy. The current and future budget deficits appear to be unsustainable and the Obama administration has not yet presented any credible plans to reduce the amount of debt the government will be creating. In addition, the Federal Reserve has already put so much liquidity into the financial system that Bernanke’s statements about removing the liquidity as the crisis retreats seem less than serious. The added concern is what role the Fed will play in helping the Treasury place all the debt that it must issue. As I have stated before, history has repeatedly shown that this is not a good combination either for keeping interest rates low or for keeping the value of the currency up. Such movements over time will be brought on by the international markets. The only response that will avoid this is to bring the budget under control and take the pressure off the central bank to support the placing of the debt.
The second point refers to the shift in world economic power. If the BRIC countries find that they can work with the IMF, a new power structure will emerge in global finance. Financial and non-financial companies in emerging markets will become much more relevant. Important financial centers will be distributed throughout the world rather than being concentrated in just one or two cities. As with the evolution of the financial power in the 1920s and 1930s, these changes will not take place overnight. What I am suggesting, however, is that we are seeing the beginning of a shift in financial power in the world that will continue to evolve over the next ten to twenty years.
This has important ramifications for the regulation or re-regulation of the United States financial system. As usual, Congress and the Administration are fighting the last war. Right now the policy makers in charge in Washington D. C. are responding to the populist discontent being expressed in the country. Get rid of greed! Regulate salaries and bonuses! Emasculate the role of derivatives! This is not the way to prepare the economic and financial system for the future.
Yes, the world is changing. The economic base of the global economy is shifting and the resulting need to restructure is the reason for the severity of the current recession. Financial power in the world is being re-distributed and this trend is just beginning to show itself. These movements are going to define the conditions for investment in the coming years. It will require new and creative thinking.