Capital in the Capitol

To alleviate the financial crisis, we need to rethink our financial and foreign-policy bureaucracy.

If anyone doubts the increasing importance of finance as a tool of foreign policy, one need look no further than Iceland, a NATO member, which this past week announced that it is in negotiations for a 4 billion euro bailout from Russia. Iceland's prime minister was blunt: "We have not received the kind of support that we were requesting from our friends, so in a situation like that one has to look for new friends."

While denied by the Icelandic government, there have been suggestions that one area of discussion is the possible use by Russia of a former-NATO military base on its soil. Others suggest that Iceland may be prone to more favorable consideration of future Russian claims to the resource-rich arctic. Regardless of how this turns out, the use of financial resources to achieve international goals is the latest example of a rising trend that we call the financialization of foreign policy. The United States government is woefully unprepared for this convergence.

Perhaps the current financial crisis could serve as a much needed wake-up call to Washington that it needs to better understand and integrate financial thinking into its overall policymaking apparatus. Current events have already jolted policymakers into acknowledging that the federal government can no longer operate business (or politics) as usual. Treasury's role as a $700 billion portfolio manager is only one aspect of what ought to be a wholesale rethink of our government's understanding of finance. At a minimum, there must be significantly greater cooperation between the Treasury and State Departments, and the national security apparatus. Foreign policy separate from financial policy is no longer an option.

An important lesson learned over the past several weeks is that U.S. strategic thinking about the foreign-policy considerations and consequences of finance and market issues has been inadequate. The current crisis presents an opportunity for the United States to reshape how our government responds to these new economic realities.

Upon taking office, the next president will confront a world far different from that of his predecessors. The new administration will face a more complex global landscape, where American financial pre-eminence is no longer taken for granted and where other nations use their own increased financial resources to further their national interests. The United States will certainly remain a major center of global finance, but has been weakened. The so-called "exorbitant privilege" of the United States to print the world's de facto reserve currency-and thus operate beyond the financial constraints that apply to other nations- may have become a bit less exorbitant.

Today, the United States is no longer capital rich. Rather, America is a significant international debtor with a sizeable portion of that debt held by central banks in China, Japan, Russia and the Gulf states. This wealth transfer from the United States to other nations is significant and appears likely to continue. The current banking crisis demonstrates that American financial institutions are becoming increasingly dependent on capital from foreign sources, such as central banks and sovereign wealth funds. One of the probable outcomes of the current crisis is the acceleration of the development of alternatives to American financial markets, capital and currency.

While the future course of how these issues will develop remains uncertain, the strategic considerations that they raise are likely to be permanent features of the global political, financial and national security landscape. Earlier this year, for the first time, the director of national intelligence's annual threat assessment included financial issues as one of the leading security threats facing this country. Director McConnell cited "concerns about the financial capabilities of Russia, China, and OPEC countries and the potential use of their market access to exert financial leverage to achieve political ends." That was well before the current financial upheaval.

Issues of this magnitude require more than operational tweaks-they compel a fundamental structural overhaul of the way our government integrates financial issues into its foreign-policy thinking.

The need to modify the organizational structure of the White House and executive branch to integrate financial policy considerations in the shaping of foreign policy has been undertaken at key turning points in the last half-century. In 1945, recognizing that the world had fundamentally changed after the Second World War, the Truman Administration retooled the federal government and created the National Security Council and other new structures to address the challenges of the Soviet Union, the spread of communism, decolonization and the new map of post-war Europe. This period saw the creation of the Bretton Woods system, the Marshall Plan and the establishment of the World Bank and International Monetary Fund.

Similarly, following the collapse of the Soviet Union and the onset of globalization, the Clinton Administration established the National Economic Council (NEC) as a counterpart to the National Security Council. The creation of the NEC was a positive step. But it has not proven able to confront the economic issues facing our country today.

The government must undertake a realistic appraisal of the global economy, noting the strengths and weaknesses of America's role in that economy and how other nations may seek to gain advantage through the financial tools increasingly at their disposal. In our relationships with international allies, competitors and potential adversaries, financial and economic components must be an integral part of our strategic and conceptual thinking.

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