- - Wednesday, December 17, 2014

ANALYSIS/OPINION

Two economic milestones occurred in 2014 that will have seismic impacts on the balance of global military and political power as well as impacting the global economy. First, China displaced the United States as the world’s largest economy. Second, the U.S. became the world’s largest producer of oil and gas.

Based on the International Monetary Fund’s analysis, China now has the largest economy based on purchasing power parity. China’s annual economic output in 2014 is expected to be $17.6 trillion, compared to America’s $17.4 trillion. The U.S. had the largest economy in the world from the late 19th century through 2013. It is no surprise that China has now overtaken the U.S. China’s economy has grown significantly faster than ours for the past 30 years, and it will continue to do so in the foreseeable future.

Based on historical precedent, this shift will have major implications for global economic, military and political influence. Within a generation of the U.S. overtaking Great Britain as the largest economic power, the world’s dominant trading currency shifted from the pound sterling to the U.S. dollar. Over time, the dollar became the world’s reserve currency, reducing America’s effective borrowing costs and giving it a comparative advantage in world trade and financial markets. It is only a matter of time before the yuan renminbi, China’s currency, competes with the dollar as a world reserve currency.

With its unrivaled naval power, Great Britain was the world’s policeman and guarantor of the “Pax Britannica” prior to World War I. It was able to support the world’s preeminent navy because it was the richest country in the world. As its economic power waned, so did its military power. Its military dominance was gradually overtaken in the middle of the 20th century by the military power of the U.S., by then the dominant economic power. 

China’s military has been weak over the past few centuries. Its principal source of military might was unlimited manpower. With its increasing wealth, this manpower is being supplemented with expensive, sophisticated weapons systems. Over the past couple of years, the world has seen China flex its military muscle in the South China Sea. At the same time, the world watches the U.S. withdraw from Iraq and Afghanistan with its tail between its legs. It also observes Russia, Syria and Iran crossing America’s “red lines” with impunity.

In terms of political influence, China is clearly on the rise. It is a major trading partner and investor in both the developed world and the third world. For example, China’s bilateral trade with Africa in 2013 was $210 billion, compared to U.S. trade of $85 billion. Trade leads to political influence.

World leaders now pay homage to Beijing when they make their travel plans. When President Obama traveled to Beijing in November to meet with President Xi Jinping, he was publicly lectured by his host at a joint news conference concluding their talks. The Chinese leader, reported the New York Times, “warned foreign governments not to meddle in the pro-democracy movement in Hong Kong and foreign journalists to obey the law in China.”

Meanwhile, the United States in 2014 regained its title as the world’s largest producer of oil and gas, which it had lost in the 1970s. It produced more oil and gas than OPEC leader Saudi Arabia and resource-rich Russia. America’s increased production was a result of improved extraction technology known as fracking. As a result of increased supply, the price of oil and gas dropped precipitously in 2014. The price of Texas intermediate crude oil fell from $107 per barrel in June to $66 in December. (This was not supposed to happen, according to the Malthusians who postulated that the world’s hydrocarbon resources are fixed and on the verge of exhaustion.)

From an economic perspective, the drop in oil prices put billions of dollars into the pockets of American consumers. The increased American production reduced oil imports from 60 percent of domestic needs in 2005 to 22 percent in 2015. The additional consumer purchasing power and the reduction of oil imports provided free-market stimulus to the American economy in 2014, contributing to its fastest growth since 2005. GDP grew at 4.6 percent in the 2nd quarter and 3.9 percent in the 3rd quarter. More jobs were created in 2014 than in any year since the onset of recession in 2007, and the unemployment rate dropped to 5.8 percent. The benefits from the price reduction and reduced imports came at the expense of foreign oil producers, most of whom will take an economic hit as a result of reduced oil revenues.

In addition to stimulating the U.S. economy, the falling price of oil has major implications for relative global political and military power — generally favorable to America and unfavorable to its rivals. A 25 percent drop in the price of oil will strain Russia’s economy and lead to a collapse of the ruble. This will significantly constrain its government budget, which is 45 percent financed by oil, and the financing of its military operations in the Ukraine and Eastern Europe. ISIS in Syria and Iraq, which finances most of its budget through oil, will similarly be squeezed economically and militarily by the oil price drop. In the Western Hemisphere, Venezuela will find its socialist, oil-based economy devastated by the oil price drop. 

The decline in cost of hydrocarbon energy will also have a negative impact on the development of alternative energy technology. Unless it is subsidized, relatively high-cost alternative energy will be less attractive to consumers and investors. Market forces will channel consumer spending and investment away from solar, wind, etc. 

Seismic economic events have an impact beyond the allocation of goods and services. They affect relative wealth and poverty, which in turn affects relative global political and military power.

Logan D. Delany, Jr. serves as president of Delany Capital Management Corp.

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