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Money for Nothing By: Matthew Continetti
The Weekly Standard | Wednesday, October 01, 2008

The World Is Curved:
Hidden Dangers to the Global Economy
by David M. Smick
Portfolio, 272 pp., $26.95

Feel free to disagree, but for my money the best anecdote in this entertaining and informative guide to the international economy comes near the end, when the author likens the United States of America to an obese Italian woman named Maria.

Let me explain. The author, David Smick, is a well-traveled, well-connected financial consultant who has journeyed to Rome, among other places. It was in the Eternal City in 1989, Smick writes, that he dined with "an important strategic Italian financial adviser"--or ISIFA for short--and "at least two dozen" other people, including the ISIFA's wife, Maria. Maria was a homely bambina. Smick tells us that she "was carrying at least an extra eighty or ninety pounds." Also--and this is important--she didn't speak English.

Late in the evening, after many glasses of wine, the ISIFA rose to deliver a toast. Maria, gazing upon her successful husband from the far end of the table, beamed with pride. What happened next was, well, horrible:

Our host, her husband, continued [in English]: 'And now we must toast Maria, the most beautiful flower in the desert.' Maria beamed more upon hearing her name, but the guest sitting next to me, an Italian investment banker, whispered, 'Oh boy, here it comes,' as if he had witnessed on other occasions what was about to take place. 'To Maria,' (she beamed some more), the host said again as everyone raised his glass, 'my wife, my rare gem. To Maria THE PIG!'

Smick was aghast. And yet the ISIFA kept calling Maria a pig, and Maria kept smiling, as she had absolutely no idea what her cruel husband was saying. Eventually, Smick continues, the "bizarre, perhaps even offensive," episode concluded. But he took from it a lesson. It was not that rich guys can be--and I mean this in the nicest possible way--insufferable little jerks; Smick probably knew that already. The lesson he drew was that "Maria is America--overloaded with debt, self-doubt, and self-absorption--and, more important, unable to communicate its message to the world." The United States, as they say, has "issues."

And what issues! America's twin budget and current account deficits (the government spends more than it takes in, and the value of the goods coming in to the country is more than the value of the goods going out); the rising price of oil; the weakening dollar; the mortgage and credit crises; rising protectionist sentiments--the list goes on. Smick has a knack for explaining these economic problems in everyday language. His is a friendly authorial presence. The book reads like a pleasant conversation at a cocktail party. The topic of the conversation--what's going on outside the party--is not so pleasant, however. Not pleasant at all. Actually, it's frightening.

The fundamental problem is simple. What we call globalization--free trade, international capital flows, relatively pro-market public policies worldwide--has led to unprecedented prosperity. But the engine of globalization is an international banking and financial system that is subject to frequent turbulence. Fortunes rise and fall overnight. Jobs appear and vanish with astonishing speed. The very hint that authorities lack confidence in the system can cause a panic. No one is entirely in control. And that means no one is entirely accountable.

"Today's world economy," Smick writes, "bears a striking resemblance to the integrated markets and overwhelming prosperity of the period from 1870 to 1914." Look how that turned out.

The World Is Curved is a discursive book, ranging from Tokyo to Martha's Vineyard, from European Central banker Jean-Claude Trichet to the decidedly non-European New York senator Charles Schumer. The attentive reader will quickly grasp two key themes. The first is that the so-called information economy is imbued with ignorance. A lack of transparency rules. "[I]n the new global economy," Smick writes, "this crazy ocean of global liquidity has not only increased the number of unknowns but also re-arranged their relationships and relative importance." What you don't know really can hurt you.

The "Great Credit Crisis of 2007-2008" is a case in point. When real estate prices tanked in 2006, the world's most prestigious investment banks became saddled with bad debt from the subprime mortgages which lenders had issued in the belief that anyone--anyone--could own a home, and that home values would never fall. (Oops!) During the boom years, pools of subprime mortgages had been "securitized" or auctioned off, contaminating the financial system. But the invisible right hand didn't know what the invisible left hand was doing. So the problem now is that the masters of the universe are stumped: Exactly how much bad debt is there? Where is it? What does it cost? Wall Street doesn't have a clue.

And it gets worse. If everyone is less knowledgeable than was previously thought, they are also less powerful. This is Smick's second theme. Treasury Secretary Henry Paulson has wielded considerable power during the crisis: arranging for the sale of one investment bank, allowing another to collapse, nationalizing a major insurer, taking over Fannie Mae and Freddie Mac, preparing a massive bailout plan that would give him ever more discretion than he already possesses.

Yet Smick warns us that even Paulson can only do so much:

The size of the financial markets, relative to the governments, has become so monstrously huge, there is no other means of maintaining stability than to establish a psychology of confidence. The governments themselves cannot by edict restore order. They can only project to the markets a sense that they know what they're doing.

That is what Paulson is trying to accomplish.

As the government's power recedes, new forces emerge. Global hedge funds, oil-producing nations, and sovereign wealth funds (pools of capital associated with and often controlled by foreign governments) wield considerable leverage over the international markets. These new actors do not necessarily have the interests of the American citizen in mind. Nor do the individuals empowered by the market or by governments who increasingly make decisions affecting the livelihoods of hundreds of millions of people.

Smick writes that the "industrialized world has surrendered control of its financial system to a tiny group of five thousand or so technical market specialists spread throughout investment banks, hedge funds, and other financial institutions." And when that tiny group of specialists truly messed things up, the future of the global economy was placed in the hands of two individuals--Paulson and Fed Chairman Ben Bernanke--whom no one had elected and whose decisions often were made outside any democratic mechanism. Nationalize AIG? Turn Fannie and Freddie into conservatorships? Congress passed no legislation on these matters. Paulson decided. And it was done.

David Smick is right to point out globalization's significant achievements, the value of entrepreneurial risk-taking, and the risk that "class-warfare" and protectionism pose to global prosperity. His timely book risks being overtaken by events, however. Events which suggest that our free-market system is not as free, and our democracy not as democratic, as we like to think.

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