The fragile superpower

AMERICA, the ailing superpower, has fresh evidence about its feet of clay, with the credit crisis supplanting Iraq as the latest malaise of the presidential election season.

The US Federal Reserve has cut the federal fund rate by 75 basis points to 3.5 per cent, the biggest cut in 25 years, while President GeorgeW. Bush has combined with the US Congress to approve an urgent $150 billion package to boost spending and combat the loss of consumer confidence.

Consider the dismal story of the Bush presidency. After the 9/11 attack, the folly of the Iraq war, the tribulations of the so-called war on terrorism, the reliance upon China's savings and its choice of high budget and current account deficits, the US now confronts the certainty of an economic downturn and the uncertainty about its depth and duration.

The unmistakable message concerns American fragility. This fragility, exposed in Iraq, now centres upon its domestic economy. In a visceral yet multifaced way it feeds into a new political mood on display in the early primaries - that the US is heading in the wrong direction and needs an injection of fresh leadership, inspiration and ideas.

At the risk of simplifying a complex situation the revival of John McCain's hopes on the Republican Party side and the excitement driving the Democratic Party campaign of Barack Obama are reflections of this yearning. How deep this instinct runs and what policy manifestations it assumes remain unpredictable. But the longing for a new beginning is palpable.

With Bill Clinton's successful 1992 campaign based around "It's the economy, stupid" nobody doubts that Hillary Clinton will project herself as the candidate best able to meet the challenge. Of course, Hillary is not Bill, despite the stunning events of the past week with Bill aggressively campaigning for his wife and prompting Obama to remark that "I can't tell who I'm running against sometimes."

History shows America's strength is to find inspiration from its past while looking towards the future. This is a watershed election because, on the pivotal issues of foreign, security and economic policy, new solutions and messages are an imperative. Will the Clinton caravan, like the Bush dynasty, loom as part of America's past rather than its future?

There are immediate and speculative implications for the US from the current crisis. It has provoked the doomsayers, with financier George Soros predicting that "a recession in the developed world is now more or less inevitable". Many dispute such pessimism.

Yet Soros has a more epic view of the crisis, writing in the Financial Times that it is the "culmination of a super-boom that has lasted for more than 60 years" and is ending because the relentless creation of new financial products has spread risk too widely in the financial system. The upshot is a crisis "more severe than any since the Second World War". It is a contested view.

There are, however, three irresistible conclusions from the meltdown - it represents an institutional crisis in US capitalism on the lending side and within the central bank with its policy of excessive liquidity for too long underwriting the growth of debt and asset price bubbles; it highlights the declining role of the US in the world economy and the power of China, East Asia and sections of the developing world where growth rates are very high and whose funds are bailing out US institutions; and it will entrench the new US political narrative about the limits to American power arising from strategic and economic setbacks that, in the post-Bush era, will focus on "getting our own house in order".

Get ready for this transformation. The historial critique of Bush will be that he misread the limits to US power and, as a result, is leaving the nation weaker than he found it. A damning legacy.

A measured view of the present US outlook is that it will experience significantly weaker growth for some time. Former US treasury secretary Larry Summers warns about the threat of recession. The past week has been dominated by unrelenting panic. Each presidential contender has championed a variation of the stimulus package.

A recently publicised comparison of the US dilemma with other financial crises conducted by American economists Carmen M. Reinhart and Kenneth S. Rogoff concluded that "if the US does not experience a significant and protracted growth slowdown it should either be considered very lucky or even more special than most optimistic theories suggest" and that America "should consider itself quite fortunate if its downturn ends up being a relatively short and mild one".

Yet the combination of a trigger-happy US Fed offering cheap money and desperate politicians offering tax cuts and investment incentives may avert recession.

The coming US downturn means more household restraint, greater pressures on the US federal budget, less money for foreign military activity and more reliance upon allies and coalitions. It will produce more introspection and work against unilateralism in foreign policy. Such economic consequences will reinforce the security conclusions drawn about the failures of the post-9/11 Bush doctrine. Any serious downturn, however, will demand political scapegoats, another danger being that China may be high on the list.

Speaking in London a week ago, Reserve Bank of Australia governor Glenn Stevens said it was "reasonable" to expect a period of "below-average performance" for the US as bad loans were written down and balance sheets repaired. But Stevens argued that Asia is removed from the US shock, that China's growth would continue, that demand for Australia's commodities would be buoyant and remarked upon the "striking difference in confidence one encounters when travelling from the Pacific time zone to the European one".

This has two implications. First, our central bank is sceptical about the US shock as an excuse to delay raising interest rates in Australia. Second, it highlights the huge structural changes in the global economy that are mirrored in financial imbalances between the US and China, tied into the credit crisis.

China has taken a strategic financial decision to run a high current account surplus and invest its capital in the US instead of lifting the living standards of its own people at home (the advantage of being a dictatorship) while at the same time US consumers have their debt-heavy living standards subsidised off the massive inflows of these Chinese savings.

It has been likened to a balance of financial terror. Financial Times economist Martin Wolf argues the cheap money stance of the US central bank in recent years is partly a response to this financial disorder. However, its political legacy is certain: it exposes China to the resentment of US populism when the system hits failure.

Soros argues that the current US credit crunch is "less likely to cause a global recession than a radical realignment of the global economy with a relative decline of the US and the rise of China",

Exactly. But no presidential candidate in this watershed election year has come to reconcile the American people to such decline. The truth is that beneath the beauty contests of the primaries the political system is not addressing the structural problems that beset the US. The primaries are about political sex appeal, not policy answers.

It may be true the key to US politics is inspiration as an enabler of policy. Leaders such as Ronald Reagan mobilised enough goodwill to run audacious policies (some good, some bad). Observe that Barack Obama infuriated many Democrats last week by saying "I think Ronald Reagan changed the trajectory of America in a way that Richard Nixon did not and in a way that Bill Clinton did not."

Obama invites the public to perceive him as a Reagan. Democrat ideologues branded him a heretic. But Obama's message was about changing America's path as well as changing its policies. He argued, in effect, that being a hard-boiled professional Washington insider wasn't enough, that it is time for a candidate able to look beyond the red-blue divisions, the culture war, the racial divide and to create a new voting constituency.

Andrew Sullivan argues in The Atlantic Monthly magazine (December 2007) that Obama's significance is precisely this ability to transcend the divisions that have plagued the US over the past generation. He says Clinton is the candidate if you think America's crisis is not deep. But if you think far-reaching change is needed then Obama is the best hope for shifting the US centre of gravity into another place.

In a sense this is McCain's tactic. He runs as a Republican anxious to distance himself from the Bush era.

The American malaise is complex, both a cause and a consequence of the defective foreign and domestic economic policies of the Bush presidency. The US public wants a break from the past but it remains unclear whether any presidential candidate can seize this opportunity to re-position the US and address the malaise.