WALL STREET IN CRISIS THE END OF THE AMERICAN ORDER

WALL STREET IN CRISIS
THE END OF THE AMERICAN ORDER
The debilitating credit crisis has knocked the U.S. from its perch as the supreme economic power. The climb back up will be steep

KEVIN CARMICHAEL

Toronto Globe and Mail

October 4, 2008

OTTAWA -- Before U.S. Treasury Secretary Henry Paulson was pressed into becoming the fire chief of the financial crisis, he had a good thing going as an economic missionary.

Basking in what he liked to call "the strongest global economy" of his business lifetime, Mr. Paulson, who joined President George W. Bush's administration in June, 2006, embraced with zeal an aspect of his new job with roots in Cold War diplomacy.

In his two years as Treasury Secretary before financial markets came totally unhinged this summer, Mr. Paulson conducted more official business in China than he did in New York. He has visited as many cities in Latin America as he has cities in the United States of America. He rolled through Calcutta, New Delhi and Mumbai in three days in October, 2007; two weeks later, he spent five days in Africa.

The places changed, but the message stayed the same: American-style banking, unencumbered by regulation and open to U.S. financial institutions, is the surest way to create wealth.

"An open, competitive and liberalized financial market can effectively allocate scarce resources in a manner that promotes stability and prosperity far better than government intervention," Mr. Paulson told an auditorium full of officials in Shanghai in March, 2007.

Mr. Paulson's brand of capitalism isn't promoting much stability these days, and prosperity isn't a word that jumps to mind as policy makers from Canada to Japan to France scramble to avert a global economic recession.

The Made in America financial crisis has seriously undermined the U.S.'s standing as the undisputed leader of the international economy, posing the first serious threat to U.S. hegemony since the height of the Soviet Union.

After decades of strong-arming governments in Asia, Latin America and Eastern Europe to keep the state out of the economy, the U.S. government in September put up $285-billion (U.S.) to nationalize mortgage giants Fannie Mae and Freddie Mac and insurer American International Group Inc.

That's nothing compared with the $700-billion Mr. Paulson got from Congress yesterday to purge the financial system of the bad debt at the root of the credit crisis. With governments saving failing banks in Europe, stock markets plunging in China and exports slowing in Brazil, the world is in no mood to take economic lessons from the U.S. government.

"There is a real element of anger and frustration around the planet that this is a U.S.-originated problem with global repercussions," John Manley, a finance and foreign affairs minister under former prime minister Jean Chrétien, said in an interview. "The world will be looking for a loss of hubris from the United States as a result of this."

America has dominated global economic affairs virtually unopposed since the collapse of the Berlin Wall, an era marked by the acceleration of global free-trade agreements, the confirmation of the dollar as the world's de facto currency, and the rise of Wall Street as the world's financial centre.

The U.S. and Britain dictated the Bretton Woods agreement in 1944, establishing the International Monetary Fund and the World Bank. The U.S. became the largest shareholder in the global institutions, which built their headquarters side by side in Washington. Unsurprisingly, the American vision of private ownership and unfettered markets dominated the prescriptions those agencies imposed on weaker economies in return for financial aid. That culminated in the Washington Consensus, a term coined in the 80s to encompass policies such as privatization, lower taxes and deregulation.

These days, countries can't distance themselves fast enough from the Washington way of economic management.

"The world is on the edge of the abyss because of an irresponsible system," French Prime Minister François Fillon said on the eve of a gathering of European Union leaders to discuss the financial turmoil.

German Finance Minister Peer Steinbrueck predicted the end of the U.S.'s status as the "superpower of the global financial system." Chinese officials are rethinking their embrace of globalization, and Colombian President Alvaro Uribe said the U.S. must ensure the situation doesn't get any worse.

"The Anglo-American model has suffered a big setback," John Snow, who preceded Mr. Paulson as treasury secretary and is now chairman of private equity firm Cerberus Capital Management, said in an interview. "We don't have the moral authority we might have had a few years ago to get others to follow our model."

Other nations appear ready to assume a more assertive role in the global economy.

French President Nicolas Sarkozy, current President of the European Union, wants to host a summit of the world's major economies next month to consider global rules for financial markets. Germany's Mr. Steinbrueck, whose push for stricter oversight of hedge funds and private equity firms last year was blocked by Mr. Paulson, will be a ready ally.

"The whole spectrum of options for regulation is now open again," said Glen Hodgson, chief economist at the Conference Board of Canada and an IMF official. "You only have moral authority when you have your own house in order."

A new era of global financial regulation - however appropriate given the serious gaps exposed by the credit crunch - will increase costs for businesses and slow global economic growth.

Say what you will about U.S.-style capitalism, its ability to produce wealth is unchallenged. The world economy expanded at an average annual rate of 3.9 per cent over the past decade, as more emerging market nations embraced free-market ideals. Over the previous 10 years, global growth averaged 3.5 per cent.

There's a risk that countries such as China and India could become more reluctant to ease barriers to international investors, especially in the financial sector.

"It's a possibility that you see countries become more protectionist," said Mr. Manley, who is now a senior counsel at law firm McCarthy Tétrault LLP. "That's going to slow growth."

There's an element of schadenfreude in the world's criticism of the U.S. government's role in the financial meltdown.

After all, nobody likes a bully, which is essentially the approach American officials have taken to international negotiations for decades, said John Curtis, a former chief economist at Canada's Trade Department. "They can be insensitive at times to others' interests," said Mr. Curtis, who is now a distinguished fellow at the Waterloo, Ont.-based Centre for International Governance Innovation.

Still, Mr. Curtis and others said it would be a mistake to get carried away with the idea that we're witnessing the death of the American empire.

The U.S. hardly has a monopoly on economic crises, and the German and French governments, among others, have had to put up billions of their own to save several European banks from collapse, which has muted their criticisms of the U.S.

"I don't think any country is in position to say they have the right regulatory system," said James Barth, a senior fellow at the Sana Monica, Calif.-based Milken Institute and a former chief economist at the U.S. Office of Thrift Supervision. "One has to be careful to say the U.S. has a terrible financial system and that capitalism doesn't work because of this particular situation."

One reason the U.S. can't be counted out is that Americans are used to such calamities.

Mr. Paulson would often tell his audiences that the U.S. copes with a financial crisis every decade or so because the country's entrepreneurs get too greedy and overreach. The cleanup is wrenching, but the country's economy is left stronger as a result, Mr. Paulson argued. The country's rebound from the collapse of the dot.com bubble is perhaps the most recent example of Mr. Paulson's creative destruction thesis.

There's also the sheer size of the U.S. economy. The spread of the Wall Street crisis to other continents is a graphic example of how much the rest of the world still depends on America for their economic growth. The U.S.'s gross domestic product is three times the size of that of Japan, the world's second biggest economy, and is four times the size of China's.

The U.S. dollar still makes up more than 60 per cent of the world's currency reserves, according to IMF data.

"They are so big, you can't get along without them," said Mr. Curtis, who also served at the IMF. "They are pre-eminent, they are no longer dominant."

The U.S.'s standing in the world of global finance may well be determined by the outcome of Mr. Paulson's $700-billion rescue package.

Observers marvel at the speed with which Mr. Paulson and U.S. Federal Reserve chairman Ben Bernanke developed the plan after earlier efforts failed to reverse the credit squeeze. It took years to sort out the mess created by the defaults of Argentina and Brazil.

If the U.S. can save its banks faster than the Europeans save theirs, Mr. Paulson will restore some of his department's reputation abroad, said Daniel Drezner, a political science professor at Medford, Mass.-based Tufts University and a former Treasury Department economist.

But gone are the days when a U.S. treasury secretary will automatically be seen as the smartest guy in the room.

"It's tough to tell other countries you should privatize and liberalize when you are going the other way," Mr. Drezner said. "The Washington consensus is dead."

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