World Can Count on Resilience of the U.S.

Newport Beach-based bond guru Bill Gross created a stir last week when he predicted the fizzling out of American economic “hegemony,” pointing to a dollar that’s falling and a military presence that’s rising.

“I’m not so sure that we are, or perhaps will be, the economic powerhouse we once were,” wrote Gross, the managing director of Pacific Investment Management. “Three years of stock market declines, a 20% devaluation of the dollar over 10 months and an inability to serve as the global economy’s locomotive ... suggests America’s ‘shining city on a hill’ may have lost some of its sheen of late.”

Certainly, Gross has a point. There is bound to be a price to pay as the U.S. increases its military budget -- to cover probable combat in Iraq, as well as antiterrorism efforts -- while offering tax cuts to spur a sluggish civilian economy. In the age-old conflict between “guns and butter,” the Bush White House wants both.

Still, Gross’s hand-wringing about “hegemonic decay” is terribly overstated. It ignores, after all, a fundamental lesson of history: The U.S. economy is remarkably resilient.

Indeed, what Gross is ignoring is that America has faced tough times before -- and has successfully worked through them, only to emerge stronger.

In the 1960s, President Johnson tried to fight the war in Vietnam without raising taxes, and that stretched the economy. The result was the runaway inflation of the 1970s and a crisis in the dollar that forced President Nixon to cut the greenback loose from the gold standard.

Still, the U.S. economy bounced back, enjoying strong growth through much of the 1980s.

In 1981, President Reagan increased the defense budget and cut taxes at the same time. The eventual result was swelling budget deficits, which raised interest rates and undermined the financial markets.

But once again, the problems were dealt with, and the nation moved on, spurred by great technological advances.

Given that track record, what lies ahead for America’s economic position in the world is clear -- and belies Gross’s notion that “U.S. domination of (and benefits from) free capital markets and free trade are nearing an end.”

It is certainly true, as Gross suggests, that a falling dollar -- it’s down 20% against the euro in the last few months -- has implications for the economy. It will, in fact, probably spur inflation a bit because imported goods and services will cost more for U.S. consumers. Living standards will dampen slightly.

But what Gross fails to mention is that the dollar tends to move in five-to-10-year cycles; a drop isn’t going to last forever.

In the meantime, the same factors that adversely affect consumers can provide a boost to U.S. industry. A lower value for the greenback, for instance, makes U.S. goods more competitive overseas. It also can help raise profits on any business U.S. companies do abroad.

Of course, the biggest issue facing the U.S. and the whole of the world right now is war. And there is no doubt that this would carry a cost -- both immediately and beyond.

It is becoming increasingly apparent that U.S. forces will be kept in the Middle East to maintain the peace well after Saddam Hussein is bounced from Baghdad. And that will mean “structurally higher federal deficits, which will put downward pressure on the dollar and upward pressure on interest rates,” notes economist Diane Swonk of Chicago-based Bank One Corp., recalling a similar pattern in the 1980s during the Cold War.

But there will be benefits from the U.S. leadership on Iraq as well. In the short term, assuming the war goes quickly and easily, long-stalled economic activity should begin to pick up among U.S. companies now beset by uncertainty.

“The bullish consequences could be comparable to what happened after the end of the Cold War,” says Edward Yardeni, chief investment strategist at Prudential Securities.

In the medium term, the rebuilding of Iraq will give a boost to a broad cross section of U.S. industry. “Iraq has suffered terrible decay. Water systems need repair, oil fields and equipment need renewal and repair,” says Mervyn Sambles, director of strategic marketing for Fluor Corp., an engineering firm based in Aliso Viejo.

And in the long term, a larger U.S. presence in the Middle East -- its 22 Arab countries contain 280 million people -- could be a tremendous boon to the fostering of democracy and the curbing of terrorist violence.

This is not the end of U.S. hegemony. If anything, this period recalls the 1950s, when the U.S. resolved to maintain a military presence around the globe and to help nations revive under its protection.

This commitment turned out not to be a drain on the U.S. so much as an investment that helped to create a better world -- a world that America came to profit from in the latter half of the 20th century.

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James Flanigan can be reached at jim.flanigan @latimes.com.