Over the first half of 2007, central banks in the world’s emerging economies accumulated over $600 billion of new reserves. That’s double the total reserve position of the International Monetary Fund (IMF) -- an institution whose mission used to include preventing the collapse of these same governments, and whose new managing director recently raised questions about the body’s “relevance and legitimacy.” Over the same period, China, Russia and Japan joined the list of governments establishing “sovereign wealth funds”, whose worldwide assets now approach $3 trillion. The U.S. Treasury, meanwhile, is focusing its attention on the Strategic Economic Dialogue with China, while attempting to influence governments from Iran to Myanmar by ratcheting up financial sanctions against them.
A message to those who think of finance as a mere footnote to foreign policy: Wake up. Today, these two worlds are intertwined as never before. Remember when phrases like “nuclear option,” “balance of power” and “mutually assured destruction” only referred to the military? Not anymore. These and other similar terms have now been embraced by strategists in the 21st century’s latest battlefield -- finance. While the U.S. remains the world’s undisputed military superpower, other nations are increasingly advancing their national interests through the use of financial statecraft -- an area where the U.S. is no longer the unchallenged powerhouse.
The past several years have seen international financial markets transformed from U.S.-dominated to being truly global in scope and leadership. Sources, intermediation and destinations of capital and financial expertise outside the U.S. have grown at a tremendous and unprecedented pace. While this may be a positive development for the rest of the world (and the financial services industry), the larger strategic impact on the U.S. remains uncertain. The U.S. continues to boast the world’s largest GDP, but its overall share is declining and American financial hegemony is on the wane.
There are now competing centers of global finance and capital, not only in Europe but also in Asia and the Middle East, with values, priorities, motivations and interests that often differ from those of the U.S.Those who seek alternatives to U.S. financial markets now have multiple options to choose from.
China, Russia, Venezuela and others are increasingly playing the financial card as an instrument of power and influence. Will China resort to the “nuclear option” of dumping U.S. dollars, or view the US-China economic relationship as one of “mutually assured destruction?” Will Russia succeed in its call for a new “balance of power” by gaining the support of rising powers in the creation of a new financial architecture? Will Venezuela succeed in winning “hearts and minds” by refinancing other nations’ IMF debt while garnering valuable IOUs and global PR points? Perhaps more important, will the U.S. recognize that these finance-related battles are being fought and rise to the challenge?
To ensure that the U.S. does not find itself running behind in a game it should be dominating, it should undertake a multi-disciplinary review of three general areas of strategic finance.
First, Washington should explore the impact of large, highly concentrated and rapidly growing pools of liquidity outside U.S. borders, as well as the markets on which global capital is increasingly traded. In particular, the rapid growth of central bank reserves and the emergence of sovereign wealth funds need immediate attention. The U.S. needs to balance economic, political and security interests in attempting to influence how and where those funds are invested -- not least of which include ensuring that the U.S. attracts its fair share. The U.S. needs sophisticated policies, structures and tools that can be used to attract and best utilize this liquidity.
Second, what will the world’s financial architecture look like in years to come? As the global financial system rapidly evolves from one that is U.S.-centric to one of true global multipolarity, changes to the status quo are both desirable and inevitable. By taking a fresh look at existing entities, exchanges and practices, including the IMF, the U.S. can and should take the lead in either reforming or establishing new institutions more suited to 21st century demands. While the coming changes in financial architecture are probably inevitable, the U.S. taking leadership on them is not. The U.S. needs to seize the momentum in the face of shifts in global finance and take the lead, rather than being reactive -- or worse, indifferent.
Third, the U.S. should intensively pursue positive uses of financial statecraft, in addition to utilizing coercive ones such as sanctions, to advance U.S. foreign policy goals. Financial innovation and market expertise remain largely untapped assets in America’s diplomatic arsenal and should be included in any discussion of how best to further our interests abroad. In particular, we should consider how the U.S. can harness the power of and cooperate with U.S.-based global financial institutions, as the British government recently did in tapping the capital markets to fund international immunization efforts.
In the coming years, as the role of finance increases, the U.S. will continue to be a global leader. It will just not be the only one. It is imperative that the U.S. understand, prepare for and manage this new global landscape. The U.S. should seize opportunities presented by this new multipolar financial reality and play to what is still one of its greatest strengths. Despite its superpower status, too often, the U.S. appears to view our international options as limited to a choice between military, traditional diplomacy, foreign aid and trade-based levers. Other nations have already taken note of the opportunities presented by rapidly changing global financial markets. Washington would be well advised to do the same.