(This will be the last WGR for 2016. The next report will be published on January 9, 2017.)
As is our custom, we close out the current year with our outlook for the next one. This report is less a series of predictions as it is a list of potential geopolitical issues that we believe will dominate the international landscape in the upcoming year. It is not designed to be exhaustive; instead, it focuses on the “big picture” conditions that we believe will affect policy and markets going forward. They are listed in order of importance.
Issue #1: The Trump Doctrine
The election of Donald Trump was the second major shock to the Western political establishment in 2016, the first being the Brexit vote. At this point, there is clearly a growing rejection of the policy consensus that has been in place since at least 1990, with the fall of communism, and perhaps even 1944, with the Bretton Woods agreement.
Although Trump’s foreign policy is still evolving, there are two key emerging themes:
There is lots of “brass” in the administration. Trump is putting a number of former generals in positions of power. Although this has raised concerns among some commentators about the loss of civilian oversight, we suspect it will make the new administration more cautious about deploying military force. We view Trump as a Jacksonian.1 This particular archetype of foreign policy figure tends to intervene abroad less than Wilsonians or Hamiltonians. The military men in the government will likely be reluctant to deploy troops and, if they do, they will likely insist on following the Powell Doctrine which places hurdles before deploying troops. Specifically:
- Is there a vital national security interest being threatened?
- Do we have a clear and attainable objective?
- Have all the risks and costs been fully and frankly analyzed?
- Have all non-violent policy tools been fully exhausted?
- Is there a plausible exit strategy?
- Have the consequences of our action been fully considered?
- Is the action supported by the American people?
- Do we have broad international support?
It is worth noting that the Iraq War, the Afghanistan War and the intervention in the Balkans would not have passed these conditions.
Jacksonians deplore limited war that ends without a clear victory. They do not brook anything but unconditional surrender. Those objectives mean that war is only undertaken if necessary. And, having former military figures in these roles means that these people have personal experience with the costs of war and will probably use it sparingly. Thus, we would expect less military activity, but if intervention is required then it would be reasonable to expect targeted operations with overwhelming force.
In contrast, Hamiltonians tend to use foreign policy to support American firms and Wilsonians deploy troops for moral causes. We would expect neither to occur under Trump which means that other nations may not be able to rely on American support without a direct U.S. interest.
The U.S. may become a malevolent hegemon. Broadly speaking, the global superpower has two roles. The first is financial—it provides the reserve currency which means it absorbs enough imports to provide enough of its currency for global trade. This also means it must have a deep financial system to provide investable vehicles that foreigners can use to hold reserves. The second role is to provide global security.
Although no hegemon is perfectly benevolent, the U.S. has been relatively benign compared to others. The last two, the British and the Dutch, had colonies, for example. They forced the colonies to provide commodities and made them accept finished goods. Instead, the U.S. has used its large relative size to absorb the world’s imports and provide dollars for reserve and trade purposes.
Militarily, the U.S. contained the Soviet Union and froze conflicts in Europe, the Middle East and the Far East. In Europe, through NATO, the U.S. essentially demilitarized the continent by providing its security. The same was accomplished in the Far East by demilitarizing Japan. These actions prevented another European war and a rekindling of Sino-Japanese tensions. In the Middle East, the U.S. honored the colonial borders which maintained hostile stability. The colonial European powers had created colonies that were designed for outside control. In most cases, tribal, ethnic and religious groups were either separated or combined in ways that were not conducive to independence. In addition, minority groups were put in power so they would be dependent on the European colonialists in order to remain in power. Although these nations were destined to be unstable without authoritarian governments, the U.S. honored these borders to maintain stability. Finally, the U.S. Navy also protected the sea lanes to foster trade.
American political leaders have always had to balance the superpower requirements with domestic needs. From 1945 to 1978, the U.S. did this by fostering the creation of high-paying, low-skilled jobs. This was done through high marginal tax rates and industry concentration which stifled the introduction of new technology and entrepreneurship. Unfortunately, by the 1970s, this economic structure was unable to contain inflation, so policymakers adjusted the model by supporting globalization and deregulation. This led to falling inflation at the cost of rising income inequality. Many households increased their borrowing in the face of falling incomes. The failure of this policy became evident with the 2008 Financial Crisis.
Since the crisis, policymakers have struggled to find a proper response. Are deregulation and globalization “self-evident truths”2 that should always be protected and supported? If so, is it possible to reduce income inequality? Can the U.S. continue to provide the global public goods that its superpower role requires?
Although it is early, there is growing evidence to suggest that Trump may rewrite America’s superpower role with the goal of improving the lot of the bottom 80% of the income distribution. It remains to be seen what form this may take. However, it appears Trump may require foreign nations that want access to the dollar to pay more for that privilege. This may mean that if a nation wants to sell its products in the U.S., it will be required to build production facilities here. If it refuses, it may find itself facing barriers to trade. The Trump administration may also penalize domestic firms that offshore production through tariffs. Nations under America’s security umbrella may be forced to pay for those services, which could be in the form of minimum purchases of arms from American firms.
Most hegemons extracted some sort of tribute from the world for the global public goods they provided. The U.S. has been relatively munificent compared to other superpowers, and it would be politically popular to create conditions that support Americans by shifting some of the costs of hegemony to the rest of the world.
However, it should be noted that such a shift carries risks. The U.S. managed to prevent WWIII through its policies. Allowing Japan and Europe to rearm might also lead them to become more aggressive and independent in foreign policy. It should be noted that the last two world wars sprang from Europe; a remilitarized continent with an independent foreign policy increases the potential for regional conflict. Raising barriers to trade may simply lead to global mercantilism and weaker global growth. The combination of falling economic growth, reduced trade and “thawing” conflict zones is a recipe for conflict.