Wednesday, January 2, 2008

Not Constantinople

At least, not yet... In the FT, Niall Ferguson has "An Ottoman Warning for Indebted America" (and it has nothing to do with getting our feet off the furniture):
[We are] living through a global shift in the balance of power very similar to that which occurred in the 1870s. This is the story of how an over-extended empire sought to cope with an external debt crisis by selling off revenue streams to foreign investors. The empire that suffered these setbacks in the 1870s was the Ottoman empire. Today it is the US.

In the aftermath of the Crimean war, both the sultan in Constantinople and his Egyptian vassal, the khedive, had begun to accumulate huge domestic and foreign debts. Between 1855 and 1875, the Ottoman debt increased by a factor of 28. As a percentage of expenditure, interest payments and amortisation rose from 15 per cent in 1860 to 50 per cent in 1875. The Egyptian case was similar: between 1862 and 1876, the total public debt rose from E£3.3m to E£76m. The 1876 budget showed debt charges accounting for more than half of all expenditure.

The loans had been made for both military and economic reasons: to support the Ottoman military position during and after the Crimean war and to finance railway and canal construction, including the building of the Suez canal, which had opened in 1869. But a dangerously high proportion of the proceeds had been squandered on conspicuous consumption, symbolised by Sultan Abdul Mejid’s luxurious Dolmabahçe palace and the spectacular world premiere of Aïda at the Cairo Opera House in 1871. In the wake of the financial crisis that struck the European and American stock markets in 1873, a Middle Eastern debt crisis was inevit­able. In October 1875 the Ottoman government declared bankruptcy.

The crisis had two distinct financial consequences: the sale of the khedive’s shares in the Suez canal to the British government (for £4m, famously ad­vanced to Disraeli by the Rothschilds) and the hypothecation of certain Ottoman tax revenues for debt service under the auspices of an international Administration of the Ottoman Public Debt, on which European bondholders were represented. The critical point is that the debt crisis necessitated the sale or transfer of Middle Eastern revenue streams to Eur­opeans.

He sees a parallel to the growing accumulation of US assets by foreigners - particularly Asian and Middle Eastern sovereign wealth funds - including the recent sales of stakes in Bear Stearns, Citigroup, Merrill Lynch and Morgan Stanley.

[W]e need to recognise that these “capital injections” represent a transfer of the revenues from the US financial services industry into the hands of foreign governments. This is happening at a time when the gap between eastern and western incomes is narrowing at an unprecedented pace.

In other words, as in the 1870s the balance of financial power is shifting. Then, the move was from the ancient oriental empires (not only the Ottoman but also the Persian and Chinese) to western Europe. Today the shift is from the US – and other western financial centres – to the autocracies of the Middle East and east Asia.

The parallel is an interesting one, but somewhat strained. The US is the largest economy in the world, and near the top in terms of per capita output. The Ottoman empire occupied a very different relative position - according to Angus Maddison's estimates (in 1990 $), Turkey's per capita GDP in 1870 was $825 (and Egypt's $649), far below that of European countries like Germany ($1839) and Britain ($3190), as well as the US ($2445). Furthermore, the US debt situation has a long way to go before it becomes as severe as the Ottoman case. In terms of government debt, according to the CBO, of total federal outlays of $2655 billion in 2006, less than 10% ($227 bn) was spent on interest payments (the publicly-held debt is $4829 bn, and according to the BEA, $2215 bn of Treasuries are held by foreigners, so slightly less than half of the interest is going overseas). More broadly, according to the BEA, at the end of 2006, foreigners owned $16.2 trillion worth of US assets, and Americans owned $13.7 tr of foreign assets, making the US net position -$2.5 tr. Relative to GDP $13.2 tr, that is equivalent to a household with an income of $60,000 having a debt of $11,400.

Ferguson is no doubt correct that the "balance of financial power" is indeed shifting. Partly this reflects natural forces of economic growth (convergence), and partly it is due to US borrowing. A decline in the relative economic position of the US is to be expected as more of the world is catching up - China and India are growing faster, and contributing a larger share of world output - exactly as Solow's growth model tells us they should. Potentially more worrying is that, because our domestic saving is less than investment, the rest of the world is indeed accumulating financial claims on us. This may, in part, reflect some degree of profligacy and bad policy. Though Ferguson's Ottoman analogy is a bit of a stretch, perhaps we shouldn't be putting our feet up...

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