From the February 01, 2009 issue of Futures Magazine • Subscribe!

The World Is Curved: Hidden Dangers to the Global Economy

If you're suffering anxiety from the credit crisis, just wait; things are going to get a lot worse -- or so argues David Smick in "The World is Curved: Hidden Dangers To The Global Economy."

In his 2005 tome, "The World Is Flat," Thomas Friedman made the case that globalization has leveled the international playing field. But Smick contends the free flow of capital has actually rendered the world "curved" in that no one can look over the horizon and anticipate the next financial cataclysm heading our way.

It would take chutzpah to precisely predict the next crisis. Few would have guessed problems in the relatively small subprime mortgage market would cause such a far-reaching, multi-faceted credit contraction. Instead, this "financial market strategist," who with former Federal Reserve Vice Chairman Manuel Johnson runs Johnson Smick International, lets you take your pick from a number of looming crises.

Something will surely implode the global "house of cards," he says. The credit crisis proves "financial instability is here to stay.... The global system is becoming more vulnerable with each passing month."

Readers might tire of Smick's frequent name-dropping, but his dealings with G-7 officials over 20 years help him tell his story. Former Fed Chairman Alan Greenspan credits him with doing "an outstanding job in drawing on his interactions of the key players in international finance to produce an insightful and entertaining book."

Others have written of the risks facing the world. What Smick provides is a personalized and quite readable compendium of the world's ills and how they could propagate into some future economic pandemic. Everywhere Smick looks he sees potential outbreaks.

He warns America's "twin" budget and trade deficits and reliance on foreign capital are leading to a dreaded showdown with China, Japan, OPEC and other surplus nations. "...(I)f Washington fails to restore the credibility of the U.S. financial system or the Federal Reserve loses its fight in tamping down inflationary expectations, the dollar will collapse in an environment of chaos."

Smick lists protectionism, capital controls, overregulation, higher taxes on entrepreneurs and/or failure to improve financial market transparency as possible "tipping point(s) for a complete breakdown of global confidence in the American system."

He says China poses the greatest danger. "When the Chinese bubble bursts -- and it likely will burst, not slowly deflate -- the consequences for the rest of the world could be catastrophic." China would dump U.S. Treasury securities and other assets and flood the world with its goods at "fire sale" prices, triggering deflation, trade war and credit contraction. Or, it could set off an inflationary spiral.

China is just one big bubble machine, he suggests. By stockpiling oil, steel and other commodities, it is has driven up prices, but "when the bubble bursts, the world economy will look like a very scary place."

He says China's undervalued yuan and massive reserves "represent a giant distortion to the global financial system" which "makes the job of controlling inflation and of managing the economic system during the catastrophic bursting of those bubbles extraordinarily difficult."

Recalling the February 2007 Shanghai stock plunge, he projects, "five years from now, in a crisis, financial developments in China could easily become the tail that wags the global financial dog."

Smick, who apparently doesn't plan to go back to China anytime soon, likens the Beijing power structure to TV gangster Tony Soprano and says the U.S. has "married itself off to the Tony Soprano family."

Smick has kinder words for Japan, but warns, "Without greater entrepreneurship and deeper economic reform, it is unlikely the Japanese economy can fully recover. Without a full Japanese recovery, the global financial system will continue to have access to Japanese capital, but at the cost of ever-continuing global imbalances."

Fed Chairman Ben Bernanke might disagree, but Smick alleges central banks have become impotent against these brewing tempests. "Today's raging ocean of capital has become so huge, complex and fast-moving that central bankers today are at an enormous disadvantage," he maintains. "...(T)he rise of globalization has robbed central banks everywhere of a considerable amount of their ability to come riding to the rescue."

Smick is equally dubious of financial supervision, calling the current credit crisis "the mother of all regulatory failures." And he says "a decline of trust in today's architecture, has made today's financial world a very danger place...."

"(T)he subprime credit crisis represented a sideshow compared to the aftermath, say, of a global trade war with China and a shutdown of Asian capital markets," he writes.

Protectionism may be the biggest threat, he suggests, noting U.S. assets are now "at relatively high values....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." Changing the rules could bring "global financial disaster."

Smick, who worked on Capitol Hill before he and Johnson discovered there was money to be made selling access to G-7 officials, goes beyond prophecy to offer policy prescriptions. He urges resistance to protectionism and a strengthening of "today's dangerously flawed financial architecture," which is undergoing "nothing less than a crisis of trust" since the Bear-Stearns collapse. To avoid a dollar "free fall," the U.S. must be made "the most attractive destination for global investment" through good tax and regulatory policies.

Notwithstanding the multiple crises which our leaders have failed to prevent, Smick fantasizes that "what is required over the next several years is a team of financial policy brain surgeons, from both the public and the private sectors, with the political backing of some powerful and sophisticated leaders in Congress."

These supposed sophisticates would create a "big think financial doctrine," a "new framework" and "Goldilocks" reforms that are "not too soft but not too strong." Readers may be pardoned for being skeptical.

Steve Beckner is senior correspondent for Market News International. He is regularly heard on National Public Radio and is the author of "Back From The Brink: The Greenspan Years."

About the Author
Steven K. Beckner

Steve Beckner is senior correspondent for Market News International. He is heard regularly on National Public Radio and is the author of "Back From The Brink: The Greenspan Years" (Wiley).

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