A “new normal” for the world economy
After the storm
The new economic landscape will be grim unless policymakers act to foster growth
IN THE political dictionary he first published in 1968, William Safire, who died on September 27th, devoted an entry to the word “normalcy”. The term was made popular by Warren Harding, campaigning for America’s presidency in the wake of the first world war. It was inescapable after the terrorist attacks of September 11th 2001. Normalcy is what people call normality when they no longer take it for granted. No surprise, then, that the word reappeared in the communiqué released by the leaders of the G20 group of big economies after their Pittsburgh summit on September 24th-25th. After the wrenching economic crisis of the past year, people crave stability and predictability—in short, normalcy. But how far off is it? And what will a “normal” world economy look like after the biggest financial bust since the Depression?
The new normal
Glance at share prices or short-term growth forecasts and you might feel comforted. Output has stopped shrinking in all the world’s big economies. In its latest forecasts the IMF reckons global GDP will expand by 3.1% next year, 1.2 percentage points faster than it forecast in April. Global stockmarkets have rallied by 64% since their trough. Corporate finance, once frozen, is thawing fast (see article). Bearish analysts are once again having to justify their pessimism (see article).
Yet closer inspection suggests caution. Despite a welcome return to growth, the world economy is far from returning to “normal” activity. Unemployment is still rising and much manufacturing capacity remains idle. Many of the sources of today’s growth are temporary and precarious. The rebuilding of inventories will not boost firms’ output for long. Across the globe spending is being driven by government largesse, not animal spirits. Massive fiscal and monetary stimulus is cushioning the damage to households’ and banks’ balance-sheets, but the underlying problems remain. In America and other former bubble economies, household debts are worryingly high, and banks need to bolster their capital. That suggests consumer spending will be lower and the cost of capital higher than before the crunch. The world economy may see a few quarters of respectable growth, but it will not bounce back to where it would have been had the crisis never happened.
That realisation alone should temper some of the optimism buoying financial markets. But the prospect of a “new normal” (a phrase popularised by Mohamed El-Erian, the boss of Pimco, a fund manager) still spans at least two distinct possibilities. One is that the world economy returns roughly to its pre-crisis rate of growth, without regaining the ground lost. That, the IMF points out, is what happens after most financial crises. The second, more depressing possibility is that growth stays at a permanently lower rate, with investment, employment and productivity growth all feebler than before.
The difference between these outcomes is huge, as our special report on the world economy points out. Persistent damage to economies’ growth potential would result in a darker future of sluggish income gains and diminished expectations. That, above all, is what policymakers must avoid. To do so, they must pull off several tricky manoeuvres: shoring up demand now without wrecking the public finances; containing unemployment without inhibiting the shift of workers from old industries to new ones; and, more than anything else, fostering innovation and trade, the ultimate engines of growth.
Shoring up demand is the most urgent task. It is no secret that global spending must be rebalanced: indebted American consumers must cut back, while thrifty countries should spend more and save less. In China this means a stronger currency, bigger social safety-nets and an overhaul of subsidies to increase the share of national income going to workers. Germany and Japan need structural reforms to boost spending, especially in services. What has long been lacking is the political will—and here the G20 seemed to make progress. The Pittsburgh communiqué promised to subject members’ economic policies to “peer review”. These reviews may prove toothless, but the commitment to them is a step forward.
Private spending in surplus economies will not soar overnight. The world economy will rely more on governments for longer than anyone would like. Premature fiscal repairs could jeopardise the recovery, as America learned in 1937 and Japan rediscovered 60 years later. Governments must eventually fix their balance-sheets, but only when the private sector is strong enough—and it must be done in a way that boosts economies’ growth potential. The bulk of the adjustment should come from spending cuts. Where revenues must rise, taxes on consumption or carbon are better than those on wages or profits.
Out with the old
Governments must also combat joblessness without ossifying their labour markets. High unemployment can do lasting damage, as people lose their skills or their ties to the world of work. This danger justifies efforts to slow lay-offs or encourage hiring. But not all such remedies are equal. Some of the most popular of today’s schemes—such as paying employers to cut hours rather than jobs, as in Germany—try to preserve the labour force in aspic. Economies must be free to reinvent themselves and allow thriving industries to replace ailing ones.
The path of productivity growth will determine the nature of the new normal more than anything else. In the rich world, innovation sets the pace. Elsewhere, trade is often more important. Both are now under threat. Cash-strapped companies are skimping on research and development. Emerging economies are having to rethink their reliance on exports for growth. Both rich and poor governments will be tempted to intervene. They should avoid cosseting specific industries with subsidies or protection. Allowing market signals to work will do more to boost productivity than cack-handed industrial policy.
Add all this up and the difficulties are formidable. “A sense of normalcy should not lead to complacency,” the G20 communiqué says, with both rhyme and reason. The storm has passed. But policymakers have a lot to do—and a lot of mistakes to avoid—if they are to make the best of the recovery.
European family firms in the recession
Dynasty and durability
Family-run firms are supposed to be safe havens in times of crisis, but many of Europe’s biggest have come unstuck
WHEN Germany invaded Denmark in 1940, A.P. Moller, founder of A.P. Moller-Maersk, a shipping company (above on the left, with his family), refused to co-operate with the Nazis. He sent his son (second left), then 26, to run the business from America instead. These days the younger Mr Moller, now 96, is helping the firm through the recession. Because of overcapacity in container-shipping, the firm is on course for its first full-year loss. Mr Moller is no longer involved in the business day to day, but he keeps an eye on cash flow and gives advice to the chief executive, who is not a family member. Events today, in Mr Moller’s view, are moving even faster than they did in the 1930s.
Having a century or more of experience is supposedly a big advantage for family firms in difficult times. Many big European family businesses, after all, have survived two world wars and successive waves of nationalisation. As a result they tend to be wary of debt and seldom panic. According to a global index compiled by Credit Suisse, a bank, family firms have outperformed the MSCI World Index by 4.8% since its launch in January 2007. Some people even argue that family firms, with their lower leverage, long-term approach and loyalty to employees could point the way toward a more stable kind of capitalism. “Family businesses value honest, careful work and keeping close to the customer,” argues Fernando Casado of the Family Enterprise Institute in Barcelona, “not easy money and speculation.”
Family-owned or closely held firms dominate Germany in particular. Of the 1,000 biggest German companies, only 170 are listed. Albrecht von der Hagen, the director of Die Familienunternehmer, a lobby group for family businesses, says members’ first priority is to ensure the survival of the family firm and that this trumps any desire to expand or increase profits. One example is B. Braun Melsungen, a family-owned medical company with 38,000 employees and nearly €4 billion ($5.9 billion) in sales last year. Equity makes up almost 40% of its balance-sheet and although it made €185m in profit last year, it paid out less than a tenth of that to its shareholders. Little wonder that even in the downturn, banks have been knocking on its door.
But several of Germany’s biggest family firms have not proved so conservative of late. Adolf Merckle, the founder of a drugs, cement and engineering conglomerate, committed suicide on January 5th after burdening his empire with heavy debts and misguided financial gambles that ultimately cost his family control. Madeleine Schickedanz, a big shareholder in Arcandor, a department-store and mail-order group which went bankrupt in June, is now living on €600 a month, after entrusting the firm to managers who restructured endlessly yet failed to modernise its drab department stores.
Schaeffler, a family-owned firm that makes bearings, was almost felled by the loans it took on to take over Continental, a car-parts company three times its size. In late August it completed a €12 billion restructuring that may just allow the family to retain control. Porsche, a carmaker controlled by the Piëch and Porsche families, also had to be bailed out after a bid to buy Volkswagen backfired. And Sal Oppenheim, a bank that has been in family hands for over 200 years, may now sell itself after a number of loans went sour.
This run of failures points to some big problems with family capitalism. The first is that one of its main strengths, the alignment of ownership and management, can become a weakness when control passes to the next generation. “Sometimes they are arrogant, sometimes they are naive, sometimes they are really very good, but they are never the original entrepreneur,” says Volker Beissenhirtz of Schultze & Braun, a German law firm.
Family-owned firms also seem to lose caution as they get bigger. In the case of small family concerns, a “house bank” often wields significant influence through its power to extend or deny credit. Such bankers understand their clients’ businesses and steer them away from excessive debt. But when family-owned firms become too big to rely on a single bank, resorting to syndicated loans and the like, their many bankers tend to monitor them less closely, says Jörg Rocholl of the European School of Management and Technology in Berlin.
Elsewhere in Europe, the crisis may prompt some welcome changes to family capitalism. Italian families have long been criticised for constructing complex chains of ownership which allow them to exercise control over large groups with minimal outlay. But banks are becoming far less willing to finance these “Chinese boxes”, because the controlling firms are usually financially weak and can collapse in hard times. “Chinese boxes are more prevalent when there is plenty of cheap money from banks,” says Emma Marcegaglia, president of Confindustria, Italy’s leading business group. “Now banks may say, ‘If you want money, let’s simplify the structures.’”
One way in which family-firms have differentiated themselves during the crisis is by refusing to slash their workforces. In Portugal, says Peter Villax, president of the Portuguese Family Business Association, large family firms have eschewed lay-offs. They have been inspired by Alexandre Soares dos Santos, chairman of Jerónimo Martins, a food-distribution firm, who declared in February that his company would sack workers only as a last resort after cutting salaries, bonuses, investment and dividends. Marcegaglia Group, a family-owned steel company, has been the only one in the industry in Italy not to fire a large portion of its staff, says Ms Marcegaglia. “We have lost fewer jobs in Italy compared to other European countries because of family firms,” she says.
Although several family firms have had a terrible crisis, in one industry they have shone. Consumers have sought out discount shops, which are largely in family hands in Europe. Aldi and Lidl, two German discount chains which have won customers across Europe, are family businesses, as are Colruyt, a Belgian one, and Netto, a pan-European one which is owned by A.P. Moller-Maersk. In clothing, too, families own value fashion brands Zara, Hennes & Mauritz and Primark.
The reason families dominate discounting, says Philippe Suchet of Exane BNP Paribas, an investment bank, is their long-term approach: they know that keeping prices low for customers is the only way to survive over generations. Listed retailers, by contrast, often face pressure to raise prices in order to meet short-term financial goals. With the exception of department stores (see article), the crisis has therefore confirmed one old truth: that families are best of all at shopkeeping.
American bank bosses
Clearing out the corner office
As an embattled boss retires, a celebrated one clarifies succession
A COMMON complaint at the height of the crisis was that too few Wall Street bosses were being forced to fall on their swords. With the fog of war clearing, exhausted leaders are rushing to leave the battlefield. James Gorman will succeed John Mack as head of Morgan Stanley on January 1st, when Wells Fargo’s chairman, Dick Kovacevich, will also retire. This week change also swept the upper ranks of Bank of America (BofA) and JPMorgan Chase.
Ken Lewis, BofA’s chief executive, announced on September 30th that he too would retire at the end of the year, signalling the end of an eight-year reign that had grown increasingly messy. Shareholders stripped Mr Lewis of the chairmanship earlier this year, irate at the handling of the takeover of Merrill Lynch, an investment bank. The deal has proved endlessly controversial and is now the subject of several state and federal probes. A settlement between BofA and the Securities and Exchange Commission over the bank’s alleged failure to disclose bonuses at Merrill was recently rejected by a judge.
Mr Lewis had suggested that he wanted to stay until the bank had repaid $45 billion in public aid and had finished integrating Merrill and Countrywide, a mortgage lender. But legal distractions were beginning to affect his ability to run the group, which faces further losses to come in consumer and commercial lending. The board must now scramble to pick a successor before he leaves. The half-dozen internal candidates include Brian Moynihan, who runs the retail bank, and Sallie Krawcheck, recently hired to lead wealth management.
By comparison, the succession process at JPMorgan Chase, which is emerging from the financial crisis stronger than any other large bank, looks wonderfully neat. On September 29th Jamie Dimon reshuffled his generals, ousting Bill Winters, co-head of the group’s giant investment bank, and replacing him with Jes Staley, formerly head of the asset-management business. The move sets Mr Staley up as the front-runner to take over should Mr Dimon leave or fall under a bus. The other investment-banking co-head, Steve Black, who is nearing retirement age, will leave after a transition period.
Letting Mr Winters go could not have been easy. He used his deep knowledge of complex financial instruments—he was part of a group at the bank that pioneered credit derivatives—to steer the investment bank away from the mortgage-backed dross that destroyed others’ balance-sheets. JPMorgan Chase is the only big American bank not to have recorded a quarterly loss in the past two years.
But the board pressured Mr Dimon to make hard choices. The lack of a clear succession plan was particularly alarming to some because of what might be called “Steve Jobs syndrome”, after Apple’s idolised boss. Mr Dimon is widely viewed as Wall Street’s sole remaining hero: the title of a new biography is “Last Man Standing”. But this means the bank’s fortunes are increasingly tied to his own. The share price would fall by 20% if Mr Dimon left, Mr Winters once said.
Why pick an asset-management man over such a battle-hardened lieutenant? Mr Staley has won plaudits running his $1.3 trillion division. He has impressed Mr Dimon, who abhors yes men, by standing his ground when they disagree. Insiders say he may also be temperamentally more suited to the top job than Mr Winters.
But Mr Staley should not hold his breath. He is only a year younger than his 53-year-old boss, who seems in no hurry to leave. “I now bleed Morgan blood,” Mr Dimon declares in the biography. He has said he is not interested in running another company. He may be tempted by a career in politics but he would have to cut down on the colourful language. He dreams of running a restaurant but that can surely wait. If Mr Dimon stays more than five years, the next leader is more likely to come from a crop of forty-somethings who have penetrated the top ranks, such as Mike Cavanagh, the finance chief, and Mary Callahan Erdoes, the new head of asset-management. Either way, JPMorgan Chase looks to be in good shape. That cannot yet be said of the institution that Mr Lewis is about to leave behind.
In an Ideal America
Every person should be free
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to pursue his ambition to the full extent of his abilities, regardless of race or creed or family background.
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to associate with whom he pleases for any reason he pleases, even if someone else thinks it's a stupid reason.
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to worship God in his own way, even if it isn't "orthodox."
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to choose his own trade and to apply for any job he wants — and to quit his job if he doesn't like it or if he gets a better offer.
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to go into business for himself, be his own boss, and set his own hours of work — even if it's only three hours a week.
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to use his honestly acquired property or savings in his own way — spend it foolishly, invest it wisely, or even give it away.
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to offer his services or products for sale on his own terms, even if he loses money on the deal.
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to buy or not to buy any service or product offered for sale, even if the refusal displeases the seller.
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to disagree with any other person, even when the majority is on the side of the other person.
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to study and learn whatever strikes his fancy, as long as it seems to him worth the cost and effort of studying and learning it.
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to do as he pleases in general, as long as he doesn't infringe the equal right and opportunity of every other person to do as he pleases.
The above, in a nutshell, is the way of life that the libertarian philosophy commends.
It is the way of individual liberty, of the free market, of private property, of government limited to securing these rights equally for all.
Leonard E. Read
Publisher
The Freeman
November 1954
Michael Moore Kills Capitalism with Kool-Aid
A friend recently invited me to a private screening of Michael Moore's new film, Capitalism: A Love Story.
The September 16 invite, not surprisingly, leaned in a certain direction:
Moore takes us into the homes of ordinary people whose lives have been turned upside down; and he goes looking for explanations in Washington, DC and elsewhere. What he finds are the all-too-familiar symptoms of a love affair gone astray: lies, abuse, betrayal and 14,000 jobs being lost every day. Capitalism: A Love Story is Michael Moore's ultimate quest to answer the question he's posed throughout his illustrious filmmaking career: Who are we and why do we behave the way that we do?
Considering Moore was going to be there for a Q&A after (moderated by Arianna Huffington), I quickly signed on. Now before painting a picture of Moore's new film, let me be honest: my belief set is essentially libertarian ("Government out of my bedroom and my pocketbook"). Not only do government solutions not excite me, they scare the living blank out of me. Remember when George Bush declared, "I've abandoned free-market principles to save the free-market system to make sure the economy doesn't collapse"? He might as well of said, "Hide your money, kids — 'cause I'm coming to take it!"
Oh sure, in theory I would like to see everyone with their own homestead, money in their pocket for regular shopping frenzies, and no health worries despite eating at Burger King 24/7, but arriving at those goals is not exactly doable unless government robs Peter to pay Paul and/or starts up the printing press.
And that view of course puts me in opposition to Moore since he has no problem with government as his and our father figure. That is his utopia. He truly believes that warehouses of federal workers, in Washington, D.C., remotely running our lives is the optimal plan. He is an unapologetic socialist who really doesn't care why the poor are poor or the rich are rich, he just wants it fixed. So not surprisingly — and with some generalization as I proffer this — Democrats like Moore and Republicans don't.
However, I was excited to see a "mainstream" film that was backed by big Hollywood bucks conclude capitalism is "evil." Arguably the most successful documentarian ever — a man who has made untold millions of dollars — was going to legitimately make the case that there was an alternative to capitalism. I sat down in a packed Mann's Bruin Theatre in Westwood, California, eager to see how his vision could possibly flesh out.
Moore is a rather simple guy. He is likable. He sees the world as good guys (people with no money) and bad guys (people with money). His Flint, Michigan, union-worker upbringing is his worldview. If you did not have that upbringing or if your life started less severe than his, you are an evil capitalist. If, on the other hand, you are a laid-off factory worker with a sixth-grade education, you are a true hero.
I don't care one way or the other that he has that view and I am not knocking union workers, but Moore sees the world through a class-warfare lens resulting in a certain agenda: force wealth to be spread amongst everyone regardless of effort.
Within minutes it was clear where Capitalism: A Love Story was headed.
We listen to heartbreaking stories of foreclosed families across America — but we don't learn why the foreclosures happened. Did these people treat their homes as piggy banks? Was there refinancing on top of refinancing just to keep buying mall trinkets and other goodies with no respect to risk or logic? We don't find out.
We meet one family that is so desperate for money that they were willing to accept $1,000 for cleaning out the house that they were just evicted from. Was it sad? Yes. But should we end capitalism due to this one family in Peoria, IL?
We are introduced to a guy whose company, called Condo Vultures, is buying and selling foreclosed properties. Since he acted like a used car salesman, the implication was that he was an evil capitalist. However, Moore doesn't tell us if his buyers were "working-class" people making smart buying decisions after prices had dropped.
We listen to Catholic priests who denounce capitalism as an evil to be eradicated. What would they put in its place and how would the new system work? The priests don't tell us.
We learn that Wal-Mart bought life insurance policies on many workers. We are then told to feel outrage when Wal-Mart receives a large payout from an employee death while the family still struggles with bills. I saw where Moore was heading here, but is this a reason to end capitalism?
We hear a story from a commercial pilot so low on money that he has to use food stamps. Moore points out that many pilots are making less than Taco Bell managers and then attributes a recent plane crash in Buffalo to underpaid pilots. This one crash is extrapolated as yet another reason to end capitalism.
I was pleasantly surprised at Moore's attempt at balance. For example, he included a carpenter who, while boarding up a foreclosed home, says, "If people pay their bills, they don't get thrown out."
There is also a dressing-down of Senator Chris Dodd (D) by name. Moore called out a top Democrat? He sure did. He nailed him.
There is a lengthy dissertation on the evils of Goldman Sachs. He rips Robert Rubin and Hank Paulson big time, and I agree with him. In fact, I said to myself, "Moore, you should have done your whole film on Goldman Sachs!"
Throughout the various stories and interviews he also weaves a conspiracy theory (all Moore films do this). The plot goes something like this: America won World War II and quickly dominated because there was no competition (Germany and Japan were destroyed). We had great postwar success where everyone lived in union-like equality. Jobs were plentiful and families were happy. However, things started to go bad in the 1970s — here Moore uses a snippet of President Carter preaching about greed. This clip was predictably building to Moore's big reason for all of today's problems: the Reagan Revolution.
Moore sees Reagan entering the scene as a shill for corporate-banking interests. However, everyone is happy as the good times roll all the way through into Clinton era. Moore does take subtle shots at President Clinton, but nails his right-hand economic man, Larry Summers, directly as a primary reason for the banking collapse. While Moore sees Japan and Germany today as socialistic winners where corporations benefit workers more than shareholders, he sees America sinking fast.
So is that it? That was the proof that capitalism is an evil to eliminate? Essentially, yes, that's Moore's proof.
What is his solution? Tugging on your idealistic heartstrings of course! Moore ends his film with recently uncovered video of FDR talking to America on January 11, 1944. Looking into the camera, a weary FDR proposed what he called a second Bill of Rights — an economic Bill of Rights for all — regardless of station, race, or creed — that included
- the right to a useful and remunerative job in the industries or shops or farms or mines of the nation;
- the right to earn enough to provide adequate food and clothing and recreation;
- the right of every farmer to raise and sell his products at a return which will give him and his family a decent living;
- the right of every businessman, large and small, to trade in an atmosphere of freedom from unfair competition and domination by monopolies at home or abroad;
- the right of every family to a decent home;
- the right to adequate medical care and the opportunity to achieve and enjoy good health;
- the right to adequate protection from the economic fears of old age, sickness, accident, and unemployment;
- and the right to a good education.
As FDR concluded and the film ended, I was shocked at the reaction. The theater of 400-plus spectators stood and cheered wildly at FDR's 1944 proposal. The questions running through my head were immediate: how does one legislate words like useful, enough, recreation, adequate, decent, and good? Who decides all of this and to what degree?
Interestingly, during the Q&A, Huffington and Moore discussed bank-failure fears during the fall of 2008. They asked for a show of hands of how many people moved money around or attempted to protect against a bank failure. I had the only hand that went up.
FDR's plan, hauled out by Moore six decades after it was forgotten, reminded me of another interchange — this one from the 1970s. Then talk-show master — the Oprah of his day — Phil Donahue was interviewing free-market economist Milton Friedman and wanted to know if Friedman had ever had a moment of doubt about "capitalism and whether greed's a good idea to run on?"
Friedman was quick in response:
Is there some society you know that doesn't run on greed? You think Russia doesn't run on greed? You think China doesn't run on greed? … The world runs on individuals pursuing their separate interests. The great achievements of civilization have not come from government bureaus. Einstein didn't construct his theory under order from a bureaucrat. Henry Ford didn't revolutionize the automobile industry that way. In the only cases in which the masses have escaped from the kind of grinding poverty you're talking about, the only cases in recorded history are where they have had capitalism and largely free trade. If you want to know where the masses are worst off, it's exactly in the kinds of societies that depart from that. So that the record of history is absolutely crystal clear: that there is no alternative way so far discovered of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system.
Donahue (and the video of this on YouTube is classic) then countered saying that capitalism doesn't reward virtue, but instead rewards the ability to manipulate the system. Friedman was having none of it:
And what does reward virtue? You think the communist commissar rewards virtue? … Do you think American presidents reward virtue? Do they choose their appointees on the basis of the virtue of the people appointed or on the basis of their political clout? Is it really true that political self-interest is nobler somehow than economic self-interest? … Just tell me where in the world you find these angels who are going to organize society for us?
Friedman's logic was what I was remembering as a theater full of people cheered wildly for a second Bill of Rights. How did this film crowd actually think FDR's 1944 vision could be executed? Frankly, it was clear to me at that moment that capitalism is on shaky ground. From Bush "abandoning" capitalism to bailouts for everyone, to Obama gifting away the future, we seriously might be past the point of no return toward a socialization of America.
At the end of his Q&A, Moore pushed the audience to understand that while they don't have the money, they do have the vote. He implored them to use their vote to take money from one group to give it to another group. Did he really say that openly with no ambiguity? Yes, sadly.
Sixty Years of Chinese Communism
The Party is increasingly out of step with the dynamic people it governs.
GORDON G. CHANG
There are, it is sometimes said, "a million truths in China." As the Communist Party celebrates the 60th anniversary of the founding of the People's Republic today, there are only three worth keeping in mind.
First, the Chinese state will try to project strength. There will be fearsome weapons and 200,000 soldiers and performers in a grand procession in the center of Beijing, meant to convince onlookers of the power of the communist superstate. Do not be impressed. If communists do one thing well, it is staging spectacles. Destitute North Korea, for instance, is even better than China in putting on perfectly synchronized parades and mass gatherings. The National Day march says little about the effectiveness, resilience or vigor of China's one-party political system.
Second, the Chinese state, for all its apparent might, is deeply insecure. The theme of the celebration is "The Motherland and I, Marching Together." But so great is the regime's worry about possible unrest or disruption in protest of its rule that the laobaixing—ordinary Chinese—will not be walking in Beijing's parade. There will be no cheering crowds lining the route along Chang'an Avenue. Citizens will be kept away by a six-province security perimeter and more than a million police and "volunteers" enforcing the tightest security in the country's history. The government has booked all the hotel rooms overlooking the route to prevent anyone from seeing the parade up close. Nearby residents have been ordered not to look out their windows or invite guests.
How many rogue nations can President Obama hold in one hand?
By DANIEL HENNINGER
In his Inaugural Address, President Obama spoke directly to the world's rogue nations. "[W]e will extend a hand," he said, "if you are willing to unclench your fist."
Question: How many rogue nations can you hold in one hand? Let's try to count.
Iran remains rogue No. 1. The world is riveted by the expanding Iranian nuclear threat, and one might expect a mess of this magnitude would occupy most of the diplomatic energies of any presidency. But this one has time for more.
Daniel Henninger discusses Obama's "open hand diplomacy" with rogue regimes.
The Monday after last Friday's bombshell that Iran has a hidden nuclear site, the State Department announced the start of a "direct dialogue" with Burma's hopeless junta. The administration has dispatched a special envoy to Sudan and its genocidal leader, Omar Hassan al-Bashir. Syrian strongman Bashar al-Assad got his own Obama envoy, plus a visit from John Kerry.
At the Summit of the Americas, Mr. Obama himself did meet and greets for "dialogue" with Venezuela's Hugo Chávez, Nicaragua's Daniel Ortega and Bolivia's Evo Morales, and reached out to Cuba's Raul Castro. Mr. Obama then dropped in on Russia's leaders for a "reset."
There is something slightly weird about all this activity. If the Obama team wanted to make a really significant break from past Bush policy, it would say it was not going to just talk with the world's worst strongmen but would give equal, public status to their democratic opposition groups. Instead, the baddest actors in the world get face time with Barack Obama, but their struggling opposition gets invisibility.
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WL
Associated Press
An Iranian pro-democracy rally asks the right question.
WL
WL
Iran's extraordinary and brave popular opposition, which broke out again this week at two universities, seems to have earned these pro-democracy Iranians nothing in the calculations of U.S. policy.
With Iran, one could argue that stopping the mullahs' nuclear program trumps the aspirations of its population. What about poor, harmless Guinea?
In July, Mr. Obama made a historic journey to Africa, giving a widely praised speech in Ghana in support of self-help and self-determination. In August, Secretary of State Hillary Clinton grandly visited seven African nations with a similar message. Three days ago in Guinea, government troops fired on a pro-democracy rally estimated at 50,000 in the capital of Conakry, killing more than 150 people. The State Department got out a written statement of condemnation. Why is it not possible for President Obama or Secretary of State Clinton, having encouraged these aspirations, to speak publicly in their defense, rather than let democratic movements rise, fall and die?
In trying to plumb why the U.S. won't promote or protect its own best idea, one starts with Mr. Obama's remarks at the "reset" visit in Moscow: "America cannot and should not seek to impose any system of government on any other country, nor would we presume to choose which party or individual should run a country."
Setting aside that no one is talking about the U.S. literally "imposing" a government in this day and age, what is one to make of a left-of-center American political leader taking such a diffident stance toward democratic movements? The people who live under the sway of the top dog in all the nations that have earned high-level Obama envoys are the world's poor, and one would expect the social-justice left to support them. That may no longer be true on the American or European left.
Transforming dictatorships into nations with reasonably competitive democracies increases the odds that their people in time will find a competent leader, such as Colombia's Alvaro Uribe, who will introduce productive economic policies. That makes it more likely these peoples will join the global trading system, raising their incomes.
For the American left, now fused to financial support from domestic labor unions, the world's dispossessed represent a threat—less costly labor selling goods into the high-cost world.
Active help for democratic oppositions in Venezuela, Syria, Egypt, Iran or even Guinea hardly serves this interest. Today, social justice stops at the water's edge. Even as Mr. Obama extends his hand to a Chávez, Morales or Castro, he makes no effort to finish free-trade agreements with certifiably democratic Colombia and Panama.
The one thing the Obama tack of talking to dictators and slow-walking free trade assures is that many of these populations may be run indefinitely by economically incompetent psychopaths who pose no threat to the interests of American labor and their Democratic dependents. This anti-democratic protectionism of course has fans on the xenophobic right in the U.S., too.
This is a risky business. What if the new authoritarian, make-believe democratic model gains? Our dictator chat partners are getting brazen about staging and then rigging elections. Iran's mullahs proved there will be no sustained push-back from the U.S. or Western Europe to a fraudulent election. Instead the great powers' energies go into pounding tiny Honduras, which tried to save itself from the Chávez- and Castro-admiring Manuel Zelaya.
What if the world's real democrats, after enough bullets and dungeon time, lose belief in the American democracy's support for them on this central idea? They may come to regard their betters in the U.S. and Europe as inhabiting a world less animated by democratic belief than democratic decadence.
Our new research shows no evidence of a Keynesian 'multiplier' effect. There is evidence that tax cuts boost growth.
By ROBERT J. BARRO AND CHARLES J. REDLICK
The global recession and financial crisis have refocused attention on government stimulus packages. These packages typically emphasize spending, predicated on the view that the expenditure "multipliers" are greater than one—so that gross domestic product expands by more than government spending itself. Stimulus packages typically also feature tax reductions, designed partly to boost consumer demand (by raising disposable income) and partly to stimulate work effort, production and investment (by lowering rates).
The existing empirical evidence on the response of real gross domestic product to added government spending and tax changes is thin. In ongoing research, we use long-term U.S. macroeconomic data to contribute to the evidence. The results mostly favor tax rate reductions over increases in government spending as a means to increase GDP.
For defense spending, the principal long-run variations reflect the buildups and aftermaths of major wars—World War I, World War II, the Korean War and, to a much lesser extent, the Vietnam War. World War II tends to dominate, with the ratio of added defense spending to GDP reaching 26% in 1942 and 17% in 1943, and then falling to -26% in 1946.
Wartime spending is helpful for estimating spending multipliers for three key reasons. First, the variations in spending are large and include positive and negative values. Second, since the main changes in military spending are independent of economic developments, it is straightforward to isolate the direction of causation between government spending and GDP. Third, unlike many other countries during the world wars, the U.S. suffered only moderate loss of life and did not experience massive destruction of physical capital. In addition, because the unemployment rate in 1940 exceeded 9% but then fell to 1% in 1944, there is some information on how the multiplier depends on the strength of the economy.
For annual data that start in 1939 or earlier (and, thereby, include World War II), the defense-spending multiplier that applies at the average unemployment rate of 5.6% is in a range of 0.6-0.7. A multiplier less than one means that, overall, other components of GDP fell when defense spending rose. Empirically, our research shows that most of the fall was in private investment, with personal consumer expenditure changing little.
Our research also shows that greater weakness in the economy raises the estimated multiplier: It increases by around 0.1 for each two percentage points by which the unemployment rate exceeds its long-run median of 5.6%. Thus the estimated multiplier reaches 1.0 when the unemployment rate gets to about 12%.
To evaluate typical fiscal-stimulus packages, however, nondefense government spending multipliers are more important. Estimating these multipliers convincingly from U.S. time series is problematical, however, because the movements in nondefense government purchases (dominated since the 1960s by state and local outlays) are closely intertwined with the business cycle. Thus the explanation for much of the positive association between nondefense spending and GDP is that government spending increased in response to growing GDP, rather than the reverse.
The effects of tax rates on GDP growth can be analyzed from a time series we've constructed on average marginal income-tax rates from federal and state income taxes and the Social Security payroll tax. Since 1950, the largest declines in the average marginal rate from the federal individual income tax occurred under Ronald Reagan (to 21.8% in 1988 from 25.9% in 1986 and to 25.6% in 1983 from 29.4% in 1981), George W. Bush (to 21.1% in 2003 from 24.7% in 2000), and Kennedy-Johnson (to 21.2% in 1965 from 24.7% in 1963). Tax rates rose particularly during the Korean War, the 1970s and the 1990s. The average marginal tax rate from Social Security (including payments from employees, employers and the self-employed) expanded to 10.8% in 1991 from 2.2% in 1971 and then remained reasonably stable.
For data that start in 1950, we estimate that a one-percentage-point cut in the average marginal tax rate raises the following year's GDP growth rate by around 0.6% per year. However, this effect is harder to pin down over longer periods that include the world wars and the Great Depression.
It would be useful to apply our U.S. analysis to long-term macroeconomic time series for other countries, but many of them experienced massive contractions of real GDP during the world wars, driven by the destruction of capital stocks and institutions and large losses of life. It is also unclear whether other countries have the necessary underlying information to construct measures of average marginal income-tax rates—the key variable for our analysis of tax effects in the U.S. data.
The bottom line is this: The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP by less than the increase in government spending. Defense-spending multipliers exceeding one likely apply only at very high unemployment rates, and nondefense multipliers are probably smaller. However, there is empirical support for the proposition that tax rate reductions will increase real GDP.
Mr. Barro is a professor of economics at Harvard. Mr. Redlick is a recent Harvard graduate. This op-ed is based on a working paper issued by the National Bureau of Economic Research in September.
George Bush succeeded in Iraq by talking to his generals regularly.
By KARL ROVE
So our top commander in Afghanistan, Gen. Stanley McChrystal, has told CBS's "60 Minutes" that he has spoken with President Barack Obama only once since June.
This is a troubling revelation. Right now, our commander in chief is preparing to make one of the most important decisions of his presidency—whether to commit additional troops to win the war in Afghanistan. Being detached or incurious about what our commanders are experiencing makes it hard to craft a winning strategy.
Mr. Obama's predecessor faced a similar situation: a war that was grinding on, pressure to withdraw troops, and conflicting advice—including from some who saw the war as unwinnable. But George W. Bush talked to generals on the ground every week or two, which gave him a window into what was happening and insights into how his commanders thought. That helped him judge their recommendations on strategy.
Mr. Obama's hands-off approach to the war seems to fit his governing style. Over the past year, he outsourced writing the stimulus package to House Appropriations Committee Chairman David Obey, washed his hands of Attorney General Eric Holder's decision to reinvestigate CIA interrogators, and hasn't offered a detailed health-care plan.
Mr. Obama's aloofness on the war will be a problem if the recent airing of Joe Biden's views on Afghanistan is a tipoff that Mr. Obama will rely on his vice president's guidance. According to reports in the New York Times and other publications, Mr. Biden supports reducing troop levels in favor of surgical attacks—mostly launched from offshore—and missile strikes against al Qaeda, especially in Pakistan.
Such an approach would almost certainly lose the war. Actionable intelligence—key to defeating an insurgency—would dry up. Tribal chieftains would cut deals with the Taliban and al Qaeda. The Afghan government would probably collapse, and the Afghan people would have little choice but to swing their support to the Taliban. Pakistan would likely come to see us as a fair-weather friend and increasingly resist U.S. attacks against al Qaeda on its soil. American credibility would be shattered. And militant Islamists would gain a victory.
Mr. Biden has a record rare in its consistency and duration of being wrong about big national security questions.
In his first U.S. Senate campaign in 1972, he called for cutting and running from Vietnam. He later voted to cut off funding for South Vietnam and spoke out against the war. After we did withdraw, communist forces conquered South Vietnam as well as Cambodia, where Pol Pot carried out a campaign of genocide.
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In the 1980s, Mr. Biden opposed President Ronald Reagan's national security approach on almost every front, including funding for the Contras in Nicaragua, building missile defenses, and increasing military spending. In the 1990s, apparently willing to cede Kuwait to Saddam Hussein, he voted against the first Gulf War. Over the past decade, Mr. Biden opposed the surge that put us on the path to victory in Iraq. Instead called for a "soft partition" that would have divided Iraq into three countries.
Mr. Biden has been right about Afghanistan at least once. In 2002, he said, "Security is the basic issue in Afghanistan. Whatever it takes, we should do it. History will judge us harshly if we allow the hope of a liberated Afghanistan to evaporate because we failed to stay the course."
The responsibility for the outcome of the war in Afghanistan rests squarely with Mr. Obama. Until now, he seems to have treated the conflict as a distraction from his efforts to nationalize our health-care system. But the war is now front and center. He has been told by Gen. McChrystal that America needs more boots on the ground to win.
About Karl Rove
Karl Rove served as Senior Advisor to President George W. Bush from 2000–2007 and Deputy Chief of Staff from 2004–2007. At the White House he oversaw the Offices of Strategic Initiatives, Political Affairs, Public Liaison, and Intergovernmental Affairs and was Deputy Chief of Staff for Policy, coordinating the White House policy making process.
Before Karl became known as "The Architect" of President Bush's 2000 and 2004 campaigns, he was president of Karl Rove + Company, an Austin-based public affairs firm that worked for Republican candidates, nonpartisan causes, and nonprofit groups. His clients included over 75 Republican U.S. Senate, Congressional and gubernatorial candidates in 24 states, as well as the Moderate Party of Sweden.
Karl writes a weekly op-ed for The Wall Street Journal, is a Newsweek columnist and is now writing a book to be published by Simon Schuster. Email the author at Karl@Rove.com or visit him on the web at Rove.com.
Or, you can send him a Tweet@karlrove.
In the past, when Mr. Obama has moved left, he moved fast and far to the left—witness his willingness to push health-care legislation even if it only has Democratic support. But when he has played to the center—as on Afghanistan, when he decided in last year's campaign that he needed to be tough on at least one of the wars America was engaged in—he has looked for appealing half-measures that ultimately prove unworkable.
It was easy in 2008 to criticize Mr. Bush's war leadership. But winning a shooting war requires a commander in chief's constant, direct and deep involvement. Mr. Obama could show he understands this if he uses his trip to Denmark this week (where he will serve as pitchman for Chicago to get the 2016 Olympics) to make a surprise visit to Afghanistan.
Refusing to provide all the troops and strategic support that his commanders are requesting will be to concede defeat. We'll soon know whether Mr. Obama has the judgment and the courage to win this war.
Mr. Rove is the former senior adviser and deputy chief of staff to President George W. Bush.
Stocks Drop After Flood of Mixed Data
WALL STREET JOURNAL ONLINE NEWS ROUNDUP
Stocks fell at the start of the fourth quarter Thursday after a deluge of data painted a mixed picture of the economic recovery.
The Dow Jones Industrial Average was recently down 103 points at 9608.44, while the S&P 500 fell 1.2% and the Nasdaq Composite also shed 1.6%.
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The Institute for Supply Management's manufacturing gauge for September was at 52.6 compared to 52.9 in August. Economists expected a reading of 54. Construction spending unexpectedly jumped in August, driven by a resurgence in a housing industry enjoying a big government tax break. Total spending increased by 0.8% to a seasonally adjusted annual rate of $941.88 billion compared to the prior month. Wall Street had expected a flat reading.
The National Association of Realtors' index for pending home sales spiked 6.4% to 103.8 in August from 97.6 in July. The increase marks the seventh consecutive rise in pending home sales. Analysts surveyed by Dow Jones Newswires had expected pending sales would rise by 1.5%.
Before the bell, the Commerce Department reported personal income rose 0.2% compared to July while spending increased by 1.3%. A key gauge of prices slid, suggesting inflation is benign at the present time. Economists surveyed by Dow Jones Newswires had forecast a 0.1% increase in income during August and a 1.1% increase in spending.
Meanwhile, initial claims for jobless benefits rose 17,000 to 551,000 in the week ended Sept. 26, the U.S. Labor Department said in its weekly report. Economists surveyed by Dow Jones Newswires had expected a rise of only 5,000. The weekly jobs data were seen as a sign the labor market is still slow to heal.
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Auto sales data for September are also expected.
Federal Reserve Chairman Ben Bernanke is testifying on financial regulation, and, after the close, two more Fed speakers will discuss the economy.
Stocks weakened Wednesday on the final day of the third quarter, with the Dow Jones Industrial Average retreating 30 points, the Nasdaq Composite losing two points and the S&P 500 slipping four points. Weak economic data on jobs and a Chicago-area poll contributed to the bearish tone.
However, the stock market ended near its highs for the year, with many of the riskiest stocks leading the charge.
The technology sector will be in focus amid mergers and acquisitions activity. Cisco Systems reached a deal to buy Norwegian video-conferencing-services firm Tandberg for $3 billion, while Comcast denied a report it was going to buy General Electric's 80% stake in NBC Universal. Cisco shares were off 1.1% in recent action. Comcast shares fell 5.8%, while GE's shares were down 1.5%.
Bank of America will also be in the spotlight after its chief executive, Ken Lewis, said he'd step down at the end of the year. A replacement hasn't been named. The bank's shares were recently down 0.8%.
In the currency markets, the euro was particularly weak after Joaquin Almunia, the European Union's economics commissioner, said the euro group will discuss the euro's appreciation ahead of the G7 meeting in Istanbul. German retail sales also disappointed.
The Bank of Japan's key Tankan survey showed companies planning to cut capital spending, which sent the Nikkei 225 down 1.5%.
Oil futures held above the $70 a barrel.
Wednesday, September 30, 2009
Mexico's southern border
Lawless roads
Where migrants meet criminals
Only the least of their perilsTRAFFIC is light on the bridge linking Ciudad Hidalgo in Mexico to Tecún Umán in Guatemala. Tricycle-taxi drivers and an armed guard idly stand around in the sun. All the action takes place on the river below. A small flotilla of rafts fashioned from trailer tyres and stacked with sacks of corn floats by, in sight of customs officials. Their cargo is destined for Tecún Umán’s bustling market, which overflows with crackers and bread made affordable by the recent depreciation of Mexico’s peso against the Guatemalan quetzal. “It’s illegal, but it’s a job for these people,” says Antonio Aguilar, the chief of Guatemala’s national police in Tecún Umán. That is one reason why he leaves the 5,000 or so small-time smugglers in this area alone. Another, he admits, is that when one of his predecessors cracked down on smuggling, a mob burnt down the police station.
Migration and the trafficking of drugs and guns across Mexico’s northern border with the United States capture endless headlines. (This week agents fired at three vans containing 74 illegal immigrants as they failed to stop at a border crossing near San Diego.) But many of these problems are quietly mirrored on its southern frontier. This is “a no-man’s land, a wild frontier,” says Conrado Aparicio, a naval commander at Puerto Madero. That is despite recent government attempts to exercise greater surveillance.
Today’s problems date from the 1990s, when traffickers began to move drugs through Central America in response to an American crackdown on their Caribbean routes. After Hurricane Mitch struck in 1998, a torrent of destitute migrants began to head north too. Mexico’s governments have come to accept that if they want the United States to reform its immigration laws and to speed cross-border trade, they have to exercise more control over their own territory.
Mexico’s southern border stretches for 960km (600 miles), snaking through remote highlands and thick jungle. Patrolling it is hard. So the government has sought to erect a “vertical border,” with army and police checkpoints spaced at 25km intervals along roads, as well as the railway that many migrants use after they have crossed the border. This strategy has forced migrants into the hills, where many fall victim to criminal gangs.
The main gang along the border is the Zetas, a group of deserters from a Mexican-army special-forces unit, some of whom were deployed against the Zapatista rising in Chiapas in 1994. They have recruited former Kaibiles, Guatemalan special forces who acquired notoriety during a long civil war against leftist guerrillas, as well as youth gangs.
This mob combines local knowledge, cruelty and violence. It has expanded from smuggling arms and drugs to both trafficking in, and preying upon, migrants. It kidnaps large groups brought across the border by coyotes (human traffickers), taking them to safe houses. The men are tortured, the women raped and ransoms demanded from relatives in the United States. Mexico’s National Human Rights Commission, a quasi-governmental body, recorded 9,758 kidnaps of migrants between September 2008 and February 2009, and calculated the ransoms paid in these cases at $25m.
The government has tried to curb this mayhem. A former state attorney general in Chiapas has been arrested on suspicion of corruption, as has a former federal prosecutor in Quintana Roo. The army boasts of regular seizures of weapons caches from the Zetas. But the mob has hit back with acts of intimidatory violence. In August the body of the director of immigrant affairs in Tapachula, the largest border city, was found in a tub of cement, months after he was kidnapped. The security forces are finding recruitment harder: the Chiapas police have 300 unfilled vacancies. And when they are pursued, the Zetas sometimes skip over the border to Guatemala.
The government has set up squads of orange-clad, unarmed officials called Beta Groups to rescue missing migrants and advise them of the risks, just as it has long done on the northern border. It has also speeded up the issue of visas for temporary workers and residents of the Guatemalan side of the border. But few Central Americans qualify and many enter illegally. Recession and tighter security on the northern border may have reduced the flow of migrants entering the United States. But sadly they have also made it easier for the gangs to recruit.
The Pacific tsunami
Paradise rocked
Over 100 people are killed as tsunamis strike the Pacific
TSUNAMIS that struck in the South Pacific on Tuesday September 29th were nowhere near as devastating as the waves that hit countries around the Indian Ocean in December 2004. Then, an earthquake of 9.0 magnitude caused a tsunami that claimed an estimated 230,000 lives. According to the Pacific Tsunami Warning Centre, the waves this week were triggered by an 8.3 magnitude earthquake that took place some 120 miles (195km) south of the Samoa group of islands (see map). On Wednesday another earthquake, well over 7 magnitude, was reported off Sumatra, in Indonesia.
Over 100 people were thought to have died in Samoa and American Samoa, which together have a population of some 250,000. American Samoa was reportedly hit by four separate waves. Another seven people were killed in Tonga, several hundred kilometres farther south. Witnesses described fleeing from waves 4.5 metres tall which swept people, cars and other debris as far as 100 metres inland. Many Samoan settlements are coastal and both Apia and Pago Pago, the capitals respectively of Samoa and American Samoa, were deluged. Thousands have been made homeless and survivors are said to be sheltering on high ground. Samoan meteorological officials suggest that some victims were killed by a second wave that swept ashore as they gathered fish washed up by the first.
The death toll might have been worse if the waves had struck in darkness rather than the early morning. It helped, too, that some lessons had been learned from previous disasters. A general tsunami alert was issued across the Pacific, as far apart as Hawaii and New Zealand. Samoa itself developed an early-warning system following the 2004 tsunami, based on the sending of text messages to local leaders, followed by the sounding of church bells and sirens. A national drill was held in 2007 after a tsunami had killed over 20 people in the Solomon Islands. But Misa Telefoni, Samoa’s deputy prime minster, said that the speed of Tuesday’s disaster left people with desperately little time to respond. “The ocean went out within five minutes [of the earthquake].”
That suggests that the best protection is training coastal dwellers themselves to recognise the signs of a possible tsunami—such as strong, prolonged ground shaking—and to seek higher ground at once. As with most hazards, the more informed the public are, the better their chances of survival.
Aid will flow quickly to many affected areas. Barack Obama, America’s president, has declared that the situation in American Samoa is a disaster and has promised that federal relief funds will be available. Australia and New Zealand, where many Samoans reside, and Britain reported their citizens to be among the dead. New Zealand’s air force is helping to search for bodies and to transport medical and other aid.
The tsunami is a setback in a region of weak economies: many of the island countries are heavily reliant on aid and remittances. The waves may also raise anxieties in low-lying islands, such as Tuvalu and the Tokelau Islands, that rising sea levels will mean greater threats from the ocean to human life and livelihoods.
Asian currencies
Hot air
The world’s bounciest economies have the most undervalued currencies
ONE of the biggest inconsistencies in the global economy today is the fact that emerging Asian economies have rebounded faster than any other region (the gap between their average growth rate and that of developed economies is likely to hit a record high this year), yet most of their currencies have fallen since 2008 in real trade-weighted terms. By many measures—from The Economist’s Big Mac index to more sophisticated gauges—Asian currencies are among the world’s most undervalued.
Take China, the fastest-sprinting economy. In the three years to July 2008 the yuan climbed by 21% against the dollar. But for the past 14 months it has, in effect, been repegged to the dollar. As a result the slide in the greenback has dragged down the yuan’s trade-weighted value by almost 10% since the start of this year (see chart). Morris Goldstein and Nicholas Lardy of the Peterson Institute for International Economics estimated in July that the yuan was undervalued by 15-25%. Some smaller Asian currencies may be even more undervalued. The IMF calculated in March that by one measure South Korea’s won was 41% below its fair value (its trade-weighted value has since gained about 10%).
The fact that Japan’s new government has allowed the yen to climb against the dollar, even though its economy is weaker, may seem to buck the regional trend. The yen is up by 18% over the past year and touched an eight-month high on September 28th, after comments from Hirohisa Fujii, the new finance minister, appeared to suggest that the government would not intervene to stem the rise. But squeals from Japanese exporters, as well as claims that the government has adopted a new “strong yen” policy, can mislead. Mr Fujii has since denied that he favours a stronger currency, and the yen still looks relatively weak by past standards: its real trade-weighted value has fallen by 7% since January and is below its 15-year average.
Outside Japan, Asian governments have been forced to step up their intervention to hold down currencies as foreign-capital inflows have surged on optimism about recovery. China’s foreign-exchange reserves rose by a record $178 billion in the second quarter, compared with an increase of only $8 billion in the first quarter.
China’s motive for halting the yuan’s rise against the dollar is to stem the collapse in its exports. Its trade surplus in the three months to August was less than half its level a year ago (though its current-account surplus is still likely to amount to a hefty 6% of GDP this year, maintaining upward pressure on the currency). The Chinese government is unlikely to let the yuan start rising again against the dollar until three conditions are met: exports show a year-on year increase, GDP growth hits 10% and inflation turns firmly positive. All three are possible by the end of the year, and there are good reasons to think that the government in Beijing will then relax its exchange-rate policy.
One reason to do so is to curb asset-price bubbles and prevent excessive inflation. Measured by the gap between current interest rates and expected nominal GDP growth in 2010, China has the world’s loosest monetary policy—too loose for its booming economy. But the cost of raising interest rates would be a stronger currency as foreign capital flows in.
A second reason why China may allow a stronger yuan is its desire to increase use of its currency in international trade and finance. In recent months China has allowed cross-border trade with some economies to be settled in yuan; it has raised quotas on share purchases by foreign institutional investors; and on September 28th it sold yuan-denominated government bonds in Hong Kong for the first time. If China wants to make the yuan a global currency this will require further loosening of foreign-exchange controls, and hence revaluation.
Last, but not least, the crisis painfully underlined the limits of export-led growth. China’s proclaimed goal of boosting household spending requires a stronger currency, which would lift consumers’ real purchasing power. If China allows the yuan to rise, other Asian countries are likely to follow suit. Only then will Asia play its full part in global rebalancing.
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