"We're in a period of transition of great powers becoming weak powers," said Professor Niall Ferguson in the keynote speech at the CLSA conference in Hong Kong yesterday. "If you don't recognise this, you will foresee incorrectly the results of the next few years."
He paints a prophetic picture of Chinese soldiers standing guard over Chinese economic interests in Africa, and protecting those assets by force if threatened. This, he says, is how you start an unofficial empire. However, nobody in China would describe it as an empire for ideological reasons, given that they got rid of their emperor in favour of a republic.
Ferguson is a historian of international renown and the author of books such as The Ascent of Money and The Pity of War. In the former book, he coined the phrase 'Chimerica' as an atavistic description of a chimera, representing a symbiotic economic marriage between China and America, a marriage in which one partner does all the spending and one does all the saving. If he was rewriting that book, he might now be speculating that this marriage is on the rocks. His Frankenstein creature is dying.
He notes that the world over the course of 2007 to autumn 2008 moved slowly to the verge of the economic precipice, caused by international hot money, financial innovations, monetary policy errors, excessive leverage and bubbles. The consequences of this included a collapse in asset prices, a banking crisis, collapses in output and trade, deflation and a rise in unemployment.
All of these features were also present in the depression of the 1930s, but this time the fall from the precipice was avoided as a result of the stimulus deriving from another unusual marriage -- that between the Friedman-style fiscal policy and Keynesian monetary policy.
So, are we on the verge of "Weimar America", by which he means hyper-inflation?
Ferguson thinks not. He gives several reasons, including the fact that core inflation is in positive territory, but consumer price inflation is negative, thanks to falling energy prices. Secondly, the developed world's wage pressure is zero, and thirdly, there have been 10% falls in both manufactured trade prices and China's export price index.
He says the US consumer is 'out', fatigued by 25% of mortgage holders being in negative equity and 12% in arrears or foreclosure. Household debt in the US is at 118% and median household income is at 1998 levels. Furthermore, consumer credit contracted by 1.7% in July.
There has been a slump in world trade and commodity price deflation to such a degree that might in another era lead one to infer that there is a world war taking place. There remains a big output gap as a result of this excess capacity, led foremost by Japan and Germany.
The banks are being squeezed, with those in the US that are 'too big to fail' still needing to deleverage and the others in jeopardy thanks to a commercial real estate problem that is still in its early innings.
Fiscally, the crisis is still deepening, with US government debt slated to hit 100% of GDP by 2017 and interest payments rising from 7% of total receipts in 2010 to 16% by 2016.
So, given all these unsavoury characteristics, why isn't the US a Latin America-style banana-case? The fact that it can issue dollar-denominated debt helps. Classically, the way out of such a mess is to inflate your way out and obliterate the 'rentier', who makes a living on a fixed income or on his cash savings.
However, Ferguson doesn't see inflation as the end result. Because of the trade deficit, he feels the outcome is dependent on China. In his visits to Washington, he says people frequently tell him that China has to play ball with them, in a variation of the 'mutually assured destruction' theme of the Cold War. Both countries need each other, and there's nowhere else to go.
Ferguson disagrees, and eviscerates his Chimerica creature. He points out that China has 70% of its reserves in US securities. It holds 13% of US government debt. At its peak, it gobbled up 75% of new issuance, but in the first half of 2009 that fell to 10%. He thinks China will be a net seller of US government debt in 2010 and points to CLSA estimates that China's trade balance will go into negative territory shortly. As the two nations' symbiosis is torn apart, there may be a greater number of trade squabbles, such as we have witnessed over tyres, autos and chickens.
"As an alternative, then, I see China building on its quasi-imperial relations with commodity suppliers in Africa and Latin America," says Ferguson. "As China exits the USA relationship, support for the dollar tapers off and long yields rise. Commodity prices rise in dollar terms to a level where the Saudis feel comfortable to produce, real interest rates are positive, and that is bad news for an economy that is still highly leveraged."
He isn't impressed by the eurozone either. The economic crisis gave propulsion to euro-scepticism and ultra-nationalism, as individual countries returned to the concept of the nation state as they sought independent solutions to financial problems, says Ferguson. This echoes his comments in the final minute of his 2006 television documentary series 'The War of the World', in which he concludes that multi-ethnic societies don't seem to get along very well when the chips are down.
He does not believe the optimists who predict 4% growth in the US for 2010, and while the tumble from the precipice has been avoided, the US is in for five to 10 years of bumbling along with extremely slow growth.