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Different Clinton, more painful bill

By Larry Elliott
THE GUARDIAN
Wednesday, Jan 16, 2008, Page 9

`The Russians like a high oil price; the Chinese need rich US consumers to carry on buying their manufactured exports. A US economic collapse would threaten both.'

It was like turning the clocks back 16 years when Hillary Clinton put her campaign to become the first woman president of the US back on track with victory in New Hampshire. It was, of course, the same small northeastern state where Bill first won his spurs as the comeback kid.

The similarity does not end there. Just as in 1992, the US economy is a mess. Unemployment is rising, the federal deficit is enormous, personal debt frighteningly high, the real estate market is in freefall.

For the first time since George Bush Sr. was booted out of the White House, the economy is going to be absolutely central to this year's struggle for the presidency.

Whoever wins the race -- be it a Republican or Democrat -- will take comfort from the fact that if economic recovery could be achieved in the 1990s it can be achieved again.

Already there is hope that swift and decisive action by the Federal Reserve in cutting interest rates will ease the burden on consumers and businesses, leading to a short- lived recession. Fed Chairman Ben Bernanke's comment last week that there was room for "substantive" action to underpin growth means the Fed funds rate is coming down by half a point this month.

There are good reasons for being cautious about this Panglossian view of the world. The first is that the objective economic position of the US is far weaker than 16 years ago, courtesy of excessive borrowing and excessive spending. Sure, the economy has avoided a deep recession like that suffered in the early 1980s -- but at a cost. The price of shallow downturns has been deliberately created asset-price bubbles that first turned dotcom shares and, more recently, the housing market into big Ponzi pyramid-type schemes.

So although consumers have carried on spending, the fundamentals of the economy have worsened. The budget deficit is 70 percent higher than it was when Bill Clinton left the White House -- the result of the cost of Iraq and tax cuts for the better-off -- and it is considered a good month for US trade when the deficit is less than US$60 billion.

As Albert Edwards said in a note for Societe Generale, the severity of the recession in corporate profits has gotten worse in each successive downturn. The threat of sharply lower profitability, exacerbated by the still-unravelling effects of sub-prime mortgage losses, aggravates the risks of a hard landing.

Sorting out this mess will not be easy. The short-term fix -- slashing interest rates in the hope that consumers load up with more debt, and bowing to election-year pressure to cut taxes -- guarantees bigger problems down the road when the next bubble bursts.

Yet the necessary long-term measures to restore the US economy to health would make the downturn longer and more painful. The consumer borrowing binge of recent years has cut the savings ratio for consumers to zero. Lifting it back up to its historic average of 4 percent would mean less spending, weaker domestic demand growth and higher unemployment.

The second, perhaps more difficult problem for the incoming president is that the geopolitical backdrop to all this is far different from that which greeted Clinton in 1993. His victory occurred immediately after the collapse of the Soviet Union but before the full consequences of China's new economic strength were appreciated.

That period of unchallenged US supremacy proved brief. In 1992, Russia was imploding, Japan's stockmarket bubble had burst, the first Gulf war had been won, oil prices were low and German reunification was causing serious adjustment problems for the rest of Europe.

Today, the US trade deficit is mirrored by a group of nations that enjoy hefty current account surpluses either due to their status as energy producers -- the Gulf states and Russia -- or because they export far more than they import, as with Germany and China. Flynt Leverett says in the magazine National Interest that the US should be seriously concerned about this so-called "axis of oil" because it has the potential to exert the same sort of financial and monetary pressure on the US as Washington put on Britain and France in 1956.

"Half a century after Suez, there is growing potential for a coalition of major energy exporters -- disproportionately concentrated in the Middle East and Russia -- and major manufacturers like China to coordinate the application of financial and monetary pressure on the United States for strategic purposes," he says.

History suggests that periods when the international balance of power is shifting tend to be particularly dangerous. Countries on the rise are tempted to throw their weight around, particularly if they consider that their rightful ambitions are being thwarted. Economic self-interest would suggest that there is no immediate prospect of Moscow or Beijing holding a gun to Washington's head.

The Russians like a high oil price; the Chinese need rich US consumers to carry on buying their manufactured exports.

A US economic collapse would threaten both.

The aim for the US, according to John Ikenberry, writing in Foreign Affairs, should be to turn short-term economic expediency into a long-term strategy. There is, he says, no innate reason why changes in the relative economic strength of nations should lead to hostility; instead it will depend on whether the global economy is flexible enough to accommodate countries such as China and whether countries such as the US commit themselves to an open, multilateral order rather than plumping for bilateral or isolationist solutions to problems.

The illusion that a unipolar world will continue indefinitely has encouraged the current US administration to prefer go-it-alone solutions. It is increasingly clear, however, that the limits of that strategy have been reached.

Bush has not been putting pressure on Israel for the return of land occupied in the six-day war out of morality or idealism but because a settlement in the Middle East is vital for the continued support of Saudi Arabia. In particular, the US needs to ensure that crude continues to be priced in dollars. Two-thirds of Middle East oil exports go to Asian customers, and producers are none too happy to see the value of their output affected by the slide in the greenback. Up until now, the Saudis have resisted pressure for changes.

Waving a big stick may look good in an election year, but in the vulnerable economic position of the US it is a daft approach. Brokering a lasting Middle East peace plan or willingly ceding to China a bigger say in the running of global organizations sounds far less attractive. Ultimately, though, the US is in hock to the rest of the world. And beggars can't be choosers.
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