One of the lasting effects of the 2008 financial crisis was the belief that the distribution of economic power had radically shifted. China rising, West fading, yadda, yadda, yadda. A minor key in this argument has been the notion that a new and important measure of economic power is the size of a country's official reserves. This has led to the occasional panicked article that "China is buying gold!!" or "Russia is hoarding gold!!" or "Germany is moving gold!!" as a first step towards pushing the dollar out as the world's reserve currency. 

Which is just so much horses**t. 

Here are three facts to remember whenever you read any story about a BRIC economy hoarding gold: 

1) Buying gold would have been extremely savvy in 2008. Now it's just silly. The price of gold peaked at over $1900 in September 2011 -- and despite massive amounts of quantitative easing and numerous reports about central bank hoarding, it's fallen by $300 since and trending downward.

2) The BRIC economies did not have a lot of gold to begin with. As Bloomberg notes, "Russia’s total cache of about 958 tons is only the eighth largest [in the world]." 

3)  So who does have the largest reserves of gold?  Real Clear World posts the latest World Gold Council report. The biggest holders of gold are: 

1. The United States (8,134 tons)

2. Germany (3,391 tons)

3. The International Monetary Fund (2,814 tons)

4. Italy (2,451 tons)

5. France (2,435 tons)

So, to sum up: To believe that gold holdings really matter in the global political economy, you have to be willing to assert that Italy is a great power in global finance. I, for one, am not going there. 

A little more than a year ago I blogged that global policymakers had reached a "focal point" moment on the merits of austerity as a macroeconomic policy during a global recession. Namely, central bank authorities had concluded that the policy doesn't really work well at all. If true, this was a big deal. One could argue that from the May 2010 Toronto G-20 summit to the end of 2011 was a period where the austerity policies were widely touted and occasionally implemented. If this was the wrong policy, and there was a shift, that's kind of a big deal.

So where are we now on this? 

On the public commentary side, I'd say we're approaching near-consensus on the failures of austerity for large economies. The passing of time has allowed for a comparative look at the data, and the results are not pretty for austertity enthusiasts. Martin Wolf sums up the indictment rather neatly, riffing off of a paper by Paul De Grauve and Yuemei Li: 

[T]he chief determinant of the reduction in spreads over German Bunds since the second quarter of 2012, when OMT [the ECB pledge to open up its monetary taps] was announced, was the initial spread. In brief, "the decline in the spreads was strongest in the countries where the fear factor had been the strongest."

What role did the fundamentals play? After all, nobody doubts that some countries, notably Greece, had and have a dreadful fiscal position. One such fundamental is the change in the ratio of debt to gross domestic product. The paper makes three important observations. First, the ratio of debt to GDP increased in all countries even after the ECB announcement. Second, the change in this ratio turned out to be a poor predictor of declines in spreads. Finally, the spreads determined the austerity borne by countries.

On the policy output side, there's been a demonstrable but partial shift. In the past year, the European Central Bank, Federal Reserve, and Bank of Japan have rejected austerity policies in favor of greater levels of quantitative easing. Furthermore, contrary to the outright hostility developing countries directed at quantitative easing in the fall of 2010, the reaction to the past half-year of quantitative easing has been far more muted. When the latest G-20 communique said: 

Monetary policy should be directed toward domestic price stability and continuing to support economic recovery according to the respective mandates. We commit to monitor and minimize the negative spillovers on other countries of policies implemented for domestic purposes.

That was code for "hey, G-7 central banks, you gotta do what you gotta do. We get that."  Which is demonstrably different from yelling "currency wars", a meme that seems not to have caught fire this time around. 

Top central bank authorities have also been willing to speak truth to power -- in this case, GOP members of Congress. John Cassidy recounts Ben Bernanke's testimony from yesterday: 

Departing from his statutory duty of reporting to the Senate Banking Committee on the Fed’s monetary policy, Bernanke devoted much of his testimony to fiscal policy, warning his congressional class that letting the sequester go ahead would endanger the economic recovery and do little or nothing to reduce the country’s debt burden.

"Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant," Bernanke told his students, who included a number of right-wing Republican diehards, such as Senator Bob Corker, of Tennessee, and Patrick Toomey, of Pennsylvania. "Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run."

Translated from Fed-speak, that meant that congressional Republicans have got things upside down. Bernanke has warned before about the dangers of excessive short-term spending cuts. But this was his most blunt assertion yet that Mitch McConnell, John Boehner, et al. should change course. "To address both the near- and longer-term issues, the Congress and the Administration should consider replacing the sharp, frontloaded spending cuts required by the sequestration with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run," Bernanke said. "Such an approach could lessen the near-term fiscal headwinds facing the recovery while more effectively addressing the longer-term imbalances in the federal budget."

So does this mean some additional policy shifts? Alas, probably not. The consensus against austerity seems pretty strong on the monetary policy side of the equation. On the fiscal policy dimension, however, austerity remains the de facto policy for a lot of economies. This includes the United States, which is conventionally depicted as not having embraced austerity. The New York Times' Binyamin Appelbaum outlines the current fiscal austerity in his story today: 

The federal government, the nation’s largest consumer and investor, is cutting back at a pace exceeded in the last half-century only by the military demobilizations after the Vietnam War and the cold war.

And the turn toward austerity is set to accelerate on Friday if the mandatory federal spending cuts known as sequestration start to take effect as scheduled. Those cuts would join an earlier round of deficit reduction measures passed in 2011 and the wind-down of wars in Iraq and Afghanistan that already have reduced the federal government’s contribution to the nation’s gross domestic product by almost 7 percent in the last two years.

The cuts may be felt more deeply because state and local governments — which expanded rapidly during earlier rounds of federal reductions in the 1970s and the 1990s, offsetting much of the impact — have also been cutting back.

Federal, state and local governments now employ 500,000 fewer workers than they did on the eve of the recession in 2007, the longest and deepest decline in total government employment since the aftermath of World War II.

Total government spending continues to increase, but those broader figures include benefit programs like Social Security. Government purchases and investments expand the nation’s economy, just as private sector transactions do, while benefit programs move money from one group of people to another without directly expanding economic activity.

The reason for this split does not require rocket science. Monetary policy is a tool of politrically insulated central bankers. Fiscal policy is a tool for elected politicians. The public might dislike specific budget cuts, but damn if they don't love austerity in theory. 

So, in retrospect, I think early 2012 was a focal point -- but only for central bankers and commentators. As Cassidy notes, there remain elected politicians who are super-keen on austerity: 

Corker, a former builder who is a long-time critic of Bernanke’s expansionary policies, called him "the biggest dove since World War Two." Toomey, a former head of the conservative lobbying group Club for Growth, questioned whether the sequester would have any real impact on the economy. Bernanke shrugged off the criticisms, calmly and methodically laying out the realities of the situation.

Developing...

As European leaders meet -- again -- to figure out what to do about the Eurocrisis, Business Insider's Pascal-Emmanuel Gobry fires a broadside at the entire edifice of independent central banks: 

If one myth has been slain by the financial crisis and the response to it, it's the idea that central banks ought to be independent and unaccountable politically.

The idea of central bank independence was that it would guarantee good monetary policy. During the Great Moderation it certainly seemed that way. But now it's no longer the case...

[The] point is that the choice between inflation and unemployment is a political, not a technical choice. What's "better"? To screw debtors or creditors? To make millions unemployed or to "debase the currency"? Those are very important questions. More important, they're questions that cannot be solved by economics. They can be informed by them, but at the end of the day what you prefer is going to come down to your own moral value system. In other words, it's a political choice. And the way we make political choices in modern countries is through the democratic process, not through unelected, unaccountable technocrats....

The bottom line is that the argument of supercompetence of central bankers is dead and once that's gone you need to revert those powers back to the political process (emphasis in original).

Now, this is a pretty powerful argument.  One would be hard-pressed to say that Jean-Claude Trichet or Alan Greenspan or Ben Bernanke have covered themselves in glory during the past five years or so.  Why not return central banking to the politicians? 

Well.... before I answer, I want to object to Gobry's framing of the issue in two ways.  First, he sets up a too-simple dichotomy between "independence" and "political control."  The devil is in the details here.  Political scientists have done a lot of research into how legislatures exert influence over supposedly "independent" institutions like courts and regulatory agencies, and this logic applies to central banks as well.  Or, to put it another way, I suspect that Ben Bernanke would be pumping more money into the economy were it not for a fear of Congressional blowback.  Furthermore, "political control" is unclear here -- which politicians have control?  Would central bankers be directly elected?  Appointed by the legislature?  Appointed by the executive subject to recall?  And so forth. 

Second, the notion that central banking decisions are strictly political seems as wrong as characterizing them as strictly technical.  It is overly cynical to believe that either technocrats or politicians gin up any old theory to justify the policy ends they seek.  As with Supreme Court disputes, there are genuine disagreements in economics on the theory side.  At this very moment, different central bankers disagree over the best way to reduce unemployment in part because of different economic theories.  Expertise is kinda important in these moments.  

OK, these contestations aside, I still have a basic problem with Gobry's argument.  For Gobry's process to work better, voters have to punish politicians for poor monetary policy and reward them for wise and prudent monetary policies.  I see little evidence that voters would have the necessary knowledge and attention span to do this.  Instead, they would likely vote on other considerations, or vote based on short-term considerations such as the unemployment rate and GDP growth without considering whether short-term pump-priming is occurring or long-term sustainable growth.  Furthermore, politicians would rig the game just a bit.  Political scientists have extensively discussed the existence of "political business cycles" due to fiscal policy. I have every confidence that political control over monetary policy would simply extend the phenomenon to that policy lever as well. 

The fact that politicians still control the fiscal lever is what leads me to think that central banking should still be independent.  A diversification of political controls over the economy seems like the best minimax strategy over the long run.  Thinking back to how U.S. politicians would have handled the last 20 years of central banking, I suspect that they simply would have exacerbated the boom-bust dot-com and housing bubbles.  It's not clear at all that the added democratic gain outweighs the loss in policy competence. 

That said, Gobry makes a powerful argument, and I'd like to hear from readers.  Has independent central banking jumped the shark?  What do you think? 

Your humble blogger is currently knee-deep in a pedagogical project on the foundations of economic prosperity.  You can imagine my delight, then, that Daron Acemoglu and James Robinson have a new book coming out on that very topic:  Why Nations Fail: The Origins of Power, Prosperity, and Poverty.  There's an excerpt in the Montreal Review -- let's see how it opens, shall we?

To understand what these institutions are and what they do, take another society divided by a border. South and North Korea. The people of South Korea have living standards similar to those of Portugal and Spain. To the north, in the so-called Democratic People's Republic of Korea, or North Korea, living standards are akin to those of a sub-Saharan African country, about one tenth of average living standards in South Korea. The health of North Koreans is in an even worse state; the average North Korean can expect to live ten years less than their cousins to the south of the 38th parallel.

These striking differences are not ancient. In fact they did not exist prior to the end of the Second World War. But after 1945 the different governments in the north and the south adopted very different ways of organizing their economies....

It should be no surprise that the economic fortunes of South and North Korea diverged sharply. Kim Il-Sung's command economy soon proved to be a disaster. Detailed statistics are not available from North Korea, which is a secretive state to say the least. Nonetheless, available evidence confirms what we know from the all too often recurring famines: not only did industrial production fail to take off but North Korea in fact experienced a collapse in agricultural productivity. Lack of private property meant that few had incentives to invest or exert effort to increase or even maintain productivity. The stifling repressive regime was inimical to innovation and adoption of new technologies. But Kim Il-Sung, his son and successor, the "dear leader" Kim Jong-Il, and their cronies had no intention to reform the system, or to introduce private property, markets, private contracts, and economic and political freedoms. North Korea continues to stagnate economically, and there is no sign that anything will be different under the new "dear leader" Kim Jong-un.

Meanwhile in the south economic institutions encouraged investment and trade. South Korean politicians invested in education, achieving high rates of literacy and schooling. South Korean companies were quick to take advantage of the relatively educated population, the policies encouraging investment and industrialization, the export markets, and the transfer of technology. South Korea became one of East Asia's `Miracle Economies,' one of the most rapidly growing nations in the world. By the late 1990s, in just about half a century, South Korean growth and North Korean stagnation led to a tenfold gap between the two halves of this once-united country---imagine what a difference a couple centuries could make. The economic disaster of North Korea, which not only prevented growth but led to the starvation of millions, when placed against the South Korean economic success, is striking: neither culture nor geography nor ignorance can explain the divergent paths of North and South Korea....

The contrast of South and North Korea illustrates a general principle: inclusive economic institutions foster economic activity, productivity growth and economic prosperity, while extractive economic institutions generally fail to do so. Property rights are central, since only those who have secure property rights will be willing to invest and increase productivity. A farmer, for example, who expects his output to be stolen, expropriated or entirely taxed away would have little incentive to work, let alone any incentive to undertake investments and innovations. But extractive economic institutions do exactly that and fail to uphold property rights of workers, farmers, traders and businessmen.

It will not shock you, my dear readers, to learn that I agree with Acemoglu and Robinson.  Indeed, as Ezra Klein showed with the following chart, the divergent paths of North and South Korea represents ironclad evidence about the power of instituions to determine prosperity: 

Well, that's pretty damn persuasive, isn't it?  It seems pretty friggin' obvious which institutions work and which ones don't! 

Actually, to be more accurate, it seems pretty friggin' obvious now.  Here's another chart that extends that graph back another two decades: 

Things look sightly different in this chart.  That massive divergence is still there, but what's stunning is that for the 25 years before that, the DPRK and ROK looked exactly the same in terms of per capital income.  Indeed, as Nicholas Eberstadt notes: 

Around the time of Mao Zedong's death (1976), North Korea was more educated, more productive and (by the measure of international trade per capita) much more open than China. Around that same time, in fact, per capita output in North Korea and South Korea may have been quite similar. Today, North Korea has the awful distinction of being the only literate and urbanized society in human history to suffer mass famine in peacetime. 

My point here is not to defend Kim Il Sung or suggest that the DPRK's economic institutions are underrated.  Rather, my point is that as data analysts, we're all prisoners of time.  Had Acemoglu and Robinson written Why Nations Fail in the mid-1970s, it would have either made a different argument or it would have had a much tougher case to make about the merits of inclusive vs. extractive institutions (during the 1970s, commodity extracting states were looking pretty good). 

Keep these charts in mind whenever anyone confidently asserts the obvious superiority of a particular model of political economy.  Because, I assure you, there was a point in time when such superiority was far from obvious.  And there might be another such point in the future. 

In my experience, pundits tend to be risk-averse in calling out a very rich person on their economic or financial analyses.  There's a couple of intuitive logics at work here: 

1)  Most pundits don't know much about economics, and so are leery of entering those waters;

2)  The really rich person likely became really rich because they demonstrated a shrewd understanding of the markets -- therefore, who is the low-six-figure-or-less-earning pundit to challenge such high-yielding wisdom;

3)  Most pundits refuse to admit that they don't understand something that reads like gobbledgook, because they're afraid this makes them look like an idiot.

Well, your humble blogger has never been afraid of looking like an idiot... which brings me to PIMCO's Bill Gross.  I'll occasionally read his monthly newsletter when a link to it pops up in my Twitter feed.  Every time, I'm amazed at the florid, rambling, not-really-related-to-his-main-point way he opens these little essays. Sometimes I find the analysis afterwards useful, sometimes I find it eerily similar to what someone says after spending too much time with Tom Friedman.  I gather he's had better years as an analyst than he did in 2011, but everyone has down years and bad predictions. 

Here's the thing, though -- I can't understand a word of his latest Financial Times column:  Here's how it opens: 

Isaac Newton may have conceptualised the effects of gravity when that mythical apple fell on his head, but could he have imagined Neil Armstrong’s hop-skip-and-jumping on the moon, or the trapping of light inside a black hole? Probably not. Likewise, the deceased economic maestro of the 21st century – Hyman Minsky – probably couldn’t have conceived how his monetary theories could be altered by zero-based money.

Things get a little clearer towards the end of the op-ed... but not much.  His February 2012 newsletter appears to be an expanded version of this op-ed (plus the usual wacky opening), so let's go there to see what he's trying to say: 

[W]hen rational or irrational fear persuades an investor to be more concerned about the return of her money than on her money then liquidity can be trapped in a mattress, a bank account or a five basis point Treasury bill. But that commonsensical observation is well known to Fed policymakers, economic historians and certainly citizens on Main Street. 

What perhaps is not so often recognized is that liquidity can be trapped by the “price” of credit, in addition to its “risk.” Capitalism depends on risk-taking in several forms. Developers, homeowners, entrepreneurs of all shapes and sizes epitomize the riskiness of business building via equity and credit risk extension. But modern capitalism is dependent as well on maturity extension in credit markets. No venture, aside from one financed with 100% owners’ capital, could survive on credit or loans that matured or were callable overnight. Buildings, utilities and homes require 20- and 30-year loan commitments to smooth and justify their returns. Because this is so, lenders require a yield premium, expressed as a positively sloped yield curve, to make the extended loan. A flat yield curve, in contrast, is a disincentive for lenders to lend unless there is sufficient downside room for yields to fall and provide bond market capital gains. This nominal or even real interest rate “margin” is why prior cyclical periods of curve flatness or even inversion have been successfully followed by economic expansions. Intermediate and long rates – even though flat and equal to a short-term policy rate – have had room to fall, and credit therefore has not been trapped by “price.” 

Even if nodding in agreement, an observer might immediately comment that today’s yield curve is anything but flat and that might be true. Most short to intermediate Treasury yields, however, are dangerously close to the zero-bound which imply little if any room to fall: no margin, no air underneath those bond yields and therefore limited, if any, price appreciation. What incentive does a bank have to buy two-year Treasuries at 20 basis points when they can park overnight reserves with the Fed at 25? What incentives do investment managers or even individual investors have to take price risk with a five-, 10- or 30-year Treasury when there are multiples of downside price risk compared to appreciation? At 75 basis points, a five-year Treasury can only rationally appreciate by two more points, but theoretically can go down by an unlimited amount. Duration risk and flatness at the zero-bound, to make the simple point, can freeze and trap liquidity by convincing investors to hold cash as opposed to extend credit (emplases in original).

And... sorry, I still don't get it.  I get why zero interest rates are bad for bondholders like PIMCO.  I get that flat yield curves + high amounts of economic uncertainty = cash hoarding.   What I don't get is that:

A)  Gross himself acknowledges that the yield curve ain't flat;

B)  Low interest rates allow for private-sector deleveraging, which is a prelude to stimulating market demand;

C)  Low interest rates prevent today's government binge from being even more expensive than it would be in normal times (by keeping financing costs down);

D)  If uncertainty is decreasing -- and that appears to be the case with the U.S. economy -- then low interest rates should spur greater entrepreneurial investments. 

So, at the risk of threatening my status in the International Brotherhood of Serious Global Political Econmy Bloggers That Talk Seriously About Economics, I hereby ask my commenters to explain Bill Gross' concerns to me. Because I don't get it -- and I'm beginning to wonder if I'm not the only one.

Let's face it, there's a general anxiety about the future of America.  There's Tom Friedman's column today, which my doctors have now forbade me from critiquing in order to keep my blood pressure down.  Books suggesting the United States is kowtowing to China are forthcoming.  The Economist recently observed on the highlights of a sobering survey of Harvard Business School graduates, which contained the following:

Fully 71% of the businesspeople polled expected America’s competitiveness to decline over the next three years. (National competitiveness is a slippery concept: countries do not compete in the same way that firms do. But the businessfolk in question answered some clearer questions, too.) Some 45% said that American firms will find it harder to compete in the global economy. A startling 64% said that American firms will find it harder to pay high wages and benefits.

Intriguingly, the Harvard alumni were gloomy about where America is headed, rather than how it is now. Some 57% felt that today the business environment in America is somewhat or much better than the global average; only 15% said it was worse. But when asked to compare its prospects with those of other industrialised economies, only 9% felt that America was pulling ahead; some 21% said it was falling behind. A striking 66% expected America to lose ground to Brazil, India and China; only 8% thought it would pull away from them.

This would seem to jibe with popular laments about why Apple can't make its products domestically.  There are a lot of reasons, but a significant one is the lack of necessary skills for higher-end manufacturing.  This is in no small part because American students shy away from the training necessary to do these kind of jobs even if they originally think they want to be engineers.   Why?  Because American college students don't like doing homework. 

So, America is doomed, right? 

To be honest, this sounds like a lot of pious baloney.  As Michael Beckley points out in a new article in International Security, "The United States is not in decline; in fact, it is now wealthier, more innovative, and more militarily powerful compared to China than it was in 1991."  The whole article is worth a read, and a good cautionary tale on the dangers of overestimating the ease of national catch-up:

The widespread misperception that China is catching up to the United States stems from a number of analytical flaws, the most common of which is the tendency to draw conclusions about the U.S.-China power balance from data that compare China only to its former self. For example, many studies note that the growth rates of China’s per capita income, value added in hightechnology industries, and military spending exceed those of the United States and then conclude that China is catching up. This focus on growth rates, however, obscures China’s decline relative to the United States in all of these categories. China’s growth rates are high because its starting point was low. China is rising, but it is not catching up.

What about the future?  One could point to the last few months of modestly encouraging economic data, but that's ephemeral.  Rather, there are three macrotrends that are worth observing now before (I suspect) they come up in the State of the Union: 

1)  The United States is successfully deleveraging.  As the McKinsey Global Institute notes, the United States is actually doing a relatively good job of slimming down total debt -- i.e., consumer, investor and public debt combined.  Sure, public debt has exploded, but as MGI points out, that really is the proper way of doing things after a financial bubble:

The deleveraging processes in Sweden and Finland in the 1990s offer relevant lessons today. Both endured credit bubbles and collapses, followed by recession, debt reduction, and eventually a return to robust economic growth. Their experiences and other historical examples show two distinct phases of deleveraging. In the first phase, lasting several years, households, corporations, and financial institutions reduce debt significantly. While this happens, economic growth is negative or minimal and government debt rises. In the second phase of deleveraging, GDP growth rebounds and then government debt is gradually reduced over many years....

As of January 2012, the United States is most closely following the Nordic path towards deleveraging. Debt in the financial sector has fallen back to levels last seen in 2000, before the credit bubble, and the ratio of corporate debt relative to GDP has also fallen. US households have made more progress in debt reduction than other countries, and may have roughly two more years before returning to sustainable levels of debt. 

Indeed, the deleveraging is impressive enough for even Paul Krugman to start sounding optimistic: 

the economy is depressed, in large part, because of the housing bust, which immediately suggests the possibility of a virtuous circle: an improving economy leads to a surge in home purchases, which leads to more construction, which strengthens the economy further, and so on. And if you squint hard at recent data, it looks as if something like that may be starting: home sales are up, unemployment claims are down, and builders’ confidence is rising.

Furthermore, the chances for a virtuous circle have been rising, because we’ve made significant progress on the debt front.

2) Manufacturing is on the mend.  Another positive trend, contra the Harvard Business School and the GOP presidential candidates, is in manufacturing.  Some analysts have already predicted a revival in that sector, and now the data appears to be backing up that prediction.   The Financial Times' Ed Crooks notes:

Plenty of economists and business leaders believe that US manufacturing is entering an upturn that is not just a bounce-back after the recession, but a sign of a longer-term structural improvement. Manufacturing employment has grown faster in the US since the recession than in any other leading developed economy, according to official figures. Productivity growth, subdued wages, the steady decline in the dollar since 2002 and rapid pay inflation in emerging economies have combined to make the US a more attractive location.

“Over the past decade, the US has had some huge gains in productivity, and we have seen unit labour costs actually falling,” says Chad Moutray, chief economist at the National Association of Manufacturers. “A lot of our members tell us that it sometimes is cheaper to produce in the US, especially because labour costs are lower.”

Now, whether this boom in manufacturing will lead to a corresponding boom in manufacturing employment is much more debatable.  Still, as The Atlantic's Adam Davidson concludes:  "the still-unfolding story of manufacturing’s transformation is, in many respects, that of our economic age. It’s a story with much good news for the nation as a whole. But it’s also one that is decidedly less inclusive than the story of the 20th century."

3) A predicted decline in energy insecurity.  British Petroleum has issued their Energy Outlook for 2030.  The Guardian's Richard Wachman provides a useful summary:

Growth in shale oil and gas supplies will make the US virtually self-sufficient in energy by 2030, according to a BP report published on Wednesday.

In a development with enormous geopolitical implications, the country's dependence on oil imports from potentially volatile countries in the Middle East and elsewhere would disappear, BP said, although Britain and western Europe would still need Gulf supplies.

BP's latest energy outlook forecasts a growth in unconventional energy sources, "including US shale oil and gas, Canadian oil sands and Brazilian deepwater, plus a gradual decline in demand, that would see [North America] become almost totally energy self-sufficient" in two decades.

BP's chief executive, Bob Dudley, said: "Our report challenges some long-held beliefs. Significant changes in US supply-and-demand prospects, for example, highlight the likelihood that import dependence in what is today's largest energy importer will decline substantially."

The report said the volume of oil imports in the US would fall below 1990s levels, largely due to rising domestic shale oil production and ethanol replacing crude. The US would also become a net exporter of natural gas.

Note that this will take a while, and doesn't mean that the U.S. will be energy independent.  Still, it's quite a trend.  Or, rather, trends.   

Since the Second World War, the pattern in the global political economy has been for the United States to adjust to systemic shocks better than any potential challenger country.  A lot of very smart people have predicted that this time was different -- the United States wouldn't be able to do it again.  These trends suggest that maybe, just maybe, that might be wrong. 

Am I missing anything? 

I was pretty dismissive of Standard & Poor's debt downgrade last month.  Re-reading that post, I stand by my political analysis of events going forward.  Furthermore, the recovery of U.S. equity markets, the sharp reduction of yields on U.S. debt, and the failure of the other ratings agencies to follow suit are further data points suggesting that the S&P decision was flawed. 

There's reality and perceptions of reality, however.  On that latter front, after a recent expedition to Washington, I've concluded that regardless of whether S&P was right, they've won the argument in terms of perception.  The summer debt debacle is, in many ways, the political equivalent of Hurricane Katrina.  Perceptions of the Bush administration never recovered from that event, even though one could plausibly argue that the policy outputs of Bush's second term were better than the first term.  Neverthelesss, Katrina was an inflection point that has caused a number of actors to reassess their perceptions about the political and policy competency of the White House and Congress. 

Something similar seems to have happened with the debt deal.  Politico's Ben White relays the dramatic effect on consumer confidence: 

The Conference Board this week reported the biggest monthly decline in consumer confidence since the height of the financial crisis in 2008, its consumer confidence index falling from a reading of 59.2 to 44.5, the lowest in two years....

“The debt ceiling negotiation is an extremely significant event that is profoundly and sharply reshaping views of the economy and the federal government,” Republican pollster Bill McInturff wrote in a presentation of survey work he has done recently that suggests the debt ceiling debate has led to a significant shift in public opinion.

The partisan struggle over raising the debt went on for weeks before Obama finally announced on the night of Aug. 1 that a deal had been reached that resolves the issue for now. But while Washington has moved on to its next drama — the deliberations of the so-called supercommittee agreed to in the deal — its psychological impact has resonated widely.

McInturff said the result has been “a scary erosion in confidence” in both the economy and the government “at a time when this steep drop in confidence can be least afforded. … The perception of how Washington handled the debt ceiling negotiation led to an immediate collapse of confidence in government and all the major players, including President Obama and Republicans in Congress.”

A recent Washington Post poll found that 33 percent of Americans have confidence in Obama to make good decisions on the economy and just 18 percent have confidence in Congressional Republicans to do so.

These are especially dangerous readings when Federal Reserve Chairman Ben Bernanke has essentially said it is up to politicians to help boost the economy now that the Fed has fired nearly all its monetary policy bullets.

Speaking of Bernanke, he had this to say at Jackson Hole last week: 

[P]erhaps most challenging, the country would be well served by a better process for making fiscal decisions. The negotiations that took place over the summer disrupted financial markets and probably the economy as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold U.S. financial assets or to make direct investments in job-creating U.S. businesses. Although details would have to be negotiated, fiscal policymakers could consider developing a more effective process that sets clear and transparent budget goals, together with budget mechanisms to establish the credibility of those goals.

Ten days before Bernanke's speech, FP's Josh Rogin reported that Secretary of State Hillary Clinton had acknowledged the global ramifications of the debt fracas, telling a forum at National Defense University: 

I happened to be in Hong Kong a few weeks ago, and I said confidently that we were going to resolve this; we were not going to default; we would make some kind of political compromise.

But I have to tell you, it does cast a pall over our ability to project the kind of security interests that are in America’s interest. This is not about the Defense Department or the State Department or USAID. This is about the United States of America. And we need to have a responsible conversation about how we are going to prepare ourselves for the future

Clinton's statements were confirmed by officials I talked to while down in DC. 

So, can this perception be changed?  Here, I'm bearish in the short-term.  These kind of perceptions can be self-fulfilling.  Economic growth is a remarkable political palliative, but growth looks anemic for a good long while.  The Obama administration can try to change the narrative, but that's almost as difficult as Inception -- for the same reasons: 

As Reinhart and Rogoff have observed, the economic aftereffects of debt crises are long-lasting.  From here on out, the political effects of such crises will be on full display. 

As someone who studies global political economy, this is fascinating.  As a U.S. citizen, this is utterly depressing. 

For the past two years, staunch monetarists and economic conservatives have warned about the evils of massive deficit spending and quantitative easing.  They have argued that such policy measures are inevitably inflationary and will debase the currency and raise nominal interest rates.  By and large, supporters of Keynesian policies have responded by loudly pointing to the data on core U.S. inflation and the dollar's performance as falsifying the conservative argument.  And, by and large, they have a point.  If inflationary concerns really were prominent, the dollar should have depreciated in value an awful lot, and nominal interest rates should have soared.  Neither of these things have happened.  Point for Keynesians.    

Right now, however, markets are providing a pretty powerful data point for Tea Party supporters who argue that hitting the debt ceiling is not the end of the world.  Last week Moody's issued the following warning: 

Moody's Investors Service said today that if there is no progress on increasing the statutory debt limit in coming weeks, it expects to place the US government's rating under review for possible downgrade, due to the very small but rising risk of a short-lived default. If the debt limit is raised and default avoided, the Aaa rating will be maintained. However, the rating outlook will depend on the outcome of negotiations on deficit reduction. A credible agreement on substantial deficit reduction would support a continued stable outlook; lack of such an agreement could prompt Moody's to change its outlook to negative on the Aaa rating.

 

Although Moody's fully expected political wrangling prior to an increase in the statutory debt limit, the degree of entrenchment into conflicting positions has exceeded expectations. The heightened polarization over the debt limit has increased the odds of a short-lived default. If this situation remains unchanged in coming weeks, Moody's will place the rating under review.

Make fun of the ratings agencies all you like, but this was front-page news last week.  One would think that markets would be pricing in the possibility of institutional investors diversifying away from dollar-denominated debt, a collapse in the dollar, skyrocketing interest rates, a drastic reduction in nominal GDP, dogs and cats living together, and so forth.  Or, as Tim Geithner put it, "catastrophic economic and market consequences." 

And yet.... last week, the yield on 10 year Treasuries fell below three percent.  Maybe markets are underestimating the likelihood that a debt ceiling deal won't happen, maybe they are underestimating the damage caused by hitting the debt ceiling, or maybe they think the Chinese will continue to buy dollar-denominated debt no matter what happens on the debt ceiling (though read this).  Or... maybe the Tea Party activists have a point. 

So, my question to readers, investors, and experts on the global political economy -- why aren't markets freaking out more about the rising probability of hitting the debt ceiling? 

With the government not shutting down and all, Washington can now look forward to the next moment of Gotterdammerung, which is when the debt ceiling has to be raised.  By risking minor things like the full faith and credit of the United States, that kind of shutdown really would have serious foreign policy implications. 

That said, there is another possibility on the horizon -- a grand bargain on long-term fiscal rectitude.  The good news is that there really is a bargaining core among the major players on entitlement reform, budget cuts, and tax reform.  The bad news is that one could say the same thing about an Israeli/Palestinian peace deal, and look how that's playing out.  The follow-up good news is that I think there are political reasons to be more optimistic about the U.S. situation. 

Seasoned DC-watchers might immediately laugh at the prospect of the kind of bipartisan brand bargain on fiscal policy that hasn't been seen since the days of Gramm-Rudman-Hollings and the 1986 tax reform bill.  That said, I think a bargain can be struck for the simple reason that there is at least a general consensus that the long-term fiscal picture for the United States is really daunting and in dire need of proactive policy measures.  This jibes with U.S. public opinion on the question.  The biggest question is what mix of spending cuts need to be taken -- though I think the fiscal picture is sufficiently dire such that there's gonna have to be serious steps taken in all possible spending spheres (Social Security, Medicare, Medicaid, discretionary domestic spending, Defense spending).  The combination of the Bowles-Simpson deficit commission, Paul Ryan's proposed budget, and Obama's scheduled Wednesday address means there will be multiple proffers on the table, so at least there are concrete measures to talk about. 

Furthermore, the tax code has gotten so complicated that there's actual room for a tax deal that would simultaneously raise revenues but be palatable to Republicans.  For all the debate over raising or lowering tax rates, the key problem is that tax revenues as a percentage of GDP are at postwar historic lows.  If distortionary loopholes were eliminated, it would be possible to keep marginal tax rates where they are, or even lower them, while still raising revenues.  

Finally, the economic argument against fiscal tightening is that the economy is still in recession, except that's not really true.  The economy has been growing at a steady clip for a yeat now.  The real concern is the job picture, but if last month's numbers are suggestive of a more robust turnaround, then this would be exactly the moment to rein in spending and signal to financial markets that fiscal probity is coming. 

So I think a grand bargain is possible.  Now, the natural rejoinder to this is that the partisan split in Washington is too great for bipartisanship to work, the Tea Party will be unyielding, yadda, yadda, yadda.  This is a possibility.  It's certainly true that the last time something on this scale was attempted, in 1993, it was a straight partisan vote.  If the Obama administration  and GOP members of Congress see this as a zero-sum game that ends with the 2012 election, then no bargain will be struck. 

There are two political reasons why I'm more optimistic this time around -- although these reasons normally don't count for much in political science.  First, the personalities of the key players suggest that they want to make a deal.  Barack Obama was the happiest I'd seen him in a long time when he announced on Friday night that a budget deal had been struck.  John Boehner, and his staff, set a nice precedent of being able to bargain with the Democrats while holding his caucus together, and earned some praise from Democrats for his dealmaking.   The personal inclinations of the pcvotal actors are biased towards cutting a deal.  [But what about the Tea Party?!--ed.  See this Dave Weigel post.]

Second, I think it's beginning to occur to GOP legislatures that their crop of 2012 presidential camdidates really and truly stinks:

A presidential primary favorite is emerging among the ranks of congressional Republicans: none of the above.

The dissatisfaction with the likely GOP field — long whispered among party activists, operatives and elected officials — is growing more audible in the House and Senate.

Interviews on both sides of the Capitol have revealed widespread concern about the lackluster quality of the current crop of candidates and little consensus on who Republican senators and House members would like to see in the race. 

It's early, and the fundamentals suggest that the eventual GOP nominee might make it a close race, but still -- whoever gets the nomination is gonna have to run against a sitting president who's still surprisingly popular given the state of the economy. 

If GOP legislative leaders calculate that they can't win back the White House in 2012, their preference flips over to cutting a deal with the Obama administration.  Bipartisan deals help incumbents and hurt challengers, which means that in cutting a deal, the House Republicans would help Obama while helping themselves.  That's not their first option, but in a political climate when Donald Trump can poll second in New Hampshire by embracing the birthers, it's not the worst calculaion either. 

I look forward to commenters telling me how wrong I am about this.  But let me close this post by pointing out something that I think is obvious but might pass by some foreign policy pundits who get scared by economics that tend to focus more on matters of hard security.  From a foreign policy perspective, whether or not a Grand Bargain can be struck is of far more importance than whether or not there's such a thing as an Obama Doctrine.  Over the long term, America's hard power and soft power resides in its economic vitality.  A close reading of Obama's rhetoric suggsts that he gets this point.  It will be very interesting to see if he decides to invest his political capital in cutting a deal. 

Developing.....

The unholy trinity in open economy macroeconomics is pretty simple. It's impossible for a country to do the following three things at the same time:

1) Maintain a fixed exchange rate

2) Maintain an open capital market

3) Run an independent monetary policy

One of the issues with macroeconomic policy coordination right now is that different countries have chosen different options to sacrifice. China, for example, has never opened its capital account. The United States, in pursuing quantitative easing, has basically chucked fixed exchange rates under the bus, no matter how many times Tim Geithner utters the "strong dollar" mantra in his sleep to reporters. 

These  policies are generating a fair amount of blowback from the rest of the world, forcing President Barack Obama to defend the Fed's actions. And it appears that the developing countries are mostly following China's path towards regulating their capital account to prevent exchange rate appreciation and the inward rush of hot money.  

How does this end? I think it's gonna end with a lot more capital controls for a few reasons:

1) It's the political path of least resistance;

2) Capital controls are seen as strengthening the state;

3) The high-growth areas of the world don't need a lot of capital inflows to fuel their continued growth. 

What intrigues me is how the financial sector responds to a situation in which their freedom of action in emerging markets becomes more and more constrained. It's possible that they could pressure the Fed to change its position in the future. It's also possible, however, that big firms could see these controls as a useful barrier to entry for new firms. 

My money is on the former response, however.

Developing…

One of the paradoxes I tried to highlight in my recent review of finance books was that it was paradoxical to claim simultaneously that capital markets were becoming more efficient even as the financial sector hoovered up an ever greater share of profits and skilled human capital. So I'm pretty sympathetic to the argument that market incentives in the United States are too heavily skewed towards a career of high finance.  

Skewed incentives, however, are not the same thing as skewed values. Unfortunately, the New York Times stable of columnists is blurring the distinction. For Exhibit A, let's look at this segment of Tom Friedman's column from the weekend: 

We had a values breakdown — a national epidemic of get-rich-quickism and something-for-nothingism. Wall Street may have been dealing the dope, but our lawmakers encouraged it. And far too many of us were happy to buy the dot-com and subprime crack for quick prosperity highs.

Ask yourself: What made our Greatest Generation great? First, the problems they faced were huge, merciless and inescapable: the Depression, Nazism and Soviet Communism. Second, the Greatest Generation’s leaders were never afraid to ask Americans to sacrifice. Third, that generation was ready to sacrifice, and pull together, for the good of the country. And fourth, because they were ready to do hard things, they earned global leadership the only way you can, by saying: “Follow me.”

Contrast that with the Baby Boomer Generation. Our big problems are unfolding incrementally — the decline in U.S. education, competitiveness and infrastructure, as well as oil addiction and climate change. Our generation’s leaders never dare utter the word “sacrifice.” All solutions must be painless. Which drug would you like? A stimulus from Democrats or a tax cut from Republicans? A national energy policy? Too hard. For a decade we sent our best minds not to make computer chips in Silicon Valley but to make poker chips on Wall Street, while telling ourselves we could have the American dream — a home — without saving and investing, for nothing down and nothing to pay for two years. Our leadership message to the world (except for our brave soldiers): “After you.”

For Exhibit B, here's David Brooks from Friday:

After decades of affluence, the U.S. has drifted away from the hardheaded practical mentality that built the nation’s wealth in the first place.

The shift is evident at all levels of society. First, the elites. America’s brightest minds have been abandoning industry and technical enterprise in favor of more prestigious but less productive fields like law, finance, consulting and nonprofit activism.

It would be embarrassing or at least countercultural for an Ivy League grad to go to Akron and work for a small manufacturing company. By contrast, in 2007, 58 percent of male Harvard graduates and 43 percent of female graduates went into finance and consulting....

[T]he value shifts are real. Up and down society, people are moving away from commercial, productive activities and toward pleasant, enlightened but less productive ones. 

OK, I'm calling a Vizzini foul on the word "values" here. 

A broad spectrum of American saved less over the past decade because they were responding rationally to massive asset appreciation. High-skilled Americans went into finance because it paid remarkably well. Americans didn't do these things because they suddenly got lazy. Indeed, the opposite was true, if U.S. labor productivity figures are any guide. And while much calumny has been heaped upon Wall Street in the past few years, is anyone actually accusing bankers of either not working hard enough or not putting in enough hours?

Americans haven't suddenly gotten contemptuous of either saving or manufacturing. They were responding to the price signals that the market communicated to them.

This is great news, by the way. Changing values is really, really hard. Shifting material incentives is not exactly easy, but it's much more doable than fomenting a values shift.

I suspect that ranting writing only about incentives and not about values makes better copy. That said, I'd prefer it if the most influential op-ed columnists in the land correctly diagnosed what ails the American political economy rather than saying "distemper" or "an imbalance of humors." 

I have a review essay of four books about Big Finance in the latest issue of The National Interest entitled "First Bank of the Living Dead."  The books reviewed were:  Sebastian Mallaby's More Money Than God, Robert Reich's Aftershock, Nouriel Roubini and Stephen Mihm's Crisis Economics, and John Quiggin's Zombie Economics.  Despite my obvious affinity for zombies, I tried to avoid any favortism towards Quiggin's awesome brilliant spot-on unorthodox metaphor. 

The opening paragraph: 

Earlier this year, Goldman Sachs CEO Lloyd Blankfein attempted to justify his professional existence, proclaiming, “We’re very important. We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. . . . We have a social purpose.” This all sounds good enough, except that finance went from being responsible for 2.5 percent of GDP in 1947 to 7.7 percent in 2005. And at the peak of the housing bubble, the financial sector comprised 40 percent of all the earnings in the Standard & Poor’s 500. The incomes of the country’s top-twenty-five hedge-fund managers exceeded the total income of all the CEOs in that index. And by 2007, just about half of all Harvard graduates headed into finance jobs. If capital markets merely serve as conduits from savers to entrepreneurs, then why does such a large slice get siphoned off to compensate people like Lloyd Blankfein? To put it more broadly, what is the role of finance in a good and just society?

And the thesis paragraph: 

Some of these books address some of the big questions some of the time. Most of the authors, however, focus on the retrospective at the expense of the prospective. With the partial exception of Roubini and Mihm’s Crisis Economics, these authors seem more concerned with looking back at the halcyon days of the postwar era than looking forward to the twenty-first century. Unfortunately, none of these books recognizes two important facts of life. First, at present, no economic model perfectly captures the interrelationship between the financial sector and the global economy. Second, no matter what regulatory arrangements are put in place, the next global financial order will last no longer than a generation—because whatever ideas replace the current ones will also prove fallible over time.

I fear that last paragraph reads a bit harsher than the rest of the essay.  I learned something from all four books, and enjoyed engaging with all of them. 

Go read the whole thing. 

Is it just me, or is this less-than-exquisite timing for this particular roll-out? 

Europe’s first Christian equity index was launched on Monday in response to increasing demand by investors for so-called ethical stocks in the wake of the financial crisis.

The Stoxx Europe Christian Index comprises 533 European companies that only derive revenues from sources approved “according to the values and principles of the Christian religion”.

BP, HSBC, Nestlé, Vodafone, Royal Dutch Shell and GlaxoSmithKline are among the companies in the index. Only groups that do not make money from pornography, weapons, tobacco, birth control and gambling are allowed to be listed.

A committee, which Stoxx says includes representatives of the Vatican, screens shares, which are drawn from the Stoxx Europe 600 Index (emphasis added).

Umm...... to state the obvious, I'm not sure this is the right moment for the Catholic Church to present itself as the arbiter of all things ethical.  But hey, I'm a nonbeliever. 

That said, I do wonder if there's an index fund that could be created that would be the inverse of this fund -- one that did nothing but profit from the seven deadly sins. 

Readers already doomed to eternal damnation in  hell with a mischevious streak are encouraged to suggest the appropriate companies to put into that fund in the comments. 

Yesterday President Obama delivered a speech fleshing out his National Export Initiative -- the doubling of U.S. exports in the next five years.  Longtime and short-time readers of this blog are already aware of my deep skepticism of this idea. 

Others at FP, however, observe that it has happened in the past (1981 most recently), so  perhaps "Obama's plan to double the number by 2015 does not seem so far-fetched." 

So, let's clarify:  the possibility of U.S. exports doubling in the next five years is pretty small, but within the realm of the doable.  Obama's National Export Initiative will have no appreciable effect on export flows. 

The fundamental drivers for U.S. exports are the rate of economic growth of the rest of the world and the exchange rate value of the dollar.  If the dollar depreciates in value and the rest of the world experiences high rates of economic growth, then exports will take off.  Everything else would generously be described as window dressing. 

Let's consider the content of the key parts of Obama's speech to see what I'm saying:

I know the issue of exports and imports, the issue of trade and globalization, have long evoked the passions of a lot of people in this country.  I know there are differences of opinion between Democrats and Republicans, between business and labor, about the right approach.  But I also know we are at a moment where it is absolutely necessary for us to get beyond those old debates. 

Those who would once support every free trade agreement now see that other countries have to play fair and the agreements have to be enforced.  Otherwise we're putting America at a profound disadvantage.  Those who once would once oppose any trade agreement now understand that there are new markets and new sectors out there that we need to break into if we want our workers to get ahead.

First of all, a quick message to Jon Favreau:  Jon, this going-beyond-old/stale-debates thing gets tedious if you use it for every friggin' policy initiative. 

Second of all, could someone, anyone, point to a politician that once opposed trade deals and are now in favor of them?  Anyone? 

So, what are the components of the National Export Initiative, beyond a couple of interagency committees that will accomplish nothing?

First, we will substantially increase access to trade financing for businesses that want to export their goods but just need a boost –- especially small businesses and medium-sized businesses.

Let's be generous and say that this would make a huge difference (it won't) and that it would really increase exports from this sector.  Given that roughly 70% of U.S. exports come from large corporations, this still wouldn't accomplish all that much.  Next!!

[T]he United States of America will go to bat for our businesses and our workers....

Going forward, I will be a strong and steady advocate for our workers and our companies abroad.

And this effort will extend throughout my administration.  Secretary Locke is issuing guidance to all senior government officials who have foreign counterparts on how they can best promote our exports.  Secretary Clinton is mobilizing a commercial diplomacy strategy, directing every one of our embassies to create a senior visitors business liaison who will manage our export advocacy efforts locally, and when our ambassadors return stateside, we’ll ask them to travel the United States to discuss export opportunities in their countries of assignment. 

SCENE:  A small factory somewhere in Malaysia. 

The PLANT MANAGER and his FOREMAN are looking at the assembly line:

FOREMAN:  You know, we could really make a better widget if only we had a better-quality thingmabob.

PLANT MANAGER:  Well, we could import it from Vietnam, Taiwan, South Korea, Japan....

[Sound of trumpets grows louder.  PRESIDENT OBAMA enters the factor on a Segway.]

PRESIDENT OBAMA:  Have you thought of buying American?  [Obama exits]

[PLANT MANAGER and FOREMAN smack hands on heads]

PLANT MANAGER:  Why, of course!!  I can't believe we didn't think of importing from the largest economy in thw world! 

FOREMAN:  I know, it's like, we never even thought of America as a producer of anything!

PLANT MANAGER:  Thanks, President Obama!!

[End scene.]

Third, we’ll unleash a battery of comprehensive and coordinated efforts to promote new markets and new opportunities for American exporters.

Yawn.  See response to point one. 

The fourth focuses on making sure American companies have free and fair access to those markets.  And that begins by enforcing trade agreements we already have on the books.

As I've said before, this is akin to saying that the budget deficit can be fixed through better tax collection measures by the IRS.  It won't accomplish much of anhything.

Of course, new trade agreements might actually expand export opportunities, but the language in the speech on that front contains nothing new. 

We’ll also work within the G20 to continue global recovery and growth.  Last year, when the G20 met to coordinate the international response to our global economic crisis, we agreed that in order for that growth to continue, we needed to rebalance our economies.  For too long, America served as the consumer engine for the entire world.  But we’re rebalancing.  We are now saving more.  And that means that everybody has got to rebalance.  Countries with external deficits need to save and export more.  Countries with external surpluses need to boost consumption and domestic demand.  And as I’ve said before, China moving to a more market-oriented exchange rate will make an essential contribution to that global rebalancing effort. 

If there were any concrete policy directives on this front, I would straighten up and put away the snark.  Global rebalamcing would have an appreciable impact on exports.  Unfortunately, there's nothing in the speech on this topic beyond this paragraph. 

Finally:

[W]e’re going to streamline the process certain companies need to go through to get their products to market -– products with encryption capabilities like cell phone and network storage devices....

[W]e’re going to eliminate unnecessary obstacles for exporting products to companies with dual-national and third-country-national employees.

My reaction to this idea is the same as my reaction to the rest of the list -- these aren't awful policy ideas so much as completely superfluous.  None of them wuill have an appreciable effect on exports. 

The primary purpose of the National Export Initiative is to function as a political excuse.  The White House now has something to point to when critics accuse them of lethargy and/or protectionism on the trade front.   That is all. 

Did I miss anything?