Australian Financial Review

By Geoffrey Garrett

Barack Obama's second inaugural address last week made an impassioned left wing call to arms on social issues, consigned a decade of foreign intervention to the dustbin of history, and turned a blind eye on the still struggling economy.

But this is unlikely to be a good guide to Obama II, which seems likely to be characterised less by a social revolution at home than by economic and geopolitical recovery from the ravages of 9/11 and the global financial crisis. No more the global hegemon, the next four years are likely to show that the US is far from the enfeebled withering power predicted by many.

The US's fiscal problems are not nearly as dire as some pundits suggest, while the fundamentals of the American economy remain strong. This will give Obama the opportunity to focus on his highest strategic priority, trying to shape China's rise in ways that complement, not clash, with America's interests, while hoping that good diplomacy can manage down potential crises in the Middle East, and with Iran above all.

Inaugurations are feel-good events for a domestic audience. With no more elections left to fight, Republicans in disarray and broad public opinion on his side, Obama revealed his true social democratic colours by calling for major action on climate change, gay marriage, gun control and immigration.

Hell will freeze over before the Republicans support this agenda. But Obama's bigger problem on Capitol Hill is within his own party, where a slew of centrist Democrats facing tough re-election battles will want to run for cover from the President's agenda.

This means Obama's domestic activism will inevitably be more about executive orders than legislation. And as those the President announced earlier this month on gun control showed, there are real limits to executive power in America.

Climate change could be different because the Supreme Court supports the Environmental Protection Agency's power to mitigate carbon pollution. But anything such as a carbon tax would clearly require the congressional approval that Obama spectacularly failed to win in his first term.

Things look much better for Obama's economic agenda of pushing off spending cuts, increasing taxes on the richest Americans, and avoiding the European-style austerity embraced by the increasingly out of touch hard right of the Republican party. With the 2102 election vindicating this approach, it is no surprise that Obama won the fiscal cliff showdown. Now the President has won again on extending the debt ceiling. In all likelihood, he will win again in March with another deal to push back discretionary and military spending cuts.

The ticking time bomb in the US budget is mushrooming healthcare costs of the rapidly rising ranks of retirees. But America has more than a decade to come up with a solution. 

In the meantime, the US can borrow unlimited money at extremely low interest rates to service net public debt that remains very low by European standards. Stabilising debt levels and gradually bringing the budget back into balance can be achieved without massive fiscal rebalancing so long as US annual economic growth returns to its historical 3-3.5 per cent levels.

The chances of this happening look good. The US remains the world's innovation engine and its immigration magnet. American multinational corporations are cashed up. Spectacular growth of unconventional oil and gas has put the US squarely on the path to energy independence. Cheap energy coupled with cheap labour is bringing American manufacturing back.

With real economic recovery and fiscal stability in prospect, Obama II can be emboldened to take the lead again on the global stage, with China at the top of the strategic agenda.

Obama's China policy is already clear. He does not want to try either to contain China nor even to hedge against the potential that China's rise turns malign.

Rather, the Obama strategy is more proactive, to "shape" the international environment to induce China not to act in ways the US opposes and to act in ways the US supports. The US is implicitly saying to China, "you may have lots of trading partners, but we have lots of friends who agree with our world view".

This is why Obama has been so active in cultivating new friends such as Myanmar and Indonesia, strengthening old alliances such as that with Australia, participating in regional institutions, and articulating "rules of the road" that America's allies, friends and partners all follow.

China will remain on the outside looking in on the US-led Trans Pacific Partnership negotiations for free trade in the Asia Pacific unless and until it is willing to make big domestic reforms on market access, intellectual property and currency liberalisation.

China will also increasingly be the odd man out unless it accepts that its territorial disputes over contested islands in the East and South China Seas are a major concern for the whole region, a high priority for Obama and the US.

Obama's calculus is that all this US engagement in the Asia-Pacific will one day cause China to decide that following these rules of the road is in its interests too without the two countries ever coming close to blows.

The biggest threat to this long game with China may be the diversion of US attention away from Asia and back into the Middle East, with a US-Iran crisis the world's worst nightmare. 

Avoiding a crisis with Iran, shaping China's rise and ensuring American economic recovery are a long way from the "we, the people" social activism of Obama's reinauguration last week. But they are probably going to be the big themes of his second term in office.

This article was originally published in the Australian Financial Review