Reflections on Inflections: Part II

In Part I of this report, we discussed the issues surrounding predicting inflection points, which are defined as reversals of long-term trends. In this week’s issue, we will examine two long-term trends that we believe are approaching inflection points and offer guideposts that we think will signal further progress toward inflection. For regular readers, these two trends should sound familiar as they are topics of frequent discussion. Some often consider them the same issue, while, in reality, they are separate but affect each other. By discussing them separately, this confusion should be laid to rest. As is our normal practice, we will offer market ramifications. Since an inflection of these two points is significant, this section will be larger than usual.

Inflection Point #1: The End of U.S. Hegemony

The world has seen the rise and decline of a parade of superpowers. Since the Age of Discovery, when Europeans came across the Western Hemisphere, we have seen Portugal, Spain, the Netherlands, France and Britain precede the U.S. in this role. On average, each hegemon has ruled for around a century. The U.S. took this role officially in 1945, although it was the de facto hegemon after WWI. So, given the normal lifetime of a hegemon, the U.S. is probably about due to leave the role.

The hegemon provides two primary global public goods, world security and the reserve currency. In return for providing these goods, the hegemon gets to enjoy a relatively stable world and the benefits of being the center of global trade. Throughout history, hegemons have tended to hold tightly to the role even as costs escalated; they usually lose the role because it is wrested from them by the incoming superpower. There is no recent history suggesting a superpower willingly abandons the role. However, it appears the U.S. may be doing exactly that.

A primary reason for abandonment is that, unlike the European nations, the U.S. didn’t really want the role. The U.S. economy was far larger than the British economy by the turn of the last century but was more than willing to “punch below its weight” and let the British rule the world.

After WWII, U.S. policymakers realized that the likelihood of a third world war was elevated if they refrained from fulfilling the hegemonic role. However, these same policymakers had to sell a skeptical American public on the wisdom of accepting this role. To build acceptance for this grave responsibility the Truman administration developed the policy of communist containment. Essentially, the American people were told that communism was a dangerous concept and had to be stopped, and they generally accepted that idea.

However, unspoken in this pitch was that the U.S. was also freezing three conflict zones. The first zone was in Europe. The European continent was unable to peacefully deal with the formation and rise of Germany. The country was in the center of Europe on the Great Northern European Plain. Because of this geography, Germany was destined to be a major economic power as it faced few internal obstacles to transportation. However, that same geography made it vulnerable to invasion because it had no natural land barriers. Thus, Germany became a massive and paranoid industrial power. The inability to manage the German Problem led to two world wars. To solve this persistent difficulty, the U.S. effectively disarmed Germany, allowing it to focus solely on economic recovery and development. The rest of Europe, protected by NATO, also disarmed, knowing they no longer had to fear Germany.