The Looming Bank Collapse

The U.S. financial system could be on the cusp of calamity. This time, we might not be able to save it.

Story by Frank Partnoy

After months of living with the coronavirus pandemic, American citizens are well aware of the toll it has taken on the economy: broken supply chains, record unemployment, failing small businesses. All of these factors are serious and could mire the United States in a deep, prolonged recession.

But there’s another threat to the economy, too. It lurks on the balance sheets of the big banks, and it could be cataclysmic. Imagine if, in addition to all the uncertainty surrounding the pandemic, you woke up one morning to find that the financial sector had collapsed.

You may think that such a crisis is unlikely, with memories of the 2008 crash still so fresh. But banks learned few lessons from that calamity, and new laws intended to keep them from taking on too much risk have failed to do so. As a result, we could be on the precipice of another crash, one different from 2008 less in kind than in degree. This one could be worse.

The financial crisis of 2008 was about home mortgages. Hundreds of billions of dollars in loans to home buyers were repackaged into securities called collateralized debt obligations, known as CDOs. In theory, CDOs were intended to shift risk away from banks, which lend money to home buyers.

In practice, the same banks that issued home loans also bet heavily on CDOs, often using complex techniques hidden from investors and regulators. When the housing market took a hit, these banks were doubly affected. In late 2007, banks began disclosing tens of billions of dollars of subprime-CDO losses. The next year, Lehman Brothers went under, taking the economy with it.

The federal government stepped in to rescue the other big banks and forestall a panic. The intervention worked—though its success did not seem assured at the time—and the system righted itself. Of course, many Americans suffered as a result of the crash, losing homes, jobs, and wealth. An already troubling gap between America’s haves and have-nots grew wider still. Yet by March 2009, the economy was on the upswing, and the longest bull market in history had begun.

To prevent the next crisis, Congress in 2010 passed the Dodd-Frank Act. Under the new rules, banks were supposed to borrow less, make fewer long-shot bets, and be more transparent about their holdings. The Federal Reserve began conducting “stress tests” to keep the banks in line. Congress also tried to reform the credit-rating agencies, which were widely blamed for enabling the meltdown by giving high marks to dubious CDOs, many of which were larded with subprime loans given to unqualified borrowers. Over the course of the crisis, more than 13,000 CDO investments that were rated AAA—the highest possible rating—defaulted.

The reforms were well intentioned, but, as we’ll see, they haven’t kept the banks from falling back into old, bad habits. After the housing crisis, subprime CDOs naturally fell out of favor. Demand shifted to a similar—and similarly risky—instrument, one that even has a similar name: the CLO, or collateralized loan obligation.

A CLO walks and talks like a CDO, but in place of loans made to home buyers are loans made to businesses—specifically, troubled businesses. CLOs bundle together so-called leveraged loans, the subprime mortgages of the corporate world. These are loans made to companies that have maxed out their borrowing and can no longer sell bonds directly to investors or qualify for a traditional bank loan. There are more than $1 trillion worth of leveraged loans currently outstanding. The majority are held in Clos.

Just as easy mortgages fueled economic growth in the 2000s, cheap corporate debt has done so in the past decade, and many companies have binged on it.

I was part of the group that structured and sold CDOs and CLOs at Morgan Stanley in the 1990s. The two securities are remarkably alike. Like a CDO, a CLO has multiple layers, which are sold separately.

The bottom layer is the riskiest, the top the safest. If just a few of the loans in a CLO default, the bottom layer will suffer a loss and the other layers will remain safe. If the defaults increase, the bottom layer will lose even more, and the pain will start to work its way up the layers. The top layer, however, remains protected: It loses money only after the lower layers have been wiped out.

Unless you work in finance, you probably haven’t heard of CLOs, but according to many estimates, the CLO market is bigger than the subprime-mortgage CDO market was in its heyday.

The Bank for International Settlements, which helps central banks pursue financial stability, has estimated the overall size of the CDO market in 2007 at $640 billion; it estimated the overall size of the CLO market in 2018 at $750 billion. More than $130 billion worth of CLOs have been created since then, some even in recent months. Just as easy mortgages fueled economic growth in the 2000s, cheap corporate debt has done so in the past decade, and many companies have binged on it.

Despite their obvious resemblance to the villain of the last crash, CLOs have been praised by Federal Reserve Chair Jerome Powell and Treasury Secretary Steven Mnuchin for moving the risk of leveraged loans outside the banking system. Like former Fed Chair Alan Greenspan, who downplayed the risks posed by subprime mortgages, Powell and Mnuchin have downplayed any trouble CLOs could pose for banks, arguing that the risk is contained within the CLOs themselves.

These sanguine views are hard to square with reality. The Bank for International Settlements estimates that, across the globe, banks held at least $250 billion worth of CLOs at the end of 2018. Last July, one month after Powell declared in a press conference that “the risk isn’t in the banks,” two economists from the Federal Reserve reported that U.S. depository institutions and their holding companies owned more than $110 billion worth of CLOs issued out of the Cayman Islands alone.

A more complete picture is hard to come by, in part because banks have been inconsistent about reporting their CLO holdings. The Financial Stability Board, which monitors the global financial system, warned in December that 14 percent of CLOs—more than $100 billion worth—are unaccounted for.

I have a checking account and a home mortgage with Wells Fargo; I decided to see how heavily invested my bank is in CLOs. I had to dig deep into the footnotes of the bank’s most recent annual report, all the way to page 144. Listed there are its “available for sale” accounts. These are investments a bank plans to sell at some point, though not necessarily right away.

The list contains the categories of safe assets you might expect: U.S. Treasury bonds, municipal bonds, and so on. Nestled among them is an item called “collateralized loan and other obligations”—CLOs. I ran my finger across the page to see the total for these investments, investments that Powell and Mnuchin have asserted are “outside the banking system.”

The total is $29.7 billion. It is a massive number. And it is inside the bank.

illustration of spreadsheet
George Wylesol

Since 2008, banks have kept more capital on hand to protect against a downturn, and their balance sheets are less leveraged now than they were in 2007. And not every bank has loaded up on CLOs. But in December, the Financial Stability Board estimated that, for the 30 “global systemically important banks,” the average exposure to leveraged loans and CLOs was roughly 60 percent of capital on hand.

Citigroup reported $20 billion worth of CLOs as of March 31; JPMorgan Chase reported $35 billion (along with an unrealized loss on CLOs of $2 billion). A couple of midsize banks—Banc of California, Stifel Financial—have CLOs totaling more than 100 percent of their capital. If the leveraged-loan market imploded, their liabilities could quickly become greater than their assets.

How can these banks justify gambling so much money on what looks like such a risky bet? Defenders of CLOs say they aren’t, in fact, a gamble—on the contrary, they are as sure a thing as you can hope for. That’s because the banks mostly own the least risky, top layer of CLOs. Since the mid-1990s, the highest annual default rate on leveraged loans was about 10 percent, during the previous financial crisis.

If 10 percent of a CLO’s loans default, the bottom layers will suffer, but if you own the top layer, you might not even notice. Three times as many loans could default and you’d still be protected, because the lower layers would bear the loss. The securities are structured such that investors with a high tolerance for risk, like hedge funds and private-equity firms, buy the bottom layers hoping to win the lottery.

The big banks settle for smaller returns and the security of the top layer. As of this writing, no AAA‑rated layer of a CLO has ever lost principal.

But that AAA rating is deceiving. The credit-rating agencies grade CLOs and their underlying debt separately. You might assume that a CLO must contain AAA debt if its top layer is rated AAA. Far from it. Remember: CLOs are made up of loans to businesses that are already in trouble.

So what sort of debt do you find in a CLO? Fitch Ratings has estimated that as of April, more than 67 percent of the 1,745 borrowers in its leveraged-loan database had a B rating. That might not sound bad, but B-rated debt is lousy debt. According to the rating agencies’ definitions, a B-rated borrower’s ability to repay a loan is likely to be impaired in adverse business or economic conditions.

In other words, two-thirds of those leveraged loans are likely to lose money in economic conditions like the ones we’re presently experiencing. According to Fitch, 15 percent of companies with leveraged loans are rated lower still, at CCC or below. These borrowers are on the cusp of default.

So while the banks restrict their CLO investments mostly to AAA‑rated layers, what they really own is exposure to tens of billions of dollars of high-risk debt. In those highly rated CLOs, you won’t find a single loan rated AAA, AA, or even A.

How can the credit-rating agencies get away with this? The answer is “default correlation,” a measure of the likelihood of loans defaulting at the same time. The main reason CLOs have been so safe is the same reason CDOs seemed safe before 2008. Back then, the underlying loans were risky too, and everyone knew that some of them would default. But it seemed unlikely that many of them would default at the same time.

The loans were spread across the entire country and among many lenders. Real-estate markets were thought to be local, not national, and the factors that typically lead people to default on their home loans—job loss, divorce, poor health—don’t all move in the same direction at the same time. Then housing prices fell 30 percent across the board and defaults skyrocketed.

For CLOs, the rating agencies determine the grades of the various layers by assessing both the risks of the leveraged loans and their default correlation. Even during a recession, different sectors of the economy, such as entertainment, health care, and retail, don’t necessarily move in lockstep. In theory, CLOs are constructed in such a way as to minimize the chances that all of the loans will be affected by a single event or chain of events. The rating agencies award high ratings to those layers that seem sufficiently diversified across industry and geography.

Banks do not publicly report which CLOs they hold, so we can’t know precisely which leveraged loans a given institution might be exposed to. But all you have to do is look at a list of leveraged borrowers to see the potential for trouble. Among the dozens of companies Fitch added to its list of “loans of concern” in April were AMC Entertainment, Bob’s Discount Furniture, California Pizza Kitchen, the Container Store, Lands’ End, Men’s Wearhouse, and Party City. These are all companies hard hit by the sort of belt-tightening that accompanies a conventional downturn.

We are not in the midst of a conventional downturn. The two companies with the largest amount of outstanding debt on Fitch’s April list were Envision Healthcare, a medical-staffing company that, among other things, helps hospitals administer emergency-room care, and Intelsat, which provides satellite broadband access. Also added to the list was Hoffmaster, which makes products used by restaurants to package food for takeout. Companies you might have expected to weather the present economic storm are among those suffering most acutely as consumers not only tighten their belts, but also redefine what they consider necessary.

Loan defaults are already happening. There were more in April than ever before. It will only get worse from here.

Even before the pandemic struck, the credit-rating agencies may have been underestimating how vulnerable unrelated industries could be to the same economic forces. A 2017 article by John Griffin, of the University of Texas, and Jordan Nickerson, of Boston College, demonstrated that the default-correlation assumptions used to create a group of 136 CLOs should have been three to four times higher than they were, and the miscalculations resulted in much higher ratings than were warranted.

“I’ve been concerned about AAA CLOs failing in the next crisis for several years,” Griffin told me in May. “This crisis is more horrifying than I anticipated.”

Under current conditions, the outlook for leveraged loans in a range of industries is truly grim. Companies such as AMC (nearly $2 billion of debt spread across 224 CLOs) and Party City ($719 million of debt in 183 CLOs) were in dire straits before social distancing. Now moviegoing and party-throwing are paused indefinitely—and may never come back to their pre-pandemic levels.

The prices of AAA-rated CLO layers tumbled in March, before the Federal Reserve announced that its additional $2.3 trillion of lending would include loans to CLOs. (The program is controversial: Is the Fed really willing to prop up CLOs when so many previously healthy small businesses are struggling to pay their debts? As of mid-May, no such loans had been made.) Far from scaring off the big banks, the tumble inspired several of them to buy low: Citigroup acquired $2 billion of AAA CLOs during the dip, which it flipped for a $100 million profit when prices bounced back. Other banks, including Bank of America, reportedly bought lower layers of CLOs in May for about 20 cents on the dollar.
Meanwhile, loan defaults are already happening. There were more in April than ever before. Several experts told me they expect more record-breaking months this summer. It will only get worse from there.

If leveraged-loan defaults continue, how badly could they damage the larger economy? What, precisely, is the worst-case scenario?

For the moment, the financial system seems relatively stable. Banks can still pay their debts and pass their regulatory capital tests. But recall that the previous crash took more than a year to unfold. The present is analogous not to the fall of 2008, when the U.S. was in full-blown crisis, but to the summer of 2007, when some securities were going underwater but no one yet knew what the upshot would be.

What I’m about to describe is necessarily speculative, but it is rooted in the experience of the previous crash and in what we know about current bank holdings. The purpose of laying out this worst-case scenario isn’t to say that it will necessarily come to pass. The purpose is to show that it could. That alone should scare us all—and inform the way we think about the next year and beyond.

Source: Based on data from Fitch Ratings. The fourth CLO depicts an aggregate leveraged-loan default rate of 78 percent.

Later this summer, leveraged-loan defaults will increase significantly as the economic effects of the pandemic fully register. Bankruptcy courts will very likely buckle under the weight of new filings. (During a two-week period in May, J.Crew, Neiman Marcus, and J. C. Penney all filed for bankruptcy.)

We already know that a significant majority of the loans in CLOs have weak covenants that offer investors only minimal legal protection; in industry parlance, they are “cov lite.” The holders of leveraged loans will thus be fortunate to get pennies on the dollar as companies default—nothing close to the 70 cents that has been standard in the past.

As the banks begin to feel the pain of these defaults, the public will learn that they were hardly the only institutions to bet big on CLOs. The insurance giant AIG—which had massive investments in CDOs in 2008—is now exposed to more than $9 billion in CLOs. U.S. life-insurance companies as a group in 2018 had an estimated one-fifth of their capital tied up in these same instruments. Pension funds, mutual funds, and exchange-traded funds (popular among retail investors) are also heavily invested in leveraged loans and CLOs.

The banks themselves may reveal that their CLO investments are larger than was previously understood. In fact, we’re already seeing this happen. On May 5, Wells Fargo disclosed $7.7 billion worth of CLOs in a different corner of its balance sheet than the $29.7 billion I’d found in its annual report. As defaults pile up, the Mnuchin-Powell view that leveraged loans can’t harm the financial system will be exposed as wishful thinking.

Thus far, I’ve focused on CLOs because they are the most troubling assets held by the banks. But they are also emblematic of other complex and artificial products that banks have stashed on—and off—their balance sheets. Later this year, banks may very well report quarterly losses that are much worse than anticipated.

The details will include a dizzying array of transactions that will recall not only the housing crisis, but the Enron scandal of the early 2000s. Remember all those subsidiaries Enron created (many of them infamously named after Star Wars characters) to keep risky bets off the energy firm’s financial statements? The big banks use similar structures, called “variable interest entities”—companies established largely to hold off-the-books positions.

Wells Fargo has more than $1 trillion of VIE assets, about which we currently know very little, because reporting requirements are opaque. But one popular investment held in VIEs is securities backed by commercial mortgages, such as loans to shopping malls and office parks—two categories of borrowers experiencing severe strain as a result of the pandemic.

The early losses from CLOs will not on their own erase the capital reserves required by Dodd-Frank. And some of the most irresponsible gambles from the last crisis—the speculative derivatives and credit-default swaps you may remember reading about in 2008—are less common today, experts told me.

But the losses from CLOs, combined with losses from other troubled assets like those commercial-mortgage-backed securities, will lead to serious deficiencies in capital. Meanwhile, the same economic forces buffeting CLOs will hit other parts of the banks’ balance sheets hard; as the recession drags on, their traditional sources of revenue will also dry up.

For some, the erosion of capital could approach the levels Lehman Brothers and Citigroup suffered in 2008. Banks with insufficient cash reserves will be forced to sell assets into a dour market, and the proceeds will be dismal. The prices of leveraged loans, and by extension CLOs, will spiral downward.

illustration of file cabinet with label "out of order"
George Wylesol

You can perhaps guess much of the rest: At some point, rumors will circulate that one major bank is near collapse. Overnight lending, which keeps the American economy running, will seize up. The Federal Reserve will try to arrange a bank bailout. All of that happened last time, too.

But this time, the bailout proposal will likely face stiffer opposition, from both parties. Since 2008, populists on the left and the right in American politics have grown suspicious of handouts to the big banks. Already irate that banks were inadequately punished for their malfeasance leading up to the last crash, critics will be outraged to learn that they so egregiously flouted the spirit of the post-2008 reforms.

Some members of Congress will question whether the Federal Reserve has the authority to buy risky investments to prop up the financial sector, as it did in 2008. (Dodd-Frank limited the Fed’s ability to target specific companies, and precluded loans to failing or insolvent institutions.) Government officials will hold frantic meetings, but to no avail. The faltering bank will fail, with others lined up behind it.

And then, sometime in the next year, we will all stare into the financial abyss. At that point, we will be well beyond the scope of the previous recession, and we will have either exhausted the remedies that spared the system last time or found that they won’t work this time around. What then?

Until recently, at least, the U.S. was rightly focused on finding ways to emerge from the coronavirus pandemic that prioritize the health of American citizens. And economic health cannot be restored until people feel safe going about their daily business. But health risks and economic risks must be considered together. In calculating the risks of reopening the economy, we must understand the true costs of remaining closed. At some point, they will become more than the country can bear.

The financial sector isn’t like other sectors. If it fails, fundamental aspects of modern life could fail with it. We could lose the ability to get loans to buy a house or a car, or to pay for college. Without reliable credit, many Americans might struggle to pay for their daily needs. This is why, in 2008, then–Treasury Secretary Henry Paulson went so far as to get down on one knee to beg Nancy Pelosi for her help sparing the system. He understood the alternative.

It is a distasteful fact that the present situation is so dire in part because the banks fell right back into bad behavior after the last crash—taking too many risks, hiding debt in complex instruments and off-balance-sheet entities, and generally exploiting loopholes in laws intended to rein in their greed. Sparing them for a second time this century will be that much harder.

If we muster the political will to do so—or if we avert the worst possible outcomes in this precarious time—it will be imperative for the U.S. government to impose reforms stringent enough to head off the next crisis. We’ve seen how banks respond to stern reprimands and modest reform.

This time, regulators might need to dismantle the system as we know it. Banks should play a much simpler role in the new economy, making lending decisions themselves instead of farming them out to credit-rating agencies.

They should steer clear of whatever newfangled security might replace the CLO. To prevent another crisis, we also need far more transparency, so we can see when banks give in to temptation. A bank shouldn’t be able to keep $1 trillion worth of assets off its books.

If we do manage to make it through the next year without waking up to a collapse, we must find ways to prevent the big banks from going all in on bets they can’t afford to lose. Their luck—and ours—will at some point run out.

Frank Partnoy is a law professor at UC Berkeley.

Welcome Back to Kissinger’s World

Neoconservatism has died, and liberal internationalism is discredited. Perhaps it’s time to return to the ideas of one of the last century’s greatest realists.

By Michael Hirsh

U.S. Secretary of State Henry Kissinger appears before the Senate Appropriations Committee in Washington on April 15, 1975, to urge approval of President Gerald Ford's request for military and humanitarian aid to South Vietnam.
U.S. Secretary of State Henry Kissinger appears before the Senate Appropriations Committee in Washington on April 15, 1975, to urge approval of President Gerald Ford's request for military and humanitarian aid to South Vietnam. Bettmann Archive/Getty Images

You can hate Henry Kissinger and think him evil. What you can’t do is ignore him—especially now.

So argues Barry Gewen in his incisive new intellectual history of Kissinger and his times, The Inevitability of Tragedy. Indeed, not only can we not ignore the old statesman, who turned 97 in May, but we need him more than ever. To be precise, we desperately need Kissinger’s ideas and instincts about how to muddle our way through a world that, we now realize, isn’t working very well—and probably never will.

The world, from Washington’s perspective especially, has gotten Kissingerian again. America’s crusades are over or at best are corroded and crumbling at their derelict foundations. The Wilsonian crusaderism that transformed sensible Cold War containment into a futile and delusional battle against the myth of monolithic communism, ending horribly in Vietnam; and then reawakened in the post-Cold War era as a neo-Reaganite call to end “evil” regimes, finishing tragically in Iraq, has all but exhausted itself.

No one wants anything to do with transforming the world anymore—so much so that Americans put a frank neo-isolationist, Donald Trump, in the White House so that he could shut the country off from the world.

The coronavirus crisis has accelerated Trump’s agenda, inspiring a new wave of “America First” isolationism, as his trade representative, Robert Lighthizer, argued in a recent essay calling for a reversal of U.S. economic offshoring in response to China’s “predatory trade and economic policies” and deceptions over the origins of the pandemic. The Trump administration is even invoking the power blocs of previous eras, mulling the creation of an “Economic Prosperity Network” of like-minded countries that would detach themselves from China.

With the 2020 presidential race in full swing, Democrats too are sounding more and more like Cold Warriors toward China, with the party’s presumptive nominee, Joe Biden, hammering Trump for his occasional praise for Chinese President Xi Jinping. And as a party, Democrats are questioning as never before liberal internationalist institutions that came out of their own tradition, such as the World Trade Organization (WTO)—largely because of a growing sense of grievance that China has exploited and violated WTO rules to rob middle-class Americans of their jobs.

The United States is not ready for any of this.

Certainly, U.S. diplomats have not figured a way out of it. To be sure, the liberal international order and the system of alliances that emerged out of World War II three-quarters of a century ago still exist, thankfully, and we’ll continue to make use of them. But mistrust among allies is high, cooperation all but nonexistent, and each country seems inclined to go its own nationalist way.

Global institutions like the United Nations and WTO have become meek poor relations at the table, pleading for policy scraps, while Washington, Beijing, and Moscow jostle for a seat at the head. Among nations the great ideological struggles are over—or at least in deep hibernation.

Over the course of the past century or so, we have witnessed the debunking of monarchy, authoritarianism, fascism, communism, and totalitarianism, each of them tried and tested to destruction. And now, to a degree, we are also experiencing the failures of democracy, which in so many places seems polarized into paralysis, as in Washington, drowning in memes of misinformation and hacked by malign external forces like Russia.

We have also seen how capitalism—though it bested Cold War communism in terms of ownership of the means of production—has proved grossly unequal to the test of producing social equity. The world’s chosen system is prone to continual collapse.

U.S. President Richard Nixon and Kissinger confer aboard Air Force One as it heads toward Brussels for NATO talks on June 26, 1974.
U.S. President Richard Nixon and Kissinger confer aboard Air Force One as it heads toward Brussels for NATO talks on June 26, 1974. Bettmann Archive/Getty Images

Just as significant, American prestige and power are as low as they’ve been in living memory, especially following Trump’s divisive, polarizing first term, which culminated most recently in international condemnation of his brutal approach to the protests that erupted following the killing of a black man in police custody in Minneapolis.

Beyond that, the president’s puerile jingoism and fumbling coronavirus response have only completed the road to reputational ruin begun under President George W. Bush. It is difficult now to remember how high American prestige was less than two decades ago, as recently as Sept. 10, 2001—that post-Cold War unipolar moment when the Yale University historian Paul Kennedy observed that the lone superpower had surpassed even ancient Rome in economic and military dominance—and how quickly that went off course.

In what was possibly the worst strategic misdirection in U.S. history, Bush and his neoconservative abettors (who are all in hiding now, conceptually speaking) turned what should have been a globally unifying struggle against the international community’s remaining criminal holdouts, Islamist terrorists, into an exhausting imperialist game of invasion and whack-a-mole, exposing in the process America’s worst vulnerabilities on the ground and in the air.

Then Bush did commensurate damage to the U.S. economy, ending in the Wall Street crash and Great Recession. China, meanwhile, rose and spread its monied influence across the world, Vladimir Putin preened and plotted, and the Viktor Orbans, Narendra Modis, and Jair Bolsonaros went their own ways.

And Americans, disgusted with how badly they’d been misled, responded first by electing a freshman senator (Barack Obama) who rose to prominence by calling Iraq a “dumb war” and who then vacillated for eight years over U.S. involvement overseas and finally by embracing America First populism.

All this brings us directly back to Kissinger, the great realist Hans Morgenthau (who was his mentor), and the fierce geopolitical urgency of now. Global anarchy beckons, and proliferating great-power rivalries demand savvy, hardheaded strategic diplomacy of the kind that Morgenthau conceived in theory and Kissinger mastered in practice.

Kissinger in 1969 (left) and 1963 (right) and with North Vietnam’s Le Duc Tho during peace talks on the Vietnam War in Paris on Jan. 24, 1973.
Kissinger in 1969 (left) and 1963 (right) and with North Vietnam’s Le Duc Tho during peace talks on the Vietnam War in Paris on Jan. 24, 1973. Jack Robinson/Condé Nast/Fred Stein Archive/Archive Photos/Daily Express/Archive Photos/Getty Images

The answer to the future of U.S.-China relations—and the global peace and stability that largely depend on getting them right—may lie in the past, Gewen suggests. It’s no small coincidence that Kissinger and his philosophy had their moment in the sun at a time of U.S. weakness, during the Vietnam War, civil unrest, Watergate, and the stagflation of the 1970s, when diplomats had to find common ground and a balance among the major powers.

Because a weakened and disordered Washington may be in an analogous place today vis-à-vis China, Kissinger’s favorite subject and the focus of his greatest diplomatic triumphs. In particular, Washington needs a reversion to tried and tested realpolitik that will be deft enough to turn great-power rivalry into a stable and peaceable modus vivendi.

As former Australian Prime Minister Kevin Rudd, a scholar of China who has watched Beijing’s rise up close, wrote in a recent essay about the coronavirus pandemic in Foreign Affairs: “The uncomfortable truth is that China and the United States are both likely to emerge from this crisis significantly diminished.

Neither a new Pax Sinica nor a renewed Pax Americana will rise from the ruins. Rather, both powers will be weakened, at home and abroad. And the result will be a continued slow but steady drift toward international anarchy.”

Yet it is just this likelihood of mutual weakness between the two great world powers that may provide a way out. The answer begins by recognizing and accepting what we face today—which is a permanently gray world.

This is hard to accept for Americans, who for several generations since World War II and in the triumphalist aftermath of the Cold War have grown used to unquestioned world dominance. But it is largely this chaotic 21st-century world that Morgenthau, though largely forgotten now except in academia, presciently described in the ur-text of modern realism more than 70 years ago, Politics Among Nations, and which Kissinger expanded on in his diplomatic career, as Gewen brilliantly documents in his book.

Morgenthau anticipated the present breakdown in the belief about the progress of human society when he said that the rationalists who pined for perfection in human governance and society denied the “inevitability of tragedy,” to pick up Gewen’s main theme.

That is what every great statesman has known—that the “choices he faced were not between good and evil … but between bad and less bad,” writes Gewen, a longtime editor at the New York Times Book Review (who, full disclosure, has occasionally assigned me reviews).

This describes much of Kissinger’s career, including the opening to China, the 1973 truce in the Middle East, even the chaotic and bloody end to the Vietnam War and the thousands of lives lost Kissinger must have on his conscience.

Kissinger’s ideas have more resonance now because we are clearly in a place similar to the American weakness in the ’70s, when foreign-policy elites weren’t thinking of triumph but just survival.

Kissinger, it is true, is not an easy man to restore to good public opinion, as Gewen notes in considerable detail. Kissinger and Richard Nixon oversaw the brutal campaign to force Hanoi to the table, dropping more bombs on Cambodia than all the bombs Allies dropped in World War II, ultimately leading to hundreds of thousands of innocent deaths; that policy, along with their indifference to the 1971 genocide in Bangladesh and apparent support of the coup in Chile, helped provoke a generation of prominent liberals from Seymour Hersh to Christopher Hitchens to label Kissinger a paranoiac and a war criminal.

There was always a duplicity about his beliefs and shrouding of his motives—he knew that Americans weren’t going to fight to, in his words, “preserve the balance of power.” (Gewen notes that Kissinger had concluded as early as 1965, after a visit, that Vietnam was unwinnable but still supported the war.)

Gewen tries to place Kissinger in the lineage of German Jewish thinkers who escaped the Holocaust and were haunted by the failures of Weimar democracy, along with Leo Strauss and Hannah Arendt—though he’s not entirely persuasive here, given that some of Strauss’s often-obscure ideas later inspired the neocons and another such European refugee from Hitler, Madeleine Albright (nee Korbel), ended up a passionate hard-power Wilsonian.

But Kissinger’s ideas have more resonance now because we are clearly in a place similar to the American weakness in the ’70s, when foreign-policy elites weren’t thinking of triumph but just survival, as they should be now, especially when America’s internal problems are arguably as enervating as they were back then.

Perhaps the biggest disappointment of Gewen’s book is that after spending hundreds of pages delving into the biographical and historical sources of Kissinger’s nuanced, Hitler-haunted realism, the author doesn’t apply it much to the present—and only fleetingly to China.

Because there is no greater vindication of Kissingerian realism than what has happened in China during the first decades of the 21st century. After a quarter century in which it became fashionable in Washington to think that co-opting China into the post-Cold War system of global markets and emerging democracies would gradually nudge that country toward Enlightenment norms—what Kissinger once archly called “the age-old American dream of a peace achieved by the conversion of the adversary” —such illusions have faded away.

All we have left is an emerging superpower that fits Kissinger’s hardheaded view of a country he visited some 100 times, dating back to his first talks with Mao Zedong. And if Kissinger’s analysis is correct—as it probably is—the United States and China can find accommodation if they work at it, with preaching kept to a minimum.

Kissinger accepts food from Chinese Premier Zhou Enlai during a state banquet in the Great Hall of the People in Beijing on Nov. 10, 1973.
Kissinger accepts food from Chinese Premier Zhou Enlai during a state banquet in the Great Hall of the People in Beijing on Nov. 10, 1973.Bettmann Archive

What the post-Cold War triumphalists didn’t understand, Gewen writes, is that after the collapse of the Soviet Union we confronted “a world without ideology, in which transcendent prescriptions for democracy were no answers to the problems at hand.”

Indeed, it has become far worse than that. We should frankly confront the postmodern reality that all hopes for the perfectibility of society and governance have fallen short; there is no longer any Great Cause to launch a revolution over.

Thomas Jefferson’s “ball of liberty,” which Americans once expected to roll unfailingly across the globe, has ended up in a gutter. The recent Nations in Transit report from Freedom House documents a “stunning democratic breakdown”—in particular pointing to failures in Central and Eastern Europe and Central Asia, saying that there are “fewer democracies in the region today than at any point since the annual report was launched in 1995.”

History will trundle on, weak Afghan-like states will continue to fail, and democracies and autocracies like the United States and China will remain in contention with each other.

But no one should delude themselves any longer that this clash of wills will yield some Great Teleological Outcome—a resolution in favor of one form of social and political organization over another.

What Should We Be Preparing For?

In most emerging and developing countries, COVID-19 is causing an economic hurricane. It looks increasingly like a Category 5, but the international community and many national governments prepared for a tropical storm.

 Ricardo Hausmann

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CAMBRIDGE – Suppose you knew that a hurricane was coming, but meteorologists were uncertain if it would make landfall as a Category 2 or a Category 5 storm. Which scenario should you prepare for?

The problem you face reflects the costs of assuming that it is a Category 5 when it is only a Category 2 and vice versa. The latter scenario implies deaths and destruction that could have been avoided through evacuations, well-supplied shelters, and precautionary shutdowns. The first scenario implies unnecessary preventive costs.

In the case of hurricanes, we all agree that it makes sense to err on the side of caution for the same reason that it is better to be five minutes early when catching a train than five minutes late.

In most emerging and developing countries, COVID-19 is causing an economic hurricane. It looks increasingly like a Category 5, but the international community and many national governments prepared for a tropical storm. To marry my metaphors, this is a recipe for a train wreck.

It did not start that way. Arguably, on the epidemiological front, the world acted quickly: more than 80 countries imposed lockdowns between March 9 and April 2 – some, like El Salvador, before they had their first confirmed case.

The strategy, in Tomas Pueyo’s evocative terms, was to hit the coronavirus with a “hammer” (the lockdown) and then to “dance” with it by adopting much less stringent policies that can contain its spread while permitting a return to a semblance of normality.

The strategy worked remarkably well in places as diverse as Albania, Jordan, Israel, Lebanon, Tunisia, Costa Rica, Belize, Uruguay, Thailand, and Namibia – so well that a strategy based on testing and contact-tracing became both feasible and effective. But it did not prevent deadly peaks in Italy, France, Spain, the United Kingdom, and the United States that have been very slow to subside. Declining support for continuing the lockdown means that these countries are trying to reopen with many infectious people around.

Moreover, lockdowns failed to stop the exponential growth of cases and deaths in countries such as India, Russia, Argentina, Chile, Mexico, Peru, the United Arab Emirates, Saudi Arabia, Qatar, Oman, South Africa, and Djibouti. These countries are now between a rock and a hard place: they cannot reopen safely, but they cannot sustain lockdowns for much longer.

Beyond their varying epidemiological effectiveness, lockdowns have been economically devastating.

The wreckage in advanced economies is bad enough: the UK is facing its worst recession since 1706, and 36 million Americans have claimed unemployment compensation since March. Now add to that the fact that 25% of workers in Lima, Peru, have lost their jobs, but cannot rely on their government for help because it cannot borrow at the scale of the US and the UK.

Emerging and developing economies around the world will shrink by 20-40% in the second quarter, with double-digit contractions for the year. They and the international organizations fear announcing such projections because they may spook markets and make matters worse.

More bad news: the post-lockdown period will not be one of strong recovery, because economic activity will remain severely constrained by the need to contain COVID-19. For example, truck drivers coming from neighboring countries caused outbreaks in countries like Jordan and Namibia, which had been highly successful at suppressing COVID-19, prompting a further tightening of controls.

Travel and tourism will not recover at least until a vaccine is widely available. Companies now realize that operating under social-distancing protocols is harder than they expected. Capital has been flowing out of emerging markets, and credit rating agencies are on an unprecedented downgrade spree.

As a result, most emerging and developing economies will have financial needs that will be hard to meet. First and foremost, they need money just to fund huge collapses in tax revenues caused by the shrinking economy. In addition, they will be asked to help hospitals, households, and firms, just as in advanced countries.

They will not find the needed finance domestically, because everybody at home is hurting. It must come from abroad. In the past, smaller shocks have led to triple whammies: currency, debt, and banking crises. Recovery has taken not a year but a decade.

All this adds up to the worst financial crisis that the Bretton Woods institutions have ever experienced in their 76-year history. Their response so far has been both admirably fast and utterly inadequate. They wish they could do more, but the existing rules and funding parameters are inadequate to the task.

For example, the International Monetary Fund has been giving countries Rapid Financing Instrument loans equivalent to 100% of quota – a formula-determined number that typically adds up to less than 1% of a country's GDP. If the number was 800% of quota, and this amount was disbursed in the next 18 months, it would start to make a difference.

The World Bank has a woefully insufficient balance sheet, and the regional development banks even more so. They should be recapitalized rapidly, but this is unlikely to happen, because the development banks have become another area of US-China rivalry.

In addition, as I argued earlier, the US Federal Reserve and the European Central Bank should include emerging-market bonds in their asset-purchase programs. Mauricio Cárdenas, Colombia’s former finance minister, has proposed a plan that should make this more palatable by pooling credit risk.

Moreover, this crisis is bound to require many countries to restructure their pre-pandemic debt to bring claims on future income in line with unexpectedly worsened expectations. Harvard’s Carmen M. Reinhart – recently appointed as Vice President and Chief Economist of the World Bank – and co-authors have documented how long and cumbersome restructurings have been in the past.

This may have been made intentional, to dissuade borrowers from abusing the option to restructure. The world now would be better served by a more efficient and expedited mechanism, such as the Sovereign Debt Restructuring Mechanism that Anne O. Krueger, then the IMF’s first deputy managing director, proposed in the early 2000s, before the US Treasury quashed the plan.

For humanity, this is a “whatever it takes” moment. To treat it as a “whatever makes us look good enough” moment would be a Category 5 mistake.

Ricardo Hausmann, a former minister of planning of Venezuela and former Chief Economist at the Inter-American Development Bank, is a professor at Harvard's John F. Kennedy School of Government and Director of the Harvard Growth Lab.

Saudi’s City of the Future Is a Mirage

By: Hilal Khashan

In October 2017, Saudi Crown Prince Mohammed bin Salman launched the New Future project, his vision of what would drive Saudi economic development in the post-oil era.

The project, thereafter dubbed Neom, is a novel idea as far as the Saudis go; it’s a far cry from Prince Mohammed al-Faisal’s idea in 1977 to tow a 100 million-ton iceberg to the desert to solve a water shortage problem.

But whereas the oil boom dashed al-Faisal’s iceberg dreams, the oil bust has convinced Salman that the future of Saudi prosperity lies in other industries, even a futuristic city that is believed to cost $500 billion.

The Case for Neom

The idea behind the city is to concentrate development and thus foster the accumulation of wealth and ensure the sustainability of growth. Each city would comprise an integrated metropolis consisting of economic clusters equipped with modern facilities providing services, logistics and residential quarters.

The Saudis argue that economic cities such as Neom have a competitive edge because they attract capital for intelligent investments, largely because they require advanced digital and technological systems.

The project, which would cover more than 26,000 square kilometers (10,000 square miles) of waterfront property near Jordan and Egypt, will also focus on renewable energy, water desalination, transport, food production and manufacturing, technical and digital science, advanced industrialization, media production, and recreation.

As part of the framework for Vision 2030, Neom aims to transform Saudi Arabia into a cultural model worth emulating.

The Saudi Public Investment Fund, which owns the project, is marketing it as an ultramodern technological achievement found nowhere else on Earth. Promotional efforts also note that 70 percent of the world’s population would be able to access the city in less than eight hours, thanks to King Salman’s causeway that will connect Neom to Africa and Europe via Sinai. As a unique investment region, the project is exempt from Saudi laws and regulations, such as taxes, customs, and labor laws, and so is designed to attract more foreign direct investment. The execution of the first phase of the project is slated for 2025, and it will take 30-50 years to complete.

But the case for Neom is born of necessity as much as it is of ambition. Saudi Arabia has compelling reasons to search for new sources of revenue. Oil exports account for 87 percent of total exports, 70 percent of the budget, and 46 percent of gross domestic product. The advent of alternative energy sources such as electric cars is expected to dramatically reduce demand for hydrocarbons by 2025. Oil revenues are expected to drop by 33 percent in 2020 and 25 percent in 2021. The economy, therefore, is vulnerable to vagaries in the market, and always will be so long as it relies overwhelmingly on oil.

The Saudi Economy: Overreliance on Oil

Even now, the budget deficit continues to grow, leading to further borrowing and excessive debt levels. The last annual budget deficit exceeded $100 billion. Saudi Arabia has lost more than one-third of its foreign reserves since 2014.

The most dramatic decrease occurred in March this year, with a $24 billion loss. The public sector is bloated, and the cost of maintaining it is high. The country’s expensive military expenditures are meaningless since it is unable to defend itself against foreign threats.

Economic diversification is a necessity because it reduces the financial consequences of fluctuating demand for hydrocarbons and unstable oil prices. Economic cities are Riyadh’s way of empowering the private sector and the long-sought-after solution to the dilemma of development.

Indeed, Neom intends to achieve what 10 previous plans tried and failed to: economic development. Riyadh’s first five-year development plan, which meant to transform the kingdom into a welfare state, started in 1970. The second and third development plans focused on building the infrastructure of economic development.

From the fourth through the ninth development plans (1985-2014), Saudi Arabia emphasized domesticating the workforce and focusing on human resource development. Government efforts encountered resistance because of public preference to seek employment in the public sector and aversion to manual or skilled labor and any position that assumed responsibility for making decisions.

The 10th development plan (2015-2019) set the stage for initiating the Neom project. It outlined the intention of transforming the kingdom into an international logistic center and launching grand economic initiatives without compromising Islam’s foundational values and tenets. In keeping with growing public demand and international pressure for political change, the plan paid lip service to the importance of citizenship and national belonging, strengthening the principles of justice and equality, and protection of human rights in accordance with Sharia law.

The 10th plan built on the principles of previous plans – that is, the exploration and development of economic diversification opportunities, investment in less water-intensive crops, development of a fisheries sector, and increasing human resource efficiency – though it differs in that it calls for the spread of information throughout the population, the activation of the role of economic cities, and the return of migrant capital to invest in productive sectors.

It is also, notably, built on ideas introduced in the seventh and eighth development plans, which recognized that cities could create the economic development Riyadh needs. This is embodied in the creation of King Abdullah Economic City, north of Jeddah, in 2005 at an estimated cost of $100 billion. The blueprint of the project included the construction of a container harbor and an industrial valley and the expectation that it would create 1 million jobs.

Other planned economic cities in the Northern Borders province and Jizan region concentrate on agriculture, food canning, vocational training, and storage. The government proposed that the economic cities in Mecca and Medina serve pilgrims in undertaking religious rites and providing high-end shopping. But these cities have either stumbled or atrophied, making Neom all the more consequential.

Science Fiction

Neom is a high-tech project that intends to provide advanced IT solutions. But its success is questionable in a country that scores low on the key indicators of a knowledge-based economy: skilled labor, incentives and motivation. Jamal Khashoggi, for example, was critical of Salman’s megaprojects, calling on him to launch smaller projects for the poor in Riyadh and Jeddah instead of complicated endeavors that don’t benefit local workers. He was killed inside a Saudi consulate in Istanbul in October 2018.

Saudi Arabia is also very censorial, curbing what its subjects are allowed to access via the internet and making sure that connections are always slow. The free and uninterrupted flow of information is crucial in developing independent and critical thinking that Saudi formal education views with disfavor. Neom cannot possibly thrive in a politically repressive and culturally closed environment.

Then there is the pesky problem of financing. Saudi Arabia’s finance minister recently announced that the country would implement painful measures to slash public expenses, given the dramatic decline in oil revenues due to the coronavirus pandemic.

The minister’s announcement led to a sharp decline of over 7 percent in the Saudi stock market. The unprecedented oil slump prompted Moody’s to downgrade Saudi outlook from stable to negative.

It is difficult to imagine that the Saudis can lure foreign investment to take part in Neom under the existing financial, social and political conditions.

And even if they can, Neom is like a mirage in the desert. The project does not differ fundamentally from similar initiatives in the United Arab Emirates and Qatar. The Port of Jebel Ali (Dubai) and the Hamad Port (Doha) are world-class seaports. The two countries have premier international airlines that Neom cannot dislodge.

Contrary to Saudi Arabia’s promotion of Neom as a site that straddles three continents, its location, surrounded by a vast swathe of barren desert, has no unique value. If anything, it would cripple the flagging Jordanian economy and destroy its tourism sector, as well as Egyptian resorts in South Sinai. Neom is just too much for the Middle East and way beyond what it needs.

The risks associated with the implementation of the project are high, and its outcome is unpredictable. The Neom scheme is unsustainable and potentially catastrophic. The introduction of flying taxis and robots capable of performing any task nullifies the claim that Neom would create millions of jobs. Saudi Arabia needs to import all the required technology to transform Neom into a reality, which is too costly to make the project feasible, especially with unclear benefits.

The plan does not benefit the local population that the government is coercing to vacate land needed for the project. Recently, the security forces killed a resident from the Huwaitat tribe because he refused to abandon his house and relocate.

In short, Neom is a project inspired by science fiction. It seems to have been influenced by the gated communities that American and British companies built in Saudi Arabia to keep their personnel disconnected from the locals. In November 2017, Salman ordered the arrest of hundreds of prominent Saudi princes and businessmen on the grounds of money laundering, embezzlement of public funds and corruption.

He subsequently announced recovering $50 billion to the state’s coffers, ostensibly contributing to development projects like Neom. He expected to get a similar amount before closing the Ritz-Carlton dossier.

There is little evidence that Neom is progressing except for the construction of five gigantic royal palaces serviced by a private airport and 10 helipads.

No, the Pandemic Will Not Bring Jobs Back From China

The Trump administration says manufacturing jobs are coming home. The facts tell another story.

By Edward Alden

A worker assembles a car at the newly renovated Ford Assembly Plant in Chicago, on June 24, 2019.
A worker assembles a car at the newly renovated Ford Assembly Plant in Chicago, on June 24, 2019. JIM YOUNG/AFP via Getty Images

No idea has been more central to U.S. President Donald Trump’s philosophy of “America first” than bringing jobs back home. In his 2017 inaugural address, he lamented that “one by one, the factories shuttered and left our shores, with not even a thought about the millions upon millions of American workers left behind.” Under his presidency, a newly elected Trump promised, “we will bring back our jobs.”

More than three years later and in the most unlikely of scenarios—a pandemic that has killed 100,000 Americans and destroyed more U.S. jobs than any time since the Great Depression—the Trump administration finally believes its opportunity has come.

The disruption caused by the coronavirus pandemic, U.S. Trade Representative Robert Lighthizer wrote earlier this month, has left U.S. companies with no choice but to “bring the jobs back to America.”

Lighthizer cast the pandemic as an overdue comeuppance for U.S. companies that had offshored production to lower-wage countries in a “lemming-like desire for ‘efficiency.’” Lighthizer was echoing another top official, Commerce Secretary Wilbur Ross, who had said in January—when the new coronavirus still appeared to be confined to China—that it would “help to accelerate the return of jobs to North America.”

The administration seems to have been working overtime to make prophets out of these two men, and it has landed some big fish. Last week, Taiwan Semiconductor Manufacturing announced it would build a new chip fabrication plant in Arizona that will partially reduce U.S. dependence on Asia for advanced semiconductors that are critical for defense and industry.

The federal government has also awarded $354 million to a Virginia start-up that will produce generic drugs and their ingredients, including those used to treat COVID-19, in the United States.

Peter Navarro, the third member of Trump’s nationalist trade triumvirate, touted the production decision as “a great day for America. This has all of the elements of the Trump strategy. It’s made in the USA. It’s innovation that will allow American workers to compete with the pollution havens, sweatshops, and tax havens of the world.”

The concern over manufacturing jobs lost to China and other countries certainly has merit. U.S. leaders, especially after China’s admission to the World Trade Organization in 2001, had long been inexcusably dismissive of job losses caused by offshoring and imports. Whether one blames Chinese imports for roughly half of the 5 million manufacturing jobs lost in the past two decades, or for fewer (there are still furious debates among economists), the social costs have been enormous. Lighthizer has tied the loss of good jobs to the breakdown of families and rising opioid addiction, and he was right to do so.

Whether one blames Trump or Chinese President Xi Jinping for the deterioration in U.S.-China relations, a fundamental reassessment of U.S. supply-chain vulnerabilities is long overdue. The administration’s signature actions on trade—imposing tariffs on steel and aluminum, renegotiating the North American Free Trade Agreement with Canada and Mexico, pursuing a trade war with China—were all crafted with an eye toward forcing U.S. companies to bring production back to the United States. Since January 2018, the average tariff rate on U.S. imports of Chinese goods has risen from just 3.1 percent to nearly 20 percent.

But will any of these efforts to bring production back work in the way Trump and his men are hoping? Putting aside the damaging foreign-policy consequences of an “America first” trade policy, the effort is flawed in two major ways. First, the combination of trade war and the pandemic is unlikely to force companies to bring manufacturing operations back to the United States on a significant scale. And second, with the advances in automation, any such reshoring is unlikely to bring the promised benefits in terms of well-paying employment for Americans.

Three years into the trade war, those tariffs should already have forced many U.S. companies to relocate production from China. Yet there is no evidence of any coronavirus-induced rush by companies to return operations to the United States. Prior to the pandemic, many companies had already been reconfiguring supply chains to try to escape the tariff burden, but they had returned little production to the United States.

The most comprehensive data has been collected by Panjiva, an arm of S&P Global that closely tracks supply-chain movements, and it shows the winner of the trade war has been Southeast Asia—especially Vietnam. Production of Google’s new Pixel 4A smartphone has largely been shifted from China to Vietnam, while Microsoft is now making the Surface tablet there as well. Google is also expanding manufacturing of smart-home products in neighboring Thailand.

Foxconn, the Taiwanese company that assembles Apple’s iPhones in China, has increasingly been moving to Vietnam as the new base for its consumer electronics exports to the United States. Telecommunications products such as smartphones now account for more than 20 percent of Vietnam’s exports to the United States, double the share in 2015. The data shows no trend of companies moving production back to the United States.

Nor is there any indication of a U.S. manufacturing resurgence in the most recent Reshoring Index published by the management consultancy Kearney, which Lighthizer cited as proof that Trump’s policies have been successful. Instead, Kearney found that the trade war had significantly reduced imports from China, which dropped by 17 percent between 2018 and 2019. Half of that hole was filled by other Asian countries and by Mexico.

Overall, manufacturing imports from China dropped by $90 billion, while imports rose by $13 billion from Mexico and by $31 billion from Asian countries that offer low-cost sourcing such as Vietnam. U.S. manufacturing output stayed flat, with higher domestic sales offset by lower exports. That performance is even more underwhelming given the generous tax cuts and aggressive deregulation the Trump administration has gifted companies in an attempt to entice them to raise their U.S. investments.

Could the pandemic accelerate these shifts? In all likelihood, yes. Chris Rogers, who heads global trade and logistics analysis for Panjiva, says the trade war has been a cost issue; companies can choose to pass the tariff costs on to consumers or relocate production to escape those costs. But the pandemic, he says, is a risk issue—border closures, transport shutdowns, and the growing use of export restraints will likely force companies to diversify sources of supply to guard against such disruptions.

The Kearney report similarly anticipates that “the threat of future crises will compel companies to restructure their global supply chains with an eye toward increased resilience, as well as lower risks and costs, as resilience is the key to operating profitably in the face of ongoing disruptions.” Could the United States be the winner from this second wave of relocations? “It seems unlikely,” Kearney concludes. “The limitations that held U.S. manufacturing to flat growth in 2019, even as the trade war put Chinese manufacturing at a decided disadvantage, will continue to work against a U.S. manufacturing revival.”

Even if the pandemic somehow succeeds where the trade war has failed in bringing U.S. manufacturing home, would that truly help Americans by bringing back the days of generous wages and stable employment? The evidence suggests this is wishful thinking based on “Make America Great Again” nostalgia.

Manufacturing simply does not determine the conditions for the U.S. workforce the way it once did. In 1970, one in four Americans worked in manufacturing; today it is fewer than one in 10. Where companies are choosing to expand U.S. manufacturing operations, their new factories are heavily automated. For example, LG Electronics, the South Korean company, recently built a new 1 million-square-foot plant in Clarksville, Tennessee, partly in response to the threat of tariffs the Trump administration slapped on imported South Korean washing machines in 2018. But inside the plant, most of the work is being done by industrial robots made by LG’s own Robostar affiliate in South Korea.

If anything, the pandemic is likely to accelerate the trend toward automation. As Mark Muro and his colleagues at the Brookings Institution argue, automation happens in bursts, and the virus is likely to trigger a fresh round. In economic shocks such as the one the world is currently experiencing, Muro and his co-authors write, “humans become relatively more expensive as firms’ revenues rapidly decline. At these moments, employers shed less-skilled workers and replace them with technology and higher-skilled workers, which increases labor productivity as a recession tapers off.”

In short, while some manufacturing may return to the United States due to the pandemic, the employment gains are likely to be modest at best. Even small gains should not be dismissed. The 600 or so jobs that LG is creating in Clarksville will be a boost to the city and its 160,000 residents. And there are certainly sectors where the United States should be ensuring some level of domestic production for national security reasons. The Reagan administration did similar things in the 1980s when it created the Sematech consortium and imposed tariffs to respond to the competitive challenge from Japanese chipmakers.

But none of this will transform the lives of American workers. Trump’s trade advisors are trapped behind glasses that are every bit as rose-colored as their boss’s—a desperate longing for the good old days in which men (and they were mostly men) supported families by working on assembly lines and bending metal, and passed that legacy on to their sons. But a 21st-century economy that provides good jobs for more Americans and protects vital public health and security interests will not remotely resemble the manufacturing economy of the 1950s.

Consider for a moment the big corporate winner from the pandemic, Amazon. It has built the most efficient distribution chain on the planet, which of course has left in its wake thousands of smaller retailers and their employees. But in the current coronavirus lockdown, it feels like a blessing to be able to have the things we need miraculously dropped on our doorsteps the next day.

U.S. companies such as Zoom, Facebook, Microsoft, and Google are keeping most of us connected, enabling the continued education of our children (admittedly inferior but certain to improve with time), and allowing contact with colleagues, friends, and family. The pandemic has only accelerated the shift to the digital economy of the future, an economy in which the United States leads the world.

The real questions should be about how to spread the benefits of that success—to the Amazon distribution workers, the grocery cashiers, the meatpackers, the sanitary workers, the millions of others who are keeping the economy going during the shutdown, and the millions more who will return to low-wage service jobs when it starts back up.

There are many ideas on the table for how to reconstruct the social compact for the 21st century—from more progressive taxation to free college to lifelong learning to universal basic income—but none of them is being championed by the Trump administration.

For an administration that decries its opponents as “socialists,” Lighthizer and his comrades show a deep distrust of the underlying dynamism of the U.S. economy. What is capitalism, after all, if not a lemming-like desire for efficiency?

The secret of U.S. economic success is Americans’ endlessly restless pursuit to find better, more efficient ways to invent, produce, and deliver the goods and services people want. To distrust that impulse is to distrust the motor force that built the greatest economy in the world.

Edward Alden is the Ross distinguished visiting professor at Western Washington University, a senior fellow at the Council on Foreign Relations, and the author of Failure to Adjust: How Americans Got Left Behind in the Global Economy. Twitter: @edwardalden