The British Empire as Window Into Today’s Global Economic Distortions

You have to think big on why Chinese investment in the US and UK as opposed to the other way around is so bizarre. Historically, it was the opposite. Take the Pax Brittanica for example. I read the book by John Darwin called the Empire Project – The Rise and Fall of the British World System 1830-1970. https://www.cambridge.org/core/books/empire-project/46746325454EED5E53FB34923460740F#fndtn-information. Unlike most books on the British Empire, this one concentrates on the economic world system and the commercial mechanics of how the British managed everything, in addition to the usual political history. Up until 1914, the British successfully and profitably managed a very complex system of imports and exports, worldwide industrial development, monetary and stock exchanges and a currency system based on the gold standard, banking, shipping, insurance and other financial services, and a worldwide portfolio of investments, all centered on and managed from that Imperial Cosmopolis – London. After the mid-nineteenth century, the British ceased to focus as much on their own industrial development, and began to invest in other countries, including, not just parts of the Empire, but also in North and South America, Asia, etc. The vast scale of British capital employed in foreign projects, most notably, railroad construction, enabled the British to reap enormous benefits in terms of annual interest and financial returns back to Britain, and which, in combination with other invisible earnings such as banking, insurance, shipping, etc., covered the trade deficit resulting from importing more goods and raw materials than the British exported. In fact, the British ran surpluses from the invisible earnings that continually enriched Britain. And nowhere else in the world could compare with the financial sophistication and industrial and other expertise offered by London and London firms, so that these foreign investments and British commercial enterprise worked synergistically together whereby one furthered the other. Moreover, all of these foreign investments controlled by British banks and businessmen enabled the British a disproportionate informal invisible control of other countries. For example, in Argentina, which no one would ever consider to be a part of the British Empire, the vast majority of all investment and virtually all foreign investment employed to develop the country’s infrastructure came from Britain and was managed by London firms from London. The Argentinean elites could not make a move without assistance and approval from London and were dependent upon business and financial expertise of Britons, but they benefitted financially as well, so they were aligned and did whatever they could to keep markets open to British capital and prevent revolution and nationalization or other political risks. In all these ways and more, Argentina, and indeed, much of the world, if not formally a part of the British Empire, was dependent upon and in many ways controlled by London, thus part of an informal British Empire.

This system worked well and London was able to essentially run the world and reap a lot of benefit, but it was very fragile politically and militarily. It depended on the relative stability of the world and the status quo. Once the World Wars occurred, Britain was forced to liquidate much of its foreign investment portfolio to pay for the wars and the munitions to fight them (a lot went to the USA from which the British bought weapons). This was a catastrophe for Britain and the world economy since the system that theretofore had worked relatively well could no longer function. Britain’s balance of payments was all out of whack as the invisible earnings from foreign investment income began to vanish as these investments had been liquidated. In turn, the Pound Sterling as the world reserve currency based on a gold standard, began to fail and lose its value. A world economic Depression eventually ensued as the USA refused to step into the vacuum of economic leadership that existed after Britain could no longer assume the role it did pre-1914. And after World War II, Britain was essentially bankrupt and could no longer even pretend to world power status. It had no power to prevent the break-up of its Empire, nor to its credit and unlike the French, did it even try. By the 1950s, Britain was essentially a vassal of the United States. The book was mesmerizing and it also demonstrates that it is critical to have an understanding of financial history and economics if you really want to understand History, how the world works and where we may be going.

And as far as China investing in the U.S. as opposed to vice versa, you really start to see why things have become so distorted. Historically, and in an efficient world economy, developed economies like Britain invest in developing economies which have need for the capital and expertise. Developed economies do not have a need for this investment since capital is abundant and sophistication, technology and expertise are readily available. It is distortions in capital flows that result from domestic policies in developing countries like China which financially represses its citizens and distorts its trade and capital account balances that force its artificial excess savings into developed economies, really to their detriment. If you want to read about this more, I highly recommend reading everything Michael Pettis has written. You can start with his blog here: https://carnegieendowment.org/chinafinancialmarkets/, but he has also written several brilliant books.

I think one point in this analysis is that you have to think big, from a 50,000 foot level, with examples from history in mind, to really get a good picture of what is going on and why things are so distorted. You can’t figure out how to fix something if you don’t even understand the problem.