The mounting financial crisis isn't just going to hurt our pocketbooks, job prospects and retirement funds. This mess -- and how it gets worked out -- will also have a powerful impact on America's ability to exert leadership abroad.
Since the Cold War's end, the United States has been the strongest military power on the globe. But its stature also has rested on the fact that it is the world's economic powerhouse. The dollar's status as the world's reserve currency has given the United States special privileges. The Bush administration has been able to run huge budget deficits because China and oil-rich nations have been willing to hold dollars, even as the greenback slid in value.
America's global economic standing and the powerful position it guaranteed are now in real peril. The Bush administration's failure to confront the rot in the financial system, until now, may damage America's foreign influence even more than the Iraq war. Already, experts are debating whether the dollar can retain its exalted position.
"The dollar's status as a reserve currency ... has given the United States a privileged measure of economic stability relative to its rivals," according to journalist and author Sebastian Mallaby of the Council on Foreign Relations. "It has allowed the United States to project power abroad, too."
China and Arab Gulf states aren't likely to dump dollar reserves overnight -- that would cause them bigger losses than they are now suffering. The shift may come more slowly. But the financial crisis undercuts U.S. power abroad in ways that go beyond the threat to dollar supremacy.
The implosion of America's financial structure undercuts our image as the home of stable institutions and reliable markets. Instead of serving as an anchor for the global economy, Washington has become a source of financial turmoil that threatens the rest of the world.
"Obviously, this is a shock to America's global standing," said former U.S. Treasury official Brad Setser, who writes the blog "Follow the Money" for the Council on Foreign Relations. "It changed the perception that the United States had an advantage in financial engineering. It is a huge blow to U.S. credibility."
The anger and fear caused by America's crisis were evident at the opening last week of the U.N. General Assembly, where world leaders repeatedly referred to the market turmoil. Chalk up the anger to memories of U.S. lectures about the virtues of unregulated markets. In the Asian financial crunch of 1997-98, U.S. officials sternly opposed bailouts for ailing banks in countries such as Indonesia and South Korea; many of those banks failed with a painful impact on Asian middle classes. But U.S. officials have taken a totally different tack when their own banks were at risk.
Beyond anger, though, many foreign leaders fear that America's financial muck-up will affect their own economies by creating a global liquidity freeze. Even close U.S. allies have been criticizing the U.S. style of market management. German Chancellor Angela Merkel told journalists that she had urged the United States and Britain last year to exert more rigorous oversight of banks and financial activities and made specific suggestions about regulation.
"We did what we were supposed to do," she told one German paper, referring to financial regulations adopted by the European Union, but "when it came to it, the Americans said, 'That's not for us.' "
Growing skepticism about America's economic competence adds to widespread doubts abroad about U.S. competence on broader foreign-policy issues, doubts generated by the Iraq war and growing problems in Afghanistan. The next president will have to not only recoup credibility squandered by the Bush team but also convince the world that America has not lost its economic touch.
Ironically, the financial turmoil comes at a time when U.S. officials recognize that "soft power" is as essential to America's security strategy as "hard" military power.
America's economic "soft power" can be exerted in several ways. First, our free-market model of growth has long been a beacon for other nations. Second, we have been able to provide markets for goods from developing nations and financial aid to poor nations. Third, top U.S. defense, intelligence and military officials stress that reconstruction funds are as important as military action in stabilizing Afghanistan and Pakistan. The financial crisis threatens our ability to project soft economic power on all of these fronts.
The financial squeeze will tarnish an American model already being challenged by China and oil-rich nations. The Chinese are promoting their brand of authoritarian state with mixed state-private ownership of the economy; they are investing heavily in infrastructure in developing countries. The Chinese model is likely to have growing appeal.
Oil-rich nations such as Russia and the Arab Gulf states have state investment companies flush with oil money that are ready to invest globally at a time when capital flows in America are frozen.
Economic upheaval at home may also constrict our ability to deliver aid to poorer nations. U.N. Secretary-General Ban Ki-moon is worried that America will be less willing to contribute to global projects on relieving poverty and HIV-AIDS.
"The global financial crisis endangers all our work," he said at the General Assembly opening. "We need a new understanding on business ethics and governance, with more compassion and less uncritical faith in the 'magic' of markets."
The domestic economic mess also may make it harder for the next U.S. president to finance projects abroad where America has crucial security interests. Congress, for example, may be unwilling to endorse current bipartisan plans for billions in new economic aid to Pakistan to try to counter the appeal of jihadi terrorists in tribal areas.
President Bush's foreign-policy legacy -- already defined by errors in the Middle East -- will be further scarred by this debacle. Let's hope the situation doesn't get even worse.