What happens when a hegemon falls?

The “Kindleberger Spiral”, a graph of world trade between 1929 and 1933, looks like water circling a drain, or a small animal curling up into a ball. It was produced by Charles Kindleberger, an economic historian, in “The World in Depression”, a book published in 1973, and has recently enjoyed a new lease of life as a demonstration of the self-harm that protectionism inflicts. From month to month, Kindleberger charted how the global economy turned in on itself throughout the late-1920s and 1930s, spiralling towards disaster. Another idea from his work—the “Kindleberger gap”, referring to a leadership void—is also proving helpful.

Kindleberger had a front-row seat for the Depression. As a graduate student completing his thesis in the 1930s, he worked at the US Treasury for Harry Dexter White, chief architect of the post-first-world-war system of fixed exchange rates. Graduation led to a job at New York Federal Reserve. After the second world war, during which he worked at the Office of Strategic Services, a precursor to the CIA, he moved to the State Department, where he helped shape the Marshall Plan, America’s programme for the reconstruction of Europe. In time he found his way to academia—he had probably had enough excitement, his biographer speculates—becoming one of the first members of the economics department at the Massachusetts Institute of Technology.

At MIT, Kindleberger was something of a pre-war figure in a post-war world. He was not a mathematical-model builder in the mould of Paul Samuelson and Robert Solow, two supremely talented colleagues. Instead, he followed a methodology he called historical economics, not economic history. “It is better, I believe, to err on the side of an artistic feel for the relationships and the data,” he wrote. Despite this, in 2009, it was his work to which Larry Summers turned as he co-ordinated America’s response to the financial crisis while director of the National Economic Council.

“The World in Depression” answers fundamental questions: “How and where the Depression originated, why it spread so widely and why it went so deep and lasted so long.” The book starts with the venomous diplomacy of first-world-war debts and reparations, travels through the stockmarket crash of 1929, the turn to protectionism, subsequent bank failures and the seemingly never-ending economic slump, until it concludes with German rearmament—stopping short of the second world war.

Kindleberger’s conclusion is that the Depression was such a disaster because the global economy lacked a leading nation to stabilise it. “Britain could not and America would not,” he wrote. Britain, which under the gold standard was the dominant economic as well as military power, was exhausted by the first world war. America was isolationist, protectionist and overrun by hard-money thinking, which insisted on balanced budgets and a gold peg. France was too small to stabilise the world but big enough to destabilise it, he wrote, as when the country attached conditions to bail-outs or dug in its heels over German reparations. The Kindleberger gap refers to this void of economic leadership.

Stability, Kindleberger argued, is a global public good that must be provided. It is not a naturally occurring equilibrium. The leading economy—a “hegemon”, as later thinkers would term it—can capture some of the benefits of this stability for itself, and push the system in a direction favourable to its interests. However, it needs to take on the burden of providing, among other things, an open market for goods, countercyclical finance and the role of lender of last resort. President Donald Trump now appears to reject this thinking altogether. He demands that allies pay for military protection and views a trade deficit as straightforward evidence of being ripped off. Members of his administration have mooted charging countries for the privilege of lending to the American government. All told, he simply does not see the gains that emerge from global stability as being worth their cost.

Hélène Rey of the London Business School identifies a “New Kindleberger Gap”. This time a “self-destructing hegemon” is, she says, uninterested in providing global public goods, while an ascendent one (Ms Rey refers to the European Union, but China is another candidate) lacks the ability. The Fed’s swap lines lie at the heart of her concerns. These offer central banks in allied countries, including the European Central Bank, the Bank of England and the Bank of Japan, access to dollars in exchange for their own currency. They should help forestall any crisis that bids up the price of dollar borrowing, but are just the sort of burden-sharing to which Mr Trump normally objects. In an attempt to bolster their position, sophisticated policymakers are talking in Trumpian terms. “The reason we do it is it’s really good for US consumers,” Jerome Powell, chairman of the Fed, has said.

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What are the contingency options? Despite Mr Powell’s assurance that America will continue to offer swap lines, Ms Rey suggests that European central banks should encourage commercial lenders to reduce exposure to dollar assets, build up precautionary dollar reserves and play a part in turning the euro into an international currency. Robert McCauley of Boston University advocates the creation of a “dollar coalition of the willing”, pointing out that the central banks which would normally receive swap lines from America already have $1.9trn-worth of dollar-reserve assets, which they could agree to pool in advance of a crisis. That amount is far more than they borrowed from the Fed during either the global financial crisis of 2007-09 or the early stages of the covid-19 pandemic. In the short term, such actions may help cement the role of the dollar, as central banks build up reserves. In the longer term, however, it may mean that American monetary hegemony becomes a subject fit only for historical economics. ■

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This article appeared in the Finance & economics section of the print edition under the headline “Caught in a spiral”

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