The Economy Of The Next Four Years

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In today’s City, cocktails at noon are a thing of the past, but so too is the cocky American investment banker. Lehman is bankrupt; Merrill is a subsidiary of Bank of America; Morgan and Goldman, fearful they were about to become subsidiaries of the People’s Republic of China or perhaps even meet the same fate as Lehman, have converted themselves into commercial banks; and Goldman has sold a chunk of itself to Warren Buffett. Washington Mutual is gone. Citi, another big player in London, is referred to in some circles as the Bank of Arabia. (Following the firm’s latest mishaps, Arab investors own about 20 percent of its equity.)

The eclipse of Wall Street is mirrored in the demise of the Washington Consensus, an interrelated set of free-market policies that the U.S., often operating through the World Bank and the International Monetary Fund, once imposed on less developed nations. Stripped to its basics, the American recipe for economic success had three elements: open markets, deregulation, and macroeconomic stability—all of which have now been called into question.

Even Summers, who in many ways embodied the Washington Consensus, today opposes elements of it. Summers recently advocated a more restrained approach to future trade treaties, since previous agreements, such as Nafta, had failed to benefit American workers. In an interview with Lloyd Grove on Portfolio.com, Summers also questioned the wisdom of excessive financial deregulation. Comparing the Asian crisis, which decimated the banking system in countries such as Korea, Taiwan, and Thailand, with what the U.S. is now experiencing, he said, “Some of the very same mistakes—excessive budget deficits, failure to regulate financial institutions, excessive leverage—that led to those problems are what led to our problems.”

With the Treasury Department taking over Fannie Mae and Freddie Mac, the two biggest mortgage firms in the country, the Federal Reserve purchasing 80 percent of the biggest insurance firm in the country, and Congress grappling with possible bailout plans, it hardly needs pointing out that the U.S. is no longer in a position to lecture others on the virtues of laissez-faire and sound economic management.

The demise of the Washington Consensus undercuts America’s ability to use what Joseph Nye, the Harvard political scientist, refers to as “soft power”—or economic heft—rather than military might, to exert its influence. One way the U.S. did this was by relying on the attractiveness of the American ideal to shape the preferences and beliefs of people around the world. When countries in economic transition, such as Poland and Vietnam, opened their markets to McDonald’s and Budweiser and Microsoft, they did so not because their leaders were kowtowing to powerful American multinationals but because their citizens demanded it. “Soft power uses a different type of currency—not force, not money—to engender cooperation,” Nye wrote in a 2004 article. “It uses an attraction to shared values and the justness and duty of contributing to the achievement of those values.”

Today, the images of America being broadcast around the world often feature desperate homeowners, failing banks, and panicked policymakers—none of which are likely to inspire confidence in, or affection for, Uncle Sam. On the Monday after Treasury Secretary Hank Paulson announced his bailout plan, the dollar suffered its biggest fall against the euro in almost a decade. Currency traders know an overstretched government when they see one, and the sight of the U.S. Treasury taking on what looked, at first glance, to be the financial equivalent of another Iraq war sent them fleeing from the greenback. “What’s weighing on the dollar is the question of how [the bailout] will ultimately be financed,” Sue Trinh, a currency strategist at RBC Capital Markets, told Reuters.

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