Good times.
From Barron's:
Ferguson sees more trouble ahead for Europe, China, and Saudi Arabia. But countries with cheap stocks and political stability could beckon investors.
Niall Ferguson, the historian, Harvard professor, and author of more than a dozen books on the nexus of economics, finance, and geopolitics, argues that America’s abdication of its role as the world’s policeman is one cause of the global economic malaise. U.S. policies, or lack thereof, have allowed terrorism to breed and dictatorial states such as Russia and China to assume a larger role in world affairs.
The author of Civilization: The West and the Rest, Ferguson says China’s attempt to move to a true market economy probably will fail, potentially causing serious disruptions to other markets. He likens Saudi Arabia to Iran in 1979—a state ripe for destabilization. In the U.S., he sees tax reform coming, but worries that America’s love affair with regulation will continue to dampen its growth prospects. India gets a thumbs-up, but Europe’s prospects are bleak.
Ferguson recently announced that he’ll leave Harvard next year to become a senior fellow at Stanford University’s Hoover Institution. He spoke with Barron’s at our offices just after November’s terrorist attacks in Paris, and was every bit as thoughtful and provocative as when we last chatted, three years ago.
Barron’s: The U.S. economy has been growing by only 2% to 3% a year. Why isn’t it firing on all cylinders?Ferguson: There are at least three theories. The seven-year hangover theory suggests that the U.S. will shake off the effects of the 2008 financial crisis next year. The secular-stagnation theory posits that, for a variety of reasons, the economy is in a depressed state. That is most obviously [expressed] in interest rates.
I’m attracted to a third argument, the geopolitical one, that says growth in modern American history has tended to be high at times of national strength and low at times of national weakness, because our weakness has ramifications for the world as a whole. One has to combine the three theories to understand why growth is lower than expectations. It isn’t low based on a pretty long-term average, but it is sluggish compared with the glory days of the Cold War.
What was so glorious about the Cold War?There were two phases of growth, one associated with the Eisenhower and Reagan administrations, and one with the depressed period in between. Since 9/11, things have gone from bad to worse. We find ourselves in a deflationary version of the 1970s, marked by stagnation, not stagflation. [Russian President Vladimir] Putin is doing his best to give us reasons to man up. But we’re not really doing so.
The global economy needs a strong hegemonic power to reduce conflict, ensure freedom of the seas, and so forth. In the 19th century, it was Great Britain, and for much of the 20th, the U.S. But in 2013, President Obama said there was no global policeman. There are deleterious consequences if the leading power in the world abdicates its leadership role.
What are some of these ramifications?Part of the reason the world isn’t as buoyant as it might be is that Europe is doing much worse than the U.S. It doesn’t help Europe to have a massive influx of real and “not so real” refugees. Some 220,000 people arrived in the European Union in October, a direct consequence of the disintegration of order in a whole bunch of countries, Syria principally, but not only.
The U.S. walking away from the Middle East has had a direct impact. We’re only beginning to see the ramifications, in Paris most recently. It isn’t going to stop there. There is growing anxiety in East Asia about the rise of China. Japan remains a large economy, but a depressed one in yet another recession. Economists tend to underestimate geopolitical factors because they aren’t in their models. Global order and stability need to be underwritten. It doesn’t just happen spontaneously.
Are you suggesting that the U.S. ought to be the world’s policeman?Somebody’s got to do it. It better not be the Chinese or Russians. The market system requires an effective state that enforces the rule of law. That is true internationally, as well. As the world becomes less secure, it becomes a less safe place to do business.
A world in which the U.S. yields regional power to China or Russia is one in which the rule of law is driven back. We underestimate the extent to which the age of globalization depended on an American underwriting, and that is gradually unraveling.
Can the U.S. afford to keep the peace?The U.S. has a fundamental problem: Gradually, its national security is being squeezed by Social Security, particularly its health-care system. It will be squeezed by the burden of interest payments on Federal debt as interest rates go up. In theory, as the biggest economy in the world, the U.S. should be able to afford to build up its military power. In practice, the congressional budget sequester was a blunt instrument applied to the defense budget, cutting it indiscriminately.
The U.S. should be investing to maintain its lead, particularly in areas where it is vulnerable, such as cybersecurity. No matter how many aircraft carriers we have, it might not be that big of a technological leap for us to be matched in the new theaters of war that are emerging.
But as you note, our finances are hobbled.Entitlements are the obvious problem. Republicans discovered that if you want to cut entitlements, it is hard to win the presidency. I’m optimistic that the U.S. can make its health-care system far more efficient and less expensive as new technology comes into place. With the application of technology, we will start seeing not only stuff about our own health, but also which doctors and hospitals do which things best.
The employer-pays insurance system is loopy and ripe for revolution, in the way that Uber is revolutionizing transportation. We will see similar types of companies revolutionizing health care. At that point, you may be surprised to find that costs start coming down. I can’t imagine in 10 years’ time that when you visit your doctor, someone will hand you a clipboard with a badly photocopied form that you’ll have to fill out for nth time. That’s ludicrous.
You have written about the toxic combination of litigation and regulation in the U.S. What are the odds of reform?I don’t see any light at the end of the tunnel. The Federal Register has never been so large. The Dodd-Frank and Affordable Care Acts alone produced a staggering volume of regulation. Now we have the Trans-Pacific Partnership Agreement, with a document even larger than Dodd-Frank. It is really disheartening. That there hasn’t been more rapid U.S. growth is due at least in part to these head winds.
Many U.S. companies won’t bring home the cash they have overseas because it would be subject to a hefty tax. Is there any chance this might change soon?The income-tax code has to be simplified, and corporate tax has to be reduced to some internationally competitive rate. Otherwise, corporations are going to continue to emigrate to wherever the tax burden is lower. Tax reform must be on the agenda of the next president in year one. Tax reform will happen. The political class gets it; the voters get it. It is much harder to tackle excessively complex regulation because there are too many people who benefit from it.
Let’s turn to Asia. You have said that regarding China as an emerging market is absurd. Why?It is now the second-largest economy in the world, or the largest based on purchasing-power parity, with an influence on the global economy second only to the U.S. China is sui generis. Is China is going to go further in the direction of a market economy? Will it reduce the importance of state-owned enterprises and remove the state from the financial system? Is it going to open its capital account and allow the Chinese to invest abroad freely? Each answer has ramifications for the rest of us like no other economy.
Give us your answers.We don’t know whether China will be more of a market economy 10 years from now. It is risky for a one-party state to continue increasing the economic freedom of its citizens. President Xi Jinping, who is more interested in power than anything else, understands this well. Consequently, plans for privatization of state-owned enterprises, liberalization of the financial system, and the opening of the capital account will remain plans, but won’t be implemented.
China has created the biggest middle class in history, but middle-class people want property rights. That implies law courts and officials who aren’t corrupt. The moment you demand these things, you are asking the one-party state to loosen its grip on power. The Chinese are terrified of anything like that.
What impact might Jinping’s foreign policy have on markets around the world?To ensure the one-party state’s legitimacy, Jinping won’t shy away from a relatively saber-rattling foreign policy, because this plays well [domestically]. There is also an element that isn’t propaganda. China is building up its naval capability, modernizing its pretty antiquated army. It has a financial diplomacy that has proved effective. The Chinese have been using their considerable resources to win friends and influence people around the world, including in Central Asia and Africa. China says, “Let us build your infrastructure.” That increases its leverage over a whole bunch of countries that the U.S. has neglected.
What is the outlook for India?The Indian economy looks to be growing faster than the Chinese economy. India is good for a couple of reasons, including demographics, which turn out to be a lot more important than most people thought. India didn’t have the one-child policy, unlike China, whose workforce is shrinking.
India has rule of law—slow, maybe, but it is there, and a representative government and free press. Unless you think the success of the West is pure luck, which I don’t, those are advantages. There are many thickets of vested interest, but I’m broadly bullish about India’s prospects. The problems India faces are fixable, like infrastructure and housing. China’s problems are much more difficult.
Will the Middle East roil markets in the years ahead?I expect next year to be more violent than 2015. Many investors don’t realize that since the outbreak of the Arab Spring in 2011, fatalities due to armed conflicts are up by about a factor of four; terrorism is up by a factor of six.
The events in Paris are a reminder that the jihadist network doesn’t confine itself to the majority-Muslim world. It is now embedded in minority-Muslim communities all over Europe. There will be more such attacks, and at some point the terrorists will be successful in the U.S. again. [This interview was conducted before radicalized Islamists killed 14 people in San Bernardino, Calif.] The resources that go into producing radicalism aren’t about to disappear. Networks are difficult to decapitate.
The president has failed to understand this because his model is decapitation. You think, let’s take out the boss. Then you are amazed to find the network [still] grows. We won’t see this go away in the next 10 years. The threat of violent instability in the region will go up, and probably will affect Saudi Arabia. Support for the Islamic State is high among the Saudi population.
Why is that?An Islamic state can credibly argue that the Saudi royal family is corrupt, Westernized, and hypocritical. The family itself is divided. Saudi Arabia is a weak link, the way Iran was in 1979. If you had to ask what headline would move markets tomorrow morning, a revolution in Riyadh, especially a messy one, would be a pretty good answer. You could see a big terrorist attack on Saudi facilities, and markets would move the price of oil up.
The dollar is strong, and commodity prices are weak. What does that mean for countries like Brazil and Russia?There comes a point when an investor says, “Hey, that’s attractively priced.” Argentina has been one of the great trades of the year. You might ask, “Where is the political problem horrible, and where is it about to get solved?” It is pretty horrible in Brazil, and I don’t see a fix in the short run. Things will be solved in Argentina, more or less. South Africa? No, that looks bad politically. Turkey? [Prime Minister Recep Tayyip] Erdogan is a dodgy customer. Egypt? I don’t like the way that’s going.
The key is attractive prices and political stability. Money is going to start flowing back into emerging markets that don’t have a political problem, such as Indonesia and maybe Malaysia. In Russia, suppose the sanctions get relaxed, as seems likely next year. Russian bonds have been one of the great performers this year. Everybody was too negative about Russia. There are some interesting opportunities in the rest of the world. It is hard to see the dollar- strength story continuing indefinitely....MORE
