Such is the end of Empires

Niall Ferguson has a critically important article out at RealClearWorld. History and economics. Facts are hard things.

We have been raised to think of the historical process as an essentially cyclical one.

We naturally tend to assume that in our own time, too, history will move cyclically, and slowly.

Yet what if history is not cyclical and slow-moving but arhythmic, at times almost stationary, but also capable of accelerating suddenly, like a sports car? What if collapse does not arrive over a number of centuries but comes suddenly, like a thief in the night?

Great powers and empires are complex systems, which means their construction more resembles a termite hill than an Egyptian pyramid. They operate somewhere between order and disorder, on "the edge of chaos", in the phrase of the computer scientist Christopher Langton.

Such systems can appear to operate quite stably for some time; they seem to be in equilibrium but are, in fact, constantly adapting.

But there comes a moment when complex systems "go critical". A very small trigger can set off a phase transition from a benign equilibrium to a crisis.

Examples?

... imperial falls are associated with fiscal crises: sharp imbalances between revenues and expenditures, and the mounting cost of servicing a mountain of public debt.

Think of Spain in the 17th century: already by 1543 nearly two-thirds of ordinary revenue was going on interest on the juros, the loans by which the Habsburg monarchy financed itself.

Or think of France in the 18th century: between 1751 and 1788, the eve of Revolution, interest and amortisation payments rose from just over a quarter of tax revenue to 62 per cent.

Finally, consider Britain in the 20th century. Its real problems came after 1945, when a substantial proportion of its now immense debt burden was in foreign hands. Of the pound stg. 21 billion national debt at the end of the war, about pound stg. 3.4bn was owed to foreign creditors, equivalent to about a third of gross domestic product.

And were do we stand in comparison?

Alarm bells should therefore be ringing very loudly indeed in Washington, as the US contemplates a deficit for 2010 of more than $US1.47 trillion ($1.64 trillion), about 10 per cent of GDP, for the second year running. Since 2001, in the space of just 10 years, the federal debt in public hands has doubled as a share of GDP from 32 per cent to a projected 66 per cent next year. According to the Congressional Budget Office's latest projections, the debt could rise above 90 per cent of GDP by 2020 and reach 146 per cent by 2030 and 344 per cent by 2050.

These sums may sound fantastic. But what is even more terrifying is to consider what ongoing deficit finance could mean for the burden of interest payments as a share of federal revenues.

The CBO projects net interest payments rising from 9 per cent of revenue to 20 per cent in 2020, 36 per cent in 2030, 58 per cent in 2040 and 85 per cent in 2050. As Larry Kotlikoff recently pointed out in the Financial Times, by any meaningful measure, the fiscal position of the US is at present worse than that of Greece.

You have heard me warn of the budetary train wreck that is coming. The shipbuilding "Terrible 20s" - and the fact that the salad days are long gone. Why?

There is a zero-sum game at the heart of the budgetary process: even if rates stay low, recurrent deficits and debt accumulation mean that interest payments consume a rising proportion of tax revenue. And military expenditure is the item most likely to be squeezed to compensate because, unlike mandatory entitlements (social security, Medicaid and Medicare), defence spending is discretionary.

It is, in other words, a pre-programmed reality of US fiscal policy today that the resources available to the Department of Defense will be reduced in the years to come. Indeed, by my reckoning, it is quite likely that the US could be spending more on interest payments than on defence within the next decade.

We have a lot of friends in the world, we like to tell ourselves, but remember - nations do not have permanent friends, but permanent interests.

...half the federal debt in public hands is in the hands of foreign creditors. Of that, a fifth (22 per cent) is held by the monetary authorities of the People's Republic of China, down from 27 per cent in July last year. It may not have escaped your notice that China now has the second-largest economy in the world and is almost certain to be the US's principal strategic rival in the 21st century, particularly in the Asia-Pacific. Quietly, discreetly, the Chinese are reducing their exposure to US Treasuries. Perhaps they have noticed what the rest of the world's investors pretend not to see: that the US is on a completely unsustainable fiscal course, with no apparent political means of self-correcting. That has profound implications not only for the US but also for all countries that have come to rely on it, directly or indirectly, for their security.

Australia's post-war foreign policy has been, in essence, to be a committed ally of the US.

But what if the sudden waning of American power that I fear brings to an abrupt end the era of US hegemony in the Asia-Pacific region? Are we (Australians) ready for such a dramatic change in the global balance of power?

The view from the outside is often needed.

Things are fixable - but time is money, and we are running out of time to stop this run to the cliff's edge.

Ponder.