About this week’s show:
- Complexity is creating huge moral hazard
- Currency Wars are now the primary form of leverage
- Insensitivity to danger makes us RIPE for Collapse
- Be sure to read and purchase: The Power Curse: Influence and Illusion in World Politics
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“It is very natural for this hubris to manifest itself. It is very natural, because you are powerful. And when you are powerful, you think you are powerful, and you should think you are powerful. But just how powerful you are – that’s problematic. And that’s when you need to ask questions. ‘Just how strong am I?’ And that is something we don’t do.”
– Giulio Gallarotti
Kevin: We have a return guest, Giulio Gallarotti. This book that he has written, really, could be summarized in just a simple phrase of, “Pride cometh before the fall.” Don’t you think?
David: Absolutely. I’m grateful for the many rabbit trails, intellectually, that I’ve gone down. Some of them aren’t very productive, and some of them are incredibly rewarding, and you would have to roll the clock back almost ten years to reading Michael Bordo’s Monetary Regimes in Transition, which led me to The Anatomy of an International Monetary Regime, which led me to a conversation with Giulio Gallarotti, who wrote that book.
The Power Curse: Influence and Illusion in World Politics is a more recent work, and, I think, very important for understanding the world as it is, and some of the foibles that we continue to come across, sort of across border, and if you wanted to even expand that, across time, there is a consistency in the theme of mistakes that humans make.
Kevin: I know, Dave, that I was captivated with the historical stories. I love it when someone writes a book and says, “Look, this is the peg that I’m going to hang different things on,” so that when you are learning it, you think, “Okay, these four things – I can get my head around four things if it is a repeating pattern.” He talks about complex systems.
We have talked to Joseph Tainter about complexity and how, ultimately, it has to collapse to a lower complexity when it becomes too expensive to maintain. He talks about over-stretch, when a country starts to get a little too far out of reach that they are reaching so far they can’t afford to continue to reach more, and have to retract. Moral hazard – when you’re so big you start acting like you really have no vulnerability. And then, Dave, the fourth hook that he talked about putting our thoughts on regarding these historical cases is unilateralism. That is, again, you’re so powerful you really don’t ask permission, you just go do.
David: Mr. Gallarotti has always done a great job of thinking across fields. That is his role at Wesleyan University, as a political economist.
Kevin: Yes, Dave, he is well regarded in the entire academic realm. You look at the recommendations that come from Princeton University, that come from Columbia University, Harvard University, just looking at the back of his book gives enough account as to why you should actually open up the front, go from front to back.
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David: I am ever grateful for the time and energy that those in academia, you included, Giulio, put into research. It’s a skillset that shrinks a vast amount of content into a synthesized and condensed form. If I commit 20 hours to reading a book, I suspect that the research and writing process took 15-20 times that, 300-400 hours, at a minimum. So, we approach the work that you did a few years ago, The Power Curse: Influence and Illusion in World Politics, and there is a broad range of examples you draw from to understand the risks of power accumulation by the state.
You look at Athenian Imperialism in the 5th century B.C., you look at U.S. foreign policy in the 20th century, several examples there, and monetary policy in Britain in the 19th century. You might even say monetary imperialism, which is an area of particular expertise for you, going back to your earlier work, The Anatomy of an International Monetary Regime. You link these to what you describe as a power illusion and power curse which ultimately weakens and victimizes those great powers. Please expand on this.
Giulio: Well, I think the book came from thinking about American foreign policy under Bush, and the goals that were espoused about making us less vulnerable, and I thought about what was being done, and I question just how vulnerable we may have become as a result of making ourselves less vulnerable, and this made me think of principles of Zen, that sometimes trying too hard can be counterproductive, the idea that more is less. I started thinking about the costs and consequences of these actions – invasions, and using all this military power.
I thought of a quote made famous by the Dalai Lama, who said, “Measure your success by what you have to sacrifice in order to achieve it,” and when I thought about foreign policy in that respect, I realized that much of what we were doing was counterproductive, and that in the end, this crusade, as he called it, to make us stronger and less vulnerable, only made us weaker and more vulnerable. And the fundamental idea of power illusion is that people are deluded into thinking we’re more powerful because certain things about us exude strength, but that strength can become a weakness. And examples abound, just like the muscle-bound person who believes he can be a good warrior, or a wrestler, who in becoming too muscle-bound, becomes less flexible, and loses his ability to wrestle. He loses his ability to fight.
I started the book with an analogy, a little tale about David and Goliath, and I think that’s a great analogy to America and what America has been doing under Bush, this great champion that is completely invulnerable. But in his invulnerability, in creating that invulnerability, he became quite vulnerable. And if I had to put it in a nutshell, that’s really the theme of the book. I show how it has happened throughout history to different great powers, that there is something inherent in a great power that leads them to a power illusion. So, great powers have to be careful about that. And I talk about ways that leaders need to think about this so that they don’t fall prey to such illusions.
David: So, these inherent qualities that can weaken a nation. Again, the augmentation of power appears to have certain advantages, but you are saying also that there are inherent qualities that weaken a nation, and potentially, have weakening effects that generate the seeds of destruction. We then look at the four areas of a power curse which you discuss in your book, and these are areas where you illustrate, again, across time, and across cultures, a similar vulnerability. So yes, the U.S. in the present tense, but you can go back to the fifth century, you can look at the 19th century, you can go hither and yon, and come to some similar conclusions. So, enlighten us, if you will, on the four ways that the power curse manifests.
Giulio: For our contemporary audience I have a chapter on how the power curse manifests itself in all four ways under Bush, and that is something for people who are much more interested in contemporary policy and the applicability of my idea to the present day. Historically speaking, I’ve done four cases, one of which involves America, and of course, I applied it to Bush, as well. Historically, of course, I applied it to four categories of power illusion.
Basically, the message is that there are four ways that lead to power illusion, and these are inherent in great powers. They just inhere. These are things that are natural. So, just like they are inherent, you have to be careful because, basically, it comes with the territory, and that is why it is so devastating, because it is a natural outcome of becoming powerful. So, as I said, leaders need to be very, very perspicacious, and very, very attentive to just how strong they are, not so much in terms of power they have, but in terms of outcome.
I listed four categories under which power illusion can manifest itself, and one is, of course, over-stretch. It is kind of like, the rich get richer, and there is a natural tendency for great powers to want more power. I talk about various ways in which this happens, and of course, we only have limited time here, and I do want people to buy the book, so I’d rather they read about the specifics.
But Athens was no different than many great imperial powers. As they gained more territory, they wanted more territory. One of the reasons this was inherent and self-feeding is because as you gain more, you need more to support that which you have gained. And so their empire, their imperial network stretched so far that they had to get ever more and more to support it.
One of the weakening effects of this is that as you rely on external assets, or external resources, more and more, you kind of get a little bit lax in generating your own, so Athens didn’t need to develop a great wealth machine, even though it was very, very rich, because it was getting all this tribute, or what some people might call booty. As time went on, its internal ability to support its external empire just withered, and they had to depend on more and more. And the final blow to this was trying to conquer Sicily, which was a task that was well over their head, and they couldn’t do it, and that really just decimated the Athenian navy. After that, as a military power, Athens fell.
David: To kind of juxtapose Athens in the 5th century with us today, when you are describing the structural reform needs in the 5th century Athens, whether that is restricting certain economic practices, or fiscal caution, and the like, you note that Athens failed to make these changes because the political costs would have been too high, and because they preferred to lean on the easy money of empire expansion. That is a very interesting point, and I wonder if easy money in any form, in the form of empire expansion or credit expansion, is a part of the curse and a part of the end game for empires allowing circumstances to get beyond the point of repair.
Giulio: Yes, that’s absolutely true. Why work for money when you can get it for free? Why work hard for money when you can get it for minimal work? And I think this is something that has driven imperialism throughout its history. The gains from imperialism have been very large, and as a result, you don’t need to generate the internal economic processes. You don’t need to be an aggressive economic machine to maintain that as long as you have an empire.
And this is true of Athens, this is true of Great Britain, this is true of the major imperial instances in history where we see growing greed, growing dependence – certainly Rome. And concomitantly, as the greed grew, these countries kind of crumbled from within. And it’s another effect which I call moral hazard, the two kind of overlap, the idea that when you have so much you get lazy, and you stop doing the things that got you there. And because of that you deteriorate. And this is a good example of what happened in Great Britain, it is a good example of what happened in Rome and Athens, and I would argue is happening today in the United States.
David: Isn’t the bottom line there? When you talk about moral hazard, aren’t we really talking about complacency, when there is an overestimation of strength or security leading to an underestimation of other various risks?
Giulio: Absolutely, and I think America is just as complacent now, and more so, than perhaps other powers in the past, because of our global domination, which is out of the bounds. It is something no power has ever achieved, the idea of having 700 bases in over 130 countries – we have a global reach and access that no power has ever had in the past. This is truly an amazing accomplishment.
David: I am hoping that the audience for your book includes politicians and bankers, as well as the general public, because clearly, we have, in theory, the expansion of derivative products, and that is supposed to diversify and transfer risk, and yet what that has allowed for is an over-leveraging of the financial system, and an increase in risk-taking.
Giulio: Oh, absolutely.
David: And that’s the same thing. We see invincibility in the banking system and on Wall Street, we see invincibility in our foreign policy, and so yes, moral hazard, over-stretch. You also talk about adapting to complex societies, and I remember Joseph Tainter, if you are familiar with his book, The Collapse of Complex Societies…
David: He suggested that complexity reaching an unsustainable level is a cause for collapse of societies. And similarly with your power curse thesis, you are suggesting that the management of complexity for powerful nations is harder and harder as you increasingly engage with the international system.
Giulio: Sure. Just a simple analogy, but crude – it is more and more difficult to manage a family as you have more children. There are many more points of concern, many more actors involved, greater networking, and greater complexity. You have to manage all sorts of things. It gets harder and harder and harder. And at some point the difficulties of managing grow exponentially, and if you have these other natural weakening effects going on, moral hazard and over-stretch, you have a weakening within the nation.
So, basically, the nation, itself – its capacity to manage is either flat or not increasing at the same exponential level of difficulty of managing a system, and this is true of the financial system, as well. Financial instruments are becoming so complex and so difficult, the ability to regulate them can’t possibly catch up to the complexity. It tries, so it’s always lagging. And it’s the same thing, the fact that regulators think that they can manage that complexity effectively is an elusive idea.
David: I like your analogy of the family. It reminds me, too, of a dinner party, where for every one party that you add at the table, you’ve just increased the number of relationships at the table exponentially. So one party does not equal one new relationship, you have all the interconnected relationships, which makes dinner party management – if you have five people versus 25 people, it’s infinitely more cumbersome to carry on a conversation, and to make sure that everything is delivered with the food still hot, etc.
There is also this issue of mission creep, where the original intention was one thing and you talk about the Delian League, which was the effort by the Greek City States to address the concern with the Persians, and they all kind of banded together and decided that they, together, could accomplish something. Then of course, the Athenians sort of kept the headship, if you will, of the Delian League, and changed their mission altogether, went from a defensive posture to an offensive posture. I wonder if you might look back at that, and also reflect, what has changed? I know this is a big leap, but the Fed has shifted its singular mandate to a dual mandate. Now they have a third unofficial mandate to manage asset prices. Is mission creep just common across all power structures?
Giulio: Yes, absolutely. Every time you extend your authority to something, you are going to have to invest in instruments that support that extension. Think of a trade network. I talked about this with Athens. Every time they got a new colony, they needed to secure trade routes. Securing trade routes is expensive. You need ships, you need to make alliances, you need to pay off local warlords. So, with every extension comes far greater expenses that are involved in the colony, itself, so that is true of the Fed. If it extends its authority, it is going to have to extend its means of managing all these points of authority and that means investing in greater networking. And that networking has costs. And it also creates greater complexity.
David: So, external dependencies – I’m still kind of stuck on Athens. This is sort of two for two, the book I originally was introduced to you by, The Anatomy of the International Monetary Regimes, anyone interested in the history of money and its role – boy, it has to be on the shelf and it should be read. And I think this is one, too, that needs to be read. You bring up this issue of external dependencies, and again, the Athenian state was now sort of relying on tribute, and we see that also with Britain in the 19th century, relying on a form of tribute from India and other places, and it allowed for lax local adaptation. It seems we have put off a number of fiscal reforms in favor of monetary expansion.
Now, this inflationary monetary expansion has for 10 or 15 years been offset by the deflating costs of imported consumer goods, so the net for households has not been that great. But there is this external dependency, nonetheless, and I’m sure you’ve heard it said, on a more contemporary quote, “You can’t eat an iPad.” But hasn’t global trade and tradable goods, deflation, allowed us to be a bit lax in terms of our own monetary policy?
Giulio: Yes, I think so, but I think the consequences are even greater and they carry into industry, the idea when changes in currency can make you more competitive – it makes you a little lazier about introducing changes, evolving, changing your products. This is something that Americans have never been very good at, making industrial adjustments to compensate for currency changes. We tend to think that our products are the thing, and that people are buying them, and we don’t have to work hard to generate a demand for them – well, in the past anyway. And the Japanese have been just the opposite. They are very good at making changes to their products to compensate for changes in currencies. So, in that respect, yes, we have been a victim of a kind of power curse in that respect, and the Japanese have been much better at it than we have.
David: We’ve talked about complexity, which was one of your points. Another was over-stretch, and moral hazard. I want to get to unilateralism in a minute, but while we are on the theme of currency, is it surprising to you that the most volatile markets today are not the stock markets, but our currency markets?
Giulio: No, it doesn’t surprise me. The amount of currency that is being exchanged every day is astronomical. There is so much fluctuation because there is so much volume, and of course, that volume has grown over time. The speed at which these transactions can be made, and now kind of evolving into maybe new kinds of money with Bitcoin and these other innovations that may enhance the speed of transactions because they are reducing transaction costs so much. So no, it doesn’t surprise me at all.
David: I guess I think of the euro’s steep decline over the last several months, the yen, the ruble, the Canadian dollar, the Australian dollar. In percentage terms, we have seen fairly significant declines in short periods of time, and benchmarked against gold, we are talking about three or four different currencies which have dropped by 20-30% in a fairly short period of time, trying to make sense of that in light of countries maintaining a competitive trade advantage, and using the currency as their primary lever. It seems like the whole world is becoming enamored with the idea that we can get ahead by just manipulating the value of our currency, that the structural reforms that come at a high political cost – put those off for monetary measures.
Giulio: Right. And this idea of being able to manage markets is probably more prevalent among policy makers than economists. Economists don’t really believe markets can be managed that effectively without maintaining extensive capital controls, and capital controls impose a tremendous cost on a nation as you try to manipulate currencies. But to the extent that, your point being that, if countries and if leaders do believe that they can get ahead through currency manipulation, then that, again, has negative consequences, and power illusion type of consequences, because they feel they are strong enough, powerful enough, to manipulate currencies. And you do have to be a powerful nation to do that.
That will make them lazier in other ways, and will make them avoid the structural reforms at all sorts of levels that need to be made in order to make a product competitive in the long run. And that is really the most important thing – making products competitive in the long run. You can make small changes. The Japanese are very good at that. That is how they conceptualize corporate goals, creating products that have a long-run demand, and adapting to changes in currencies and other idiosyncratic changes in markets by changing costs, by manipulating costs.
But if what you say is true, and it is certainly true among some policymakers, that they believe that they can, in fact, alter currency to give their products an advantage, then in fact, they are ripe for power illusion. They are engaging in this idea that they can do something that they really can’t, in the end. By not making structural reforms, they are actually going to hurt their economies.
David: I have brought your book to both the breakfast and dinner table at home. On the last point of the way power curses manifest, you talk about unilateralism. At breakfast a few weeks ago, our family was discussing the difference between unilateralism and multilateralism, of course as I was reading your book. At the front end, you have unilateralism, which seems justifiable on the basis of its efficiency, flexibility – you don’t have the encumbering checking in with your peers. You can just go. But maybe you can explore the problems that it creates.
Giulio: Again, I look at the manifestations of this in two cases historically, with Great Britain, as a great financial power, and America, as a great military power. And in talking about Great Britain, in the late 19th century, the decline of silver imposed tremendous costs on Great Britain because India, mainly, but a number of their colonies, were on silver standards. So, as the silver declined, and of course, British expatriates were being paid in silver, they were making less vis-à-vis gold, so when they exchanged their silver wages for gold, they were getting less and less, and also, the financial chaos that it caused in their colonies – these created tremendous problems for the British.
The British had a number of opportunities to create treaties and agreements that would support the price of silver, and they never did it. And one of the big reasons behind that was the tradition of financial primacy, that they were too big and too strong to have to worry about it, and that it would work itself out. They didn’t need peons to help them, as they say, pull their chestnuts out of the fire.
So, this idea of perceptions of power really got in the way of their need to cooperate with other powers to maintain the price of silver, or at least a kind of managed decline of silver so the financial conditions in India and the colonies could be a little bit more stable in transitioning to gold. This is the classic example of an inherent need to unilateralize because you feel so powerful you want to be free of other commitments and you want to go it yourself.
And as far as Bush goes, his own approach to terrorism and the wars that we undertook, the terrorist threat, was freeing himself of entangling commitments and entangling alliances, and he was quite clear that this was going to be a unilateral effort on our part. We were going to do what we needed to do to make America safe. And he acted that way. And he acted with impunity in a number of ways, and in a number of international fora. And the problem with that is, no one is ever powerful enough in an interdependent world. No country is every strong enough. And clearly we weren’t, and we needed help.
Acting that way alienated many of our allies, and when we did need their help, like with helping us transition out of Iraq, helping pay for Iraq, they came back and said, “Well, you didn’t play ball with us earlier, you decided to invade Iraq without the Security Council’s permission, and if you’re going to go it alone, well then, you’ll have to support the war by yourself.” So, in the end, we are actually more needy than we think we are.
David: So, unilateralism can give you that misperception. We know the old quote, “No man is an island,” and yet, we can live for a long time as if that were the case. You mention on page 65, consistent with the power curse effects, that it took several decades of adverse consequences to stimulate action on the part of the great power Britain. Then it realized it was being nicked to death. So, in this context of the rupee devaluation in the 19th century, the drop in the price of silver, they felt they were fine on their own, and they thought they were big enough on their own, and then finally, they did have to change course, but nobody wanted to work with them at that point, and at that point a lot of their power had been gutted. Isn’t that correct?
Giulio: Yes, indeed. And they always felt that the problem would take care of itself. They didn’t see this major secular decline occurring. Had they foreseen it, they might have done something different, but as silver started falling through the floor, then they basically demonetized it around the turn of the century. But it took 20 years for them, and in those 20 years there were some severe declines in the 1980s and 1990s. It took that long to make them figure out, “You know, we’re not financially strong enough to do this, to support this.”
But one of the points that I make on the power curse, the power illusion, is that these things are so inherent, sometimes you are blind to adverse outcomes, so the fact that things are going badly really doesn’t penetrate because you think you are so powerful, and that is an inherent malady of power. When you are strong, you can deal with adverse outcomes. Just like a very rich person can say, “Well, I lost some money in the stock market yesterday.” Or this business deal went belly-up. You don’t pay much attention to it. But when you look around and that starts happening a lot, you become insensitive to failure like that, and you’re ripe for a collapse at some point. But it takes a while for that to sink in.
I think it’s natural for very powerful actors, whether they are people or nations, to want to do things alone. Why wouldn’t you? Why would you want to bother dealing with other people? They just make problems for you, they get in the way, and they create complexities that you don’t want to deal with. So, of course, that’s the whole idea of becoming wealthy and becoming successful because you want to be independent. And once you become independent, you like being independent.
David: This was one of those sort of ah-ha moments in reading The Power Curse. You describe paradigmatic versus comprehensive analysis, and you look at Athens and you say, “They assumed a lot of themselves, in part, because they had an amazing navy.” And I’m thinking to myself, this was the same presumption that the British had. And we still live with it. I’ve talked to a number of geopolitical strategists and analysts who have said, “Listen, it doesn’t matter what our economy does, just be aware of one thing. We have the tanks and bombs and guns. Look at who rules the waves, and you know who rules the world.”
And yet, I’m looking at this and thinking, in the 5th century Athens made that mistake. They knew that they could ignore the losses on land because they still were, after all, the great naval power. Again, that is that paradigmatic thinking. If you believe that power is X, Y and Z, when in fact, it needs to be more expansive in terms of the resources that you bring to bear, here they found that their resources actually weren’t adequate.
Giulio: That’s precisely right, and at this point, I think you’re doing a better job summarizing my book than I, myself, am. I’d like to hire you as an agent.
Giulio: But I think we’re in a similar situation today with the United States, a military that is the greatest military the world has ever seen and this leads us into a false sense of security and power. But if you look at our domestic problems, our country has some major domestic problems. One could say that we’re withering away from within. And yet, this external reach, the fact that we rule the world – really, truly, rule the world – diverts us from our true weaknesses and they are internal, and they are the same thing that destroyed empires in the past that this feeling of external strength masked and made people insensitive to weaknesses that eventually destroyed the empires. And I think that is happening here.
David: Was the world offended when the Bush doctrine rolled out? It wasn’t too popular overseas. We do a lot of travel, and I know that in that decade, 2001 to 2008 and 2009, that timeframe, we weren’t particularly popular anywhere in the world. I am just wondering if the Bush doctrine and what we have talked about, and you could even call it the neoconservative movement, obviously we are still an empire. It doesn’t matter if it’s Bush or Obama, or before Bush or after Obama, we are what we are, we still have our bases, we still have Guantanamo, we still have all of these things.
Was it offensive to the world just to hear it, for the first time in decades, put out there in the public square, “This is who we are, this is what we’re going to do, we’re going to have it our way?” It was almost like the neoconservatives forgot that they needed to be diplomatic in the explanation of who and what we were. But we haven’t changed. We were no different before, we are no different after. Is it really just a question of diplomacy?
Giulio: Well, again, this is a manifestation of the power curse. Once you get that big, it’s really hard to scale back. It’s very, very difficult to scale back. You set up all these networks that depend on that expansion. So now, a lot of our military industrial complex depends on that expansion. Many of our corporations, Haliburton, and those that provide ancillary services, and even military services, are making tons of money from that expansion.
To come to these major corporations in the United States that hire thousands of people and say, “Sorry, my friend, no contracts next year,” that’s difficult to do. I think one of the points that I’m trying to make in the book is that it’s really, really hard. It’s very similar to our human weaknesses. Overcoming our human weaknesses is very, very difficult, but these weakness are inherent and we really need to step outside the box and look at ourselves very seriously, in a way that is uncommon for human beings to do. It is very uncommon for human beings to do that, to step outside of the box.
David: It’s uncomfortable.
Giulio: And for nations, too. So, yes, we’re still an empire under Obama, as hard as Obama has tried. We’re talking now about closing a number of bases, but when you think about it, 700 bases, dozens of bases in Germany and Europe – are we still fighting the Second World War? And yet, if we start talking about statistics, about our domestic situation, it is just appalling that this nation reads at an eight-grade level, the idea that we spend more per capita on health than any other country, and we’re not even one of the top ten healthiest countries, the fact that we have 1.5 million people in prison, 80% of which are going to be going back, over two million homeless, college is becoming unaffordable, even paying health insurance premiums is becoming unaffordable, real wages for the middle class have been flat? I don’t know.
David: We went through our expansion phase in terms of empire, the United States did. So, Athens needed money to control its domestic politics, keep people happy, take care of vested interests, and deal with a larger population and make sure that – the butter policy, we know what guns and butter means – the butter policies, if you will, were taking place. And it was empire-building that provided it.
David: We get our money, so to say, via an ever-expanding stock of liabilities, particularly our balance sheet liabilities. I’m thinking of the long-term obligations that we are creating in the treasury market. In a very short time we have gone from 10.8 trillion in liabilities to over 18 trillion, and that is just national debt. Corporate debt is closer to 12 trillion. If you’re looking at shadow banking liabilities, the IMF can’t even wrap their minds around it, they just estimate between 15 and 25 trillion. So, we’re continuing to march on as an empire, and yet it seems we’ve reached the natural limitations of geographic expansion, but are continuing to maintain the status quo by – it’s not exactly money-printing, it’s credit creation.
David: And so I’m just wondering where we begin to lose credibility as we continue to throw more liabilities onto the balance sheet.
Giulio: You mean, how long can people remain confident in the American dollar and America, itself, as an economic power?
David: That’s kind of what it ties to.
Giulio: Well, there is an old joke. There were these two guys trying to run away from a bear, and one of them stopped to lace up his boots, and the other one asked him, “Why are you lacing up your boots? You’re not going to be able outrun that bear with laced boots.” And he said, “I don’t really need to outrun the bear, I just need to outrun you.”
And yes, I think that we’re in a phase, probably, of financial over-stretch. That’s what led to the collapse of the Bretton Woods system. And are we in that same position now? Yes, I think that as we grow stronger, you’re right, even though we have reached a geographic limitation, there is no boundary as to how much we can expand our liabilities, and we will continue to do that as long as we feel that we can support that. And sometimes the moral hazard effect can be devastating, that we are so rich and we have so many liabilities out there, we don’t really need to worry because the dollar is pervasive, everyone is using it, and people will always have confidence in it.
And if you think that way, then you will act in a way that may be perverse, and this is classic moral hazard. “Oh, I don’t have to worry about my banking system as much. People always have faith in the dollar, we’ll always be able to get investments, and people will always buy our government bonds.” Faith in the financial system is unparalleled.
But on the other side of the ledger, the political side, we have problems passing a budget every year, and the political problems over the budget are getting bigger and bigger and bigger. And this reflects more than partisan politics. This reflects some real problems about our financial strength.
So, the manifestations of power illusion are there, and we’re not seeing them. We’re not seeing them because now the dollar is becoming stronger, people have faith in the dollar, and America is the top dog. And quite frankly, we can continue to deteriorate as long as everybody else deteriorates with us. It’s like that guy who says, “I only need to run faster than you.” So, as long as America is doing better than everybody else, then we’re okay. But that may not necessarily be the case in the future, and so we need to watch out.
David: I love the example of 19th century Britain, where the Bank of England is presuming that by moving the discount rate, they can basically be masters of the universe. And it is somewhat reminiscent of policy-makers today. Just a few minutes ago you said that economists don’t believe in market management. We do, to some degree, have market management, given central bank activity through QE programs, through setting interest rates at the zero bound, etc. So policy-makers are not exactly on board with the standard economist’s view that markets can’t be managed, because they are doing everything they can to manage markets.
And you illustrate in The Power Curse how those are the same presumptions that the Bank of England was under in simply managing the discount rate and not doing much else in terms of policy tools, which ultimately caught up with them in a major way. We are talking about Britain, the once great nation, and they still are, we’re not talking about a third world nation, but they certainly control land mass the size of a postage stamp as opposed to three quarters of the world.
Giulio: Yes, and in my book, my gold standard book, I really talked about the stability of the system, and it was stable despite the Bank of England, not because of the Bank of England. The Bank of England didn’t have nearly the power it thought it did. Its discount rate couldn’t grow money from the moon. But it just happened to be in a period, the Pax Britannica was also a very stable period, no war. No real major financial crisis. It was never really tested.
And because it was never really tested, it was probably under the impression that it was doing a good job managing a system, but it was never its intention to manage the global economy. That’s not right. And so I cleared that it saw itself as a necessary manager of the entire British financial system. Bankers tended to be responsible in that period, unlike the period today. They had rules and they followed rules. We don’t do that anymore, not in the same way. We don’t have the same financial orthodoxy that they had back then.
David: It’s discretion versus rules.
Giulio: Yes. So it’s a different game.
David: Well, as a teaser for our listeners, there is a whole host of other things that we could talk about, and we’re going to leave to their perusal of your book, how you look at the combination of hard and soft power, and you are driving, ultimately, toward your next book dealing with cosmopolitan power, I think.
And then, there is also coping with complexity. I think people will want to see the parallels and what could have been learned by the U.S. going into the Vietnam War from the British in the Milan emergency circa 1948 to 1960. That is a fascinating parallel. You illustrate a number of cases of strength leading to underdevelopment of other very necessary tools – again, the Bank of England, and Iraq and Afghanistan. And so, if I can just summarize this way. Number one, it’s worth ordering the book and reading it.
Giulio: Thank you.
David: I read it twice, and usually if I read something once, it’s because I either have obligated myself to read it, or whatever. If I’ve read something twice, it’s because I really wanted to read it again, and liked it.
Giulio: I’m honored. Boy, I wish they paid me twice.
David: Yes, well, we’ll see if anyone would like to read it, as well. To me, it seems like this is where we end, and you included this on page 154: “Hubris generated an insensitivity to the growing difficulty of managing an imperial network in ancient Greece.” If hubris landed us in the Vietnamese conflict with an Americanized and militarized approach that ignored strategies which could have led to a very different outcome… We have hubris which led the Bank of England to under-reserve its gold holdings and go it alone in the context of cross-border financial crises, illustrated by your unilateralism theme. We have hubris which put the American effort in Iraq and Afghanistan at the spear point of a military and sociopolitical exchange. We have hubris that has led the modern cast of bankers and financiers to believe that risks can be hedged and remain very low probability, sort of fixated on a Gaussian instead of a power curve.
And in some, it seems that the power curse and the power illusion boil down to a basic problem, rooted in a human condition, our tendency to pride, and the blind spots that that creates. I would not have seen it as clearly had you not brought it together showing that this is the case throughout history and across cultures. Do we have it?
Giulio: You just wrote my postscript, (laughs) if I ever re-write this book. Let me write that down, that’s beautiful and eloquent. Yes, the power curse ultimately boils down to hubris. And again, the point I make is, it is very natural for this hubris to manifest itself. It is very natural, because you are powerful. And when you are powerful, you think you are powerful, and you should think you are powerful. But just how powerful you are – that’s problematic. And that is when you need to ask questions. “Just how strong am I?” And that is something we don’t do. And that is something it takes a very, very special and perspicacious leader to understand, because there are many pitfalls, and natural pitfalls. So, eloquently stated, Dave. Eloquently stated.
David: Well, I can’t believe it has been five years, four and change, since our last on-air conversation when we were talking about The Anatomy of an International Monetary Regime. Time flies. I think the one thing that is missing here, and of course we don’t live in the same city, but if we did, I think we would enjoy sort of a Thursday evening Briar and Cask. I can imagine a dram of scotch and smoking a pipe to discuss the issues of the day, and I would continue to lean heavily on you for the historical context.
Giulio: I love the idea of the pipe, but I’m more a sherry man than a scotch man. But certainly, the idea of a pipe is very, very good.
David: Well, we’ll try to make that happen. Listen, thanks so much for joining us again. I am assuming that Amazon is the best place for people to order The Power Curse: Influence and Illusion in World Politics, unless you say otherwise.
David: Highly recommend it. Thanks, again, for joining us. Great to speak with you.
Giulio: Thank you so much. Thank you.