In the Year 2009 . . .

I’m way overdue for this one, I know. But I’ll make it up to you! This year, the predictions will be fewer – but they will be much more significant. I won’t be predicting the outcome of the Oscars (it’ll look an awful lot like the Golden Globes: Slumdog, Slumdog, Rourke, Winslet . . .); or the New York mayoral election (Bloomberg); or the Israeli elections (Netanyahu, leading a government of national unity with Barak as Defense Minister and very possibly Livni as Foreign Minister); the direction of the markets (S&P 500: down; European stocks: down; U.S. government bonds: down; U.S. investment-grade corporate spreads: tighter; oil: up – yes, up; gold: way, way up); or big-ticket events in the corporate world (General Motors, Citigroup and AIG will all be bankrupt or broken up or both; a major U.S. technology company such as Microsoft or Google will buy The New York Times).

Instead, I predict:

1. The end of Europe’s drang nach osten. Since the fall of the Berlin Wall, Europe has refused to choose between two visions: the “ever-closer union” and “Europe from the Atlantic to the Urals.” The financial crisis has made this choice for them, and the “ever-closer union” has won. Apart from the central bank, European organs of governance are too weak to respond effectively to this crisis. The failure of a UBS or a Deutsche Bank is not an event any national government is equipped to handle. Therefore, European institutions will be strengthened at the expense of these national institutions. Moreover, the former vision of a federal Europe has always been more closely identified with Germany, while a Europe of states has been more closely identified with a French vision. And while France under Sarkozy continues to be the public face of Europe, Germany – the largest economy – is now the power to be reckoned with on the economic questions that will dominate Europe’s agenda. Germany is the leading advocate within Europe for a (relatively) tighter money policy as well as the leading advocate for greater political union. The measure of their success in both efforts will be the decision by at least one and probably several of the candidates for joining the Euro either delaying their adoption date or falling out of the ERM II or significantly devaluing their currencies versus the Euro. Hungary is obviously the most likely candidate for massive devaluation, and the Czech Republic the least-likely, but I’m predicting an overall change in trend where the door closes before all these countries get in, and suddenly the future of the region is in real question. It’s even conceivable countries currently in the Euro could drop out. This turmoil will, needless to say, be very bad for the Euro relative to the dollar over the course of the year.

2. The end of dollar domination of East Asia. Over the same period of time as the foregoing trend of European expansion eastward, we have seen a period of massive economic integration across the pacific. The character of this integration has been: individual Chinese have enormously high savings; the excess capital generated in China is invested in American government-issued (and GSE-issued) securities; this keeps American interest rates low, stimulating American demand for products, which are increasingly manufactured in China, which in turn stimulates employment growth in China sufficient to absorb the huge increases in the Chinese labor force due to migration from the countryside and the interior to the coastal cities. All of this is made possible by the Chinese currency peg to the US dollar, which requires ever-increasing Chinese investment in America to maintain. This investment, and hence the peg, are going to end. In the wake of the greatest financial crisis since the Great Depression, American domestic savings rates must rise, and consumption must fall. China will need to stimulate domestic demand to replace American demand. I do not think China will start encouraging its citizenry to save less and spend more; rather, it will recycle the people’s savings through massive increases in public works, as they have already begun to do. This will necessitate a reduction or even an end to the massive purchases of US Treasury securities that have been the Chinese government’s favored investment to date. The Chinese currency peg cannot survive such a massive shift in patterns of investment. Expect a significant move upward in the Chinese currency against the dollar, and possibly an outright float of the currency. In either case, expect much of the rest of the Greater Chinese Co-Prosperity Sphere to follow suit and for other currencies currently pegged to the US dollar to drop their pegs or shift to the Renminbi.

3. Obama’s first year will be a striking success on the domestic front and a nightmare on the foreign-policy front. Some version of national health insurance will pass, and will be more comprehensive than Obama’s campaign promises. A major stimulus package – larger than the original proposal – will pass, including massive aid to the states and a kitchen-sink collection of infrastructure projects. And rapidly dropping oil prices will make it economically feasible to pass some version of a carbon tax or “cap-and-trade” scheme. Basically, Obama will get whatever he wants. All of these initiatives will prove popular, even though they won’t stop the unemployment rate from rising inexorably higher. On the foreign front, by contrast, everything is going to go wrong. The Iraqi government and anti-government factions are going to begin to position themselves for a post-American period, leading to an increase of violence there; meanwhile, the shift of forces to Afghanistan will inevitably lead to more points of conflict in that war. Relations with China will worsen over the currency shift described above. Relations with Pakistan will deteriorate over the Afghan escalation and increased American covert strikes over the border. Mexico will experience a serious uptick in political violence as unemployment rises in that country from the combination of a slowing domestic economy and the return of millions of emigrants formerly employed in the U.S. construction industry. Turkey will experience a constitutional crisis as the Turkish military attempts to assert its waning authority against the ascendant civilian authorities. Pro-Russian groups in Ukraine will stage a provocative incident in a Russian-dominated region (such as the Crimea) raising fears of a Ukrainian civil war and Russian intervention. Israel’s current war will lead to chaos in Gaza and a third intifadeh in the West Bank. Obama’s attempt to engage in face-to-face negotiations with the dictator of North Korea will hit a snag when the CIA informs him that the Dear Leader discorporated some time in the past five years, and that the current ruler of North Korea is either Kim Yong-nam or an army clique behind the Dear Leader’s son, Kim Jong-chul. Embarrassment over the situation will almost lead to war on the Korean penninsula and plans will be drawn up for the withdrawal of American forces from Korea. Basically, Obama is going to face a perfect storm in 2009 on the foreign policy front, and there’s almost nothing he’s going to be able to do to navigate the minefield successfully. Fortunately, Pakistan and India will not exchange nuclear blows, but that’s about the only good news I have for 2009 on the foreign front.

Have a happy New Year, folks.