History shows that nothing causes fiscal and monetary instability quite like multiple big, long conflicts.
Niall Ferguson. BLOOMBERG
23 octobre 2022
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Niall Ferguson is a Bloomberg Opinion columnist. The Milbank Family Senior Fellow at the Hoover Institution at Stanford University and the founder of Greenmantle, an advisory firm, he is author, most recently, of “Doom: The Politics of Catastrophe.”@nfergus
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A large proportion of the world’s top tourist destinations are the remains of dead empires. A week of sightseeing with my younger children in Italy reminded me of this. The city of Rome was the capital of an empire that at its height stretched from Britannia to Babylonia. The city of Venice once ruled a realm that extended across what are now Albania, Croatia, Cyprus, Greece, Montenegro and Slovenia.
To walk among the monuments of the most Serene City and the Eternal City is at once inspiring and melancholy. Like Edward Gibbon, “I sat musing amid the ruins of the Capitol” — but musing about the decline and fall of other empires.More fromBloomberg Opinion
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My grandparents and parents witnessed the decline and fall of the British Empire, but not before it had helped polish off the more ephemeral empires of Mussolini, Hitler and Hirohito. I experienced the decline and fall of the Soviet empire built by Lenin and Stalin. There are those who subscribe to the delusion that the age of empires is over. But all history is the history of empires.
The world today is dominated by two empires: the US, which originated in the British colonization of North America, and the ethnic-Han-dominated Middle Kingdom we call the People’s Republic of China. But a number of former empires continue to play disproportionate roles in world politics: The Russian empire limps on in the guise of the Russian Federation; the Persian empire is now the Islamic Republic of Iran; one might say the Holy Roman Empire has been reincarnated in the form of the European Union, at once extensive, German-centered and weak.
It is not civilizations that clash, but empires. Indeed, it is often border clashes that define their extents. As a schoolboy, I was taught the world wars as if they had been contests between European nation states. Only later did I see that they were struggles between empires. That was why they were global and not just European conflicts.
More recently, I saw that the term “world war” was a kind of optical illusion. What my paternal grandfather’s Victory Medal called “The Great War for Civilisation, 1914-1919” was really many conflicts: Austria’s against Serbia; Germany’s against Russia and its ally France; Britain’s to preserve Belgian neutrality (the one my grandad fought in); Britain’s and France’s to acquire Germany’s overseas colonies and to partition the Ottoman Empire between themselves.
My mother’s father served in the Royal Air Force in Burma and India between 1942 and 1945, returning home via the ruins of Germany. His was Britain’s imperial war to prevent its vast Asian empire from being taken over by the Japanese. But there were many other wars: Japan’s against China; Germany’s with the Soviet Union against the rest of Europe; then Germany’s with much of Europe against the Soviet Union; America’s war against all the Axis powers.
And after the world wars came the Cold War. We think of this as a struggle between two empires that pretended not to be empires: the US and the Soviet Union. But its conflict zones were largely defined by the process of decolonization, as the European empires disintegrated.
Like the world wars, the Cold War was an agglomeration of conflicts. What happened in Vietnam had little to do with what happened in the Middle East or southern Africa, aside from the fact that both superpowers had dogs in each fight — dogs that they armed and financed, enlarging and prolonging local conflicts by turning them into proxy wars.
These great conflicts were the dominant phenomena of the 20th century, transforming economic, social and political life almost everywhere. But in recent times, their importance has somewhat faded in most minds. It would not be too much to say that during the interwar era of 1991 to 2018 — in other words, the period between Cold War I and Cold War II — many economists and policymakers lost interest in war.
Because the wars of the interwar era were relatively small (Bosnia, Afghanistan, Iraq), more closely resembling colonial policing operations, we forgot that war is history’s most consistent driver of inflation, debt defaults — even famines.
Large-scale war is simultaneously destructive of productive capacity, disruptive of trade, and destabilizing of fiscal and monetary policies. Compare global battle deaths from interstate conflict with international inflation data from the Organization for Economic Co-operation and Development. You will see that behind the era of economic stability known as the Great Moderation, there was period of declining conflict that lasted from the early 1970s until the outbreak of the war in Ukraine. The coming of peace, like monetary policy, acted with lag.
Rising Prices, Rising Tensions
Seven Decades of Casualties
Source: Our World in Data
The events of this year have reminded us of what is at stake in cases of great-power conflict. The war in Ukraine qualifies because Russia is still clearly a great enough power that it would probably have achieved its annexationist aims by now had it not been for large-scale financial, military and technological assistance to Ukraine from the US, the European Union and other associated states. This is a big war, measured by both casualties and costs.
There are honorable exceptions to the modern economists’ neglect of war. For example, in a nice 2008 paper on “Macroeconomic Crises since 1870,” Robert Barro and José Ursúa pointed out that of the 70 consumption and output disasters they identified for OECD countries in the modern period, one-third (23) were war-related.
A new paper I have co-authored with Martin Kornejew, Paul Schmelzing and Moritz Schularick, which draws on four centuries of data, shows that central bank balance sheets have been as much affected by geopolitical crises as by financial crises. The large quantities of government bonds held by central banks today are not exceptional by the standards of the 18th and 20th centuries. (The years 1815-1914 saw few really big, expensive wars.)
Economists tend to treat wars as “exogenous shocks,” generally omitting them from their models. From the historian’s standpoint, however, war is not exogenous, but the endogenous prime mover of the historical process — “the father of all things,” as Heraclitus said.
Two general points are especially worthy of notice. First, wars have played a very noticeable role in the history of inflation expectations. Thanks to the excellent historical work of the Bank of England, we can trace the history of UK inflation expectations all the way back to the late 17th century. The peaks in short-run expectations nearly all align with wars (generally years when they weren’t going well): 1709 (the Spanish War of Succession); 1757 (the Seven Years’ War); 1800 (Napoleonic Wars); 1917 (World War I); 1940 (World War II). The upward move in 1975 is the exception. (See here for the chart.)
Second, wars have often been responsible for discontinuities in the history of interest rates. As Schmelzing has argued, there has been a long-term “supra-secular” decline in nominal and real interest rates, dating back to the period after the Black Death of the 14th century (probably the greatest pandemic in history). The major breaks in the downward trend were nearly all associated with wars, particularly those that destroyed capital stock and generated monetary financing of debt.
An unusual feature of the recent past is that in 2020 a pandemic had the fiscal and monetary consequences of a world war. This was unprecedented. No previous pandemic, including the much more devastating 1918-19 influenza, had elicited comparable responses from finance ministries and central banks.
Because most (not all) countries followed the US in offsetting the supply-shock caused by lockdowns and spontaneous behavioral changes with generous transfers and significant monetary expansion, the first pandemic year was associated with extraordinarily large deficits and monetary growth rates — comparable in their size with those of the world wars.
Regrettably, major policy errors were committed in the second plague year of 2021. The newly elected Joe Biden administration embarked on an overambitious and supposedly “transformative” fiscal stimulus, while the Federal Reserve retained its accommodative stance, even as the rapid rollout of vaccines permitted a gradual return to normal social and economic behavior. Like those who thought the pandemic would last forever, those who argued that inflation would be “transitory,” as it was after World War II, turned out to be wrong. Those who saw a better analogy with the Fed’s “great mistake” of the late 1960s have been vindicated by the persistence of inflation.
Most accounts of the Great Inflation of the 1970s tend to underestimate the role that war played. Obviously, the 1973 Yom Kippur War played a significant part in driving up inflation in 1974 because of the oil embargo imposed by the Arab members of OPEC on the US and other countries supporting Israel.
But it is worth remembering that the August 1968 monetary policy mistake (cutting rates by 25 basis points, despite the fact that inflation was creeping up) coincided with the peak of US intervention in the Vietnam war, a conflict that played as big a part as President Lyndon B. Johnson’s “Great Society” policies in widening the US fiscal deficit — tiny though it was by modern standards — and ultimately breaking the dollar’s peg to gold in 1971. In 2022, a war played an analogous role in pouring kerosene on the inflationary fire. Food and energy prices were driven up the outbreak of the war in Ukraine and the sanctions imposed on Russia by the US and the EU.
It goes without saying that the return of great-power conflict has made the life of policymakers difficult, just as it did in 1973. I recently heard it said that the 2020s are not likely to be as inflationary as the 1970s because labor is less organized, so the risk of a wage-price spiral is lower. But I would draw your attention to a number of important differences that make our contemporary circumstances more worrisome than the situation in the 1970s.
Monetary growth rates were significantly higher between the second quarter of 2020 and that of 2021 than at any point in the 1970s. Year over year, they remained in double digits even after velocity, the rate at which money changes hands, had recovered.
Productivity growth is lower today in nearly all OECD countries than it was 50 years ago. Demographic trends are worse today, with a significantly higher ratio of dependents to the working-age population. Fiscal positions are worse today, with much larger amounts of government debt and projected deficits relative to GDP, not least in the US.
Financial markets are more complex today and therefore more fragile. There were no such things as liability-driven investments for pension funds in the 1970s. The onset of Covid in March 2020 exposed fragility in the US Treasury market not dissimilar to what we saw in the UK gilts market at the end of last month.
Then we had pollution; now we have climate change. Our political stability looks even worse than it seemed at the time of Watergate. In a recent poll, Americans were asked: “Do you think the nation’s democracy is in danger of collapse, or don’t you think so?” — 69% of Republicans and 69% of Democrats answered in the affirmative.
The war in Ukraine is lasting much longer than the war of 1973 (approaching eight months compared with 19 days). So far, there is no sign of détente in Cold War II — quite the opposite, in fact — so there is a non-trivial risk that we could soon witness a confrontation between the US and China over Taiwan.
Finally, although media attention currently focuses on the women’s protests sweeping Iranian cities, they coincide with the failure of the attempt to revive the Iran nuclear deal. The Tehran regime will likely speed up its effort to acquire a nuclear weapon, increasing the probability of war in the region, as no Israeli government will countenance a nuclear-armed Iran.
We may get lucky. We may get away with just re-running the 1970s — though judging by recent events in the UK, we may do it at a rather higher speed: from the inflationary Barber budget (1972) to the Winter of Discontent (1978-9) in a matter of weeks rather than years. (When a head of lettuce has a longer shelf-life than a prime minister, British politics has entered the realm of Monty Python, the best of 1970s comedy.)
Yet there is a much worse scenario, in which we get something closer to the 1940s, with regional conflicts coalescing into something like World War III — albeit with smaller armies, many unmanned weapons systems, and far more powerful and accurate bombs.
What makes me worry more about this scenario is the Biden-Harris administration’s new National Security Strategy, belatedly published last week. “We do not seek conflict or a new Cold War,” write the authors, presumably led by National Security Adviser Jake Sullivan. They then proceed to delineate an unmistakable cold war strategy. As they say, “the post-Cold War era is definitively over and a competition is underway between the major powers to shape what comes next.” In other words, Cold War II has begun, in all but name.
Strip away the woke stuff about “climate change … the greatest and potentially existential [problem] for all nations” and “the needs of the most marginalized, including the LGBTQI+ community,” and you are left with a significant amount of President Donald Trump’s NSS from five years ago, which was all about “great power competition.” In fact, the word “competition” appears 44 times in the new NSS, compared with just 25 in the 2017 edition.
See if you can spot the difference. “China and Russia challenge American power, influence, and interests, attempting to erode American security and prosperity. They are determined to make economies less free and less fair, to grow their militaries, and to control information and data to repress their societies and expand their influence.” That’s 2017.
“Russia poses an immediate threat to the free and open international system, recklessly flouting the basic laws of the international order today, as its brutal war of aggression against Ukraine has shown. The PRC, by contrast, is the only competitor with both the intent to reshape the international order and, increasingly, the economic, diplomatic, military, and technological power to advance that objective. … Russia and the PRC … seek to remake the international order to create a world conducive to their highly personalized and repressive type of autocracy.” That’s 2022.
“We will work with our partners to contest China’s unfair trade and economic practices and restrict its acquisition of sensitive technologies.” 2017.
“We must ensure strategic competitors cannot exploit foundational American and allied technologies, know-how, or data to undermine American and allied security.” 2022.
Biden’s plan for Russia might be described cynically as fighting to the last Ukrainian, but to what end? Ostensibly the US is determined to “support Ukraine in its fight for its freedom,” but the real goal is “to degrade Russia’s ability to wage future wars of aggression.” That is why the administration has made almost no effort to broker a cease-fire, much less peace. The White House seems to want this war to keep going, though I suspect that will change after the mid-term elections.
Given that China is clearly the administration’s higher priority, it is not immediately apparent what purpose is served by a protracted war in Eastern Europe. But a recent speech by Sullivan provided the answer.
“On export controls” against China, he said, “we have to revisit the longstanding premise of maintaining ‘relative’ advantages over competitors in certain key technologies. We previously maintained a ‘sliding scale’ approach that said we need to stay only a couple of generations ahead. That is not the strategic environment we are in today. Given the foundational nature of certain technologies, such as advanced logic and memory chips, we must maintain as large of a lead as possible.”
And here’s the key point. Sanctions on Russia, Sullivan declared, have “demonstrated that technology export controls can be more than just a preventative tool … they can be a new strategic asset in the U.S. and allied toolkit.” In other words, the US-led economic war against Russia is like a demo for China’s benefit: This is what we can do to you, too.
The remarkable thing is that the US has not waited for China to invade Taiwan to go ahead and do it. New restrictions just imposed by the US limit the transfer of advanced graphics processor units to China. (These are chips used in AI applications in data centers.) Washington has also limited the use of US chips and expertise in Chinese supercomputers, and China’s imports of chipmaking technology.
The aim is to impair Beijing’s ability to deploy artificial intelligence by driving up the cost of computing in China, whether for companies or the government. In short, the Biden administration aims to halt technological progress in China — rather in the way Trisolarans try to stunt Earth’s technological progress in Liu Cixin’s science-fiction novel The Three-Body Problem.
As Edward Luce noted in the Financial Times, “The new restrictions are not confined to the export of high-end US semiconductor chips. They extend to any advanced chips made with US equipment. This incorporates almost every non-Chinese high-end exporter, whether based in Taiwan, South Korea or the Netherlands. The ban also extends to ‘US persons,’ which includes green card holders as well as US citizens.”
The most extraordinary thing about these measures is how little comment they have elicited in the media. Trump did nothing so radical. As Luce put it: “A superpower declared war on a great power and nobody noticed.”
To understand the full significance of this move, you need to read Chris Miller’s brilliant new history of the microprocessor, Chip War: The Fight for the World’s Most Critical Technology. Last week, I interviewed Miller, and asked him if this might be a repeat of the mistake the US made with Japan between 1939 and 1941, when economic sanctions so boxed in the imperial government that in the end there seemed no better option than to gamble on surprise attack.
Miller thought this was the wrong analogy, because US sanctions against China today are more targeted than those against Japan. I am not so sure. Cutting China off from high-end chips today seems a lot like cutting Japan off from oil in 1941. And it is an especially hazardous move when more than 90% of the production of those chips takes place in Taiwan, an island that China claims as its own.
“Taiwan is China’s Taiwan,” President Xi Jinping declared at the 20th Chinese Communist Party Congress last Tuesday. “Resolving the Taiwan question is a matter for the Chinese, a matter that must be resolved by the Chinese. We will continue to strive for peaceful reunification with the greatest sincerity and the utmost effort, but we will never promise to renounce the use of force, and we reserve the option of taking all measures necessary.”
The spectacle of Xi’s predecessor, Hu Jintao, being humiliatingly and publicly removed from the closing ceremony of the party congress on Saturday was a chilling one. The intent was clear: to signal to the world that China now has, for the first time since 1976, a leader as powerful and as ruthless as Mao Zedong. What did Xi say so coldly as Hu seemed to remonstrate? “You’re out, Tom,” from The Godfather came to mind. (And why did Michael Corleone drop Tom Hagen? Because he was not a “wartime consigliere.”)
Empires fall. Two weeks ago, I optimistically suggested that I would live to see the fall of the empires of the Chinese Communists, the Russian fascists and the Iranian theocrats. But we must not make the mistake of assuming that the US is an indestructible empire, for there is no such thing. The Biden administration would not be the first Democratic administration elected on a progressive domestic program that stumbled into a major war: Woodrow Wilson, Franklin D. Roosevelt, Harry Truman and Johnson — they all did it. The record is: won two, tied one, lost one.
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The city of Washington once ruled over an empire that stretched from North America across both the Atlantic and Pacific oceans — and beyond. I was in the nation’s capital last weekend for the International Monetary Fund meetings and saw abundant evidence that the empire still rules. The restaurants were crowded with the representatives of poorer countries — the “global South” as they sometimes call themselves — whose principal goal was debt renegotiation, not tourism. The governors of lesser central banks sat on panels; the mighty Fed chair, Jerome Powell, absented himself.
Yet can one imagine the White House as a future Palazzo Ducale, our Capitol like the Roman Capitol, a ruin where some future historian will one day “sit musing”?
The answer is: All too easily, if we pursue Cold War II to the extent of stumbling into World War III.