The economic crisis in advanced economies is accelerating the timeline in which big emerging nations like China rule the global economy. Instead of the market focusing on American shopping habits, they’ll be focused on consumers in Shanghai and Mumbai. Unless the US can recover the 8.5 million jobs it lost in the recession, and unless incomes begin rising, the U.S. will be knocked off its pedestal within a generation. The post-Western world is coming faster than we think.
Historic Credit Rating Declines…
For the first time in its history, the U.S. lost its coveted AAA credit rating status on Aug. 5. After market hours, credit rating agency Standard & Poor’s cut the U.S. rating to AA+, one notch below the AAA rating U.S. Treasury debt has been ranked since 1917. Had they made the announcement when the market was open, the downgrade might have been a circuit-breaker day for Wall Street — when the NYSE automatically stops trading when the index loses 10%. That same day, the European debt crisis was looking worse yet again with Italy’s trillion euro debt in the spotlight, and what it could mean for European private banks. The European Central Bank (ECB) had to jump in to calm markets, saying the ECB would backstop Italy in case of a default. Now Italy is forced to cut benefits to workers there, a budget decision that has caused riots in Greece this year. The comforts that came with living in a rich country are fast becoming something only for the rich to enjoy from Rome to New York. In the U.S., the middle class is shrinking with age. In many European countries, entitlement programs are being trimmed, thus cutting into the life styles of older Europeans who will see their spending power eroded. With the U.S. as Dorothy and the EU as Toto, neither are in Kansas anymore.
The loss of AAA status is not to be taken lightly. Although the Federal Reserve Board directed banks to continue holding U.S. Treasurys and keep interest rates stable, the downgrade is meaningful. Most money market funds, pension and mutual funds investing in bonds have rules, or covenants, that require them to hold only AAA debt. Most funds will likely be forced to change those covenants in response to this extraordinary situation, but not all will do so. There are trillions of dollars in U.S. government debt held by fund managers around the world, a small 10% sell-off would dump over a hundred billion dollars worth of bonds into the market, causing bond prices to fall. And when bond prices fall, yields rise. New bond issues, including state and municipal bonds, may very well have to increase coupon rates in order to attract bond investors who now see a greater risk of default and therefore want to be paid for that risk in lending to new issues. It would be unprecedented if a bond rated AAA was paying 3% and gets downgraded to AA and still pays 3%. The lower the credit rating, the higher the interest. Will the U.S. be the exception, and if so, for how long? Nobody knows. But everyone has a pretty good guess.
Earlier this week, President Barack Obama said that a credit downgrade would cause adjustable rate mortgages to rise, and credit cards and auto loan borrowing costs to rise, too.
As rich economies’ prospects dim under their crushing debt burdens and political paralyses, the world’s hope for economic dynamism rests with developing nations, writes Dani Rodrik, Harvard professor of international economic policy. “These countries had an exceptionally good decade before the global financial crisis hit and most among them have recovered quickly.”
Their biggest problems at the moment are inflation, much of it caused by the easy money policies of the US and EU, and multinational corporations investing heavily in the big emerging markets like Brazil and China, thus flooding the countries with dollars. For their stock markets, the biggest problem is the systematic risk coming from Washington and Europe.
Special Interests and Elites Control U.S. Congress
In the U.S., the biggest problem is Washington. It is becoming clear that they work for maybe a hundred billionaires and five industry groups and that’s about it.
Standard & Poor’s said that “difficulties in bridging the gulf between political parties” was the major reason for the downgrade. Ironically, China’s biggest national credit watchdog, Dagong Global, said the same thing on Aug. 2 when they downgraded U.S. debt for the second time in 12 months. Both rating agencies said they didn’t trust Washington’s ability to work together to address its debt problems. S&P said Friday the $2.5 trillion in cuts did not go far enough. They wanted $4 trillion.
Both political parties used S&P’s downgrade to make their cases and attack the other side. House Speaker John Boehner said he hoped the downgrade served as a wake-up call to the Democratic Party. Boehner mimicked his friend Neil Cavuto at Fox News who said on the July 27 broadcast of his show “Your World” that he would “welcome a credit downgrade” so the country would “wake up.” Boehner speaks to the one-percenters, and Fox News CEO Roger Ailes, and not much else.
Meanwhile, the U.S. economy is slowing. Its credit view is negative in the best case scenario, presented by Fitch and Moodys, who have not downgraded U.S. from AAA. At the same time, the credit ratings of developing nations are on the rise. Brazil was upgraded another notch on the investment grade scale this year. Colombia was upgraded to investment grade.
The economic outlook in the developing world looks far better than advanced economies. The International Monetary Fund projects that the developing world will be responsible for more of the world’s GDP than the advanced economies within three years. Then it will accelerate. The fix is in.
Changing of the Financial Guard on the Horizon
If the 19th Century belonged to Europe and the 20th Century belonged to the U.S., the 21st Century will likely belong to Asia, for better or for worse.
The U.S. decline has moved along since its high point of power after World War II. The remarkable triumphalism of the post-Gulf War ’90s was mostly self-delusion, writes Noam Chomsky, a U.S. foreign policy expert and professor at MIT in Cambridge, Mass. The economy has had fits and starts ever since. The dot com high wore off, the Nasdaq never saw 5k again. The housing bubble popped, and home prices have yet to recover nationwide.
But outside of the markets, another common theme is that America’s decline is in no small measure self-inflicted. “The comic opera in Washington this summer, which disgusts the country and bewilders the world, may have no analogue in the annals of parliamentary democracy,” Chomsky writes. “The spectacle is even coming to frighten the sponsors of the charade. Corporate power is now concerned that the extremists they helped put in office may in fact bring down the edifice on which their own wealth and privilege relies, the powerful nanny state that caters to their interests.”
The post-Western world looks like this: the IMF bails out Europe, not Latin America, and not Asia. India lends money to Europe to help solve its debt crisis. When the U.S. and Europe feel the need to bomb a country with a GDP the size of New York, the big emerging markets reject it and there is nothing the U.S. or Europe can do to punish them because they would be hurting their own corporate interests. The U.S. has no say over economic policy anywhere anymore. The Washington Consensus that dominated Latin America just 10 years ago, is dead and gone. Hollywood makes more money outside the U.S. Will Thor play in Peoria? Who cares, so long as it plays in Shanghai, Mumbai and São Paulo. Investors want to know what kind of shoes Chinese women are buying this summer, not what Americans are buying. General Motors wants to know what Chinese drivers like more than what any European driver likes.
Made in the USA?
We are already living in the post-western world. Massachusetts based luggage maker, Samsonite, knows it. They chose to go public this year in Hong Kong, not the U.S.
The U.S. commands a sizeable portion of the world’s attention. It is by far the largest economy on earth and, for what it’s worth, the strongest militarily. No one wants to fight us, except for cavemen armed with flea market ex-Soviet weapons who don’t know any better. More importantly, the U.S. prints the world’s reserve and trade currency. But for how long? Some give it 10 years. Others give it 20, but within the lifetime of most Americans that coveted status is predicted to erode.
China still has a long way to go before it catches up with the U.S., and China is a command and control economy. China says that its style of economics is not for export, and other emerging nations, like Brazil, have not tried to emulate it. They don’t have to. Nor does India, or Thailand or Indonesia, for that matter. Their populations are getting richer, ours are getting poorer, with average incomes declining in 2009 and 2010, according to the U.S. Census Bureau. Their corporations are investing at home and creating jobs; ours are either hamstrung from doing so, demanding more tax breaks from a revenue strapped government, or investing where the growth really is.
And where is it? Far and away from the U.S., new cities are being built, new industries, new entertainment centers rivaling Hollywood; new brands and a new middle class. In some of these countries, like Brazil, disparity between rich and poor is shrinking, not widening. It’s not Nirvana. It’s better. It’s worse. But it’s growing, and it’s hiring, and it is peaceful.
With every major crisis in Europe, with every made-for-TV ideological battle in Washington, they are catching up and they are running faster.
It’s not a bad thing that the developing world is catching up with us. But like the Mexican teenager who dreamed of going to California just to get a job at a lumber yard and see where it leads, American teens will dream of learning Portuguese and living in Rio de Janeiro to work as a petrochemical engineer, or for the kid with only a high school education, it’s off to Jakarta to cater to the Chinese on an Indiana Jones vacation, sipping Singapore Slings and enjoying the 25 year-old exotic Californians who still can’t find a job at home. Φ
Kenneth Rapoza manages the BRIC Breaker page at Forbes. He covered Brazil for Dow Jones Newswires and The Wall Street Journal from 2005 to March 2010