Growth through saving or consumption: Part 1
The changing of world orders, that is, a change from one dominant economic power to another, are often remembered by single events. History is brimming with tales of lost wars and overthrown leaders. The Suez Canal Crisis of 1956 made it clear Britain no longer had sufficient influence to bend the world economy in its favour. The 2021 Capitol Hill riots have shown the current world order to be internally divided, and the withdrawal of troops from Afghanistan have only tempered the thesis that America will inevitably lose its status as the world’s great economic power.
The world order has changed before, and it will, inescapably, change again. This raises the first of two key questions:
How do we know who the world economic power is?
World powers have so many forms of influence it can be difficult to note a single litmus test to discern who controls the world economic order.
Military influence has monumental economic influence, yet who holds the greatest military power changes from region to region. Despite having unarguably the world’s strongest military, and being the undisputed world economic power, American military campaigns in both Vietnam and the Middle East have only ended in shades of catastrophe.
Qualitative factors like cultural and religious influence can often be overlooked as an indication of power. Captain America: Winter Soldier earned half a billion dollars at the international box office. The main villain was a “super-soldier” who had been brainwashed by Russians during World War II. While many Marvel fans may not associate their favourite movies with cultural propaganda, the power of American cultural influence is undoubtedly strong. However, such cultural influence is highly subjective, especially in our ever globalising world. After all, Beatlemania did not signal a resurgence of British economic power.
In a similar vein, the Spanish Empire was at its most powerful during the most fervent years of the Spanish Inquisition. In this period Jews, Muslims, Anglicans and Protestants were persecuted for the sake of Catholic homogenisation. Yet in the modern West, religion is less a mechanism of indoctrination and increasingly, a form of identity, or for many, utterly unimpactful. While history tells a different narrative, it is clear faith is becoming increasingly less indicative of where the balance of economic power lies.
I offer a simple, yet imperfect metric to discern who the world’s great economic power is. The world economic order is controlled by the nation who controls the world’s reserve currency. The tenet behind this is that the nation with the greatest economic power will dominate world trade thus they will have the worlds most coveted currency. This test is useful as it is relatively easy to see which currency is traded most among countries who have no ability to regulate its global supply.
There are many benefits to wielding such power. What I believe are the most potent are listed below:
- Control over the supply of reserve currency gives superpowers the ability to decide who has access to the world’s currency. The ability to starve rival governments of aid and loans may be politically motivated yet, at its core, it is an exercise of economic power.
- Controlling the supply of world currency gives superpowers significant control over the value of world currency. Fluctuations in the value of the dollar have profound impacts on the trade balance of all nations and can determine which nations become net importers or net exporters.
- If mass foreign defaults threaten the private market central banks can step in and supply firms widely accepted currency. This occurred in the US when foreign defaults threatened the domestic banking system. By assuring the repayment of loans, the Federal Reserve saved the nation from a recession and had menial impact on inflation.
- Similarly, the US possesses an ‘exorbitant privilege’ whereby its currency has artificially high demand. This has two key implications.
- The value of the US dollar is artificially high. This gives the US enormous buying power.
- High demand for US currency means there is huge demand for US bonds. This lowers yields and thus decreases US borrowing costs. To use less jargon, because so many entities require US currency to do business, the US can sell it’s currency at a interest rates below other countries with similar risk profiles. Note that while this is true in theory, it is not necessarily exhibited under current market conditions.
Admittedly there are faults with using reserve currency as a means of discerning the worlds economic power. The US dollar is undisputedly the worlds reserve currency, followed by the Euro and then probably the Pound. Yet the state of the world economy shows that it is China, not Europe or Britain that will be the next world power. There are other factors that influence what the world’s reserve currency is as it takes far longer for the world to change to a currency habits, than it does for a new world power to emerge.
The Chinese Renminbi (denominated in yuan) is also an inferior substitute. The dollar is a fiat currency. That is, it is not tied to any hard asset like gold, silver or a currency bundle. While admittedly the dollar was tied to the gold standard as a part of the Bretton Woods system until 1971, a fiat currency allows for independent monetary policy and increases a nations spending power. The Renminbi is a currency tied to a basket of international currencies, most notably the dollar, and its lack of popularity is perhaps a symptom of global mistrust in the opaque management of the Chinese financial system.
My argument is that great economic powers hold the world’s reserve currency. Their power is most strongly enforced not through their guns, movies or religion but by their central banks, as to control the value of the world’s currency is to control the value of the world’s goods.
While the dollar will likely be the world’s reserve currency for some time it is unquestionable that the tide of power and influence is shifting, and it is flooding Eastward. China has grown at a rate so astonishing many economists have labelled it a “miracle”. The transition of power from a nation who promotes individual liberties and freedom (how free a nation can be with over 1.7 million incarcerated is more than debatable) to one that is that is notionally collectivist and effectively authoritarian has many in the West uneasy.
Without question, the US controls the world economic order and its powers lie with Jerome Powell and the Federal Reserve (Fed). America’s inability to contain COVID-19 to the same degree as similarly developed nations and the lack of direct military action in both Taiwan and Ukraine are of course not indicative of the Fed’s inability to implement monetary policy. Rather, we are viewing the political symptoms of waning economic influence resulting from generations of overconsumption. This regression, and understanding why we are viewing the stagnation of US influence through a lens of TikTok’s on Shenzen made phones, is crucial for Western economists to accommodate a transition into a new world order.
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