Argument

The Fire Next Time

Why another debt crisis would be a national security disaster.

The Congress finally found a way to enable the U.S. Treasury to service and repay America's financial obligations -- this time. But it's only a temporary fix; the United States will hit the so-called "debt ceiling" again in just a couple of months. If Washington can't figure out a way to stop lurching from one debt crisis to the next, the result won't be just a catastrophe for the U.S. economy. It will severely damage America's foreign policy and national security interests around the world, as well. American leadership will suffer as our nation's reputation as a reliable and predictable partner diminishes.

Since the founding of our republic, America's leaders have recognized the close links between ensuring the creditworthiness of the federal government and protecting the nation's security. Alexander Hamilton wrote repeatedly of the need for the nation to honor its Revolutionary War debt, so that if there were another war the country would once again be able to borrow to pay for it. After the Civil War, America's leaders placed great emphasis on servicing and repaying the Union's debt to keep faith with creditors and to ensure continued access to world financial markets; that was the reason for the clause in the 14th Amendment that read, "The validity of the public debt of the United States … shall not be questioned."

Keeping faith with America's creditors goes to the very heart of foreign perception of America's reliability -- financially, politically, and militarily. If the country fails to honor its debts, friends, allies, and competitors alike will see this as a reason to question not only America's financial and economic credibility and predictability but also its reliability on numerous foreign and national security policy matters in many parts of the world.

In such circumstances, a multitude of questions are likely to be asked: Is the United States a reliable partner in the Middle East, in East Asia, and in standing up for its interests or international agreements such as those on nuclear proliferation and the use of chemical weapons? Can the United States be counted on to keep its word to support friends and allies in critical parts of the world if they are threatened? Can countries that wish to challenge the United States do so with a greater sense of confidence that the types of confrontations that caused the United States to default -- or even come to the brink of default -- on its solemn financial obligations will lead to an impasse or tentativeness in meeting other obligations as well? Will an inability to put America's financial house in order and establish a long-term policy to place the nation's finances on a sound financial footing -- as opposed to lurching from crisis to crisis -- lead to resource constraints that will limit America's ability to conduct a sustainable and predictable foreign policy and maintain a reliable military posture around the world?

In short, a default will certainly risk catastrophic financial consequence. But it will go well beyond that. A default -- or even a series of crises that bring America to the brink of default -- will also raise serious questions about the predictability of America's foreign policy and reliability as a partner and ally, thereby undermining the country's national security with potentially major long-term consequences.

The very close, historical connection between America's financial policy and outlook -- especially its creditworthiness -- and its national security often receives little attention. Yet this close connection was well understood from the time of our Founding Fathers until quite recently.

During the American Revolution, large sums were borrowed by the Continental Congress from Americans and from foreigners, mainly the French and Dutch. Our first treasury secretary, Alexander Hamilton, wrote that this debt was the "Price of liberty. The faith of America has been repeatedly pledged for it, and with solemnities that give particular force to the obligation." Hamilton went on to write, "Loans in times of public danger, especially from foreign war, are found an indispensable resource, even to the wealthiest" of nations. To be able to secure loans when needed, however, Hamilton recognized that a nation had to be creditworthy -- which meant that it must have faithfully serviced and repaid earlier debt obligations. To emphasize the importance, President George Washington, Hamilton, and other Founding Fathers included a provision in the Constitution stipulating this -- Article 6. It reads: "All Debts contracted and Engagements entered into, before the Adoption of this Constitution, shall be as valid against the United States under this Constitution, as under the Confederation."

Following the Civil War, in which the federal government had also accumulated an enormous amount of debt, voices were heard arguing for repudiation of some of that debt -- or at least considerable delays in repayment. Many suggested that repayment be made not in gold, as originally contracted, but in depreciated greenbacks (recently created paper money). In 1866, the government's interest payments alone were twice the size of the entire budget in the year before the war, so these arguments had significant numbers of supporters.

To dispel all doubts about the government's intention to service and repay its (the Union's) debts, an extraordinary clause was incorporated into the 14th Amendment to the Constitution -- one much discussed of late. It read: "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned."

Another president who understood the linkage between good national credit and national security was Dwight D. Eisenhower. In a conversation with advisors early in his administration, Eisenhower underscored that "the relationship between military and economic strength is intimate and indivisible." His premise was that the maintenance of sound government finances was basic to a sound economy, which was in turn vital to national security. His concern was that overspending (especially on the military) combined with insufficient revenues could literally "bankrupt" the United States and dramatically weaken its ability to prevail in the Cold War.

While the political leaders at these historic moments lived in different times and circumstances, they all understood and emphasized the links between sound American finances, a strong foreign policy, and the national security of the United States.

Those who see default as an option -- or the threat of a default as a useful lever to extract concessions or produce policy changes they favor -- fail to recognize that it reverses nearly two and a half centuries of American history and undermines the creditworthiness of the country so painstakingly established over that period. And in so doing, it also does serious damage to America's reputation as a reliable financial leader and trustworthy foreign policy and national security partner. During periods when American debt was a much larger portion of GDP than it is today -- such as after major wars -- the country has rallied and political parties have come together to agree on the need to service that debt and, over time, to pay it back, and on policies to do so. Fortunately, such an agreement was just reached, but this kind of last-minute frenzy itself is harmful to foreign perceptions of the United States, and a series of them would be highly damaging.

As President Eisenhower noted, sound long-term national finances are critical to national security and a strong foreign policy. So simply agreeing on a series of temporary measures from time to time to get through a few weeks or months without a default merely prolongs the uncertainty, unless one of these periods is used to produce a long-term solution. If not, lurching from near crisis to near crisis is almost as bad as no solution at all.

With every one of these debt showdowns, we seem to get closer and closer to an actual default. So while a short-term deal is better than default, the continued prospect of this financial sword of Damocles hanging over America and the world -- and the possibility that in the future a deal to avert a default will not be reached, producing a major financial crisis -- conveys very disturbing and harmful messages to the rest of the world:

  • The United States is no longer reliable as the world's financial leader;
  • U.S. government bonds cannot be counted on to be the rock-solid security they have been for generations;
  • The American political system finds it difficult -- or in the worst case, is unable -- to produce a compromise on a matter of fundamental interest to the economic and financial well-being of the country;
  • A relatively small number of people in this country -- representing narrow interests -- can cause severe damage to America's national interest, severely damaging its economy as well as the broader global economy; and,
  • The American political system finds it difficult to agree, or, in the end, cannot agree, on what had been a fundamental principle of American economic and financial policy for so many generations. Then, how can it be expected to agree on other policies -- particularly economic and financial policies, but others as well -- basic to America's national interest in the future?

It would become impossible to avoid a growing belief abroad that U.S. unpredictability and unreliability in the financial sphere will have severe repercussions in other spheres as well. The country increasingly risks being seen as an unreliable and unpredictable partner in many areas of foreign policy and national security policy. Repeated acrimony and gridlock in Washington -- and last-minute near crises over such fundamental issues as maintaining the creditworthiness of the United States -- raise questions abroad about dysfunctions in America's market capitalist system and our democracy that weaken America's soft and hard power.

Competition in the world today is not just for markets. We are also competing for capital. And repeated threats not to honor, or even worse, an ultimate failure to honor, basic financial commitments to our own citizens and creditors around the world will have a chilling effect on the flows of capital into this country -- which in turn will diminish prospects for creating jobs here at home.

Of the nearly $10 trillion in outstanding U.S. government debt not held by agencies such as the Social Security system or the Federal Reserve, more than half is owned by foreigners: $1.2+ trillion by China, $1.1+ by Japan, and between $100 billion and $200 billion by countries such as Switzerland, Belgium, Britain, Luxembourg, and Ireland. All would suffer losses from a default as the value of central bank reserves and private savings deteriorated, too. But it is important to emphasize that this would come not just from the fall in the value of U.S. government debt, but, as mentioned, the sharp drop in various other categories of financial assets. The appetite for additional U.S. financial assets, accordingly, would chill substantially, making the rising deficit more difficult and expensive to finance.

Far from reducing the budget deficit, which those who support the default strategy seem to desire, a default and suspicion abroad about the reliability of U.S. government assets would likely raise interest rates, which, in turn, would increase the deficit. And higher interest payments would also crowd out financial resources for other government programs -- domestic and foreign alike.

Of course, as the above numbers indicate, it's not just Americans who would feel the consequences -- although Americans are likely to be most directly and severely affected. A default would cause U.S. government bonds and the trillions of dollars of other domestic- and foreign-issued bonds benchmarked to U.S. Treasury securities -- and indeed many other kinds of assets, as well -- to depreciate sharply in value. This means the citizens and central banks of many other countries will suffer, too. Harsh criticism of the United States on the streets and in parliaments around the world can be expected, depending on the duration and degree of the default and the ensuing pain. Relations with many countries would suffer as aggrieved citizens blamed their economic pain on the United States, making cooperation between their leaders and Washington more strained. Foreign leaders would be on the defensive when it came to cooperating with the United States on financial matters, even though cooperation would be imperative following a default, given the likelihood of extreme volatility in financial and currency markets around the world. That distrust would likely carry over to foreign policy and security matters, as well.

There would also be serious political debates in some countries about the wisdom of heavy reliance on the dollar as a reserve currency and on the wisdom of investing in American capital markets. Depending on how long the default lasted, the debate over such matters would be more or less serious. A quick reversal of a default would minimize the damage. But there certainly would be recriminations -- and damage to America's reputation for reliability in these and other areas would surely linger.

Beyond that, it is worth noting that the United States is engaged in a kind of systemic competition with other nations. Questions are frequently raised abroad as to which model best can deliver benefits to a country's citizens. When our system appears dysfunctional on such issues as the debt ceiling and closing down the government, it not only damages America's international reputation, but it also raises questions relating to whether political divisions will prevent the United States from addressing a wide range of other major policy issues for a sustained period of time.

The foreign policy consequences of internal divisions and lurching from near-crisis to near-crisis loom larger. Many countries rely heavily on the United States for leadership, for its sustained military presence in key parts of the world, and for resoluteness in defending not only its national interest but also international treaties and norms. Questions will be raised as to whether failure to resolve fundamental financial issues at home, and the unpredictability of fiscal events in Washington, will spill over into other areas.

For example, while the United States attaches growing importance to its ties with Asia and its sustained economic, political, and military presence there, internal impasses and divisions are bound to raise questions in that region over whether it will it have the resources or the political will over the long term to sustain a broad presence. There are many similar examples around the world -- especially in the Middle East -- where American reliability is critical to key friends and allies.

While it would be nice to be able to reassure countries that divisions and impasses on financial issues will have no impact on America's foreign policy or military role in the world, other countries might not see it the same way. Those who feel they cannot rely on the United States may conclude that they have to make deals with other countries to protect their interests. And challengers for influence in various parts of the world will likely feel emboldened if they perceive a divided America to be less capable financially or politically of rising to such challenges. Markets and observers throughout the world are relieved that a default will not occur this time, but they know that this is but a temporary deal. Lurching from impasse to impasse and crisis to crisis is hardly a way for the world's greatest power to conduct itself and certainly undermines confidence it its world leadership.

And there is always the risk that next time a miscalculation or a last-minute glitch could prevent a compromise. For whatever reason this occurs, failure to avert a default would produce a financial disaster for the United States and the world. While the myriad financial implications of a default are difficult to predict with precision, they are bound to be extremely serious and deeply harmful to American interests. The same can be said of the consequences for America's foreign and national security interests. All told, the negative impact on this country of repeatedly bringing the United States and the world to the brink of crisis will grow more and more serious. And the harm done by an actual default will be enormous and lasting. We may have avoided a catastrophe this time. The next time, we may not be so lucky.

So the next few months requires a major national effort to produce a consensus on fiscal policy -- and to take the threat of default off the table -- to avoid this risk recurring. This is needed to give the world and our own citizens confidence that this country is on a sustainable financial footing for the future. That will make America a more credible financial leader and considerably boost confidence in the predictability and sustainability of America's foreign and national security policy as well.

BRENDAN SMIALOWSKI/AFP/Getty Images

Argument

The End of OPEC

Forty years after the Arab oil embargo, new technologies are dramatically reshaping the geopolitics of the Middle East.

Forty years have passed since the Arab oil embargo went into effect on Oct. 16, 1973, triggering a period of incredible change and turmoil. After the United States provided support to Israel during the Yom Kippur War, a cartel of developing-world countries (via the Organization of the Petroleum Exporting Countries, or OPEC) banned the sale of their oil to Israel's allies and thereby set in motion geopolitical circumstances that eventually allowed them to wrest control over global oil production and pricing from the giant international oil companies -- ushering in an era of significantly higher oil prices. The event was hailed at the time as the first major victory of "Third World" powers to bring the West to its knees. Designed in part to bring Arab populations their due after decades of colonialism, the embargo opened the floodgates for an unprecedented transfer of wealth out of America and Europe to the Middle East. Overnight, the largest segment of the global economy, the oil market, became politicized as never before in history.

But four decades later, the shoe may finally be on the other foot. Now, on the 40th anniversary of the 1973 embargo, the United States has a historic opportunity to lead a counterrevolution against the energy world created by OPEC as innovation in the U.S. energy industry looks poised to end the decades-long, precarious "dependence on foreign oil." Washington should seize the opportunity and push to democratize energy globally, just as its Silicon Valley giants have democratized information.

In the run-up to 1973, two-thirds of global ownership of oil moved from the private sector of American and European companies to public-sector national oil companies. Rather than let the forces of supply and demand determine prices, post-1973, the lowest-cost oil producers, such as Saudi Arabia, Iraq, and Iran, artificially shut production and discouraged capital investment, creating a lasting wedge of rents or financial profitability that market conditions never warranted. (Today, oil prices in real terms are more than four times higher than in 1972.) A massive industrial restructuring occurred over the course of a half-decade, as state-owned enterprises, with limited project-management skills and bloated workforces, surpassed the oil majors like Chevron and Shell in both capitalization and size.

The 1970s witnessed a profound and unprecedented transfer of wealth to the Middle East that continues to have significant repercussions today -- from democracy movements to terrorism to civil wars. The region's leaders failed to set up long-term mechanisms to distribute the benefits of that wealth transfer broadly to their populations and to establish an equitable stake in governance of resource proceeds that would have brought a newfound stability to the region. Instead, they bought lavishly, gilding their palaces and buying fleets of luxury autos. For decades, they squandered the opportunity to use oil wealth to modernize their societies and train their populations for future global economic competition. The result -- unfolding not just in the Middle East but in other oil-producing countries as well -- is a crisis of governance that is itself triggering a round of oil-supply disruptions.

Massive petrodollar inflows brought with them a new political paradigm of "rentier" patronage, characterized by financial excesses, corruption, repression, and billions of dollars in accumulated weapons purchases. Populations of oil-producing states, for the most part, are little better off today than in 1973. Many of the countries have been war-ravaged or riven by sectarian hatreds. And, even with decades of relatively high oil prices and associated worker remittances, most countries of the Middle East still see modest GDP per capita, below $30,000 person on a purchasing-power-parity basis.

Deep income inequality means that much of the region's population is in fact still living in poverty, even in places like Saudi Arabia. So it should be no surprise that 40 years after the 1973 embargo, citizens of the region are rising up against those who squandered their futures. Tired of waiting for the day when rising oil revenues would somehow magically bring back the promise of prosperity, youth are taking to the streets; port and oil workers are mounting strikes; and jihadists are taking up arms to end the oil curse once and for all. Their frustrations do not unfold in a vacuum. High oil prices associated with all this unrest is propelling energy investment elsewhere to great success. Energy efficiency is also getting a boost, shrinking the long-term market for Middle East oil. The upshot will be that it will be harder and harder over time for Arab rulers to count on oil money to keep them in power. And that has a trickle-down effect to the populations they've been keeping quiescent with handouts for decades.

Ironically, just when political revolutions were gaining momentum across the Middle East, a different kind of revolution was emerging that looks likely to bring a new epoch of dislocation and distortion to prevailing oil and gas structures. This second energy revolution is also ameliorating the impact of the first.

Since January 2011, at the dawn of the rebellions against dictatorial governments in North Africa, the amount of oil "offline" or being blocked from production by either domestic turmoil (in Iraq, Nigeria, Sudan, Syria, Yemen) or international sanctions (in Iran) has generally been above 2 million barrels per day (m b/d), four times the average level of supply outages before the so-called Arab Spring. Then Libya erupted once again this past summer, taking another 1.2 m b/d, or more, offline. But the impact of these disruptions has been relatively mild, given that over the same period, production in North America, the heartland of the three revolutionary changes in unconventional hydrocarbon production (shale, deep water, and oil sands), has grown by more than 2.5 m b/d. And more is on the way.

Growth in renewable energy has also been significant in recent years in the United States and beyond, and rising fossil fuel costs and strong government intervention have created new market opportunities. World biofuels production has doubled to over 1.2 m b/d since 2006, but wind power has grown in oil-equivalent terms from 1 m b/d to 2 m b/d since 2008 (and is accelerating at about a 20 percent annualized clip). Solar power, meanwhile, grew from 20,000 b/d of oil-equivalent energy in 2008 to 400,000 b/d last year.

But the impact of all this change in the energy world will go far beyond just replacing continuing Arab Spring outages. Unconventional oil and gas and the clean-tech booms are spawning a host of new, smaller oil and gas exploration companies committed to innovation and willing to take on risk. They have no stake in the multibillion-dollar megaproject world of the international majors and national oil companies, and as such, they have fewer concerns about sustaining high profits from giant assets found decades ago. They are enabling the United States the opportunity to take a lead in changing the way energy is bought and sold -- not just in the United States, but globally.

Energy innovation is taking many forms in the United States, creating major export opportunities and giving Washington the tools it needs to ensure that the conditions of a 1973-style oil embargo will not repeat themselves. The oil embargo was so devastating because strong economic growth throughout the 1960s had taken up the margin of spare oil-productive capacity in the United States and across the world, leaving the Middle East's oil producers with undue monopoly power. Similar razor-thin extra productive capacity left markets highly vulnerable in 2006 and 2007, when OPEC made contraseasonal cuts in output to increase prices, instead of considering the risks to global economic growth. But as oil and gas production from U.S. and Canadian shale formations rises, the ability of oil producers like Russia to use an "energy weapon" to gain extra benefits from consuming countries is diminishing.

U.S.-led innovation in alternative fuels (including natural gas-vehicle fueling technology and electric vehicles), energy-efficiency technologies, battery storage, and smart-grid solutions, working together with and complementing the supply surge in unconventional oil and gas, should also change the face of demand, giving consumers around the world more freedom of choice. And as the United States becomes an energy exporter -- at competitive prices -- that should seal the deal. By providing ready alternatives to politicized energy supplies, the United States can use its influence to democratize global energy markets, much the way smartphone and social media technologies have ended the lock on information and communications by repressive governments and large multinational or state-run corporations.

Abundant U.S. natural gas is just the first step. Booming domestic natural gas supplies have already displaced and defanged Russia's and Iran's grip on natural gas buyers. By significantly reducing American domestic requirements for imported liquefied natural gas (LNG), rising U.S. shale gas production has had the knock-on effect of increasing alternative LNG supplies to Europe, breaking down fixed pricing from entrenched monopolies. But this is just the beginning: Over the coming decade, the United States looks likely to overtake Russia and rival Qatar as a leading supplier of natural gas to international markets.

The geopolitical role of U.S. natural gas surpluses in constraining Russia's ability to use its energy as a wedge between the United States and its European and Asian allies should strengthen over time, to the extent that Barack Obama's administration stays the course with approving the construction of LNG export terminals. American unconventional oil and gas plays from Texas to Pennsylvania are also generating new surpluses of natural gas liquids, which are increasingly exported as transportation fuel or petrochemical feedstock to Europe, Asia, and elsewhere -- reducing demand growth for oil from the Middle East. And U.S. crude oil exports might also be possible some day, strengthening America's lead in market-related pricing for kingpin crude oil, much the way rising North Sea production did in the 1980s.

As an increasing number of companies and investors flock to North America to develop prolific unconventional resources, Middle East heavyweights like Saudi Arabia, Kuwait, and Iran are losing their lock on remaining exploitable reserves, reducing their ability to band together and create artificial shortages. Already, Mexico and Argentina are reading the tea leaves and reversing protectionist resource nationalism policies, instead pushing through reforms to attract capital investment to their doorsteps.

Abundant U.S. natural gas is also spawning new American-designed engine and modular fueling station technologies to readily use natural gas as a fuel in trucks, trains, and ships, ending oil's monopoly in transport. Some 40 m b/d of the global 85 m b/d oil market is open for competition from natural gas -- in the form of compressed natural gas for cars and buses, and LNG for heavy-duty vehicles and marine transportation. We conservatively expect at least 2 m b/d of currently projected oil demand to cede to natural gas by 2020, further weakening perspectives on future global oil-demand growth and once again chipping away at Middle Eastern influence.

American innovation and exports of energy supply and technology will open global energy markets to competitive investments and consumer choice. But Washington needs to embrace this choice by resisting the call to continue to ban energy exports to protect vested business interests or for resource nationalistic reasons. Indeed, we need to reverse the mindset of the oil embargo years -- a mindset of supply shortages and husbanding of resources -- and move back to a more traditional promotion of free markets. The energy sector has done this in the trade of petroleum products, where the United States is simultaneously the world's largest importer and exporter. The United States is heading in this same direction for trade in natural gas, whether by pipeline to Mexico and eastern Canada or the export of LNG. And it should move in the same direction with crude oil exports as pressures mount from growing surpluses midcontinent and on the U.S. Gulf Coast.

The expanding wind and solar businesses in California and Texas are encouraging new complementary battery-storage options and smarter networks, laying the groundwork for greater consumer choice and control. The move to distributed energy, right now focused mainly on affluent customers who can afford private backup generation, may spread to broader applications. Some day soon, it will enable increased remote energy solutions for villages in sub-Saharan Africa or Southeast Asia. 

The U.S. government needs to support the reform of the electricity utilities to enable this transition, which will entail more-efficient technologies, locally produced and distributed generation, time-of-day pricing and peak-demand shaving. Such reforms are critical to the integration of renewable energy whose output varies widely over the course of a day. By leading the charge to these new energy technologies, the United States can fashion a global energy world more to its liking, where petropowers can no longer hold car owners hostage or turn off the heat and lights to millions of consumers to further geopolitical ends.

Just as it was difficult to predict the impact of Apple computers on future global social trends, it may now seem hard to depict the exact time and place that America's unconventional resources and smart-grid innovation will democratize energy markets. But Apple did reset the way we think about computing and changed the world. Similarly, the dislocations currently unfolding in the energy sector are pointing to markets taking back pride of place over government control and consumer choice winning over supplier monopolies. The pace of change may be slow in coming at first, but eventually it will be no less stunning than Oct. 16, 1973, a day that sent shock waves into the global economy, the ripples of which are still visible today.

MARK RALSTON/AFP/Getty Images