Next: The Great Unraveling
By
Thomas Schinkel
November 19, 2010
We are living in turbulent times. In fact, we are witnessing a political earthquake that ranks right up there with events such as the collapse of the Soviet Union, the reintegration of the two Germanys, and the collapse of the Bretton Woods Agreement that had served the world from 1945 to 1970 and had resulted in a prolonged period of prosperity for many nations. (In 1971, Richard Nixon disconnected the fixed parity that existed between the value of the U.S. dollar and a certain quantity of gold. During the period of Bretton Woods One, the price of an ounce of gold was US $35.)
Today’s earthquake promises to be more severe than these past events, as it is economic in nature and global in scope. It relates to what is known as the “Washington Consensus”. What is that? During the early stage of the Reagan administration, a series of new mantras and belief systems about the organization of the global economy entered the collective thought processes of economists and politicians in the U.S. and Britain. Both unleashed a series of changes that reverberated throughout the world for the next thirty years. To make a long story short, these mantras and belief systems (propped up by highly dubious arguments of a theoretical nature) included a belief in privatization, liberalization and deregulation. Privatization applied to government-sponsored and owned enterprises. Liberalization applied to the free flow of capital and goods (not people), and deregulation applied to the dismantling of numerous rules and regulations that the proponents of these new belief systems believed to be strangling many Western economies. Vocal proponents of the new mantras included President Reagan and Prime Minister Margaret Thatcher.
After a slow start, the mantras began to take hold of larger and larger groups in academia, which in turn spread the gospel to the world at large. Businesses began to take advantage and after the collapse of the Soviet Union – an event the proponents of these belief systems claimed was directly attributable to their efforts - there was no stopping the avalanche of freedom. Some scholars even went so far as to argue that history had come to its logical conclusion and that a new and lasting equilibrium had arrived.
A signature moment in the march to liberty was the signing of the North American Free Trade Agreement (NAFTA), much heralded as the launching pad for a new age of prosperity among the U.S., Canada and Mexico. As more free trade agreements were entered into, it became clear that below the surface something was amiss. Right after the signing of NAFTA, Mexico was thrown into a severe crisis that wiped out the green shoots of prosperity that had seemed to be taking hold of their economy during the early 1990s. I was there when the crisis hit, and it was an ugly scene.
Later in the decade, crises erupted in Asia followed by Argentina, and then the bursting of the dot com bubble which hit closer to home. Whenever these crises hit a country, a standard recipe was rolled out that reflected the Washington Consensus. The recipe was to privatize government companies, open the market to imports, and reduce government spending.
There were plenty of critics, but I won’t review all the trials and tribulations between the forces in favor of and against the Washington Consensus. What’s clear is that the Crisis of 2008 (which originated in the U.S.) removed the underpinnings of any global consensus on world economics. What was lost was the faith that the mantras would actually be effective. More importantly, many observers inside and outside America could not help but notice that the financial crisis was laced with the F-word, fraud. Fraud before, during and after the crisis. Two lonely professors from Kansas University, who had massive experience in the handling of previous crises, screamed at the top of their lungs about the systemic fraud that is being perpetuated by the financial services industry, yes, the highest echelons of it.
Perverse as it may be, what comes on the heels of this witches’ brew of issues is the Quantitative Easing embarked upon by the Federal Reserve. If the tipping point in the unraveling of the Washington Consensus was reached on September 15, 2008 when Paulson asked Congress for a blank check in the amount of $700 billion, the avalanche happened during the later part of 2010, culminating in the G20 meeting in Seoul. The Chinese are deathly afraid of QE2, fearing a firestorm enveloping their financial system that could trigger a wave of deflation a la Japan of the 1990s. Brazil has taken a beating with sky-high exchange rates that make their exports uncompetitive. They have taken steps to manage speculative capital inflows. Official protests coming out of Germany and the European Union focus on the imbalances within the American economy itself.
Folks everywhere are frustrated, uncertainty is rampant, and sober analysis is in short supply. The Asians want to go it alone, the Obama administration is wooing the largest democracy in the world to join it in the formation of what can best be described as a “Maginot Line of Economic Prosperity”. The Scandinavians remain quiet, as always going their own, often well-reasoned way. Sixty years of a modicum of consensus in the world around themes of economic prosperity has come to an end.
The contours of what is next are already coming into view. Here are three aspects of what seems to be around the bend:
1. The upper echelons of “Global governance,” organizations such as the World Trade Organization and the World Bank, are probably rewriting their business plans as we speak, trying to incorporate the mind shift that just has taken place. If they do, there is a chance they will maintain some level of relevance when the world turns next.
2. In terms of international trade negotiations, expect the Doha round to be another polite manifestation of “agreeing to disagree”.
3. The rest of us, especially here in America, should expect “Import Inflation”. And frankly, that may not be such a bad thing. One could argue that this is exactly what the doctor ordered. If imports are getting more expensive, opportunities will arise for domestic production, which means job creation and adding more value within the dollar-zone.
4. Members of the business community, especially those who are heavily invested in global outsourcing and overseas sourcing, can expect challenges to their business models in various degrees. Some will have to retool the core of what has driven their success for so many years. Others can get by with tweaking one or more aspects of their mode of operations. Others, especially those who anticipated the turmoil, will have a splendid opportunity to reap the benefit of their foresight.
In this context, those of you who have read my blogs before will not be surprised to hear me say that for some there may be salvation in looking for local solutions with local resources. Globalization may have run its course, the pendulum will swing back. It is a great time for entrepreneurial, disruptive innovation and the development of new business ideas. The more things change, the more they stay the same.
Thomas Schinkel
