It wasn't the world that got flat, contrary to New York Times pundit Thomas
Friedman, but the emerging markets that got flattened.
Faddish conventional wisdom over the past few years held that American
influence was fading as technology radiated to the far reaches of the world.
When America's economy went into a ditch, though, the supposed economic
superpowers of the future went flying, like children on skates holding onto the
back of truck.
The American consumer, it turns out, played Atlas to the global economy, taking
the exports of Asia, so that Asia could buy the commodities of Russia, Latin
America and Africa. Remove the
American consumer, and Asian exports crash, taking commodity prices along with
The financial crash exposes the fragility of large swaths of the world. The
political consequences will be terrible. The worst of it is that America will
not be around to moderate the melee, not if Democratic Senator Barack Obama is
elected president, that is. Those who objected to America's role as world
policeman will get what they wanted, but they won't like it: a religious war
reaching from Lebanon to Pakistan, and Colombian-style narco-war spreading to
Mexico and Brazil.
The wave of American self-pity that may carry Obama to the White House stems,
in turn, from a global crisis that has sunk a good deal of the developing
world. Worst affected are the most populous Muslim countries, and Russia's
"near abroad". Pakistan, Ukraine and Belarus are out of funds and have applied
for help to the International Monetary Fund. Indonesia and Turkey face
drastically increased borrowing and import costs. Iran's economy will implode
with oil in the mid-US$60s.
The table below shows the cost of default protection, a gauge of hard-currency
borrowing costs, for some emerging markets. The numbers are somewhat arbitrary,
reflecting a freeze on credit to emerging markets.
Annual cost of five-year default protection in basis points above the London
interbank offered rate (LIBOR):
Basis Points Above
That is, with LIBOR at 3.5%, the Russian government will pay roughly 15% for
dollar funding, while Ukraine and Pakistan will pay about 30%, and Turkey about
11%. That does not accurately gauge the damage to their economies, though, for
many of these countries depended on huge borrowings from short-term credit
markets that now are frozen.
The economic crisis buoyed Obama out of his post-convention slump and exposed
the emptiness of the Republicans. But it also has crushed the aspirations of
the most populous Muslim countries. Even before the financial crisis, Pakistan
and Turkey had turned towards political Islam. Pakistan's intelligence service
is providing support to the Taliban in Afghanistan, jeopardizing the Western
position. The financial crisis will push Pakistan further towards radical
Islam. Now this proclamation will be preached from every mosque from Tyre to
Lahore: "The corrupt West tried to seduce you with consumerism. Now the
poisoned gifts of the West are shown to be an illusion, and those of you who
lusted after them are left only with your humiliation."
Just what has the rest of the world done to challenge the economic hegemony of
the United States? The commodities boom has evaporated in a matter of months,
with most raw materials trading at half of their May 2008 peaks. Like the
housing bubble in the United States, the commodities bubble turns out to have
been a way for the capital of the West to invent profits where there were none
to begin with. With the commodities bubble came a fad for investment in
emerging market currencies, drawing hundreds of billions of dollars into
high-yielding currencies like the Brazilian real, the Turkish lira and the
South African rand. The most popular emerging market currencies have fallen by
30% to 50% from their peaks.
The stock exchanges of the BRIC (Brazil-Russia-India-China) combination have
fallen half again as far as the US stock market this year in dollar terms:
Stock Market Change
2008 to Oct. 22
No one in Asia, it appears, knows how to make money when American import demand
shrinks, and when Asian growth falls, raw materials prices collapse. No one in
Latin America, for that matter, seems to know how to make money when raw
materials prices collapse. For all the preening and posing of the emerging
world's nouveau riche, it turns out that the American consumer was the center
of the world economy, and without the American consumer, all that is left are
busted stock markets and bad credit.
for the flat-worlders is the observation that the
emerging markets crashed when the world concluded
that Washington would not be able to reverse the
financial crisis. The economic bomb that detonated
in America caused more collateral
damage in the emerging markets than casualties at home.
Until July 2008, commodity prices rose as stock prices deteriorated because
investors falsely assumed that Washington would set off a new wave of inflation
as it rescued the banking system. The commodity producers thumbed their
collective nose at economic distress in the industrial world and expected the
boom to go on forever. Once the markets concluded that Washington would not be
able to prevent a financial collapse, the commodity indices crashed along with
stock prices. The commodity producers went from boom to bust almost overnight.
Iran's theocrats, as I reported in June (Worst
of times for Iran, Asia Times Online, June 24, 2008), managed to steal
$35 billion from oil revenues. Luxury real estate prices rose to Parisian
levels while poor Iranians lacked necessities. With the collapse of the oil
price, subsidies for essential items will disappear and the regime will face
economic collapse. Before it does so, I believe Iran will undertake an
adventure to assert its hegemony in the region, probably at the expense of
The low level of violence in Iraq during the past several months owes something
to the skill of American arms in the so-called "surge", but it owes even more
to a tacit agreement between Iran and the George W Bush administration: in
return for leashing its irregular forces in Iraq, Iran would get a free hand
with Hezbollah in Lebanon, and American forbearance with respect to its nuclear
The Bush administration's motive to bribe Iran and avoid political damage in
Iraq disappears on US presidential election day on November 4. Whether the US
administration (or for that matter Israel) has the nerve to launch an air
strike on Iran's nuclear facilities is anyone's guess (and everyone is guessing
that the answer is negative). Nonetheless, Iran has created the strongest
Shi'ite presence since the original battles that determined the succession to
the Prophet Mohammed. It can watch the Shi'ite cause fade away with the price
of oil, or it can attempt to use its capabilities before they are lost for
another thousand years. Nothing at all that we know of the Iranians indicates
that they would go quietly into another long night of Sunni oppression.
Iran's leaders, in short, find themselves in a position similar to, but more
urgent than, the one that Adolf Hitler described to his senior commanders three
weeks after the German invasion of Poland. I have quoted this before, but it
deserves to be tattooed onto the foreheads of analysts who think that economic
weakness reduces the likelihood of armed conflict.
We have nothing to
lose, but much indeed to gain. As a result of the constraints forced upon us,
our economic position is such that we cannot hold out for more than a few
years. [Hermann] Goering can confirm this. We have no other choice, we must act
... At no point in the future will Germany have a man with more authority than
I. But I could be replaced at any moment by some idiot or criminal ... The
morale of the German people is excellent. It can only worsen from here.
Iran's ultimate target will be Saudi Arabia, whose largest oil fields are found
inconveniently in Shi'ite-majority areas just across the Persian Gulf from
Iran. The Saudis will not sit quietly while Iran gains the upper hand in Iraq.
Pakistan and Turkey, Sunni powers with large armies, will be loath to allow
Iran to dominate the region, and they also will be all the more dependent on
A whole generation of Western analysts looked approving on Turkey's turn to
Islamism, as I reported last summer (Turkey
in the throes of Islamic revolution, Asia Times Online, July 22). Now
Turkey will be Islamist - and broke. Turkey paid more than 20% for local
currency deposits in order to attract the funds to finance a current account
deficit amounting to 7% of gross domestic product. The Islamist government of
Prime Minister Recep Tayyip Erdogan now faces the worst of all possible worlds.
The Turkish lira has lost a third of its value in the past month, and almost
all of the devaluation will turn up in higher domestic prices. Credit
availability for Turkish businesses will vanish, and Turkey will enter a
profound economic crisis.
A belt of ungovernability now stretches from Lebanon to Pakistan, with
incalculable political and military consequences. I believe that a
Shi'ite-Sunni version of Europe's 17th-century Thirty Years' War will engulf
Latin America presents a different malady: it has the middle class that wasn't.
The raw materials boom turned into a windfall for Brazil and Argentina, and the
windfall financed spectacular rates of internal credit growth (31% and 38%
respectively during the past year). For the first time, Brazil's auto
manufacturers produced for internal demand rather than exports, and Sao Paolo
choked in traffic while the helicopters of ethanol billionaires buzzed
overhead. Argentina is now effectively broke, and the government of Cristina
Kirchner has expropriated the country's private pension plans to obtain cash.
Its foreign credit has collapsed completely.
Brazil's central bank still has formidable reserves, but the fragile political
compromise that has kept a nominally leftist government in power cannot hold
under present circumstances. Brazil's enormous underclass is ruled by drug
gangs that are better armed than the police. A Brazilian congressional
committee was told in February 2006 that corrupt elements in the Argentine army
were selling heavy weapons to the Brazilian drug mobs, including anti-tank
Mexico in some ways is the most worrying place in the Western hemisphere. A
low-level civil war between the drug cartels and the federal government has
been fought over the past two years, and the cartels are winning. Senior
Mexican officials charged with suppression of the cartels have been moving
their families quietly out of the country. The collapse of the oil price and
the likely collapse of remittances from Mexicans in the United States threaten
the stability of the financial system, and the Mexican peso has lost nearly 40%
of its value during the past several weeks. With the collapse of the American
construction industry, a major source of employment for illegal Mexican
immigrants to the US, the economic safety valve has broken, and the cartels
have in inexhaustible supply of young men willing to risk their lives for a
Apart from Western and Central Asia and Latin America, the part of the world
most affected by the economic crisis will be the Russian periphery. Ukraine has
already joined Pakistan and Iceland at the mendicants' queue before the
International Monetary Fund, and a number of other countries may not be far
behind. Euphoria over the prospects of Eastern European economies permitted
them to borrow massively on the now-frozen interbank market and eat up the
proceeds in imports. Eastern Europe has the highest current account deficits in
the world, and the greatest dependency on short-term foreign borrowings. "The
risks of a hard landing are highest in Eastern Europe," warns the International
Monetary Fund in its just-released Global Financial stability report.
Although Russia has taken on water in the crisis, its position relative to its
former satellites has actually strengthened, as the table below makes clear:
Eastern Europe countries, current account deficit and net dependency on foreign
(% of GDP)
Net Borrowing From Foreign Banks
(% of GDP)
Source: International Monetary Fund, Global Financial Stability Report (October 2008).
There are no winners, but losing the least is the next best thing to winning.
If America turns inward, even an economically damaged Russia will loom larger
in the world.