Euro in crisis

A failed euro would define Angela Merkel’s legacy

Germany’s critics feel vindicated. This will be stronger if Greece leaves, writes Marcel Fratzscher

By: Marcel Fratzscher  

The breakdown of negotiations on Greece has come as a shock. Berlin and other European capitals look in disbelief at the Greek government’s resolve to inflict huge economic and financial damage on its own country and its citizens.

But Greece will not be the only loser. The stakes for the German government are high, both domestically and internationally. Yet Berlin has a rare window to use the present Greek tragedy to push for the implementation of urgently needed reforms, thereby making the euro sustainable and giving European integration again a stronger legitimacy.

Across Europe financial market risks are likely to be tremendous in the coming days and weeks. The most immediate challenge for eurozone governments is damage control. The risks from contagion have repeatedly been downplayed. But no one can reasonably predict whether and how the crisis will spill over from Greece.

Many eurozone economies are still vulnerable. Italy’s economy has shrunk 10 per cent since 2008, while sovereign debt has increased to about 135 per cent of gross domestic product.
The European Central Bank had to intervene in July 2012 to promise to do “whatever it takes” in order to protect the integrity of the eurozone and prevent a sovereign default of Italy and others. The most likely scenario for the immediate future is that Europe’s politicians will again hide behind the ECB, hoping that it will do the heavy lifting to prevent market turmoil and stabilise the eurozone economy.

But what is at stake is not only economic and financial stability. The long-term political damage could be devastating, in particular for the German government. The blame game is heating up about not only who is responsible for the Greek tragedy but why the eurozone failed to get its act together over the past five years and end the crisis. This is a game Berlin and Angela Merkel, Germany’s chancellor, can hardly win. As the strongest economic and political member of the eurozone, Europe and the world have been looking to Berlin to solve the crisis and to reform Europe.

Sure, Ms Merkel may have done the right thing in the negotiations trying hard to broker a deal and making significant concessions to the Greek government. Short of capitulating, she had no chance of succeeding with this Greek government. But this will be no more than a footnote in history.

What is at stake for the German government is no less than its credibility, both at home and internationally. It promised its citizens a more stable Europe in exchange for financial help. It promised them to not accept any haircut on its loans, a promise it now has to renege on. Ms Merkel’s declaration that “Europe fails, if the euro fails” is correct, but it might come to haunt her and shape her legacy as chancellor. Germany’s many critics now feel vindicated. This feeling would be even stronger if Greece left the euro and returned to its national currency.
A Yes result will be a defeat for Tsipras and he will have to resign, writes Aristides Hatzis
Still Berlin has a chance to turn the tables and transform the Greek disaster into an instrument to push for much needed reforms of Europe, and hence a stronger eurozone. The most important policy decisions over the past decade were taken under duress and in times of crisis. Governments and central banks stabilised global markets through their joint declaration at the G20 meeting in New York in 2008. The decision to pursue the European banking union was made at the height of the European crisis in June 2012.
The so-called five presidents’ report from the heads of the main European institutions, released last week, contains many of these elements. This includes a fiscal union, with credible and binding rules, and insolvency mechanism for states and a joint fiscal capacity. This would not only provide protection for individual countries, but also smooth economic fluctuations and allow countries to reap the full benefits of the common currency for euro area members and of the single market for all EU countries. Such reforms will require changes to the EU treaties. This would allow Germany to also look beyond the eurozone to the concerns of the UK, which are widely shared in Berlin.
Berlin should think beyond short-term damage control and push its European partners to commit jointly to much-needed reforms of EU institutional architecture. This should include a stronger fiscal union, capital market union and treaty change also to avoid a British departure from the EU, the so-called Brexit, which would be an even greater tragedy for Europe than the Greek crisis.
This may be the only chance for the German government to protect both its credibility and legacy in Europe.

Bubbles Never Pop Painlessly

By: Michael Pento

Monday, June 29, 2015

Investors are obsessed over predicting the timing of the Fed's first interest rate hike. Will it raise the Fed Funds rate in September, or wait until next year? But it is far more important to get a grasp on the pace of rate hikes. Will it be a one and done move, or does this mark the beginning of an incremental tightening cycle? Those of us who are not in the inner circle are forced to only speculate.

But one thing is certain: If history is any guide, whatever they do the Fed will get it wrong.

Most market commentators place unfounded belief in the Fed's acumen. But the truth is: I wouldn't trust the Fed to tell me what the weather is going to do in the next 30 seconds -- even if they were looking out the window.

Once you understand the nature of bubbles -- how they are created and how they burst -- you can be assured this latest manifestation will also end in disaster. If the Fed raises rates in the manner in which the dot plots currently suggest it will quickly burst the bubbles already created in the real estate, stock and bond markets. On the other hand, if the Fed opts to only make a small token move higher in the cost of money it will allow asset bubbles to spin out of control until inflation destroys the vestiges of economic growth.

Our Central Bank has been deluding itself into believing it can easily escape from its nearly $4 trillion expansion of the monetary base and 7 years of virtually free money. But that is a spurious belief. Bubbles never die slowly and always bring about dire consequences. The bigger the bubbles the worse the backlash--and never before in the history of economics have central banks distorted market prices to this extent.

All bubbles share the conditions of the asset being overpriced, over-supplied and over-owned when compared to historical norms. And all bubbles are built on a massive increase in debt.

For examples; the Tech Bubble was fueled by a rapid increase of margin interest, and the housing bubble was fueled by the ownership of properties with little to no equity. Bubbles always sit atop a humongous pile of borrowed money. Today we have a tremendous amount of margin and leverage in both equities and fixed income assets.

For example, we see in this chart from the NYX data website that the percentage growth rate of margin debt vastly outstripped S&P 500 returns in real terms just prior to the collapses of 2000 and 2008.

Continued debt accumulation only makes sense if the underlying asset is increasing in price.

Once the principal of the asset stops rising, there is a massive unwinding of leverage, which causes the asset in question to plummet in value. Why do asset prices stop increasing in price?

Because the spigot for new credit gets turned off once the cost of borrowing funds becomes unprofitable for banks and/or consumers.

This is why true bubbles always bust in violent fashion. Overleveraged buyers are forced to panic out of the investment as soon as its price plateaus. And that panic selling begets more selling until there is a total washout of leveraged ownership; that is, until prices can be supported easily by highly-liquid investors.

However, the Fed wants investors to believe it can raise interest rates at the absolute perfect pace that will not deflate the bubbles in equities, real estate and all fixed income classes. But this a just a sophomoric and quixotic fantasy.

If the Fed raises rates expediently (in other words, gets ahead of the inflation rate in short period of time) the yield curve will flatten out more quickly than in past tightening cycles. This is because the spread between the Fed Funds rate and the belly of the yield curve is currently at a historically low starting point.

And importantly, the Fed won't be raising rates into an environment of robust inflation, as in the norm: instead, it will be raising rates just because it has become exceedingly uncomfortable being at the zero bound range for so many years. Once the yield curve flattens or inverts, money supply growth will get chocked off and asset prices will tumble into a deflationary death spiral similar to what occurred in 2008. This is exactly what will occur--after she begins liftoff from ZIRP -- if Ms. Yellen doesn't convince the market that she has fully repudiated the Fed's current dot plot model, which has the F.F. Rate at 1.625% by the end of 2016.

On the other hand, if the Fed stays at zero, or does a token one-and-done move on rates, asset prices could become even more grossly distorted in the immediate future. Then, after several more quarters of free money and asset bubble growth, the rate of inflation will begin to pick up serious momentum -- especially since the rise in the dollar on the DXY from 80, to 100 during the past year will quickly unravel.

In this case, pressure building up on long-term rates should explode in a sudden and violent manner.

Rates will soar not because the Fed is increasing short-term rates but precisely because the free market will awaken to the idea that our central bank has, at least temporarily, caused inflation to become intractable.

The Fed's "success" with creating inflation and the concomitant spike in long-term interest rates will, by definition, pop the fixed-income bubble, which will then cause a pernicious collapse in real estate, most equities and the economy as a whole. There shouldn't be any doubt that spiking long-term rates will become the bane for the additional $8 trillion increase in non-financial debt piled onto the U.S. economy since 2008.

Our view at Pento Portfolio Strategies is that the Fed will take the latter approach and cause the rate of inflation to grow at dangerous and intractable pace. But a prudent investor needs to be prepared for either scenario because the slope of the central bank's increase in the Fed Funds Rate will be crucial in determining the outcome. And the investment course will be vastly different for each situation. Most importantly, it is essential to be aware that an unprecedented period of market and economic turmoil lies just ahead. The good news is having the proper preparation and strategy will enable investors to profit from it.

What is Full Employment?

Martin Feldstein

JUN 29, 2015

job interview

CAMBRIDGE – In an important sense, the US economy is now at full employment. The relatively tight labor market is causing wages to rise at an accelerating rate, because employers must pay more to attract and retain employees. This has important implications for policymakers – and not just at the Federal Reserve.

Consider this: Average hourly earnings in May were 2.3% higher than in May 2014; but, since the beginning of this year, hourly earnings are up 3.3%, and in May alone rose at a 3.8% rate – a clear sign of full employment. The acceleration began in 2013 as labor markets started to tighten. Average compensation per hour rose just 1.1% from 2012 to 2013, but then increased at a 2.6% rate from 2013 to 2014, and at 3.3% in the first quarter of 2015.

These wage increases will soon show up in higher price inflation. The link between wages and prices is currently being offset by the sharp decline in the price of oil and gasoline relative to a year ago, and by the strengthening of the dollar relative to other currencies. But, as these factors’ impact on the overall price level diminishes, the inflation rate will rise more rapidly.

Accelerating wage growth implies that the economy is now at a point at which increases in demand created by easier monetary policy or expansionary fiscal policy would not achieve a sustained rise in output and employment. Instead, this demand would be channeled into higher wages and prices.

There are of course other definitions of full employment. Some would say that the United States is not at full employment, because 8.7 million people – about 6% of those who are employed – are looking for work. There are millions more who would like to work but are not actively looking, because they believe that there are no available jobs for people like themselves. And an additional 6.7 million are working part-time but would like to work more hours per week.

In many cases, these unemployed and underemployed individuals are experiencing real hardship. By that indicator, the US economy is not at full employment. But, for the Fed, it is, in the sense that excessively easy monetary policy can no longer achieve a sustained increase in employment. At the same time, other types of policies that change incentives or remove barriers can lead to increased employment and higher real incomes, without raising wage and price inflation.

Consider, for example, the high rate of non-employment among men aged 25 to 54, a group too old to be in school and too young to retire. More than 15% of men in this age group are not employed. Among those in this age range who have less than a high school education, 35% are not employed. Programs to provide market-relevant education and training should be able to raise employment among this group.

Or consider the employment experience of men and women over age 65. This group is eligible for Social Security (pensions) and Medicare (health insurance), and the majority are retired. But experience shows that the decision to retire or to work fewer hours is influenced by the compensation that members of this group receive. And this amount partly reflects the fact that employed people who collect Social Security and Medicare are subject to the payroll tax that finances them.

The payroll tax paid by employees is 6.65% (employers pay the same rate), and is in addition to the personal income tax. Moreover, because of the complex rules that govern the level of Social Security benefits, the older worker who pays this payroll tax is likely to receive no extra benefits.

For many older workers, the choice is not whether to work, but how much. We now have less than full employment in the sense that the payroll tax encourages older workers to work fewer hours than they otherwise would.

The Affordable Care Act (“Obamacare”) also reduces hours worked, in two different ways.

First, for some individuals, working fewer hours reduces incomes enough to entitle them to a larger government subsidy for health insurance. Second, some employers are being incented to reduce the number of working hours for individual employees, because, above a specified number, Obamacare imposes a larger burden on them.

Or consider minimum-wage legislation, which reduces employers’ willingness to hire low-skilled workers. As the minimum wage is increased, employers’ incentive to substitute equipment or more skilled employees strengthens. This reduction in the demand for low-skilled workers could be offset by taking into account the hourly equivalent of transfer payments when calculating the minimum wage.

For example, someone who receives $8,000 a year in transfer payments (such as food stamps, housing assistance, and the Earned Income Tax Credit) might be deemed to have received the equivalent of $4 an hour toward meeting the minimum wage. That individual’s combined income would be achieved with a lower cost to the employer, increasing the individual’s ability to find employment.

I could easily extend this list. The basic point is that employment can be increased, and unemployment decreased, by removing barriers to job creation and reducing marginal tax rates. By contrast, increasing demand by prolonging easy monetary policy or expanding fiscal spending is likely to result in rising inflation rather than rising employment.


jueves, julio 02, 2015



The Next Gold Bull Market 

  • The gold bull market died in 2011.
  • Die hard supporters are throwing in the towel.
  • Investors seeking the next gold bull market need to watch one key variable.

This should come as no surprise, but the gold (NYSEARCA:GLD) bull market is dead. The 40% plunge from its 2011 high of $1921.17/oz has turned the gold market into a wasteland.

Even the most ardent supporters - buyers of physical bullion and coins - have scattered. US Mint gold coin sales have dropped in half since 2010 (see chart from Bloomberg below).

(click to enlarge)

Physical dealers are feeling the hit. From a recent Bloomberg article:
"Some of the coin buyers are the diehard believers in gold, and seeing them stay away from the market means their faith may have been shaken," said Phil Streible, a senior market strategist at RJO Futures in Chicago who has been following prices for 15 years. "Demand for all kinds of physical gold products has taken a hit."
Why Did the Gold Bull Market Die?

After all, weren't pundits calling for $3,000, $5,000, $10,000 gold? The arguments all seemed quite rationale. Here are a few popular ones:
  1. Gold-to-DJIA Ratio: At the peak of the 1970s gold bull market the ratio approached 1. People argued that we wouldn't see another peak until the gold-to-DJIA ratio again approached this level.
  2. Massive Money Printing: People pointed to the huge growth in assets bought and held by the Federal Reserve as an eventual trigger for runaway inflation.
  3. Debt-to-GDP Ratio: Some argued that the public debt-to-GDP ratio would eventually destabilize the financial system as government debt is monetized (see point 2 above).
These arguments appear rational on the surface. Perhaps one day gold gets there, but there is one variable that tells me it won't in the foreseeable future: real interest rates.

The 'real interest rate' is the rate on a risk-free asset, adjusted for inflation. There are different measures, but one example is the 1yr US Treasury [1-3yr US Treasury ETF (NYSEARCA:SHY)] yield minus the 1yr change in CPI. Real interest rates can swing from positive to negative, depending on the economic environment. These rates say a lot about the state of the markets.

A negative real interest rate implies that investors are not adequately compensated for investing in US Treasuries. This makes US Treasuries less attractive to investors seeking safety.

In contrast, a positive real interest rate suggests that US Treasury investors are staying ahead of inflation. This makes US Treasuries more attractive to investors seeking safety.

As you have probably surmised, the appeal of gold (any asset, for that matter) is partly derived from the relative appeal of competing assets. For those that view gold as a safe haven, US Treasuries will become more attractive as real interest rates rise.

The chart (data source: St Louis Fed) below compares the real interest rate (right scale) to the price of gold (left scale). Real interest rates bottomed in September 2011 and have risen ever since. With this rise in real interest rates, gold became less attractive relative to other safe havens and has since collapsed by 40%.

Going back further, you can see the relationship between real interest rates and gold prices is fairly strong:
  • During the gold bull market that ended at the end of the 1970s, real interest rates were low / negative.
  • During the gold bear market from the early 1980s to the early 2000s, real interest rates were high / positive.
  • Finally, during the gold bull market from the early 2000s to 2011, real interest rates were low / negative.
(click to enlarge)


Investors watching gold today need to pay attention to real interest rates. If the real interest rate continues to strengthen, the relative attractiveness of gold will continue to erode. I believe the next gold bull market will occur when there is a clear and lasting indication that real interest rates are headed towards negative territory.

Greece threatens top court action to block Grexit

Exclusive: European leaders warn in concert that a 'No' vote on Sunday means Greece will be pushed out of the euro

By Ambrose Evans-Pritchard

9:52PM BST 29 Jun 2015

The one-week closure of the Greek banks and the drastic escalation of the crisis over the weekend caught investors by surprise Photo: Konstantinos Tsakalidis/Bloomberg
Greece has threatened to seek a court injunction against the EU institutions, both to block the country's expulsion from the euro and to halt asphyxiation of the banking system.

“The Greek government will make use of all our legal rights,” said the finance minister, Yanis Varoufakis.
“We are taking advice and will certainly consider an injunction at the European Court of Justice. The EU treaties make no provision for euro exit and we refuse to accept it. Our membership is not negotiable,“ he told the Telegraph.

Greek finance minister Yanis Varoufakis (Photo: Kostas Tsironis/Bloomberg)
The defiant stand came as Europe’s major powers warned in the bluntest terms that Greece will be forced out of monetary union if voters reject austerity demands in a shock referendum on Sunday.

“What is at stake is whether or not Greeks want to stay in the eurozone or want to take the risk of leaving," said French president Francois Hollande.

Sigmar Gabriel, Germany’s vice-chancellor and Social Democrat leader, said the Greek people should have no illusions about the fateful choice before them. “It must be crystal clear what is at stake. At the core, it is a yes or no to remaining in the eurozone,” he said.

Chancellor Angela Merkel – standing next to him after an emergency meeting of party leaders – was more oblique, but the message was much the same.

She praised hard-liners in her own party and insisted that the eurozone cannot yield to any one country. “If principles are not upheld, the euro will fail,” she said.

The refusal to hold out an olive branch to Greece more or less guarantees that it will not repay a €1.6bn loan to the International Monetary Fund on Tuesday, potentially setting off a domino effect of cross-default clauses and the biggest sovereign bankruptcy in history.

Any request for an injunction against EU bodies at the European Court would be an unprecedented development, further complicating the crisis.

Greek officials said they are seriously considering suing the European Central Bank itself for freezing emergency liquidity for the Greek banks at €89bn. It turned down a request from Athens for a €6bn increase to keep pace with deposit flight.

This effectively pulls the plug on the Greek banking system. Syriza claims that this is a prima facie breach of the ECB’s legal duty to maintain financial stability. “How can they justify setting off a run on the Greek banking system?” said one official.

Mr Varoufakis said Greece has enough liquidity to keep going until the referendum but acknowledged that capital controls introduced over the weekend were making life difficult for Greek companies.

Money is being rationed by an emergency payments committee made up of the key agencies and the banks. “We are having to prioritize spending,” he said.

The one-week closure of the Greek banks and the drastic escalation of the crisis over the weekend caught investors by surprise. Most had assumed that a deal was in the works.

Yields on Portuguese 10-year bonds spiked 47 basis points to 3.17pc before falling back as hedge funds look more closely at other EMU crisis states suffering from political dissent and austerity fatigue.

The sell-off ripped though debt markets in southern and eastern Europe. Yields jumped 24 basis points in Italy and Spain, and 22 points in Romania. German Bund yields dropped 13 points to 0.79pc on safe-haven flight.

The iTraxx Crossover index measuring risk on European corporate bonds jumped 42 basis points to 332 in one of the most violent one-day moves since the Lehman crisis in 2008, an ominous sign that any fall-out from ‘Grexit’ may be harder to contain that supposed.

European leaders insist that there is no longer any serious risk from contagion now that the EMU bail-out fund (ESM) is in place and the ECB has full power to act as a lender of last resort, if necessary by buying the bonds of vulnerable states on a mass scale.

This insouciance is not shared by the US Treasury or the US Federal Reserve. Britain’s Chancellor, George Osborne, warned that Grexit could be traumatic. "I don't think anyone should underestimate the impact a Greek exit from the euro," he said.

Luxembourg PM quits amid spying scandal European Commission president Jean-Claude Juncker (Photo: EPA)  Photo: EPA

The clash between Greece and the creditor powers has become deeply personal. “Goodwill has evaporated,” said Jean-Claude Juncker, the European Commission’s president.

He lashed out at the radical-Left Syriza government, accusing premier Alexis Tsipras of failing to tell his own people the “whole truth” about the terms on offer. “Playing off one democracy against 18 others is not an attitude worthy of the great Greek nation," he said.

Mr Juncker said angrily that he had “tried again and again” to stick up for the Greek people but warned that there is little he can do to stop events running their fateful course. "A 'No' would mean that Greece had said 'No' to Europe," he said.

"This isn't a game of liar's poker. There isn't one winner and another one who loses,” he said, adding that he felt betrayed by the “egotism, and tactical and populist games” of the Greek government.

Yet at the same time, Mr Juncker intruded deeply into the internal matters Greek democracy, exhorting voters not to “commit suicide" and kicking off what amounts to a referendum campaign by the Commission itself.

He denied that the creditors were demanding pension cuts as part of the deal, a claim dismissed a “preposterous lie” by one Greek official. In fact Brussels wants a cut equal to 1pc of GDP by next year, including a phasing out of the low pension supplement, and other indirect measures.

One Syriza MP, Dimitris Papadimoulis, caught the mood in Athens. “Juncker is calling for the overthrow of the government,” he said.

Inside Business

June 29, 2015 3:53 pm

Shadow banks take up the running in risky lending

Sujeet Indap


For decades local upstarts and foreign powerhouses have tried to crack the US corporate banking sector, usually resulting in expensive failure (looking at you, HSBC). In the latest offensive, however, the challengers may have an unwitting ally: regulators.

The American agencies responsible for overseeing the banks that dominate risky lending to companies have been cracking down on loans they deem to be loose. That effort has created a lucrative opening for institutions outside the grasp of the new rules. As a result, an unmistakable big three — Jefferies Group, Nomura Holdings, Macquarie Capital — of these “shadow” banks that do not rely on US deposits has slowly emerged.

In March 2013, the US Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation updated their decade-old views on leveraged loans — the financing that backs private equity buyouts or companies whose credit is speculative. They were trying to rein in systemic risk in the financial system at a time when the Fed’s easy money policy was potentially creating asset bubbles.

The new guidance was not intended as a strict test, but banks focused on a provision that expressed concerns about transactions where the resulting leverage would be six times cash flow or greater. This boundary, the agencies said, “would raise concerns” about the borrowers’ ability to repay the loans.

The guidance initially did not restrain risky lending. Leveraged loan volume in 2013 and 2014 continued its post-financial crisis surge. Investors were eager to gobble up floating-rate loans and confusion about or indifference towards the new standards did not stop the big banks from feeding that beast.

But since late last year, the mood has shifted. In November, the bank regulators clarified and reinforced the standards. Their annual audit of lending also said that a third of loans in the previous year “exhibited structures that were cited as weak”. Separately, it was widely reported that Credit Suisse had been rebuked for flouting the leverage guidance.

But the questionable deals have not ceased. Rather, Jefferies and friends have increasingly stepped up to provide big leverage that the banks did not. This has raised both their profile (Jefferies, Macquarie and Nomura are all now in the top 15 of the leveraged buyout finance standings) and the eyebrows of market observers. In one example that has become emblematic, Bain Capital secured a loan from Jefferies for the $2.4bn buyout of Blue Coat Software at well in excess of six times cash flow.

Despite their growth, the big three non-banks’ share of the leverage loan market share still adds up to only 8 per cent, according to Thomson Reuters. The regulated banks still have the heft and expertise needed to lead complex loan assignments. And sometimes they do still push the envelope on risky lending.

One head of a non-bank lender pointed to the recent $5bn buyout of another software company, Informatica, where leverage was seven times cash flow. The lending group featured not only Macquarie and Nomura but also Bank of America Merrill Lynch, Goldman Sachs, Deutsche Bank and Royal Bank of Canada. Still, overall leveraged lending is down by a third this year, at least partially because the big banks have curtailed their underwriting and the unregulated firms have only partially filled the void.

For bankers, the market has become a source of frustration and wounded psyches. They argue that leveraged loans, whether arranged by big banks or entities that do not take deposits, are almost fully purchased by third-party investors rather than retained on balance sheets.

Banks and non-banks alike are mostly functioning as middleman, so why is one subject to constraints when the other is not, they ask. One senior person at a regulated bank complains that the artistry of lending — evaluating businesses and optimising their capital structures — has been unduly seized. A lawyer who works with bankers says that morale has slipped as the sector is buried under a pile of internal compliance memos. A steady exodus of professionals to both the shadow banks and to private debt funds has been noticed.
Wall Street believes it has learnt its lessons from poor pre-crisis underwriting. When the next crisis come around, we will find out if they are right, depending on which type of lender turns out to be responsible.

Renovating the World Order

Dominique Moisi

JUN 29, 2015

fighters in Iraq

WARSAW – Russia-instigated violence has returned to Ukraine. The Islamic State continues its bloodstained territorial conquests. As violent conflicts and crises intensify worldwide, from Africa to Asia, it is becoming abundantly clear that there is no longer a guarantor of order – not international law or even a global hegemon – that countries (and would-be state-builders) view as legitimate and credible.
To develop a strategy for restoring order requires an understanding of the complex drivers of today’s fissures. And the best place to start is with the fate of four major empires.
That story begins in 1923 with the collapse of the Ottoman Empire, which, at its peak in the sixteenth and seventeenth centuries, controlled much of southeastern Europe, western Asia, and North Africa. Nearly seven decades later came the dissolution of the Soviet Union, followed by the renaissance of a Chinese empire that aims to translate its economic success into geopolitical influence.
Finally, and most important, there is the declining influence of the United States – what Raymond Aron called “the Imperial Republic.” After all, it is the US that organized and supported the post-1945 multilateral institutions – the United Nations Security Council, the International Monetary Fund, and the World Bank, among others – to sustain global stability. The failure of that system to adapt to changing geopolitical and economic realities has raised serious questions about its legitimacy.
With the world now divided less into “empires,” the number of actors (including many dysfunctional ones) on the world stage has multiplied – a trend propelled by the notion that identity and national sovereignty are inextricably linked. In the aftermath of the decolonization of Africa, the proliferation of states – including those that some considered “artificial” – was widely criticized for fueling tensions and instability on an already-fragile continent. A similar phenomenon may now be occurring on a global scale.
Still another factor contributing to the rise of disorder is the explosion of inequality. With globalization, the divide between the richest and the poorest – both within and among countries – has grown larger, diminishing the sense of unity of purpose that is so important to a legitimate international system. How can one speak of the “common good,” when so few have so much, and so many have so little?
Against this background, it will undoubtedly be extremely difficult to create an international order that strikes the needed balance between legitimacy and power. To meet this challenge, three potential approaches stand out.
The first approach entails redefining the international order so that it better reflects geopolitical realities. After World War II, a bipolar world order, dominated by the US and the Soviet Union, emerged. When the Soviet Union collapsed, the world became unipolar, with the US as the sole superpower. But, in the last decade, as the US has retreated from its global leadership position, no other country has stepped in to fill the void, leaving the system vulnerable to instability.
Clearly, another power must help the US to support global stability and promote multilateral cooperation. The European Union, mired in crisis, is not prepared to fill this role. Russia not only lacks the means to assume such a position; it has also proven itself to be a primary generator of disorder. And emerging countries like Brazil and India, as well as developed countries like Japan, are great regional powers, but have yet to develop a global mindset.
In fact, the only country with the means and ambition to serve alongside the US as a world leader is China (an obvious conclusion, perhaps). Together, these countries can reinvigorate the international system so that it is better able to stem the tide of chaos and violence.
Of course, the creation of such a bipolar world order would not be a panacea. Despite its relative decline, the US still possesses important structural advantages over China relating to innovation and values, not to mention vastly greater energy resources. As a result, the new order would be lopsided.
Still, the recognition of China as a true global power would force the US to come to terms with its declining hegemony and compel China’s leaders to recognize their international responsibilities.
The second approach to revitalizing the international system is to reinforce the values that underpin it. At the end of the eighteenth century, Jean-Jacques Rousseau was convinced that the absence of democracy in Europe constituted one of the main causes of war. Today, it seems that what is missing is the rule of law.
The dynamic is simple. As ordinary citizens have watched the wealthy get wealthier – often aided, directly or indirectly, by corrupt governments – they have become increasingly frustrated. In order to quell popular unrest, many governments have turned to nationalism, often in its most revanchist form, blaming some external enemy – say, the Western countries that imposed sanctions on Russia – for their citizens’ struggles. An international system that enforced the rule of law effectively would go a long way toward mitigating such conflict-generating behaviors.
The third approach is to reevaluate the functioning of multilateral institutions. Specifically, the best way to transcend the paralysis of the UN Security Council is to shift some important decisions to a more informal institution like the G-20, whose composition, while far from ideal, is more representative of today’s geopolitical dynamics.
These three approaches are not the only options that global leaders have for reforming the international system. But the one approach that they must not choose is to do nothing – unless they are willing to countenance further erosion of the global order and, with it, a continued descent into chaos and violence.