January 2, 2011 Patrick Oliver-Kelley

No sector anywhere has changed less than the state.  Bureaucrats may replace Investment Bankers as Top Public Nasty. They will play a pivotal role. The risk is that they do damage with blunt fiscal austerity and currency wars. The main battle will be between thrifty politicians and public sector unions. Neither side will be particularly sympathetic to each other, nor engender much sympathy from ‘everyman’. Average wage in the public sector is relatively higher, retirement earlier and more lavish, than in the business world. Since the rich world’s recovery is so fragile, the current fiscal mess opens the door to examination of what the state actually does. The state has willfully ignored the consequences of ageing populations allowing the populace to question what might be done to make the state work better. Government is planning spending cuts and tax increases, the largest collective dose of deficit cutting on record, but, austerity should not be done at any price. Collective budget cutting will sap the vigor from the recovery.

Considering the global economy, everyone wonders how things will fare once the artificial supports are removed. If few wish to borrow and governments are winding down its stimulus, the private sector will have to take the strain and signs are not encouraging. The American economy will fall far short of 2010. Western Europe is equally hamstrung. The big borrowers on the rim of the Eurozone are the candidates least able to meet their undertakings and will be in a pretty miserable state in 2011. Greece will probably have to restructure its debt, Britain and France are subdued, Germany, while pretty strong now, is expected to cool sharply.

It is sunnier in the emerging world, though inflation is a worry as is the fear of asset bubbles appearing. China’s vast appetite for commodities is particularly worrying, especially for Brazil, Australia, and Sub-Saharan Africa. China may let its currency rise a bit higher, but not much.  Its intervention may trigger trade tensions between America and China. India should do very well in 2011. Expect a wave of foreign investment from America and Europe into Asia, Latin America and Africa. What is needed is a growth strategy. Focusing too narrowly on austerity will divert attention from reforms that rich countries need. They must have free labor markets to boost productivity and growth, liberalize services, over haul training schemes and the US, Spain and Ireland need to fix the still festering housing crisis.

China’s leaders are in no mood for risk. They would like to see their galloping economy settle back into a slow trot. 2011 is the 90th anniversary of the founding of the communist party and it will be a trying one. Dissidents and party liberals will want to remind officials of unfulfilled promises of more democracy and that further delay could be even more dangerous. The new five year economic plan will stress the importance of domestic consumption. High level military dialogue with America must resume, though presumably frostily. Why? The South China Sea.

Four trends swim in that same ocean.

  1. The Obama administration wants to reassert America’s role as an Asian Power;
  2. China’s growing regional assertiveness.
  3. The increasing military muscle China is putting on to back up that assertiveness.
  4. The so far fruitless search for an effective regional forum.

The two Koreas will continue its slow rumble, if not intensify. Nothing is known about the Kim Jong III.  China regards the South China Sea its ‘core interest,’ though its definition of the sea seems to be enlarging.  China treats the sea as a Chinese lake. Its maps show Chinese sovereignty extending far bigger than fact. For example it sent a submarine two miles down to plant a Chinese flag on the Sea bottom. There are no fewer than six other countries that have territorial claims in the sea which China colors Chinese. Any one claim can, and most likely will, lead to conflict.  Sri Lanka and Pakistan opened multi-billion dollar ports built by China, and Chinese warships called on Myanmar, fueling India’s fears of a ‘string of pearls’ to stifle Indian ambitions locally. China’s unannounced military modernization includes an aircraft-carrier program, and it developed the first anti-ship ballistic missile noted as a game changing carrier buster.  America reposted that it has a national interest in freedom of navigation. America will remain the region’s dominant maritime power, but this does not assure peace. What are needed are regional forums to discuss disputes. Thus far, China refused to continence the need for such forums.  America’s umbrella keeps the region safe, for now.

India’s economy is racing China’s. Since it is poorer, it has more scope to catch up. China’s leaders’ no longer seek growth at any cost. ‘Growth must serve a harmonious society.’ India still has massive catching up to do in infrastructure. It is more old-fashioned, especially hampered by neglected roads, railways, ports, and energy supply. It is plagued by bad building, corruption, sloppy contractors and abysmal waste. It lacks cold storage facilities, sufficiently capable distribution networks and it seaports are jammed. Still more money, bright minds and resources than ever will be dedicated to fixing infrastructure. It requires better skilled labor. Cumbersome politics and local democracy can be hampering. Pervasive corruption will further erode progress.

Business winners will be the companies that combine scale with the agility to respond to fast-changing market conditions. Being able to sense and move quickly to high-value market niches will be crucial.

Sometime during 2011/12, the seven-billionth person will be born, doubtless encouraging a Malthusian panic. It has taken only a dozen years to go from 6 to seven billion people on earth. Yet the era of shortening time lapses is already over. The total fertility rate has been falling for a long time. Over half of mankind lives in regions where population growth is below the replacement rate. This pause will give us time for solutions to start working. The next billion will be in 13/14 years, and the next after that one, will take 20/25 years.

President Obama wants to make a mark. He will have to do it in the wider world in which American power is perceived to be waning. His work is cut out for him. Afghanistan is troubling; expect him to hedge again; keeping some troops in the country, while scaling down American goals. He seems to be giving up on full scale counter insurgency, in favor of air power and Special Forces operations. Iran continues to twist its negotiating stance to the rhythm of its centrifuges. The longer they spin, the higher the likelihood of Israel taking overt action, (un)wittingly dragging America into the fray.  Turkey and Brazil, along with Israeli/Palestinian presence need attention, though he is particularly fettered, especially by Mr. Netanyahu.

American power is best exemplified by its ability to bring others to the table to solve problems. We must build alliances, institutions and regional organizations to solve shared problems. We are at our best when we can do this, do this now, we must.

Domestically, America’s economy will surprise the pessimists. It will grow faster than the 2.5-3%, presently projected and unemployment may drop below 9%, from its present level of 9.8%. But this is still far below what we could rightfully expect. The Gordian knot of a financial system needs the Alexandrian solution. Write the bad mortgages off, this would allow the low interest rates of today do their magic for commerce. Banks are reluctant to lend and households saddled with wrenching mortgages, cannot or will not borrow. Many of American’s trading partners, Japan and Europe have moribund economies.

There will be a recovery. Consumer paying down debt will, if it hasn’t already, fade. The Fed’s policy will force the dollar lower against many currencies, save perhaps the Euro and China’s unwillingness to allow its currency to significantly weaken could degenerate into to a trade war that stifles trade and harms business confidence.

Real change will come only when enough people outside Washington demand it and make it risky to stay with the status quo. Rage is all the rage. Democracy is not a spectator sport. ‘Power concedes nothing without a demand’, observed Frederick Douglass.   We, the people of America, will determine whether America is waning, or prove it is the ‘more perfect union.’

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