The Changing World

The world is changing, and politicians can’t keep up.

From the New York Times:

When Barack Obama joined Silicon Valley’s top luminaries for dinner in California last February, each guest was asked to come with a question for the president.

But as Steven P. Jobs of Apple spoke, President Obama interrupted with an inquiry of his own: what would it take to make iPhones in the United States?

Not long ago, Apple boasted that its products were made in America. Today, few are. Almost all of the 70 million iPhones, 30 million iPads and 59 million other products Apple sold last year were manufactured overseas.

Why can’t that work come home? Mr. Obama asked.

Mr. Jobs’s reply was unambiguous. “Those jobs aren’t coming back,” he said, according to another dinner guest.

Paul Krugman adds:

“The entire supply chain is in China now,” said another former high-ranking Apple executive. “You need a thousand rubber gaskets? That’s the factory next door. You need a million screws? That factory is a block away. You need that screw made a little bit different? It will take three hours.”

The point is that manufacturing plants don’t exist in isolation; they benefit a lot from being part of a manufacturing cluster, with specialized suppliers and a large pool of workers with the right skills close at hand. This is the kind of stuff I emphasized in my own work on both trade and economic geography.

As I wrote in October:

Looking at global population density — with American taxpayers subsidising the cost of a flat global marketplace — where can we expect productivity to agglomerate?

The high-density zones. But it was not always thus, because the world was not always flat. Technological, intellectual and social infrastructure once dictated that the agglomeration of manufacturing, skills and industry took place in the West. Development spirals into greater development. Alas, the world was flattened under the aegis of American imperial grandeur, and so capital, skills, supply chains, and so forth took off to where the labour was cheaper, the population denser, regulations laxer, and factories clustered:

“Our customers are in Taiwan, Korea, Japan and China,” said James B. Flaws. “We could make the glass here, and then ship it by boat, but that takes 35 days. Or, we could ship it by air, but that’s 10 times as expensive. So we build our glass factories next door to assembly factories, and those are overseas.”

This agglomeration presents a geostrategic challenge to America that I am yet to see other commentators recognise. As America’s productivity has gone overseas, America has not really experienced many negative effects beyond the obvious problem of job migration. That’s because as the originator of the global reserve currency, other nations need dollars. That has meant that the fruits of the Earth, and the world’s labour have flowed and flowed into America irrespective of America’s own productive decline.

America’s internal workings — her agriculture, her internal transport network, her consumption, and indeed even her internal manufacturing (and so forth) — are dependent on a global system of resource extraction, labour, production and shipping. More or less, America is dependent on foreign energy and goods, and her foreign policy is geared toward sustaining the global flow of energy and goods. That’s why America spends more on her military than any other nation, and over 50% of the global total. However this has meant great debt, as America is producing far less than she is spending.

So does that mean globalisation is bad? No — I am all for free trade, and global markets, and that requires a degree of security. But at the same time, free markets require proper pricing mechanisms. American manufacturing has been out-competed in the American market predominantly because Chinese products do not accurately reflect the costs of global security; those costs are reflected not in prices, but in the Pentagon’s budget, and in Federal deficits. Those cheaper Chinese goods might not have put so much American industry — and subsequently industrial infrastructure — out of business without that subsidy; for a start shipping would be costlier and less reliable. With a less obvious advantage in selling to the American market, it is likely that both China’s growth, and America’s decline would have been slower.

So America’s rising government debt burden, and America’s lost industrial infrastructure are in at least one way two sides of the same coin. Less world policeman would not only mean less debt, but more domestic industry.

These concerns are reflected in Obama’s recently announced foreign policy and global defence doctrine:.

From the Washington Post:

President Obama pledged that the $489 billion in defense cuts he has proposed over 10 years would be governed by a concerted strategy, and on Thursday he delivered one. At the Pentagon, Mr. Obama unveiled a “strategic guidance,” which aides said reflected a considerable investment of his personal time and ideas. The president’s thesis is that the need for fiscal austerity coincides with a global “moment of transition,” in which the United States is winding down a decade of land wars in Iraq and Afghanistan and facing the need to turn toward a very different set of challenges, particularly in Asia.

Several previous administrations have tried to shift to Asia from the messy Middle East, only to be dragged back by wars, terrorists, turmoil and the unending need to protect allies and the flow of oil. The Obama strategy acknowledges that history and says this pivot will be different. The means to reduce spending and build capacity in Asia, it suggests, will come not from the Mideast but from U.S. deployments in Europe, benefit and retirement costs, Cold War weapons systems and the U.S. nuclear arsenal.

The trouble is, this is much too little much too late. Had President Bush announced this in 2002 (or President H.W. Bush in 1992) years of fruitless imperialism in the middle east and trillions in debt might have been avoided. American industry, supply chains, technology, industrial infrastructure and skills have already been gutted; as Steve Jobs alluded to, the iPhone will never be made in America. America is still deeply dependent on foreign oil.

More or less, this strategy is trying to close the stable door after the horse has bolted.

The effects of decades of policy will be hard to mitigate. America must face the fact that her most important export — dollars and Treasury bonds — will be blighted by the end of the dollar as the global reserve currency.

A significant number of Eurasian nations — including Japan, India, China, Russia and Iran — have pledged to in future conduct bilateral (and surely soon also multi-lateral) trade in their own domestic currencies, including for trade in oil and other commodities.

The impact of this would be disastrous. Simply, nations would not need to sell their wares and resources to America; a hostile Chinese or Arab regime could foreseeably cut America off from essential resources, components or goods. China already limits exports in rare earth metals. How long before nations feel capable of blackmailing America by withholding or heavily taxing resources, goods and components on which America depends?

Hawks might respond that no nation on Earth would feel capable of doing that, because America has the military clout to bite back. But for all of Obama’s assertions that the military is refocussing on the Asia-Pacific, America is too broke to start a war or proxy war with her great creditor. More importantly, such an event would probably shut down or slow the flow of global goods and energy meaning immediate and disastrous economic consequences for America.

America could be taking every step imaginable to make herself energy independent  (or at least dependent only on North American energy) as soon as possible as a matter of urgent national security. This would be a solid base from which to build. Alas, Obama totally rejected the Keystone XL Pipeline, which could have formed a major plank toward this goal.

28 thoughts on “The Changing World

  1. We want a strong dollar so we can buy lots of Chinese stuff, but it doesn’t work in reverse. China doesn’t want any overpriced goods from America. Without exports to pay our bills, we’ve had to borrow. The strong dollar has allowed us great consumption, but it can’t go on like this. Somebody is going to get defaulted on.
    Foreign holders of American debt? Not likely; it would a global disaster.
    Break the promise to American citizens? No, there’d be riots in the streets.
    Default on Grover Norquist and tax the wealthy and the corporations? I must be joking.
    Then there’s inflation. The value of the dollar is going to have to drop. Americans will consume less as the standard of living falls. But a weakened dollar cannot be the world’s reserve currency. So that leaves the question, as we like to say about Europe, will the exit be orderly?
    The State of the Union is in two days and Obama will talk about boosting tourism. That’s a great short-term solution. But for the long-term, will America accept the changes or will they be forced upon it?

  2. And it appears as though he failed to carry out the law by not specifying exactly how the project fails the national interest test. The only stated reason for the decision I have been able to find is that the 2 month time limit in the law did not allow time to carry out additional environmental studies. But such additional studies were specifically excluded by the same law as reasons for non-approval of the project. The State Department had already signed off on all required studies when the environmentalists showed up at the White House in November to protest the project and that seemed to have been the trigger for Obama. It really makes little sense because there are several good reasons that approval of the project is in the national interest.

    • I was very sympathetic to the environmental arguments, I think a lot of the environmental concerns could have been taken into account in the final plan, but energy independence is a matter of immediate national security.

  3. If there is no pipeline, then say good bye to the environment. If the USA goes down because of oil embargoes or lack of credit, the USA will descend into Civil War and the Chinese will march into Alaska.

    The Chinese have made efforts to improve the environment, but without the USA and Europe to control them, the people will dictate environmental policy.

    And if the Chinese can boil live fish in hot oil, just enough so they are crispy and still flapping, then kiss the animal and environmental rights good bye.

    Based on that World Map, Australia is well placed in the 21st Century. Darwin city in the north looks like cheap real Estate. Gate way to Asia and Australias minerals.

    • I don’t see China occupying US Territories, let alone the mainland States. America would still have the might to nuke Beijing in such cases.

      • Yes, I see the danger of a breakdown of global trade, and I see the danger of civil crises in America stemming from this, but I don’t see China occupying America. Things would have to deteriorate much, much more than I foresee. Of course, anything is possible, but I think the more likely conflict is war or proxy war in the Pacific.

  4. What do you see as the fair value of USD, or USD/CNY? Exchange rates are supposed to be ultimately determined by the exports and imports of the particular country – the inflows and outflows of capital. In the case of USD this principle does not seem to apply. I see USD/CNY falling to the range of 1~2 within the next decade.

  5. This is really an excellent overview, with remarkable equanimity toward the several and many opinions on what has taken place and why.

    Of course, the Reserve Currency issue for the US is going to be a profound game changer for Americans. (I cannot think of a greater one.) It occurs to me that since the Dollar took that role in 1944, which bestowed enormous privileges (and pitfalls) on the country — there are few Americans alive today who can envision what life in the US will be like without this advantage.

    Perhaps this approaching reality would not be nearly so daunting had Nixon not severed the Dollar’s tie to gold in the early 1970s (faced with the staggering Vietnam war costs, which I see we are now calling “sustaining the global flow of energy and goods” costs). I don’t think the Bretton Woods signers had this in mind in 1944 when they turned away from the Sterling and signed on to the Dollar as a stable store of value. In any event, from tthat point forward, the Dollar was debased through the legal and easy expansion of the money supply (in order to borrow for “policing” purposes, I suppose). The Dollar is now a unit of debt and obligation rather than wealth — and the world has moved on in search of a better trading currency.

    The number of currency swaps that have been going on in recent years is astonishing. Just yesterday, India and Iran negotiated a swap of oil for Rupees — in order to trade without American interference with their purchase of required recources. Japan buys oil in Yen, South America swaps with China to avoid the Dollar; Russia, as well. The work-arounds are everywhere as countries seek to shrink their exposure to risky US debt and Dollar hegemony. As you say:

    America must face the fact that her most important export — dollars and Treasury bonds — will be blighted by the end of the dollar as the global reserve currency.

    A significant number of Eurasian nations — including Japan, India, China, Russia and Iran — have pledged to in future conduct bilateral (and surely soon also multi-lateral) trade in their own domestic currencies, including for trade in oil and other commodities.

    But the paragraph that follows this, I am not sure I understand:

    The impact of this would be disastrous. Simply, nations would not need to sell their wares and resources to America; a hostile Chinese or Arab regime could foreseeably cut America off from essential resources, components or goods.

    How and why? To me it makes little business sense — or geopolitical sense. If China does not wish to sell rare earths (to anyone, I might add, not just the US) because they feel their resources are highly limited — that’s too bad for would-be buyers, who will have to look elsewhere. Or, did you mean that the mechanism of trade blockage is that some nations might not accept US Dollars in trade? That is certainly going to be the case.

    For 70 years, nations have had to exchange their currency into Dollars in order to trade internationally (at some expense). In the near future, the US will be required to exchange Dollars into whatever currency its trading partners request (most likely an IMF synthetic currency basket). Same story; different players. The real question is what the value of the Dollar will be after the books are settled on how much debt we have monetized during the latter half of our unfortunate run as the Reserve Currency. The pitfall of this particular privilege.

    Is the alternative, as some readers suggest, to deliver our Dollars on the back of a tank?

    • How and why? To me it makes little business sense — or geopolitical sense. If China does not wish to sell rare earths (to anyone, I might add, not just the US) because they feel their resources are highly limited — that’s too bad for would-be buyers, who will have to look elsewhere.

      If there is a dollar crisis, or a credit event that brings into question the dollar’s status as reserve currency, they could temporarily close the external market, maybe accompanied by some demands that America reform entitlements before they will buy any more debt or allow American citizens access to certain markets. I didn’t mean it would be disastrous for China (although if it trigged a war it could be disastrous for everyone . I meant it would be disastrous for America. Switching to other sources for resources, energy and goods will be a long and arduous process. China controls the market for so many components, because of the agglomeration.

      The real question is what the value of the Dollar will be after the books are settled on how much debt we have monetized during the latter half of our unfortunate run as the Reserve Currency. The pitfall of this particular privilege.

      Again, as you suggest, the problems will come in the switchover. The danger is that the global trade web will freeze up and that the real economy will follow.

      Is the alternative, as some readers suggest, to deliver our Dollars on the back of a tank?

      On the back of a cruise missile.

    • @Pluto: “Is the alternative, as some readers suggest, to deliver our Dollars on the back of a tank?”

      Yes. Human nature is human nature.

      To be brutally honest, if the USA wanted to really march on the world, ignore international law and the Geneva convention on war, no one could stop them. Would countries resort to nuclear war. No. Because the USA would only march on non nuclear countries. Forget Bay of Pigs as a precedent.

      I am an avid reader of Pre World War 2 politics and history. My great grandpaprents were burned alive in their homes durng the conflict in Ukraine, so it is a topic I need to understand. Why did it happen?

      Politicians will rally the masses when the masses have no other choice.

      It would be easy to twist history to spread propaganda. For example, China deliberately manipulated their exchange rate. This is why we are in a mess. This is why you are hungry, this is why your neighbours are better off than you etc.

      We theorise and theorise, but at the end of the day we are animals, and the clever people can manipulate us quite easily to achieve their ends. Do you think the ultra rich and powerful would relocate outside of the USA? Where would they go? The USA has the best of what this planet can offer. Mountains, forrests, beaches, desert, “Living Space”. Australia has a lower crime rate and a Billionaire could feel safe walking down the street, but it does not have the lifestyle of they USA.

      The Ultra rich will keep the natives happy, and the really bad ones are locked up out of the way.

      The USD will survive. Deleveraging will take place, Zombification will be the norm, but the USD will not collapse.

      • There are compelling reasons to believe the USD will not fail, but then again, you may be overestimating the control that the leaders have on the complex systems they’re tasked to run. As stated above, Obama was clueless as to why Apple products cannot be made in USA. Also, recently read that the CEO of Bear Sterns was interrupted during some cricket match to be informed that his company was actually broke. And don’t think that only the rich Chinese are buying homes in the US. The rich Americans are buying homes in Argentina, Chile, Singapore, Thailand etc.

      • I know we shouldn’t generalise Japan onto the world because it is rather a unique situation, but Japan was the first modern (Qing China is a classic pre-modern examples) example of zombification, and Japan has done absolutely no deleveraging.

  6. I assume the Keystone XL Pipeline is going to LA so it can be exported? Or is it more to do with refining capacity? Just wondering why it cannot be piped to a more northerly refinery.

  7. Too much logic and rationality. Looking at the world in this way and constructing our models about the world and us in this way, takes away our humanity. Are we really just consumption and production units in aggregate, is this the only way to see the situation and to find a solution? Maybe individuals should stop looking at the world in this way and making problems and solutions in this way. Really the search for efficiency, cheap production and maximum profits through the god of ‘free markets’, has ruined the world.

    See:
    Title: The Conquest of Bread
    Author: Peter Kropotkin
    http://www.gutenberg.org/files/23428/23428-h/23428-h.htm

    “There are three states which are keys to every experience: intoxication, sleep and death. That is why there has never been a a lack of unbridled drinkers of life, never a lack of cheerful and gloomy aristocrats of the dream, never a lack of warriors, lansquenets and adventurers, never, in short, a lack of those to whom the whole world of employer and employee, of… merchant and money, is of supreme indifference. May they never be confounded
    or misled, never allow themselves to be deceived as to their rank and status: for it is they out of whose dreams every order is created and to whom every order again falls victim. Order itself becomes vain and useless
    as soon as the great dream can no longer be realized in it.”

    E. Junger, “The Adventurous Heart (First Version)”, 1929

    Junger of course means each individuals access to their own spiritual centre, the spiritual intoxication. Mass man has had his spirit crushed, atrophied, and he has been told, he is just a unit of production, like a machine. When the spirit awakens in many it will sweep away the old.

    • Too much logic and rationality.

      Is that aimed at me, or is that aimed at the mathematicians and central planners who brought us this mess? Because “too much logic and rationality” is exactly what I’d accuse a whole swathe of policy makers of…

  8. As usual, I’m the nitpicker🙂

    “That’s the factory next door.”

    Maybe you’re overestimating the “density” factor? I’d say this is not very important in the grand scheme of things. With internet/videoconferencing etc. it would surely suffice if the factory was on the opposite coast of the US. You wouldn’t want to change screws every day. If the factory was in the US, you’d have them ship the new screws and they’ll arrive in a few days. If the entire supply chain was in the US and with low production costs, I surmise it would be the same thing (even with factories located on the opposite coasts of the US).

    “shipping would be costlier and less reliable”

    Maybe you’re overestimating the protective effects of the US Military? As Doug Casey put it, if ships could arm themselves (as they did in the past), things would not be much different. Also, consider that the seas are full of military ships from many other nations that spend much, much, much less on military projects. Recently watched a Discovery documentary about an Australian military ship sent to protect ships against Somali pirates. I think this small and effective ship was just as efficient against pirates as an US Aircraft Carrier.

    • Slightly off-topic, but on-topic as it relates to US economic power in the short term: what do you think of the so called “shale gas/oil” revolution?

      Pro:

      http://www.zerohedge.com/news/guest-post-dont-frack-me

      Con:

      http://www.zerohedge.com/news/guest-post-energy-independence-big-lie

      Neutral:

      http://www.chrismartenson.com/forum/doomsday-postponed/64193

      From the “Neutral” link: “I read recently (sorry can’t cite source right now) that production from wells in the Bakken formation (fracking horizontal drilling) collapse by about 75-80% within two years. Wouldn’t that just lead to exponentially increasing drilling until the surface of the entire formation will be pockmarked with wells?”

    • Maybe you’re overestimating the protective effects of the US Military?

      This is a two-tiered problem (and solving it would kill two birds with one stone) and I am in no way underestimating the perilous zombifying effects of the debt.

      I am by no means stating that a less-engaged will America will cause a precipitous rise in shipping costs. I am talking 1-8%. But 1-8% adds up when the finished product’s components are all shipped around a whole lot. It’s not just one journey from China to America, but many journeys: Africa, Germany, Korea, Japan, China, Saudi Arabia, America, etc.

      • I don’t really have an emotionalised opinion of shale the way I do, say, solar. I’ve just factored it in as a coming boon to keep energy costs down (and when I say “down” I only mean less than the peak oil doomers say, I don’t mean cheap — energy is getting more expensive, at least for the next generation before we can truly capitalise on the solar revolution).

        • Maybe you’re overestimating the “density” factor?

          Read Krugman’s paper on New Economic Geography, it’s brilliant. (And you know very well I would not praise Krugman unless I had REALLY good reason to).

          Noah Smith’s (http://noahpinionblog.blogspot.com/2011/09/great-stagnationor-great-relocation.html) explanation:

          The basic idea of the theory is this: It is expensive to move products around. This means that if you have a factory, you want to locate it close to where your customers are, to avoid paying a bunch of shipping costs. Now consider two factories. The workers in the first factory will be the consumers for the second factory, and vice versa. So the two factories want to locate near each other (“agglomeration”). As for the workers/consumers, they want to go where the jobs are, so they move near the factories. Result: a city. The world becomes divided into an industrial “Core” and a much poorer agricultural “Periphery” that produces food, energy, and minerals for the Core.

          Now when you have different countries, the situation gets more interesting. Capital can flow relatively easily across borders (i.e. you can put your factory anywhere you like), but labor cannot. If you start with a world where everyone’s a farmer, agglomeration starts in one country, but that country gets maxed out when the costs of density (high land prices) start to cancel out the effect of agglomeration. As transport costs fall and the economy grows, the industrial Core spreads from country to country. Often this spread is quite abrupt, resulting in successive “growth miracles” that get faster and faster (as each new industrial region starts out with a bigger global customer base). The evidence strongly indicates that agglomeration is the driver behind developing-world growth.

          But here’s the thing: in the theory, the “old Core” doesn’t keep getting richer. In fact, under some scenarios (which are difficult to explain concisely), the old Core even gets slightly poorer while the “new Core” catches up. For a while, the negative effects of relocation trump the positive effects of progress.

          (I really wish Professor Krugman would take his theory to its logical conclusion).

  9. I’m ll for free trade too, but that implies a level playing field, which is rarely the case.

    But the question is, what that is “unlevel” is legitimate and what is not? I would argue that geography is fair, as is population density, and even labour costs (Wikipedia argues differently, but I disagree). What is not legitimate (ie fair) is labour laws with respect to safety (or lack thereof), food standards with respect to chemicals, environment etc, and others such as tarriff, industry aid, dumping and other anti-competitive practices. Of course, much of this comes under a very grey area, but trade is the difference between producers and their different environments.

    The most important consideration is whether the externalities from trading is positive or negative in a given situation. Where both parties benefit in trade and there are external benefits to society, it is fair and right.

  10. India and China converging on Thailand, then travelling down through Indonesia. All in a axis of “Liberation” of living space in Australia. Look up Ord River Scheme. Lots of fresh water on the driest continent with the most natural minerals and Gas.

    And the Australian Defense Force to stop them.

    • @ Buddy

      All in a axis of “Liberation” of living space in Australia.

      You are thinking with a Western mind about the intentions of the East. Such anticipations are best analyzed with historical evidence. In the case of China, we can look back 10,000 years on a continuous civilization — which provides plenty of evidence.

      China is not an imperialist nation. It is not in their DNA. Except for land skirmishes with bordering regions, they decided long ago, thousands of years ago when they had the largest navy in the world, to dump their ships and stay put in the Middle Kingdom. They are not invader types. Because of that — they’ve been invaded and occupied numerous times. The Chinese are inward-looking, as they’ve demonstrated for thousands upon thousands of years.

      It’s the West that is constantly on an international murder spree — invading other nations, toppling their rulers, and stealing their resources. Iraq, Afghanistan, South America, Central America. Next target, Iran. Now sending battle fleets toward China. It is the West that is the Great Threat to global decency and world peace.

      Factually speaking.

      • To amend that, slightly, China is looking outside, now. They are looking toward the stars and focusing their national vision on that vista. Within the next five years they will have a very advanced space station, designed as a shipping dock to further exploration. Within a decade they will colonize the moon and take off from there to parts unknown.

        Someone has to do it — and big visions can only come into being with the resources and leadership of a big government. That’s China. The US aspires to return to a more hillbilly way of life, where it’s every free man takes care of himself and his family. Not a thing wrong with that. Indeed, I approve. It would certainly be the best thing that could happen for the rest of the world.

        • The only thing that Ron Paul is really enthusiastic about in government is NASA. And me too. Time for America to get out of those 900 bases around the world and get into space.

          Racists throughout the years have accused people from the Orient of looking imagination. Not the way the Orient is conducting space policy. It’s America that is lacking imagination.

        • Looking inward or looking outward are not positive or negative in and of themselves. It will take newly created knowledge to achieve success in space and both East and West should work toward that objective because that will likely be a part of the solution to our world’s modern problems. Economic growth will be required to insure we continue to increase knowledge. Sustainability comes with the creation of solutions to problems, not we curtailing human activities based on prophecy. The West is suffering a touch the no-growth or limited growth syndrome now.

          On your comment about racists. Static societies are led by people who lack imagination (or who see that imagination and creativity are a threat to their power) and this can generate observations by those in more dynamic societies that imagination is lacking. I do not interpret this view as racism but as a realistic view of what is limiting performance in the static society.

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