The early years of the twenty-first century have been characterized by generally benign global macroeconomic conditions.footnote1 The equity bubble has continued to expand, and the us recession many expected in the wake of 9.11 has failed to materialize. Growth rates in much of the developing world are at record-breaking levels, above all in China, trends which have helped the us sustain ballooning current-account deficits. As a result, according to Kenneth Rogoff, chief economist at the imf from 2001–03, ‘the policy community has developed a smug belief that enhanced macroeconomic stability at the national level combined with continuing financial innovation at the international level have obviated any need to tinker with the [international financial] system’.footnote2

Yet the global economy and interstate system are displaying signs of fragility that could easily tip the world into economic depression and geopolitical conflict. No less than the always-cautious Bank for International Settlements, the club of rich-country central bankers, says in its Annual Report for 2007 that the world is ‘vulnerable to another 1930s slump’. There are several reasons to be seriously worried. Firstly, the extraordinarily high and rising levels of debt to equity in the world financial system hold the potential for a ‘great unwind’. The assets invested in hedge funds have more than tripled in the seven years since 2000, to around $1,500 billion. The ceo of a us hedge fund recently described the current situation as possibly ‘even more alarming’ than that which produced the crash of Long Term Capital Management in 1998: ‘the explosion of hedge fund investments in illiquid assets combined with leverage currently pose a greater risk to the global financial markets than we experienced at the time of the ltcm debacle.’footnote3 Second, this run-up of debt reflects the boom in global liquidity—propelled by the surge in commodity prices since 2003 to the highest levels in more than two decades, the ballooning of the us current-account deficit, and the incorporation of giant savings pools in China and India into world capital markets. The liquidity boom has increased financial instability by enabling many developing-country governments to postpone improvements in financial regulation, as well as helping rebel groups to finance militias once they control a commodity-exporting base.

Third, we must take into account the precarious state of the us economy. Internationally, the us has in recent years been losing its position of economic dominance in both trade and finance, especially to the eu and China—European financial markets now have a higher capitalization than their us counterparts for the first time in a century. Domestically, the us middle class is being squeezed by falling house prices, spiralling mortgage foreclosures, declining real wages in manufacturing and lower-skill service jobs, and historically very high levels of debt to disposable income. Economic growth has slowed to near 1 per cent, while the inequality of income between the top percentile of households and the bottom 90 per cent has reached its highest level since 1928. When the Great Depression struck, the us was in the ascendant. Being in relative decline today may make Washington more likely to react to these trends in an even more unilateralist, more defensive way than in the 1930s. The us has already begun to substitute bilateral and multilateral trade agreements, such as cafta, for commitment to the wto process—allowing it to circumvent the wto’s consensual procedures in order to establish agreements loaded with predatory provisions favourable to the us: open access for American agricultural exports, for instance, and stringent patent protection for us drugs.

Fourth, the relative decline of the us is part of a larger shift in the interstate system. In particular, the previously closed club of advanced capitalist states is under pressure to admit new challengers such as Russia, China and Brazil. In the past, the rise of such contenders has almost always been accompanied by interstate conflict; geopolitical tensions and rivalries are likely to rise this time too—though perhaps not on the scale of the twentieth century’s wars. In particular, neo-imperialism is again in the air—not only the us variety, but also the less noticed neo-imperial ambitions of Russia, based on its control over vast energy resources and raw materials and its consensual authoritarian rule. The tensions between these neo-imperialisms, especially over access to energy, have pushed the West to redouble its efforts to open markets in the rest of the world and reconfigure domestic political economies to facilitate the operations of Western, especially Anglo-American firms—with little more than lip service paid to the idea of compromise with the interests of developing countries.

The international financial system lacks the bodies that set rules and enforce compliance at the national level, such as a central bank, a financial regulator, a bankruptcy court, deposit insurance, and the like. Rather than try to create international counterparts, in the decade since the Asian Crisis the West has sought to build a comprehensive regime of global economic standards of best practice in areas such as data dissemination, bank supervision, corporate governance and financial accounting. The imf and other organizations have been undertaking systematic surveillance of national compliance with the standards. Governments and other bodies are expected to comply with the latter in order to obtain cheap and abundant finance, on the assumption that financial firms will reward compliance and punish non-compliance.