Dangerous Economic Territory

The last quarter century has represented a relatively seamless, bipartisan political consensus in favor of free trade and liberalized financial markets.

In the United States during this period, globalization was not a Republican or Democratic phenomenon.

Indeed, there was not much difference in economic policymaking between Democrat Bill Clinton and Republican Ronald Reagan. The reality is that Bill Clinton as president was even more a free trader than Ronald Reagan.

Clinton became the champion of globalization and liberalized financial markets. He was a lead participant in a quarter-century of amazing prosperity and global poverty reduction.

Both Reagan and Clinton grabbed on to globalization as a flawed yet essential tool to break away from the economically suffocating 1970s.

The young Bill Clinton came of age in the 1970s, so he was particularly aware of the economic disillusionment of that period. Reagan was born in 1911, so he came of age during the Great Depression.

In a sense, therefore, once in the White House, both recognized the urgency and opportunity of being able to ride the great globalization wave.

The question today is: What happens when global financial market participants fully realize that this remarkable period of policy consensus is at risk of coming to an end?

Both political parties in the United States today are quickly backing away from the pro-globalization policies championed by Bill Clinton.

Clearly, part of the financial market turbulence, and dollar weakness, in recent times stems not only from subprime-related credit uncertainties, but also from the uncertainties about the direction of U.S. politics.

These fears have been heightened by U.S. politicians who increasingly engage in populist attacks on capital formation, entrepreneurial initiative and wealth creation.

Here’s the problem with politicizing globalization. World financial markets until now have set the price of U.S. financial assets, including the price of stocks, at relatively high values.

This is based on the bullish assumption that the Clinton-Reagan model of free trade, liberalized capital markets and long-term robust growth will remain largely intact.

Now a new political universe appears to be emerging, with less patience for freely liberalized trade. The questions of the hour are: How will markets in coming years reprice the changing nature of the political environment? And will an aggressive downward repricing of financial assets happen in a climate of panic?

The threat for financial markets of unwise political change is very real. Today there is the growing belief that the financial world, politically speaking, has entered uncharted political waters.

One reason the world is curved is that today’s median-aged voters in the United States look at globalization’s downsides with not enough appreciation of its tremendous upsides in helping the U.S. economy pull itself out of the 1970s period of economic heartache.

They don’t remember the difficulties of this period and can’t imagine a less-than-fully-employed economy with low inflation and low interest rates. Everything about the seventies — the economics, the foreign policy, the music, even the fashion — was ugly.

Remember, this was just after the humiliating end of the Vietnam War. It was less than a decade after a scandal-plagued President Nixon was forced out of office. The sense still lingered that the 1963 Kennedy assassination had robbed the nation of its innocence, and its promise.

In contrast, the 1980s and 1990s produced a renaissance of American confidence and optimism about the future.

All of which brings up two important questions about today’s situation: Could America and the world be slowly returning to a period as economically devastating as the 1970s? And is the phrase “the seventies” even relevant to most voters today?

I agree with Barack Obama when he said in March 2008: “The core of our economic success is the fundamental truth that each American does better when all Americans do better. That the well-being of American business, its capital markets and the American people are aligned.”

That is why dramatically expanding the base of the so-called investor class is essential if globalization is to survive.

Today the future of globalization is politically unpredictable fundamentally because the base of financial capital ownership is so small. Meanwhile, the wealth gap is widening. As a result, globalization’s political base of support remains tenuous at best.

The United States in particular sits at a crucial point in its economic history. Today’s politicians have experienced a quarter-century of extraordinary bipartisan economic success.

They have witnessed a level of global wealth creation and poverty reduction that would have seemed far-fetched, verging on pure fantasy, in the late 1970s.

And yet they flirt with protectionist, class warfare policies that would unravel this economic success that a broad international coalition, including Reagan and Clinton, worked desperately to achieve.

What I hope is clear is that the U.S. political community, in rejecting the free-trade, liberalized financial market agenda of Bill Clinton, is at risk of creating the conditions for a global financial disaster.

At first, we’ll see a steady loss of global investor confidence in the United States, followed by the shrinking of liquidity and credit availability and then a protracted period of stagnant economic growth far below potential.

Weaker growth will beget even more protectionist, class warfare rhetoric and policy, which will further shrink confidence in the United States throughout the international system.

That is why when today’s politicians dare to be different on the issue of free trade and liberalized capital, they should remember that often dares can be deadly.

Editor’s Note: This feature is excerpted from THE WORLD IS CURVED: HIDDEN DANGERS TO THE GLOBAL ECONOMY by David M. Smick by arrangement with Portfolio, a member of Penguin Group (USA), Inc., Copyright (c) David M. Smick, 2008.