On the Economy, Be Careful What You Wish For

Halfway through 2011, we’ve already seen an extraordinary year of volatility: turmoil across the Middle East and North Africa, the eurozone’s ongoing fiscal crises, Japan’s triple disaster, the killing of Osama bin Laden. Yet these dramatic events have obscured a slow-moving, underlying shift of much greater long-term importance: global rebalancing. In its simplest form, rebalancing means this: a reset of the global economy shifting the balance of accounts between the world’s established and emerging powers or between its biggest consumers and biggest savers. That alone, of course, is a transition of landmark historic significance. Yet it is far from the only consequence, for rebalancing is not just an economic story, but one that will result in a seismic shift in the international balance of power, in every region of the world.

And I have bad news for the United States: Rebalancing won’t be the relatively pain-free process some in Washington hope. Faced with an increasingly ugly bilateral trade deficit, many of the most senior U.S. officials — including many who should know better — have repeatedly called on the Chinese leadership to empower Chinese consumers to buy more Chinese-made products and to allow the renminbi, China’s currency, to appreciate to help them afford it. The Foreign Policy Survey results reported here also suggest Washington is on solid ground: Nearly 100 percent of the leading economists consulted told the magazine they think the renminbi is undervalued.

But in reality it’s hard to imagine a better example of "be careful what you wish for."

At a moment when Western-led globalization is under threat from a new brand of emerging-market mercantilism, this sort of decoupling will produce a lot of pain. This is what’s happening already in many areas of the fast-transforming global economy — but unfortunately, U.S. leaders aren’t doing much to prepare for this transition, perhaps because they’re in denial about its inevitability and its implications for American power. Talk of "winning the future," whether from President Barack Obama or his Republican rivals, allows Americans to believe that all their country needs is to become more "competitive." But rebalancing means that the U.S. economy can’t simply grow its way back to the pre-financial crisis era of American profligacy. Instead, it will have to thrive in a new world in which U.S. primacy is no longer a given.

In years to come, U.S. diplomats will have to do more than jet around the world twisting arms and cutting deals. They’ll have to find creative solutions to transnational problems that involve multiple players who don’t necessarily accept U.S. leadership. American power has always been a mix of hard and soft forms of persuasion: a blend of liberal values, military muscle, and economic leverage. Those values endure, even if the United States itself might not always be loved in foreign capitals. It’s the third element of power that is fast waning: the paramount position of the United States in a global economic order built to its advantage. For decades, American consumers have been the engine of growth around the world, and the U.S. economy remains by far the world’s largest, two and a half times the size of China’s. But the latest projections from the International Monetary Fund forecast that China will surpass the United States by 2016. And China is far from the only rising power on the horizon.

American consumer purchasing power will continue to be an important variable for global growth and the economic health of many countries, but Americans won’t have as much money to spend. The financial crisis pulled huge amounts of money from the pockets of U.S. consumers by, among other things, deflating the value of their biggest asset: their homes. And the loss in U.S. purchasing power will be felt in every economy that depends on access to U.S. markets. That’s exactly why Chinese policymakers are now working to decouple — not because Washington wants them to, but because excessive long-term dependence on U.S. consumers puts China’s future growth trajectory at risk.

The dollar’s preeminent position may be the first casualty of this shift. The United States borrows about $4 billion per day, much of it from China. That borrowing finances the ballooning U.S. debt — in effect, China loans Americans the money that allows them to live beyond their means (and, of course, purchase Chinese goods). But the meltdown in U.S. financial markets and the dive into recession persuaded many within China’s leadership that this system is unsustainable. China’s domestic economy can no longer depend quite so heavily on foreign consumers to drive the creation of domestic jobs. As China works to stoke the growth of domestic consumption by investing more of its cash at home, the renminbi will appreciate against the dollar and Americans will pay higher prices until cheaper alternatives become available. And as China develops a consumption-driven economy, Chinese consumers will increasingly be spending their hard-earned cash abroad, leading to the development of deeper and more liquid renminbi debt markets, a necessary prerequisite for China’s currency to become a leading global reserve currency. This will be a gradual process, but it will come at the expense of the dollar and the big-spending habits its preeminence enables for both U.S. consumers and their government.

Washington’s security role in East Asia has long paid economic dividends as the United States has translated its military ties into greater trade and investment throughout the region. But as China’s consumer markets take on added weight and Americans see their purchasing power reduced by the need to restore the country to long-term fiscal health, East Asian countries will trade increasingly with one another and with fast-growing China. It’s already happening. According to Xinhua, China’s state-run news agency, "China became the largest trading partner and the single biggest export market of Southeast Asian countries in 2010." China’s free trade agreement with the 10 countries of the Association of Southeast Asian Nations, which came into effect last year, is the world’s largest in terms of population, and it underscores Washington’s inability to continue in its traditional role of free trade champion.

Then there is the reform process in Europe, which also threatens to undermine the dollar in the long run. Of course, America’s traditional ties with Europe and the enormous trade volumes moving in both directions across the Atlantic demand U.S. support for a strong European economy. But if Europe’s resilient core economies can help build a coordinated European fiscal policy and buttress cash-strapped governments like those of Greece, Ireland, Portugal, and other so-called peripheral countries, a strengthened euro can offer another viable alternative to the dollar as a reserve currency. And a recovered eurozone will further weaken America’s ability to act as global lender of last resort, reduce the central role of the United States in the global banking system, and further erode America’s singular international influence.

Indeed, the American way of capitalism itself is now under threat. That model was built on open market access and minimal government meddling. But the world loves a winner: China’s heavily top-down approach is finding adherents from Vietnam to Venezuela, while the idea of American-style market-driven capitalism has lost some of its allure. As the appeal of state-driven capitalism grows, we can expect a much less efficient global economy. We’ll see politics injected into economic policymaking much more often and on a much larger scale — within both emerging and established powers. We’ll see governments defend their political interests with new sets of tools and weapons, like currency policies, market access, intellectual property rights, and new forms of resource nationalism that move beyond oil, gas, metals, and minerals into commodities like food.

For Americans, what this all means is that the long, postwar party is over. The U.S. debt-to-GDP ratio has climbed above 84 percent, putting America’s ability to meet its obligations in question for the first time in memory. To close the gap, U.S. consumers will have to pay higher taxes, save more money, delay retirement, and accept less generous pension and health-care benefits.

In coming years, an increasingly cash-strapped U.S. government will have to become more sensitive to the costs and risks of its foreign adventures. It will be harder to persuade more cost-conscious Americans (and their lawmakers) that the stability of countries such as Afghanistan, Iraq, or even a longtime U.S. protectorate like Taiwan is worth a bloody and costly fight. Questions will arise abroad about the U.S. commitment to the security of particular regions, encouraging local players to test American resolve and exploit any weakness they find.

Then there are the economic risks. The dollar has provided the global economy with a deep, liquid, and stable reserve currency that reduces costs and increases efficiency for enormous volumes of commercial transactions. It has offered investors a safe port during many a financial storm, including the 2008 financial crisis. But other governments have already begun to move toward a more diversified basket of currencies and commodities to hold in reserve, weakening confidence in the dollar’s long-term dominance. Europe will eventually recover, boosting the euro, and a big wave — a sharp spike in crude-oil prices or another deep and lasting U.S. recession, for example — will only accelerate the global drive to diversify. Borrowing costs in the United States will rise, in part because there will be fewer lenders. The cost of doing business will increase along with the complexity of settling transactions in a world of multiple currencies.

Some might argue that the impact of the relative decline of the U.S. economy has already been felt and that a weaker dollar will ultimately make American products more competitive abroad. FP‘s survey results seem to reflect this optimistic view, though the vast majority of those surveyed are clamoring for rebalancing, with all its pitfalls and dangers. There is no reason to doubt, moreover, the long-term resilience of America’s political and economic systems. Democracy offers a degree of domestic political legitimacy that cannot be earned in any other way. America’s achievements in higher education and innovation are, and will remain, the envy of much of the rest of the world.

But rebalancing will upend lots of assumptions, in the United States and around the world, about American economic resilience and its importance for other countries. This transition is not a product of poor decisions or myopic political leadership — though leaders of both parties in Washington have offered plenty of both in recent years. This is a structural shift, one that has been decades in the making. Resistance is futile. Adapting to its impact can help Americans, and everyone else, thrive in the era to come.