The world economy
Dangerous froth
Asset prices could push central bankers off course long before any bubbles burst
THE post-crisis challenge for central bankers has long seemed easy to describe. They must steer between the shoals of short-term deflation and the longer-term risk of accelerating consumer prices. But recently a new concern has cropped up: that loose monetary conditions are creating dangerous bubbles in all manner of assets, from oil prices to Asian apartments, that could capsize the global recovery.
Asset prices have certainly risen impressively. The S&P 500 index is up by 62% from its low on March 9th; the MSCI index of emerging-economy shares has climbed by 114% from its nadir of a year ago; the price of oil is 155% higher than it was in December 2008. Gold prices set a new record of over $1,120 an ounce on November 12th (see article). Chinese house prices rose at their fastest pace in 14 months in October.
However, these rebounds have followed even more dramatic slumps, so asset-price levels are less eye-popping. Gold apart, commodities are still well below the peaks of mid-2008. The earnings multiple for Shanghai’s A-share index is less than half the level it reached during the 2007 bubble. American shares may be richly valued relative to earnings, but they are less unhinged than in earlier booms. According to Smithers & Co, a research firm, the price-earnings ratio for America’s S&P 500 on a cyclically adjusted basis is about 40% above its long-term average, compared with over 100% in the late 1990s.
There are other reasons for calm. Earlier this year investors were in panic mode. Much of the rebound since then reflects a return to more normal risk appetites. Nor is today’s asset boom fuelling the kind of leverage that made the bust so awful. Bank lending is contracting in America and weak elsewhere in the rich world. In Asia, property-related borrowing is heavily curtailed compared with America’s pre-crisis boom. And from Singapore to Seoul, the authorities are demanding higher down-payments from borrowers and restricting lending to developers (see article).
Nonetheless, it would be a mistake to be too sanguine. Another violent drop in share prices could have disproportionate effects on confidence and hence demand. Equally important, frothy asset prices could cause damage long before any bubbles burst, by increasing the risk that central bankers make mistakes.
This risk is most obvious in those countries—mostly emerging markets—where domestic conditions call for tighter monetary policy. China is Exhibit A. With a vigorous domestic recovery under way, China ought to tighten soon, before asset prices bubble out of control. But China is loth to allow the yuan to appreciate rapidly. And it will not be pressured by high consumer-price inflation, as it was in 2008. Thanks largely to soaring pork prices, China’s annual inflation rate reached almost 9% early that year. Today it is negative and few expect consumer prices to rise by much more than 3-4% in 2010.
Asset-price rises are also a problem for emerging economies with flexible exchange rates. Many have seen their currencies soar as foreign money pours in. Raising interest rates to tighten domestic monetary conditions can attract yet more foreign money. Increasingly countries are turning to controls on capital inflows. Brazil has already introduced a 2% tax on foreign portfolio investments to stem the rise in the real. On November 10th Taiwan banned foreign investors from putting money into Taiwanese fixed-term deposits. More such measures are likely, increasing the chance of distortions.
In weak, rich economies the danger is not too little too late, but too much too soon. Jumps in asset prices risk causing premature inflation jitters. Oil prices, especially, pose a danger. In recent months year-on-year headline inflation rates in most of the world’s big economies have been negative, largely because oil prices have been far below the heights of mid-2008. That is about to change dramatically, as the slumping oil prices of late 2008 and early 2009 affect the comparisons.
In America headline consumer prices fell by 1.3% in the year to September. By December they could be up by 3%. Even if oil prices stay around $80 a barrel, these “base effects” could keep America’s headline inflation above 2% for much of the first half of 2010. Many expect commodity prices to continue rising. Analysts at Goldman Sachs expect a barrel to cost $95 by the end of next year. Long-dated futures contracts are now flirting with the $100 mark.
An energy-driven headline inflation rate of 3% hardly spells disaster. Core inflation, which strips out jumpy food and fuel prices, is low, at 1.5%, and falling, thanks to the huge amount of slack in the economy. With a jobless rate of 10.2% and oodles of idle capacity, America still faces a bigger threat from deflation than from inflation.
The risk is that higher headline inflation is misinterpreted as a sign that policy is too loose. Judged by the “breakeven” rate between inflation-protected and other Treasury bonds, financial markets’ estimates of long-term inflation have jumped of late, although consumers’ expectations have remained stable (see chart). Worries about the size of America’s budget deficit and fears about the potential politicisation of the Federal Reserve are rising. (A proposal released this week by the Senate Banking Committee which strips the Fed of supervisory powers and introduces political appointments to the regional reserve-bank boards hardly helps). There is a danger that higher headline inflation will be misread, even as rising energy costs sap demand.
Vince Reinhart of the American Enterprise Institute worries about a replay of the summers of 2007 and 2008. On both occasions a weaker dollar, rising oil prices and a “decoupled” world economy made America’s central bank more hawkish. Although it did not raise rates, “inflation jitters” were pervasive. The European Central Bank actually raised rates in July 2008.
History will not repeat itself exactly. But bubbly asset prices do risk overreaction from rich-world central bankers. That may temper worries in the emerging world but at the risk of pushing the global economy back into recession. Central bankers ignore asset prices at their peril. But dealing with them is not easy either.
General disarray
America and Afghanistan
General disarray
America’s senior men in Kabul disagree over sending more troops to Afghanistan
WHICH of his generals will President Barack Obama listen to? Will it be his commander in Afghanistan, Stanley McChrystal, who has asked for some 40,000 extra troops to reverse the recent gains of the Taliban? Or will it be one of General McChrystal’s predecessors, Karl Eikenberry, now Mr Obama’s ambassador to Afghanistan? He insists that no such reinforcement should be sent until President Hamid Karzai tackles the corruption and mismanagement that is rife in the country.
The debate over what to do in Afghanistan has raged in Washington for more than ten weeks since General McChrystal gave warning in an initial assessment that “resources will not win this war, but under-resourcing could lose it”. In recent days, though, Mr Eikenberry has pitched in forcefully with messages expressing his opposition to a troop surge.
The details of his messages are not known, but Mr Eikenberry is said to be doubtful about Mr Karzai’s reliability as a partner and his willingness to curb corruption. In the weeks of political wrangling that followed last August’s fraud-riddled election, Mr Karzai was first forced to accept a second round of voting (after nearly 1m ballots were deemed to be fraudulent). He was then declared the winner after the withdrawal of his main opponent, Abdullah Abdullah.
Mr Karzai is due to be sworn in on November 19th, with several Western foreign ministers in attendance. Despite the West’s seal of approval for the election result, support for Mr Karzai in the long term is ambivalent and conditional on his doing a better job of running a clean and competent government.
It is unclear whether Mr Eikenberry’s call to refrain from sending more troops is intended as a short-term tactic to increase pressure on Mr Karzai to make bolder reforms, or as an expression of the hopelessness of the Afghan venture.
Nevertheless, Mr Eikenberry’s 11th-hour intervention could tip the scales in the White House. Admiral Mike Mullen, chairman of the joint chiefs of staff, Hillary Clinton, the secretary of state, and Robert Gates, the defence secretary, are said broadly to support General McChrystal’s call to add substantially more troops to the roughly 68,000 American and 35,000 allied forces in Afghanistan. Against them have stood Joe Biden, the vice-president, who is reckoned to favour a narrower focus on counter-terrorism operations, and Rahm Emanuel, the White House chief of staff, who is thought to be worried about the impact of the deepening war on Mr Obama’s prospects for re-election.
Mr Obama is said to be weighing four options. These range from a minimal increase of 10,000-15,000 troops focusing mainly on intensifying the training of the Afghan army, to General McChrystal’s favoured option of about 40,000 troops to conduct a more fully-fledged counter-insurgency campaign focused on “protecting the population” to isolate insurgents.
Mr Obama has now put off his decision until after he returns from his trip to Asian countries beginning this week, and may not make a choice until December. Many accuse him of dithering, and even close allies such as Britain are expressing exasperation with the delay in Washington. But others think Mr Obama’s caution has proven wise, given the political mess in Kabul. What is undeniable is that the protracted debate within the administration is increasingly being fought in public.
It is also apparent that the hope of recreating the dream-team that oversaw the successful surge in Iraq—with General David Petraeus, the military commander, working in lock-step with Ryan Crocker, the ambassador in Baghdad—has not been realised in Afghanistan.
Reserve currencies
Reserve currencies
Cross my palm with euros?
The dollar’s days as the world’s reserve currency are far from over
WORRIES about the dollar’s dominance of the global monetary system are not new. But debate about replacing the beleaguered dollar, whose trade-weighted value has dropped by 11.5% since its peak in March 2009, has resurfaced in the wake of a global financial and economic crisis that began in America. China and Russia, which have huge reserves that are mainly dollar denominated, have talked about shifting away from the greenback. India changed the composition of its reserves by buying 200 tonnes of gold from the IMF.
None of this threatens the dominance of the dollar yet, particularly as a dramatic shift out of the currency would be damaging to the countries (such as China) that hold a huge amount of dollar-denominated assets. But a new paper by economists at the IMF, released on Wednesday November 11th, acknowledges that the global crisis has reignited the debate about anchoring the world’s monetary system on one country’s currency.
Some say that America’s role as the principal issuer of the global reserve currency gives it an unfair advantage. America has a unique ability to borrow from foreigners in its own currency, and wins when the dollar depreciates, since its assets are mainly in foreign currency and its liabilities in dollars. By one estimate America enjoyed a net capital gain of around $1 trillion from the gradual depreciation of the dollar in the years before the crisis.
In a sense the world is hostage to America’s ability to maintain the value of the dollar. But as the IMF points out, the currency’s primacy arises at least partly because China and other emerging countries have chosen to accumulate dollar reserves. The depth of America’s financial markets and the country’s open capital account have made the dollar attractive. So some of the advantage has been earned.
But large and persistent surpluses in countries like China mean continued demand for American assets, reducing the need for fiscal adjustment by either country. This, in turn, has contributed to the build-up of the macroeconomic imbalances that many blame for the financial crisis.
Dealing with these imbalances could begin by finding ways to reduce reserve accumulation in emerging countries. The IMF reckons that about two-thirds of current reserves (about $4 trillion-$4.5 trillion) are held by countries as insurance against shocks, including sudden reversals of capital flows, banking crises and so on. In theory, groups of countries could pool reserves, so that a smaller amount would suffice than if countries each maintain their own buffers. Other alternatives include precautionary lines of credit, such as the American Federal Reserve’s with the central banks of Brazil and Mexico, or the IMF’s flexible credit line.
But what are the alternatives to relying on the dollar? One possibility is a system with several competing reserve currencies. Over time, the euro and China’s yuan (if it became convertible) could emerge as competitors. This would require a great deal of policy co-ordination among issuing countries. But by having several reserve currencies the “privilege” that America now enjoys would be available more widely, providing an incentive to compete to attract users to different currencies.
Another alternative is a greater reliance on SDRs, the IMF’s quasi-currency, which operates as a claim on a basket of currencies: the dollar, euro, sterling and yen. Because the SDR’s value depends on several currencies, it shares many of the benefits of a multiple-currency system. But even the IMF says that using SDRs seems “doubtful unless the system…fails in a major way”.
The most radical solution of all is a new global currency that could be used in international transactions and would float alongside domestic currencies. The fund argues that this would have to be issued by a new international monetary institution “disconnected from the economic problems of any individual country”. This currency could serve as a risk-free global asset.
Radical as this may sound, it is not a new idea. John Maynard Keynes had something similar in mind when he proposed an International Clearing Union. This global bank would issue its own currency, called the bancor, in which all trade accounts would be settled. In the absence of such a bank the world will have to make do with the current system. So worries about the dollar’s value aside, its global dominance is secure for now.
The Palestinians
Will he jump?
Whether or not Mahmoud Abbas goes, the Palestinians look both divided and leaderless
AFTER five hapless years as the Palestinians’ president, Mahmoud Abbas (also known as Abu Mazen) suddenly declared on November 5th that he would not seek re-election in January, when the Palestinian territories are due to hold general and presidential polls. On the face of it, his decision was a blow to the cause of peace. Even before he succeeded Yasser Arafat, who died in 2004, Mr Abbas stood out as a man of peace who preferred negotiation to violence, whereas Mr Arafat, at least in most Israeli eyes, had always juggled the two. After Mr Abbas steps down, who will take over? And in which direction might the new man go?
But within hours of Mr Abbas’s declaration confusion had set in. For a start, it soon became unclear whether Mr Abbas really would step down. He has often threatened to resign. Angered by a recent decision of the American administration to rescind its previous vaunted insistence that Israel’s government should completely stop building and expanding Jewish settlements in the West Bank, the core of a would-be Palestinian state, Mr Abbas may have been seeking to win concessions as his price for staying in office—and for returning to the negotiating table.
He may, for instance, still seek to persuade Barack Obama to issue a statement that a Palestinian state’s borders must accord with those of 1967, albeit with land-swaps to allow Israel to keep some of its biggest settlement blocks, and that Jerusalem must be shared, with its eastern side becoming the capital of a Palestinian state. A few days after Mr Abbas said he had had enough, Binyamin Netanyahu was meeting Mr Obama in the White House. The pair would certainly have discussed such ways of keeping Mr Abbas on board.
Some of the Palestinian leader’s aides, however, insisted that this time he would go. Others predicted that he would be persuaded to stay. Still others speculated that he could drop his post as president of the Palestinian Authority (PA), while continuing to wield power as chairman of the Palestine Liberation Organisation, the umbrella organisation that embraces an array of nationalist groups, and as head of Fatah, the secular-minded party which has been the engine of Palestinian politics for more than half a century and which runs the PA.
In his resignation speech, Mr Abbas castigated Israel’s government for its obduracy over the settlements, the Americans for letting him down, and the Palestinians’ Islamist movement, Hamas, for refusing to accept the terms of a Palestinian unity government proposed by Egypt. It has been trying for more than a year to bring the two bitterly opposed factions together.
Hamas won the last Palestinian general election, in 2006. A year later, it bloodily ousted Fatah from the Gaza Strip, the smaller chunk of a proposed Palestinian state. Many of Hamas’s West Bank members of parliament are in Israeli prisons. Even if an election took place on schedule, Hamas says it would refuse to take part in present circumstances. Fatah, for its part, would be unable to campaign in Gaza.
So the January timetable is likely, anyway, to slip. June has been mentioned as an alternative. In the meantime, Mr Abbas could stay in charge as a caretaker. Few seem certain of the constitutional laws governing Palestinian electoral and other procedures. In Fatah’s view, they are elastic. But Hamas says, with some cogency, that it has been illegal for Mr Abbas to retain his post as the PA’s president since January this year, when his four-year term should have run out. If no new leader of the PA has been elected within 60 days of the old one stepping down, the parliamentary speaker becomes president until an election is held. That would be awkward, for he is a Hamas man, Aziz Dweik.
So where does that leave the 74-year-old Mr Abbas? Though his opponents, both Israeli and Palestinian, should take much of the blame, the fact is that, as a leader, he has failed. He is a ditherer. He wobbled feebly over whether to endorse a recent controversial report by Richard Goldstone on the Gaza war. Perhaps worst of all, he fluffed a chance, near the end of Ehud Olmert’s Israeli prime ministership earlier this year, to grasp Israel’s best offer so far, albeit privately mooted when Mr Olmert was on his way out. Had Mr Abbas said yes, it might have been hard for a future Israeli government to back out.
No one is bidding yet to replace him. Most of his senior people, as well as many Israelis, have asked him to reconsider. The most plausible successor would be Marwan Barghouti, who is respected by Hamas as well as by Fatah’s impatient rank-and-file, so would have a better chance of creating a unity government—and of negotiating effectively with the Israelis. The snag is that he is in an Israeli prison, serving five life sentences for murder during the intifada (uprising) that began in 2000.
Reports have again begun to circulate that Hamas may free an Israeli corporal, Gilad Shalit, who has been held by Hamas in Gaza for three years. If that happened, Mr Barghouti might be part of prisoner swap that could let out some 300-400 Palestinians. Or Mr Barghouti could be elected in Mr Abbas’s place but remain in prison as a diplomatic pawn, waiting for Israel to extract some public promises from him before his release. In any event, as things stand, the amiable but tired Mr Abbas may be around for quite a while yet.
Asia's Economies
The Road Ahead for Asia's Economies
The U.S. and its trading partners together can plot a course for robust growth.
TIMOTHY GEITHNER, SRI MULYANI INDRAWATI THARMAN SHANMUGARATNAM
We have just lived through the greatest challenge to the world economy in generations. In acting together, policy makers have shown that they understand the most important lesson of this crisis: Our economies are inexorably linked. We must now work together to ensure strong, stable and balanced growth in the future.
That is why we will be working together at this week's Asia-Pacific Economic Cooperation (APEC) meeting in Singapore to couple adjustment in deficit countries like the U.S. with the more rapid growth of domestic demand in surplus countries. As U.S. households save more and the U.S. reduces its fiscal deficit, others must spur greater growth of private demand in their own economies.
We also must keep our sights on maximizing the potential of global markets. Both exports and imports remain critical stimulate the flow of knowledge and innovation that is enabling emerging economies to catch up with developed-world living standards.
APEC will play an indispensable role in establishing strong, sustainable and balanced growth. Our 21 members—which include nine members of the G-20—account for 40% of the world's population, over half of global GDP and nearly half of world trade. Our ranks include the world's largest and fastest-growing economies. In the past two decades, we have promoted open markets by lowering tariffs among member economies by two-thirds and expanding trade by five-fold. No group is better-positioned to carry forward the principles for rebalancing global growth that the G-20 leaders agreed to in Pittsburgh in September.
Each of us already has adopted fiscal and monetary policies that are helping to revive growth in our individual economies and reinforcing each others' efforts. Each of us is working to keep our markets open and to avoid retreating behind trade and financial barriers. Each of us has recognized the importance of strong financial regulation and fiscal balance, and is pursuing these goals in ways that reflect our own circumstances but complement each others' efforts.
APEC members' priorities have to be focused increasingly on strategies to sustain private demand growth as fiscal stimulus measures are gradually unwound. Depending on individual economies' circumstances, a combination of macroeconomic policy adjustments and structural reforms will be needed. Market-oriented exchange rates in line with economic fundamentals will be essential in assuring the resource and sectoral shifts to match and foster the new patterns of demand.
To achieve durable growth, all of our economies must have flexible labor markets and an educated labor force. Among other things, emerging economies must strengthen their social safety nets through sustainable health and retirement-benefit schemes, thus reducing the need for high precautionary saving that contributes to global imbalances.
Regulatory frameworks conducive to competitive markets will support private enterprise, investment and innovation. Advanced economies are working hard to improve their financial regulations, to ensure that a crisis of this magnitude cannot happen again. And in the emerging economies, deeper and more efficient financial markets will enable better intermediation of savings and enhance investment productivity.
Reforms are also necessary to promote cross-border private investments, while ensuring an institutional capacity and prudent regulatory framework to enable markets to absorb capital flows that may be large and volatile. We remain committed to APEC's work to combat money laundering and terrorist financing. And as finance ministers of our respective countries, we are keenly aware that our future prosperity will be founded on a continued commitment to globalization.
The events of the last year have shown that our economies are bound together inextricably, and in more complex ways than we previously recognized. APEC members must forge a partnership of common interests to produce strong and balanced growth among our economies. We must reinvigorate the framework of cooperation to ensure that relations between our nations are as positive and mutually productive in the future as they have been in the past.
Mr. Geithner is the U.S. Treasury secretary. Ms. Mulyani and Mr. Shanmugaratnam are finance ministers of Indonesia and Singapore, respectively.
Bear Market Victory
Bear Market Victory
Losing money still isn't a crime.
Bad judgment is still not illegal. That was the message from Tuesday's acquittal of two Bear Stearns hedge fund managers accused of securities fraud amid last year's subprime meltdown. The verdict was a welcome rejection of the political class's banker baiting, which seems to have infected the Justice Department.
The Wall Street trial had become a cause celebre for a media and public seeking criminal scapegoats for the destruction of wealth brought on by the market's collapse. Ralph Cioffi and Matthew Tannin were accused of lying to investors about the outlook for the funds they ran as credit markets began to teeter in 2007. According to prosecutors, emails among the money managers expressing concerns not shared with clients amounted to criminal behavior.
Jurors weren't convinced. After reaching a verdict in six hours, several said the government hadn't come close to proving fraud. Ryan Goolsby said he felt "there was reasonable doubt on every charge." Aram Hong said she'd invest her own money with the defendants if she could. "Just because you're the captain of a ship and it gets hit doesn't mean you should be blamed," she told the New York Times.
The remarks send a strong signal that prosecutors should reserve their efforts for clear cases of fraud, rather than imagining criminal behavior into mistaken business judgments. This is especially significant given the public anger at bailouts and bonuses, a mood the prosecution tried to exploit by calling the defendants "masters of the universe" who thought they were above the law —a reference to the conceited Wall Street characters in Tom Wolfe's "Bonfire of the Vanities."
The jury also seemed to take a mature view of emails as evidence, looking for context and complete messages, instead of the snippets that former New York Attorney General Eliot Spitzer and others have used to paint a supposedly damning portrait of motives.
Here, jurors understood that in the course of investing hundreds of millions of dollars every day, portfolio managers say things about markets and positions as they figure out what to do. That kind of discussion is part of normal investment decision-making. Criminalizing it when things go south turns the law into a vehicle for punishing people merely for taking losses.
The acquittal is especially timely because Obama Administration prosecutors have advertised their desire to make a public example of the bankers they claim are responsible for the financial mania and panic. This mindset can lead to prosecutorial excess, as it did in the Bush Administration after Enron and WorldCom. Recall the indictment of Arthur Andersen and the infamous Thompson Memo that threw over attorney-client privilege.
This mentality seems alive and well among the Bear prosecutors, who have disparaged the verdict with off-the-record quotes about the supposed dimwits on the jury. One person familiar with the thinking in the U.S. Attorney's office for the Eastern District of New York told The Business Insider that "It is frustrating to lose a case not because the jury disagrees with evidence but because they just aren't able to follow anything."
In fact, they followed it very well. Criminal law should be reserved for criminal behavior—stealing, outright fraud, the kind of stuff that Bernard Madoff did. Criminalizing bad investment decisions and imperfect disclosure in the heat of a financial meltdown is a recipe for injustice.
A 69% Capital Gains Tax Hike . . .
A 69% Capital Gains Tax Hike . . .
Pelosi's 5.4% income surtax would hit capital gains and dividends.
Our job is to read bad legislation so you don't have to, and on that score we may demand combat pay for plowing our way through the House health-care bill that passed on Saturday. This thing has economic booby traps everywhere, such as favors for the tort bar (see below) and the largest capital gains tax increase in at least a half-century.
House Democrats are funding their new entitlement with a 5.4% surtax on incomes above $500,000 for individuals and above $1 million for joint filers. The surcharge is intended to snag the greatest number of taxpayers to raise some $460.5 billion, and so the House has written it to apply to modified adjusted gross income. That means it includes both capital gains and dividends.
That surtax takes effect on January 1, 2011, or the day the Bush tax rates of 2001 and 2003 expire. Today's capital gains tax rate of 15% would bounce back to 20% because of the Bush repeal and then to 25.4% with the surtax. That's a 69% increase, overnight. The last time investors were hit with anything comparable was 1986, when the capital gains rate jumped to 28% from 20%, a 40% increase, as part of the Reagan tax reform that lowered income tax rates.
![[ 1capgains ]](http://s.wsj.net/public/resources/images/ED-AK486_1capga_NS_20091111180424.gif)
The 1986 experience was not a happy one. Tax revenues from capital gains surged before the increase took effect in 1987, as investors moved to cash in at the lower rate. Revenues then plummeted. Total realized capital gains didn't again reach their 1985 level of $172 billion until 1996. By 1992, the federal government was barely getting more in revenue ($29 billion) at the 28% rate than it did in 1985 ($26.5 billion) at the 20% rate.
Rate reductions, as in 2003 when Republicans cut the rate to 15% from 20%, have typically had the opposite effect. Treasury receipts from capital gains climbed to an estimated $117.8 billion in 2006 from $49 billion in 2002.
While the rising stock market through this period played a role, so did the "unlocking" effect from a lower rate that reduces the friction of taxes on decisions to buy or sell and thus report a capital gain. Both the economy and the Treasury also benefitted when Bill Clinton agreed to reduce the rate to 20% from 28% as part of his budget deal with Newt Gingrich in 1997.
Candidate Obama acknowledged this reality in April of 2007, when he backed away from his original proposal to nearly double the capital gains rate to 28%, and instead suggested 20%. He also promised to eliminate the tax entirely for small business. "I'm mindful that we've got to keep our capital gains tax to a point where we can actually get more revenue," he said at the time.
While families of all income levels realize capital gains, Internal Revenue Service data from 2007 show that 58% of overall capital gains revenue was reported by taxpayers with adjusted gross income above $1 million—and would be subject to the new 25.4% rate. The actual percentage of revenue subject to the penalty would be higher when counting individuals with income above $500,000.
Some readers may think that this 5.4% surtax can't possibly make it into a final Congressional bill due to Senate opposition, but we wouldn't be so sure. Mr. Obama hasn't said so much as a discouraging word about the House bill. And we've seen in the past 10 months that when Mr. Obama's campaign promises clash with the priorities of House liberals, the liberals always win.
The Fed's Woody Allen Policy
Efforts to stoke a recovery may be creating new asset bubbles in equities and elsewhere.
JUDY SHELTON
In the Woody Allen film "Annie Hall," the main character tries to explain irrational relationships by recounting an old joke. "This guy goes to a psychiatrist and says, 'My brother's crazy, he thinks he's a chicken.' The doctor says, 'Well, why don't you turn him in?' And the guy says, 'I would, but I need the eggs.'"
It takes similar reasoning to reconcile the elation felt across America every time the stock market rises—partially replenishing personal investment portfolios and 401(k) retirement plans—with the uneasy feeling that we are being set up for yet another big financial disappointment. We dare to hope that the economy is growing solidly once more, that the Federal Reserve has superior knowledge about providing liquidity, and that the U.S. Treasury knows what it's doing by guaranteeing money market-fund assets.
But what if the Fed's efforts to stoke a recovery are merely creating asset bubbles in equities and elsewhere? What if government guarantees—explicit and implicit—are encouraging high-risk investment behavior rather than restoring conditions for normal market returns? What if excess dollars produced here are being channeled by speculators into foreign stock and bond markets as part of a currency play?
The Fed's decision last week to keep pumping out money at near-zero interest rates is worrisome. In its statement, the Federal Open Market Committee (FOMC) notes that "low rates of resource utilization" are the main justification for continuing to make funds available to banks at "exceptionally low levels of the federal funds rate for an extended period"—by which it means that banks can continue to borrow at 0%-0.25% and then lend the money out to borrowers seeking to earn much higher returns. The FOMC cites "subdued inflation trends" and "stable inflation expectations" as reassuring evidence that money is not being created in excess.
Meanwhile, the Labor Department's announcement last Friday that unemployment surpassed 10% certainly testifies to "low rates of resource utilization," i.e., the considerable slack in the economy. From the Fed's point of view, the nearly 16 million people who can't find jobs represent the "output gap" between actual and potential gross domestic product. If everyone were gainfully employed, so the reasoning goes, there would be pressure on employers to raise wages and the increased cost would be reflected as inflation. Since core inflation is running low— 1.5% as measured by the consumer price index, 1.3% as measured by personal consumption expenditures (the price index preferred by the Fed)—it follows that money can be manufactured with impunity for the foreseeable future.
But wait a minute. If unemployment is high, doesn't that indicate a surplus of labor relative to the demand for labor? Wouldn't that cause the price of labor to come down? If you throw in the fact that industrial capacity utilization, at 70%, is lower now than during any prior recession since the Fed began tracking it in 1967, and that the housing vacancy rate is nearly 11%, you begin to wonder why the price level should nevertheless continue to rise, even by a little bit, every month.
"With substantial resource slack likely to continue to dampen cost pressures," as the FOMC statement so convincingly affirms, it hardly makes sense that "subdued" inflation should provide comfort. Why should there be any inflation at all?
Maintaining stable prices, after all, is one of the Fed's primary missions. The notion of price stability over time suggests that when the economy is going through a deep recession, the level of prices might reasonably be expected to come down.
Deflation is seen as the bugaboo of Keynesian economics. But it can actually serve to spur economic activity as lower prices enable struggling consumers to get back in the game, and enterprising individuals can build businesses using tangible assets that yield valid profits.
But the Fed seems to think that prices should only go in one direction—up—no matter the circumstances. It's this bias toward inflation that is revealed by the FOMC's reference to "stable inflation expectations"—which is less a paean to price stability than an inadvertent oxymoron.
The Fed's asymmetrical thinking extends as well to its treatment of financial assets—such as equity and debt instruments—en route to a bubble. As prices surge and markets soar, the Fed is reluctant to raise interest rates lest it be accused of hindering growth. But when the bubble bursts and asset prices begin to tumble, the Fed quickly steps in with dramatic interest rate reductions to "restore investor confidence" in hopes of avoiding a meltdown.
In the last eight months, the Dow Jones Industrial Average has risen from its March 6 low of 6470 to over 10290 today, a gain of roughly 59%. The Nasdaq Composite Index and the S&P 500 Index have likewise increased about 71% and 65%, respectively, since early March. Are we looking at the restoration of legitimate values or the emergence of disastrous new asset price bubbles?
The answer would seem to lie in whether the Fed's money machine is fueling an illusory recovery that is only manifested in financial markets as opposed to the general economy. The FOMC's own report acknowledges that economic activity remains weak, household spending is constrained, and businesses are still cutting back on fixed investment and staffing.
Indeed, the Fed insists that "tight credit" conditions still persist; doubtless, there are many small business owners who could attest to that reality. But looking at the huge increase in financial asset prices across broad indices—not just in America, but globally—you would never guess that monetary policy could be anything but loose.
Now here's the scary part: Even though more than half of all American households now own equities directly or through mutual funds, an increase in equity prices does not figure into the Fed's calculation of inflation. So while measures of core inflation (which exclude food and energy) carefully register minute gains in the price of a fixed basket of goods and services meant to reflect what a typical family buys to achieve a minimum standard of living, they ignore massive price surges in what has effectively become a widely held consumer good: stocks.
Moreover, the Fed's inflation-targeting approach overlooks price increases for real estate and rising commodity prices. Don't even mention gold, which has gone from $707 to $1,114 since a year ago.
Even if the Fed seems blithely unaware of the havoc it may be wreaking through its irrationally loose monetary policy, in tandem with the distortions of moral hazard inflicted by intrusive government, Americans seem willing to accept the insanity of boom-and-bust cycles. Sure, we could be facing the latest Fed-induced bubble—but so what?
We need the eggs.
Ms. Shelton, an economist, is the author of "Money Meltdown" (Free Press, 1994).
Obama's plan to nationalize the midterm elections may backfire.
By KARL ROVE
Republican victories in New Jersey and Virginia governors' races last week—despite eight campaign appearances in the two states by President Barack Obama—have unnerved Democrats.
Over the weekend, White House Senior Adviser David Axelrod tried to calm jittery Democrats who might go wobbly on the president's ambitious agenda by telling NBC's Chuck Todd that next year's congressional elections will be "nationalized." Because they "will be a referendum on this White House," he said, voters will turn out for Mr. Obama. Mr. Todd summed up Mr. Axelrod's plans by saying, "It's almost like a page from the Bush playbook of 2002."
I appreciate the reference. Only two presidents have picked up seats in both houses of Congress for their party in their first midterm elections. One was FDR in 1934. The other was George W. Bush in 2002, whose party gained House seats and won back control of the Senate.
But those midterm elections might not be a favorable comparison for this White House. The congressional elections were nationalized seven years ago largely because national security was an overriding issue and Democrats put themselves on the wrong side of it by, among other things, catering to Big Labor.
At the time, there was a bipartisan agreement to create the new Department of Homeland Security. Democrats insisted that every inch of the department be subject to collective bargaining. They pushed for this even though sections of every other department can be declared off-limits to unionization for national security reasons. What Democrats wanted was shortsighted and dangerous. Voters pounded them for it.
Mr. Bush also had a record of bipartisanship that included winning passage of the No Child Left Behind Act with the support of Democrats Sen. Ted Kennedy and Rep. George Miller. And he had a popular agenda of tax cuts, regulatory reform, and sound leadership in the wake of 9/11 that the GOP could run on. Mr. Obama lacks a comparable foundation.
Instead, the narrative Obama White House officials are writing about themselves is that they are uncompromising, ungracious, and ready to run roughshod over popular opinion. They have mastered the Chicago way of politics: reward friends, punish enemies, and jam the opposition. Voters have a tendency to quickly grow tired of pugnacious governance.
That's only the beginning of Mr. Axelrod's problems. If the 2010 midterms are nationalized, they will be a referendum on Mr. Obama's increasingly unpopular policies. For example, in the newest Gallup survey released on Monday, only 29% say they'd advise their congressman to vote for the health-care bill. This is down from 40% last month. A Rasmussen poll out this week shows that 42% of Americans strongly oppose the bill, while only 25% strongly favor it.
Mr. Obama is increasingly seen as governing from the left—the latest Gallup poll shows that 54% of Americans say the president's policies have been mostly liberal and only 34% say they are mostly moderate. That's a risky position to be in when the country leans to the right.
High unemployment and the president's low approval on jobs and the economy (which is at 46% in a CNN/Opinion Research poll released last week), won't by themselves sink Democrats. But what will hurt are the beliefs that Mr. Obama's $787 billion stimulus bill was a flop and that he doesn't know how to speed up the economic recovery.
Mr. Obama's approval on handling the deficit in the CNN/Opinion Research survey is now 39%. The president's plans to triple the deficit over the next decade is causing a level of angst among independents that we haven't seen since Ross Perot ran for president in the 1990s. This angst has given Republicans a four-point lead in Gallup's generic ballot (48% to 44%), putting the party in a better position than it was in spring 1994, just a few months before its historic takeover of Congress.
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.
Democrats increasingly recognize their vulnerability. Of the 80 House Democrats whose districts were carried by Mr. Bush or John McCain, nine voted against the stimulus, 21 against a budget resolution that called for doubling the national debt in four years, 36 against cap and trade, and 36 against health care. Defections will grow. Nothing concentrates a troubled centrist's mind like a coming election.
Maybe the Obama inner sanctum realizes that its agenda is unpopular and will cost many Democrats their seats next year but calculates that enough will survive to keep the party in control of Congress. Perhaps they have decided that Mr. Obama's goal of turning America into a European-style social democracy is worth risking a voter revolt.
Many Democrats who will be on the ballot next year may come to a different conclusion. Nationalizing the elections over an unpopular agenda isn't likely to repeat Mr. Bush's feat of picking up congressional seats. It is, however, likely to lead to more Republican congressmen than are there now.
Mr. Rove is the former senior adviser and deputy chief of staff to President George W. Bush.
White House Aims to Cut Deficit With TARP Cash
White House Aims to Cut Deficit With TARP Cash
DEBORAH SOLOMON JONATHAN WEISMAN
WASHINGTON -- The Obama administration, under pressure to show it is serious about tackling the budget deficit, is seizing on an unusual target to showcase fiscal responsibility: the $700 billion financial rescue.
The administration wants to keep some of the unspent funds available for emergencies, but is considering setting aside a chunk for debt reduction, according to people familiar with the matter. It is also expected to lower the projected long-term cost of the program -- the amount it expects to lose -- to as little as $200 billion from $341 billion estimated in August.
The idea is still a matter of debate within the administration and it is unclear how much impact it would have on the nation's mounting deficit levels. Still, the potential move illustrates how the Obama administration is trying to find any way it can to bring down the deficit, which is turning into a political as well as an economic liability.
The White House is in the early stages of considering what bigger moves it might make for next year's budget. The Office of Management and Budget has asked all cabinet agencies, except defense and veterans affairs, to prepare two budget proposals for fiscal 2011, which begins Oct 1, 2010. One would freeze spending at current levels. The other would cut spending by 5%.
OMB is also reviewing a host of tax changes. The President's Economic Recovery Advisory Board will submit tax-policy options by Dec. 5, including simplifying the tax code and revamping the corporate tax code.
White House Chief of Staff Rahm Emanuel is pressing for substantial spending cuts to go with any tax increases to try to avoid the "tax and spend" label that has bedeviled Democrats, according to administration and congressional officials.
The administration is constrained in tackling the mounting deficit, since raising taxes or slashing spending could stunt economic growth. Administration officials say the Obama economic team is especially concerned that rapid deficit reduction could hurt the economy.
![[Digging Out chart]](http://s.wsj.net/public/resources/images/NA-BB939_DEFICI_NS_20091111193626.gif)
On the $700 billion Troubled Asset Relief Program, the administration is considering a change that may appear to improve the fiscal situation. Agreeing not to spend a certain amount of TARP money will enable the White House, in its budget projections, to assume less money out the door and, therefore, less debt issued. The move would also reduce the deficit by an unknown amount since a certain level of spending and borrowing is already factored into estimated future deficits.
The Treasury Department said about $210 billion in TARP funds remains unspent, including about $70 billion returned from financial institutions. A further $50 billion is expected to be repaid in the next 12 to 18 months.
Budget experts said committing some TARP funds toward debt reduction could help calm concerns about the size and intent of the program. "I don't necessarily want them to pull back in a huge way, because there's a lot of uncertainty, but right now what we've got could turn into a $700 billion slush fund" for Congress, said Douglas Elliott, a fellow with the Brookings Institution, a liberal think tank.
The move could buy the Treasury Department time before it hits the so-called debt ceiling, which limits the amount of money the U.S. can borrow. Already, some members of Congress have said they won't approve an increase in the $12.1 trillion debt cap unless efforts to reduce the deficit are included.
Senate Budget Committee Chairman Kent Conrad, the North Dakota Democrat who is proposing a bipartisan commission, along with Sen. Judd Gregg (R., N.H.), to examine taxes, said he won't vote for raising the debt limit unless Congress and the administration start talking about cutting spending and increasing taxes.
Wednesday, November 11, 2009
When the shooter becomes the victim
Victimology gives Maj. Hasan a pass
A disturbing story line is taking shape in the wake of the Fort Hood massacre. Some are trying to explain suspect Maj. Nidal Malik Hasan's motives for reportedly gunning down 13 people in cold blood by ignoring the ideology of hate that sanctified the killings. Instead, we're supposed to seek out the "real reasons."
It's the typical victimology: Bemoan the perpetrator's troubles and then sprinkle liberally with pop psychology. Maj. Hasan supposedly felt alienated and oppressed because people did not understand his faith. They discriminated against and taunted him, then they keyed his car. Hearing the horrors of war from the wounded at Walter Reed Army Medical Center disturbed him. Orders to deploy overseas added to the psychological pressure - we might call it pre-traumatic stress disorder. These and other factors reportedly drove Maj. Hasan to do what he is accused of doing. Yes, he is guilty, the argument goes, but doesn't society also share part of the blame? Aren't we all a little guilty?
President Obama summed up this approach when he said "there are going to be instances in which an individual cracks." But the suspected killer, Maj. Hasan, did not crack. He was not a regular person who woke up one morning and went on a rampage. He was a true believer who purportedly methodically planned and executed an attack against a country he had come to view as his enemy. For Maj. Hasan, the killings of which he is suspected were a choice.
The president said Maj. Hasan's reported explosive acts of violence were "inexplicable," but that is not true. The massacre was the logical culmination of a belief system that advocates and sanctifies murderous violence. Maj. Hasan apparently saw himself as a jihadist warrior, and in 2007, when he briefed his co-workers that "[w]e love death more then [sic] you love life," they should have taken him literally.
Maj. Hasan was not someone silently suffering oppression who one day just lost control. He was a suspected practitioner of an ideology of hate who reportedly completed the logical journey he embarked on. Maj. Hasan was not insane when he purportedly pulled the trigger, he was in rapture. When he reportedly started shooting, he did not cry out in anger, but testified to his god. He was not a victim pushed over the edge but apparently a "martyr" taking a leap of faith.
Attacks like this are rare in the United States but happen frequently abroad. There is no reason the United States should be immune from it. The ideology of death reaches into every country. While some Americans won't recognize him as a terrorist, other jihadists hail Maj. Hasan, recognizing him as one of their own. "He is a hero, a hero, a hero," one advocate of jihad commented on a Middle Eastern Web site. A poster named "Al-Mahrum min al-Jihad" referred to the white traditional garb Maj. Hasan wore in video footage from earlier that morning, saying, "Brothers, notice his attire. It screams, 'I am going to kill.' " Another named "malik" said that "the attack carries the same characteristics as those of Al-Qa'ida of Jihad, my brothers."
To call this an example of "workplace violence" is absurd and dangerous. Maj. Hasan's suspected jihadist belief system inspired, directed and justified his actions. It is a mobilizing ideology focused on action. Its entire purpose is to create more people like the suspect, Maj. Hasan, and more victims.
The Fort Hood massacre cannot be understood absent this context. It was not an aberration or a fit of insanity. Maj. Hasan's purported acts were the pure expression of everything he evidently sincerely held to be true. From Maj. Hasan's apparent point of view, the only tragedy is that he was not killed in the process. Now he's not going to paradise, and those 72 virgins will have to wait.
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