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Europe's looming crisis

It all started with sub-prime loans in the United States. Or did it? As the IMF is called in to bail

It was Europe’s dark secret. While American banks were lending irresponsibly to homeowners who couldn’t pay, European banks were lending to emerging countries who couldn’t pay. Europe’s sub-prime crisis has now come home as heavily-indebted nations of the eastern bloc – Hungary, Ukraine, Belarus, Bulgaria, the Baltic states – are collapsing one by one into the arms of the IMF. “Icelandisation” is the new spectre stalking Europe.

And, as with sub-prime in urban America, this latest crisis was shockingly predictable. I visited Latvia at the height of the credit bubble 18 months ago, and it was clearly an accident waiting to happen. Riga, the capital, was bristling with upmarket shopping malls and classy bars that were all quite empty. Stalin-era flats were being sold for $200,000 in a country where the average wage was less than $400 a month. Latvia has hardly any industry, no energy and few natural resources apart from trees. But such was the irrational exuberance of foreign banks like Swedbank, it was awash with credit.

According to the Bank for International Settlements, western European banks have lent more than $1.5trn to eastern Europe. Austria has loans equivalent to 80 per cent of GDP and stands to make huge losses as Hungary and Ukraine collapse.

This week, the Austrian government had to cancel an auction of government bonds because it could not be sure that investors would buy them. It is not inconceivable that Austria itself could end up needing to be rescued.

Other European countries implicated in global sub-prime include Spain, which has loaned immense sums ($316bn) to Latin American countries such as Argentina. Britain has $329bn tied up in Asia - or did until values collapsed in the Asian stock market rout. Japan's Nikkei index fell to a 26-year low this week, wiping out tens of billions of yen. The losses are now winging their way home to British pension funds and banks such as the Royal Bank of Scotland and HSBC.

Banks behaving badly, then, but what's new there? Well, the Bank of England told us this week that global losses so far from the financial crisis amount to $2.8trn. But this includes only a fraction of the likely losses from global sub- prime, which have yet to land on balance sheets.

Until last week's rout in the Asian bourses, there were still economists who believed that emerging markets would not be greatly affected by the credit crunch. But the theory that developing countries, led by China and India, have "decoupled" from the west, no longer holds water. It is clear that they have been dependent on consumer spending in America and Europe all along - and now that western consumers are staying away from the shops, no one is buying their goods. The Baltic Dry Shipping Index, which tracks the cost of hiring ships for international trade, has fallen by 79 per cent this year, itself a signal of a severe global recession.

Gordon Brown's hints that Britain might be able to spend its way out of this recession has to be considered in this light. There is no guarantee, in such a climate, that the British government would be able to borrow sufficient to pay for further bank rescues (they are sure to come), along with the cost of three million unemployed plus a programme of Keynesian infrastructure spending, however desirable that may be.

Investors are already shunning the pound because of anticipated losses from the UK property crash. Sterling has fallen 28 per cent this year, further than in the Exchange Rate Mechanism crisis of 1992, when interest rates rose to 15 per cent. We could be heading for a classic 1960s run on the pound.

The government had hoped that a devalued pound would stimulate exports and pull Britain out of recession, as happened after Black Wednesday 16 years ago, but the economic climate is different. We make few things to export now and the world is not in a buying mood anyway. And it has had quite enough of our "innovative" financial services. Thus Britain's current account deficit of 6 per cent - what used to be called loosely the balance of payments - has suddenly re-emerged as a major economic issue. Borrowing may be a good thing in a recession, but international financiers, sovereign wealth funds, hedge funds and banks may not agree.

The UK has the honour of having been the last G7 country to call in the IMF - during the 1976 sterling crisis - and while the government is not yet filling in the application forms, Britain's finances would not impress the Fund's economists. Standard IMF lending conditions are: privatisation, cuts in government spending and increased interest rates.

We are going in precisely the opposite direction, slashing interest rates, borrowing to spend and nationalising the banks.

Seen another way, this is only an indication of the extent to which the IMF is no longer fit for purpose in the Great Deleveraging. In recent years, the Fund has been an engine of Wall Street neoliberalism and financial deregulation, which leaves it ill-equipped to deal with the new international environment of deflation and banking crashes. In addition, there is a fiscal crisis facing the IMF. It has only about $250bn in reserves to throw at a rolling financial crisis that has now engulfed half the planet, from Iceland to Pakistan. Gordon Brown has called on energy-exporting nations to stump up more cash for the Fund, but there is a strong case, too, for reviewing how the IMF operates. Set up as part of the Bretton Woods financial system in 1944, the Fund was designed to cope with episodic currency crises. It is now having to deal with potential insolvencies in countries the size of Argentina as well as bailing out entire regions such as eastern Europe.

It will have to be very much better capitalised if it is going to perform this role, and it will have to abandon much of its free-market ideology.

We need a new set of interventionist institutions capable of managing financial rescues on an international scale.

Ultimately, what is needed is an international central bank with the resources to provide liquidity guarantees, recapitalise banks and regulate international financial flows. This is an immense task, and the world may not yet be ready for it. But it is not a new idea: John Maynard Keynes argued for precisely this during the Bretton Woods negotiations in 1944. He even suggested a world reserve currency "bancor". This is the kind of thinking we need today.

The alternative, if nothing is done, is international tension, even war. Consider failing Ukraine with its large Russian population and its dependency on Russia for energy supplies, right at the moment when Russian dreams of becoming an energy superpower have been dashed by the collapse of the oil price bubble. Or look at nuclear Pakistan, where the entire country is disintegrating in financial chaos. And what about China? Will all those unemployed workers - where half the toy manufacturers have gone bust - go peacefully back to the paddy fields?

When heads of the "G20" group of nations meet in Washington on 15 November for what is being called "Bretton Woods II" they will not just be dealing with a banking crisis. They will be deciding the future of civilisation.

This article first appeared in the 03 November 2008 issue of the New Statesman, Israel v Hamas

Edel Rodriguez for New Statesman
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Rehearsing for war

From the Middle East to North Korea, Donald Trump is reasserting US military strength and intensifying the rivalry among the great powers.

As Vice-President Mike Pence arrived in South Korea from Washington on Sunday, he announced that the “era of strategic patience”, in which the US sought to monitor and manage the nuclear threat from North Korea without pushing the matter for fear of escalation, was over. “President Trump has made it clear that the patience of the United States and our allies in this region has run out and we want to see change,” Pence declared. The heat under a crisis that had already been bubbling ominously was turned up another notch.

Much has been written in recent years about the stability provided by the post-1945 world order and the dangers of letting it crumble. The conflict in Korea provided the first big test of that order almost 70 years ago, but the difficulty was never really resolved. It remains the proverbial “wicked problem” in international affairs, “frozen” in an obsessively monitored and deeply uneasy stalemate, demarcated by the Demilitarised Zone: a line 160 miles long and roughly two and a half miles wide scored across the middle of the Korean Peninsula, drawn with superpower supervision in 1953. Partition has allowed a strong and ­successful state to flourish in the South while the North has survived in a state of ­arrested development.

The problem has been passed down from generation to generation because attempting to solve the issue risked opening a Pandora’s box. The risks included the unleashing of huge military force, potential world war and a refugee crisis on a scale that could severely destabilise even China. By the 1990s, it was clear that the North Korean regime had fastened upon another strategy for survival as the Cold War passed into history and its sponsors in Beijing and Moscow began to question the value of such an ally: the acquisition of nuclear warheads. Pyongyang has long had the firepower to flatten Seoul in a matter of hours. The mission since has been to develop its missile technology to carry that material as far as possible – certainly to Japan, but ideally also to the west coast of the United States.

The day after Pence’s announcement, the US and South Korea undertook a joint air and army exercise to ensure readiness in the event of an attack from the North. This followed a joint naval war game earlier in the week and the US decision to send a navy group led by the nuclear-powered aircraft carrier USS Carl Vinson, which Donald Trump described as an “armada”, to the region. No sooner had the fleet appeared than Japanese sources reported that it had been followed by Chinese and Russian submarines as it entered North Korean waters. Such are the great-power manoeuvres of the 21st century – whether on air, sea or land – in which the world’s most potent military machines shadow the moves of their competitors, and openly rehearse for war.

***

Asia has not had a major inter-state war since the 1970s but it is not immune from the tragedies of power politics that have beset other rapidly developing parts of the world. Across the region, military spending is rising fast as states jostle in anticipation of a changing balance of power.

The purpose of Pence’s Asia-Pacific tour is to offer reassurance to America’s allies in the region, which have been watching the rise of China, in particular, with trepidation. The stark change of tone emanating from the White House – and change of gear – has been noted. After years of steady consistency in US grand strategy, there is a sense of a building crisis and the Americans are being watched in anticipation of their next move more closely than they have been scrutinised in many years.

Before he left South Korea, Pence also visited Panmunjom, where the 1953 armistice was signed at the end of the Korean War, as well as Camp Bonifas, a UN military compound near the Demilitarised Zone, set up to monitor the ceasefire that followed. It is an eerie echo from the past that Pence’s own father served in the war that divided the country. Edward Pence was awarded the Bronze Star on 15 April 1953 for heroic service. The vice-president proudly displays the medal, and a photo of his father receiving it, in his office. He is no doubt aware of the costs of a conflict in which an estimated 36,000 of his countrymen were killed.

Just over a thousand British soldiers also lost their lives in the Korean War after being sent to fight in a joint UN force. But it was far more deadly still for the peoples of the Korean Peninsula, killing more than a million people, including 400,000 troops for the People’s Volunteer Army, among whom was Mao Anying, the eldest son of Chairman Mao, the leader of the Communist Party of China and protector of the North.

History throws up strange parallels. When the Korean War began in 1950 it was understood to be the first serious test of the international system established after the Second World War. It is striking just how many of the same ingredients remain, including the identity of some of the main protagonists. On 25 June 1950, a border conflict between North and South Korea escalated into full-scale war when Kim Il-sung’s Korean People’s Army – backed by China, and with the tacit support of the Soviet Union – invaded the Republic of Korea in the south, claiming that it represented the legitimate government of all Korea. This is a claim that the regime of his grandson Kim Jong-un has not abandoned to this day.

Two days after the invasion, on 27 June, the UN Security Council voted to send a joint force, under General Douglas MacArthur of the US, the former supreme commander of Allied forces in the south-west Pacific area, to protect the sovereignty of the South and repel the invaders. Much more was at stake than the question of territorial integrity or preserving international law. By bringing the Americans into confrontation with the Chinese – and with the Russians seen to be the steering hand in the background – the conflict had all the ingredients for rapid escalation.

From the start, there were concerns that the Americans might overdo the brinkmanship, even under the cautious leadership of Harry Truman. Fears that the self-confident MacArthur would exceed his brief were confirmed when the UN forces pushed back into North Korea in October. In response, the Chinese Communists, who believed that MacArthur had designs on China itself, flooded across the Yalu River in their tens of thousands.

It was in the autumn of 1950 that the danger of another world war, this one involving nuclear weapons, reached its peak. On 28 November, after a grave reverse for the UN forces, MacArthur stated that the advent of 200,000 Chinese had created “an entirely new war”, with much higher stakes than before. Suddenly, the prospect that the US might resort to using an atomic bomb against the North Koreans, or even the Chinese forces, seemed plausible.

While the nuclear scare passed, the war rumbled on towards an ugly stalemate over the next three years. A temporary solution of sorts was found with the 1953 armistice. But there was no resolution to Korea’s frozen war. In a way that no other totalitarian state has managed, the North zipped itself into a hermetically sealed chamber, preserving a three-generation dictatorship that is both comically anachronistic and frighteningly modern in its missile technology.

***

Some of this complicated backstory was explained to Donald Trump by China’s president, Xi Jinping, during his recent visit to the United States. Trump – who had been pressuring China to do more to deal with the North Korean regime – appears to have been receptive to what he heard.

“After listening for ten minutes,” he said, “I realised it’s not so easy.”

This is the first critical test of the “new era in great-power relations” which Xi has been floating for a number of years, but Trump has now decided to put to the test. According to Trump’s most recent tweets, Beijing has continued to work with the US on the North Korea problem. He has welcomed its contribution but insisted that America’s own willingness to deal with the problem does not depend on China. In other words, there is no master plan being played out here, even if – as seems credible – America did hack North Korea’s latest missile launch to make it a damp squib.

The Trump administration is not creating the conditions for a new long game, building a fresh multilateral consensus to contain the North Korean threat. Instead, with a newfound sense of momentum serving as a tail wind, it senses a moment to “solve” one of the longest-running and most treacherous problems in international affairs. It has decided, at the very least, to severely clip the wings of Kim Jong-un’s regime. And in doing so, it has set out to demonstrate that when America speaks, it speaks with effect.

Like much current presidential policy, “the Trump doctrine” is being made on the hoof. Much of the hyperactivity of the past month or so was not scripted but emerged in response to overt challenges – beginning in Damascus and panning to Pyongyang – to the United States and the “red lines” it has laid down in the past. One foundation stone of Trump’s approach to the world is firmly in place, however: the willingness to reassert US military power with swift and decisive effect. The idea that the “America First” slogan implied anything resembling isolationism is crumbling. The growing sense that it does imply unsentimental and unvarnished power politics in the name of the US interest rather than multilateral niceties is closer to the truth.

Under Barack Obama, the US sought to withdraw from those areas in which he felt that the US had overstretched itself under his predecessor. Obama opted for a more rapier-like and cost-effective form of power projection. He drew down from formal military operations in Iraq and Afghanistan, while presiding over a huge uptick in drone warfare, cyber capabilities and selective but deadly use of special operations. Much of the full range of US power was submerged in various “secret wars”, and the diplomatic compass was reset to pivot east. This was because, as a legacy of the 9/11 attacks, national security was geared towards the containment of an elusive and amorphous enemy – various offshoots of the global jihad movement – that operated on the periphery of America’s radar.

But the real metrics of great power are those now on display off the coast of North Korea. For all the advances in drone technology, the missiles that cause the gravest threats to humanity are those on the scale that the North Korean regime is attempting to build. Trump’s test was one that a president of the United States would have to face sooner rather than later.

Not since Ronald Reagan has the US been so willing to engage in naked displays of its own military potency in quick succession – and seek to gather diplomatic yields from them as swiftly as possible. The past fortnight brought a missile attack on an airbase manned by the Assad regime – changing the tenor of US-Russian relations overnight – and the dropping of the so-called Moab (“mother of all bombs”) on an Isis affiliate in Afghanistan. The latter was a far cry from the “clear, hold, build” counterinsurgency operations in vogue half a decade ago. But it did fit with a campaign promise by the new president that he would “bomb the shit out of Isis” should the opportunity arise.

Does this fit into a wider pattern or constitute a new approach? The Trump administration is eager to leverage any opening that might have been created. In Seoul, Pence wasted no time in joining the dots: “the world witnessed the strength and resolve of our new president in actions taken in Syria and Afghanistan”. North Korea, he continued, “would do well not to test his resolve, or the strength of the armed forces of the United States in this region”.

It is the generals who have increasingly set the tone for Trump’s foreign policy. During the 2016 election campaign, he promised to give the Pentagon more leeway than it had under Obama to focus on “winning”. The new national security adviser, H R McMaster, and the defence secretary, General James Mattis, are now the steering hands.

Neither man has followed the rather crass and short-sighted fashion for running down diplomacy. Mattis once said that if the state department budget was cut, he would need more ammunition. McMaster is an urbane thinker who knows that the use of force must always be carefully calibrated and is just one tool in a continuum of factors. In this respect, it is a problem that so many jobs in the state department remain unfilled. Now that muscle has been flexed, the experienced negotiators and diplomats should be flooding through the door.

***

The policy of “strategic patience” was based on an understandable calculation. But, in hindsight, it does appear that North Korea has suffered from neglect. Mitchell B Reiss, one of the most experienced diplomats who led efforts on North Korea in the 1990s, notes that, despite unprecedented co-operation between the US and China in recent weeks, including open threats of economic pressure and military action, they were still unable to prevent North Korea from testing ballistic missiles on 16 April. Even though the missiles exploded immediately after lift off, “The failure of Washington and Beijing to stop the test in the first place has important implications for the Trump administration’s future policy options and for stability in north-east Asia.”

In Reiss’s view, it is “highly unlikely that the North can be cajoled, threatened or given incentives to surrender its nuclear weapons”. The uncomfortable truth is that “short of regime change, which could inflame the entire Korean Peninsula in war”, the US cannot halt the North’s nuclear weapons programme. But that does not mean there are no options. Slowing the pace and raising the costs would be “prudent steps”. More, too, could be done, Reiss says, to “interdict imports of sensitive technologies, to sanction Chinese and other nationals who act as purchasing agents for the nuclear and missile programmes, and to punish Chinese banks that help finance these programmes through so-called secondary sanctions”.

In the end, so much comes down to US-China relations. Could this be the basis for a reset and a new accommodation between Beijing and Washington? How much further is China willing to go to use its leverage on the North, which depends on it for energy and food? And how patient will the Trump administration be if its new strategy does not yield tangible results of the sort that are sometimes elusive in the long and often open-ended game of deterrence? 

John Bew is a New Statesman contributing writer and the author of “Realpolitik: a History” (Oxford University Press)

John Bew is a New Statesman contributing writer. His most recent book, Realpolitik: A History, is published by Oxford University Press.

This article first appeared in the 20 April 2017 issue of the New Statesman, May's gamble

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