Economic power and military power
The Bug in the Software
In the movie, "Independence Day", the hero wins the war against the aliens by implanting a software bug inside the alien's computer system. A country's monetary system is its economy's software. It is possible to put a bug in the monetary system of a potential enemy and destroy its economic capacity.
Economic and Military Power
A country’s military capability is derived from its economic capacity. A country’s economic capacity also determines its capability to exert and maintain its political, social and economic independence in the world.
The Demise of the British Empire
Great Britain was once a dominant military force in the World while it had a dominant economy. At the start of the First World War, it devalued its exchange rate. By the end of the War, owing to its military expenditure, it had large trade deficits and falling gold reserves. These forced it to abandon the gold standard and it implemented tight monetary policy following the war. Then in 1925 the chancellor, Winston Churchill, reintroduced the gold standard and re-valued the pound back to its pre 1913 level.
These policies made British products uncompetitive, depressed the British economy and created high levels of unemployment. It was during the 1920’s that Britain sought to export its unemployed and commenced assisted migrant passages to Australia. The post war recession followed by the Great Depression undermined the military capability of Great Britain. It reduced its capacity to rule and defend its extensive empire to the point where it could not defend its own borders and it needed to call upon the support of its allies. This support was provided at a considerable cost to its military autonomy and its subsequent political and economic power.
Great Britain had the people and resources to maintain its empire and continue to sustain and build upon its productive economy. But it did not have the financial means to utilise these resources. Rather, its financial system undermined its economy and brought poverty to many of its people. Among other things, this led to curtailed military spending. By the start of the second World War, the military capability of Great Britain had been severely compromised.
The bug in Great Britain's monetary system was likely to have been accidental rather than planned. Also, it was temporary flaw rather than systemic.
There is another more recent example that, while (probably) accidental, involves a systemic change to the economy. This economic software bug not only destroyed a country's industry but encouraged it to remove its industries and establish them on alien soil.
In the USA, during the conduct of the Vietnam War, the government borrowed from the Federal Reserve to finance the War. Also, there was a rapid rise in bank credit that brought about balance of payment difficulties and depleted the nation’s gold reserves. Gold reserves fell so low that in 1971 the USA terminated its policy of converting dollars into gold; the gold standard. In 1973, it floated its exchange rate.
The floating exchange rate system requires international receipts and payments to be equal. In this way it preserves official foreign reserves. The exchange rate adjusts to ensure this balanced outcome.
The system failed to treat the cause of the problem; that is, the rapid rise of bank credit.
By requiring monetary receipts entering the country to equal the monetary payments leaving the country, the system changed the effect of trade on the economy. Before the float, if the USA increased its exports, more money would enter the country and that money would raise not only the income of the exporter, but the income of other industries when the exporter spent that money in the economy. Under the floating exchange rate system, the exporter still receives income for their exports but it is matched by an immediate and equal increase in expenditure on imports. For the economy as a whole, it is as if the exporter did not earn any extra income. It meant that increased exports no longer stimulated the domestic economy.
The monetary requirement that international payments must equal international receipts translates to a real requirement that imports must increase to offset the increase in exports. The country had no additional money to spend, so the only way imports could increase was to shift domestic spending from local products to imports. That destroyed the domestic industries that were previously supplying those products.
To survive, domestic businesses shipped their entire productive capacity offshore. In the USA, what was once a giant industrial heartland is called now the "rust belt". While demand in the economy has been high, it has been directed at imports rather than demand for domestic products.
Following the float, the USA experienced what was called the “oil crisis”. The oil crisis had little to do with oil. It was the birth pangs of the new monetary system. A similar crisis occurred among the South East Asian economies when they floated (the Asian Crisis). Those Tiger economies were tamed following their float. More recently, they have been moving to a more managed float. This shift is bringing some improvement to their economies.
The US economy has not been able to duplicate or even approach the rate of economic growth and level of prosperity of the 1950’s and 1960’s under the much maligned fixed exchange rate system. Since the float, the US has experience high unemployment, the collapse of manufacturing industry (the “rust belt”) and rising foreign debt.
This weaker economy has constrained the military capability of the US. Shortly after implementing the floating exchange rate policy, the military forces of the USA were forced to withdraw, defeated from Vietnam. The USA continues to have the physical and technological hardware to make it a significant force in the world. Yet it has had difficulty financing the provision of resources to fight the relatively small battles against significantly inferior forces.
In the case of the UK, it was its monetary system that undermined its ability to recover from the First World War. In the case of the USA, its military capacity is being constrained also, not only by a lack of financial capacity and excessive debt but also by the collapse of the US industrial capacity.
Options for the US Economy
It is possible to remove the bug in the US monetary policy and revive the US economy. That would improve its military as well as economic capacity. However, US economists are ideologically tied to their "unsinkable" floating exchange rate system. This system can only continue to slow economic growth, undermine domestic industry and create unsustainable debt.
The US strategy to overcome its problems appears to be to implant the same economic bug, the floating exchange rate system, into the Chinese economy. That may deflate the Chinese economy but it would not remove the economic problems of the US.
The Japanese Economy
For example, up until the early 1990's the USA felt threatened by the Japanese economy. Like the USA, the Japanese economy had a floating exchange rate system. But Japan was a net exporter of capital. Exporting capital has the same effect on the floating exchange rate system as importing goods. That process fooled the exchange rate system into generating a low exchange rate that forced the economy to push out exports.
While this trade did not bring more money into the economy, it allowed the banks to increase lending without causing balance of payments problems. The injection of money from the banks stimulated the economy. In the early 1990's, the IMF was able to persuade the Japanese government to constrain its banking system. When the monetary stimulus was removed, the economy wallowed and it no longer threatens the economy of the USA.
The Rise of China
This economic malaise in Japan created the opportunity for other economies to grow. At first it was China and the South East Asian economies that prospered. But when the South East Asian economies adopted the floating exchange rate system, this left the Chinese economy as the only one open to prosper from the stimulus of trade. And, as we have seen from history, the dominant economic power is likely to become the dominant military power.
If the Chinese economy were constrained by adopting the floating exchange rate system, other economies would be likely to fill the gap to provide imports for the USA. Thus there is the possibility that another economy with a monetary system that is open to foreign stimulus could quickly rise and take over from where the Chinese and Japanese left off.
National Response to Floating Exchange Rate
Countries exposed to the floating exchange rate system have seen their manufacturing industries destroyed. Also, their governments have been faced with reduced incomes and rising costs associated with supporting their communities that have been suffering from the poor state of their economies. In this weakened state, these economies have been selling off strategic assets such as infrastructure and major industrial assets. In some cases acquisitions by foreign entities have been welcomed. Any possible threat to national security has been disregarded.
Yet it is probable that some countries that have avoided the perils of the floating exchange rate system may have taken advantage of the poor health of economies with floating exchange rates to purchase strategic assets. If this were sanctioned at a political level, such countries may adopt policies to restrict the growth of the bank credit within their own economies to allow them to accumulate the foreign reserves required to finance such purchases with a view to gaining a strategic advantage.
By way of example, a country may use its sovereign investment funds to acquire strategic infrastructure and thereby gain access to data bases that would enable it to identify the location of strategic defence industries, businesses and people, analyse their operations, and inspect their premises. Also, some strategic acquisitions may give them the capacity to severely undermine the operational effectiveness of national security facilities. Furthermore, a country may seek to compromise the security of a target country by acquiring strategic assets in an allied country.
Alternatively, sovereign investment funds may be used to acquire strategic economic targets such as mineral assets. In the event that economies that are currently being constrained by the floating exchange rate system are released to prosper, they may find that the mineral resources necessary for the expansion of their industries are no longer available.
Last update: 29 March 2015