Winning The Cold War: The New World Order Part IV by Bill O’Grady of Confluence Investment Management.

In this final installment of our four-part series on The New World Order, we will examine how, in light of winning the Cold War, policymakers have been unable to settle on a set of key priorities and offer what we see as “glimpses” of a new policy emerging. In a sense, the U.S. never really wanted to be a superpower; the nation’s founding story is one of wresting independence away from a colonial power. Americans were willing to put up with the economic and political distortions that came from becoming a superpower in order to defeat communism. Now that this existential threat has ended, the political class has struggled to create a foreign policy that can simultaneously provide the required hegemonic global public goods and create a working economic policy and political coalition that will build domestic harmony.

In this report, we will recap why the current policy mix is unsustainable and yet, why the U.S. remains indispensable for world peace and global growth. And so, if the U.S. cannot be replaced anytime soon, American policymakers need to create a solution that will allow the U.S. to fulfill at least some of the hegemon’s responsibilities and also create a sustainable domestic economy and political coalition. We will conclude with a broad examination of the potential long-term market effects from this evolving New World Order.

The Unsustainable Situation

As noted in earlier segments of this report, the Roosevelt Coalition created a wide road to the middle class for mostly white households. The economy it created generated steady economic activity with impressive median family income growth. However, attempts to diversify the coalition to include racial and ethnic minorities and to expand the “middle class road” to women weakened the coalition as white men rebelled against these changes. In addition, as the rest of the world recovered from the devastation of WWII, the inefficiencies required to create high-paying, low-skilled jobs led to persistent and uncontrolled inflation.

In order to maintain the superpower role and end inflation, the Reagan Coalition deregulated and globalized the economy, dramatically improving its efficiency. This change ended the economy’s ability to create high-paying, low-skilled jobs. To meet the hegemon’s importer of last resort role, policymakers needed American households to consume more goods, especially as the American economy became smaller relative to the rest of the world. The solution to this problem was to deregulate financial services and allow for an explosion of household debt.

The 2008 Financial Crisis effectively ended this solution to superpower consumption. And so global growth has been sluggish, with the rest of the world waiting for the return of the American consumer. The path to development since 1945 has been to create an export-promoting economy. As part of this process, exchange rates were kept artificially low to suppress imports and foster exports. This is done by suppressing domestic demand, which boosts savings and creates investment to build an export industry. Export promotion has been the course of nearly all successful development since WWII, as seen by the economic “miracles” of Germany, Japan, South Korea, Taiwan and China. This development model requires that the global superpower absorb these nations’ exports and also create a global free trade architecture to support their export-oriented economies.

The U.S. was willing to provide these services for two reasons. First, America needed to offer an alternative to communism and create a free trade zone for the Free World, which fostered recovery and development. Over time, the contrast between the Communist Bloc and the West, in terms of economic development, became stark. Second, policymakers became convinced that trade protection led to the Great Depression and thus wanted to avoid a repeat of that experience.

Militarily, the U.S. had to make difficult adjustments to the superpower role. America was essentially on a permanent war footing. Several inconsequential wars were fought in South Korea, Vietnam, Afghanistan and Iraq. In Western Europe, the U.S. ensured that another war for local supremacy wasn’t fought by effectively demilitarizing the continent and taking over its defense. The U.S. effectively did the same thing in the Far East with Japan. This allowed both Europe and Japan to concentrate on economic recovery and expansion without the usual cost of defense. Again, these actions were taken in part to win the Cold War. For Americans, fighting limited wars, the common conflicts that engage a superpower, ran against the grain of the American narrative. The U.S. sees itself as avoiding war until it becomes impossible to circumvent, then entering the conflict, finishing it and going home to demilitarize. Every war fought since 1945 has been framed as a fight to prevent “the next Hitler” and thus characterized as “unavoidable.” Instead, Americans find themselves either leaving conflicts unfinished (e.g., Vietnam, Afghanistan, Iraq) or being forced to maintain a sizeable troop presence for years to prevent further conflicts (South Korea, Western Europe, Middle East).

The increased anger of both the right and left-wing populists in the U.S. is an indication of rising discontent with the superpower role. When right-wing populists pine for small government, they are really saying the U.S. should end its hegemon role. After all, one cannot be a small government superpower. While left-wing populists want reduced income inequality, policies designed to bring that about will eventually be inflationary. It may take a decade or two, but these policies will make the economy less efficient. In the current circumstances, such policies would not be inappropriate as long as one knows that the eventual outcome will be unpleasant.

However, all this assumes that the U.S. could walk away from global hegemony, which may not be reasonable. Unlike Britain in the 1940s, there is no capable superpower replacement “waiting in the wings.” And, history shows that a world without a superpower becomes a Hobbesian1 cauldron for human suffering. It is also important to remember that not only is there no other nation in the world at this juncture that can fulfill the superpower role, but there is no nation that really wants it, either. It is politically much easier to let the superpower secure the world with that nation’s “blood and treasure” and “free ride” off its consumption. No nation would reasonably want that role and, as the U.S. did 70 years ago, it is only undertaken because the alternative is seen as worse.

So, in reality, the U.S. needs to create a “scaled down” model of hegemony that will allow the country to maintain global order in a sustainable fashion. This is what we see emerging.

The New World Order

The emerging New World Order, like the superpower role, has two elements, the military/foreign policy role and the economic role.

The Military/Foreign Policy Role: The U.S. spends more on its military than any nation in the world. That’s because it’s the only nation with global responsibilities and thus must be able to project power everywhere. Over the past seven decades, the U.S. has demilitarized large segments of the world, primarily Europe and the Far East, to prevent future wars from developing. It has also been heavily involved in the Middle East to ensure oil flows remain uninterrupted. This costly policy mix has become difficult to sustain. In recent

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