The term "inflection point" has become one of those overused bits of meaningless jargon in political discourse.  I'm rather more fond of the notion of a "focal point" -- that is to say, an event or cluster of events in which everyone that cares about a particular problem focuses on the same set of stylized facts -- after which, they conclude that, gee, maybe the status quo set of policies ain't working so well and there should be a new status quo. 

The fall of 2008 was one such focal point, during which there was remarkable consensus that a Keynesian boost in public spending was the only way to avert another Great Depression.  At the fiirst G-20 leaders summit in  Washington, there was consensus on expansionary fiscal policy.  Oh, sure, there were grumblings about "crass Keynesianism," but even Germany reluctantly went along. 

The Greek sovereign debt crisis was another such focal point.  Greek profligacy seemed to be a synecdoche for excessive government borrowing and lax fiscal discipline.  With the global economy seemingly still in the doldrums, a lot of Europrean governments climbed on the "expansionary austerity" bandwagon.  By the Toronto G-20 summit in June 2010, the consensus had switched from Keynesian stimulus to fiscal rectitude.  Oh, sure there were mutterings about "short-term austerity makes no macroeconomic sense whatsoever in a slack economy" but even Barack Obama started talking about slashing government spending. 

Are we at another focal point?  Consider the following:

1)  According to the New York Times' Stephen Castle, European leaders now seem to recognize that austerity on its own ain't working: 

Bowing to mounting evidence that  austerity alone cannot solve the debt crisis, European leaders are expected to conclude  this week that what the debt-laden, sclerotic countries of the Continent need are a dose of economic growth.

A draft of the European Union summit meeting communiqué calls for ‘‘growth-friendly consolidation and job-friendly growth,’’ an indication that European leaders  have come to realize that austerity measures, like those being put in countries like Greece and Italy,  risk stoking a recession and plunging fragile economies into a  downward spiral.

2)  The data is starting to come in on governments that have embraced austerity whole-heartedly, and it's pretty grim.  Cue Paul Krugman on Great Britain:

Last week the National Institute of Economic and Social Research, a British think tank, released a startling chart comparing the current slump with past recessions and recoveries. It turns out that by one important measure — changes in real G.D.P. since the recession began — Britain is doing worse this time than it did during the Great Depression. Four years into the Depression, British G.D.P. had regained its previous peak; four years after the Great Recession began, Britain is nowhere close to regaining its lost ground.

Nor is Britain unique. Italy is also doing worse than it did in the 1930s — and with Spain clearly headed for a double-dip recession, that makes three of Europe’s big five economies members of the worse-than club. Yes, there are some caveats and complications. But this nonetheless represents a stunning failure of policy.

And it’s a failure, in particular, of the austerity doctrine that has dominated elite policy discussion both in Europe and, to a large extent, in the United States for the past two years.

3)  Even commentators who would be tempermentally sympathetic with austerity are starting to bash Germany question whether it's a solution.  Consider Walter Russell Mead: 

It takes some truly talented screw ups to come up with a worse plan for Greece than the one the Greeks have developed for themselves, but the Germans have risen to occasion in fine form....

Deep reform is needed if Greece is to stay in the euro, and so far the Greek political establishment — firmly backed by public opinion — is digging in its heels.  Much whining, much talk, many promises and precious little action seems to be the favored Greek approach to the crisis.  On the other hand, the austerity policies the Germans favor are hopelessly biased in favor of German banking interests and are aimed more at the preservation of the reputations of German politicians than at helping Greece.

The German political establishment seems willing to destroy Europe to avoid telling German voters the truth about how stupid it has been. 

[UPDATE:  For exhibit B of this trend, see this Niall Ferguson interview with Henry Blodget.  My favorite part of the interview is this quotation:  "I think the reason that I was off on that was that I hadn't actually thought hard enough about my own work.... My considered and changed view is that the U.S. can carry a higher debt to GDP ratio than I think I had in mind 2 or 3 years ago."]

4)  U.S. 4th quarter data reveals that, consistent with GOP criticisms, the government has been the real drag on the U.S. economy.  Not quite consistent with GOP criticisms:  the reason why the government is dragging down the U.S. economy.  Cue Mark Thoma: 

[P]remature austerity -- cutting spending before the economy is ready for it -- is taking a toll on the recovery. The fall in government spending reduced fourth-quarter growth by 0.93 percent; if government spending had remained constant, GDP growth would have been 3.7 percent, rather than 2.8 percent. 

This is the opposite of what the government should be doing to support the recovery. We need a temporary increase in government spending to increase demand and employment through, for example, building infrastructure. That would help to get us out of the deep hole we are in. Instead, the government seems to be trying to make it harder to escape.

We do need to address our long-run budget problems once the economy is healthy enough to withstand the tax increases and program cuts that will be required. But the idea of "expansionary" austerity has failed. Austerity in the short-term simply makes it harder for the economy to recover and delays the day when you can finally address budget issues without harming the economy. The lesson is that government needs to support the recovery, not oppose it through a false promise that contraction of one sector in the economy will be expansionary.

5)  Central banks are acting more gung-ho on expansionary monetary policy.  The unspoken quid pro quo in Europe seems to the that the ECB will expand its balance sheet and turn on the monetary taps in return for some kind of fiscal compact.  The U.S. Federal Reserve announced a zero-interest rate policy for the next three years.  Even China is showing (halting) signs that its reverted back to monetary easing. 

Given that the United States has been the country to move the slowest on austerity, and given that the United States is doing the best job among the OECD economies (an admittedly low bar) of restoring confidence among investors and paying down non-governmental debt, have we reached another focal point? 

One could argue that Krugman and Thoma are just biased in favor of Keynesianism, that Greece and the other Club Med countries haven't really embraced austerity, that the Euromess is dragging down British economic growth, and that the long-term numbers on developed country debt are really very scary.  There are some large grains of truth in many of those statements. 

It doesn't necessarily matter, however.  Greece was not a genuine harbinger of the fiscal problems of large markets -- but it was a useful hook for austerity advocates to spread their gospel.  What matters now is not whether these perceptions about the failure of austerity are 100% accurate, but whether they are accurate enough to become the new conventional wisdom. 

What do you think? 

Your humble blogger is near the capital of Waterworld Pennsylvania at the moment and all conferenced out. Regular blogging will resume after some sleep.

In the meanwhile, however, please check out FP's latest Deep Dive on the future of currencies. I have a contribution on the dollar's future as the world's reserve currency. It's depressing to note that the thing I like best about it is it's title -- which, of course, someone else at FP created.

Enjoy!

Dear Chinese overlords alien visitors robot masters zombie hegemons post-apocalyptic historians: 

Greetings.  My goal in this message is to explain to you why the most powerful country in the world committed financial seppuku in the summer of 2011 AD*. 

To set the stage:  by now you know that the U.S. Congress was obligated to increase the debt ceiling in order for the United States government to continue to function normally.  President Obama, Democrats in Congress, and most of the Republican leadership recognized the gravity of the situation.  The GOP leadership, however, wanted to use the debt cekiling vote as leverage to get President Obama to commit to significant deficit reduction.  After much haggling over "grand bargains," there was a recognition that no such deal could be passed.  As a backup, leaders from both parties reluctantly advocated a bill that hiked the ceiling and put off questions about long-term deficit reduction to the future. 

The problem was, a political faction emerged that some called "debt kamikazes."  These were politicians and interest group leaders -- all Republicans -- who genuinely believed that nothing of consequence would happen if the debt ceiling wasn't raised.  There were a few others who did believe it and were nevertheless copacetic with that outcome -- I'll get to that group later. 

Sounds absurd to your futuristic ears, you say?  Consider my evidence. The Daily Beast's John Avlon detailed the position of the 2012 GOP presidential candidates:

Michele Bachmann believes it’s all a hoax. Tim Pawlenty told an Iowa crowd, “I hope and pray and believe they should not raise the debt ceiling.” Ron Paul based his first presidential ad on a call to not raise the debt ceiling, proclaiming “No Deals.”  And Rick Santorum has said that raising the debt ceiling should be avoided until a Balanced Budget Amendment to the Constitution is passed.... 

Even supposedly responsible Republican presidential candidates like Mitt Romney—whose campaign slogan might as well be ‘He’s the Sane One’—are finding it politically beneficial to flirt with debt-ceiling denial, announcing a ‘cut, cap and balance’ proposal without revenue increases as his ‘line in the sand’ for supporting raising the debt limit.

There were also interest group coalitions called "Tea Party" organizations that pressured their members of Congress not to raise the debt ceiling.  As CNN's Shannon Travis chonicled, these organizations believed that the effects of more government spending were far more disastrous than defaulting on the debt: 

What they're saying around the country is, "Do not raise the debt ceiling. It's that simple. It's time for Congress to get its fiscal house in order," Tea Party Patriots co-founder Jenny Beth Martin told CNN. The group is the nation's largest tea party organization.

Martin explained that her group's supporters want a balanced-budget amendment, significant spending cuts and lower taxes. And they don't want the debt limit raised.

Brendan Steinhauser, director of federal and state campaigns for the Washington-based FreedomWorks, explained that he and other activists understand the possible financial implications if the debt limit is not raised (emphasis added)

Similarly, Red State blogger Erick Erickson  wrote an open letter  to the House GOP that boiled down to "do not believe the doom and gloom." 

Now, future historians, you might argue that neither Tea Party activists nor presidential candidates (Bachmann excepted) were in Congress and therefore did not matter.  However, what's important to understand is that these views were prevalent inside the House GOP caucus as well.  The Washington Post's David A. Fahrenthold provided a detailed description of the members of the House of Representatives who thought a default wouldn't be such a big deal.  Rep. Mo Brooks (R-AL) offered the most extreme example of House GOP thinking:

As the Aug. 2 deadline looms, the debate over how to resolve the debt-ceiling crisis is being complicated by legislators such as Crawford who think the crisis is not as bad as it’s made out to be.

On Thursday, several House Republicans said they didn’t believe predictions that economic calamity would result from a missed deadline. That opinion — held despite a stream of warnings from both parties’ leaders — could make it difficult for the House to pass a debt-ceiling deal.

Rep. Mo Brooks (R-Ala.), another freshman, said that a much bigger fear was that raising the debt ceiling would enable Washington to spend itself into paralyzing debt in a few years.

“A debt-ceiling problem, as large as it is, is not anywhere near as a big or as bad as” that, Brooks said. If Aug. 2 arrives without a deal, Brooks said, the federal government could continue paying creditors. He said that a show of tough fiscal self-discipline could actually improve creditors’ confidence.

“There should be no default on August 2,” Brooks said. “In fact, our credit rating should be improved by not raising the debt ceiling.”  (emphasis added)

Lest you think the view that a default was not such a big deal was limited to backbenchers, Outside the Beltway's Steven Taylor found House Budget Chairman Paul Ryan telling CNBC that a "technical default" of a few days wouldn't be a big deal:

If a bondholder misses a payment for a day or two or three or four — what is more important is you are putting the govegnment in a materially better position to better pay its bills going forward.

Now, at this point, I'm sure you, future post-apocalyptic historians, must be scratching your third eye heads, thinking the following: 

WHY???!!! 

Why, why did these human beings maintain these beliefs in the face of massive evidence to the contrary?  Why did these people continue to insist that default wasn't that big a deal when Federal Reserve Chairman Benjamin Bernanke (a Republican first appointed by Republican president George W. Bush) insisted that there would be a "huge financial calamity" if the debt ceiling wasn't raised?  Why did their belief persist when Moody's, Standard & Poor's, and Fitch Ratings all explicitly and repeatedly warned of serious and expensive debt downgrades if the ceiling wasn't raised?  Why did they stick to their guns despite news reports detailing the link between the rating of federal government debt and the debt of states and municipalities?  Why did they stand firm despite the consensus of the Republican Governors Association and the Democrat Governors Association that a failure to raise the debnt cailing would be "catastrophic"?  Why did they refuse to yield despite bipartisan analysis explaining the very, very bad consequences of no agreement, and nonpartisan analysis explaining the horrific foreign policy consequences of American default?  Why did they not understand that even a technical default would cost hundreds of billions of dollars**, thereby making their stated goal of debt reduction even harder? 

Most mysteriously, why did these people throw their steering wheel out the window despite witnessing the effect of the 2008 Lehman Brothers collapse, which revealed the complex interconectedness of financial markets?  Treasuries were far more integral to global capital markets than Lehman, but the debt kamikazes refused to recognize the possibility that a technical debt default would have unanticipated, complex, and disastrous consequences.  Why? 

I would like to be able to offer you a definitive answer, I really would, but I can't.  The implications listed in the previous paraqgraph seemed pretty friggin' obvious to a lot contemporaneous observers at the time.  As near as I can determine, there are four partial explanations for why the debt kamikazes persisted in their belief that nothing serious would happen:  One explanation, which I've detailed here, is that the debt kamikazes refused to budge because refusing to budge had yielded great political rewards in the past. 

Another explanation is that the debt kamikazes convinced themselves that no possible alternative was worse than the federal government accumulating more debt.  They looked at countries like Greece and Portugal and decided that the U.S. was only one more Obama administration away from such strictures. 

A third explanation was the general erosion of trust in economic experts during this period.  To be fair to the debt kamikazes, many of the prominent policymakers who warned about calamities if the debt ceiling wasn't raised had pooh-poohed the effects of the housing bubble in 2005, or the collapse of that bubble in 2007. 

The final explanation goes back to those people who acknowledged that a default might be a big deal, but were nevertheless OK with the outcome.  These debt kamikazes had undergone a fundamental identity change.  That is to say, despite all their protestations to the contrary, they were no longer loyal Americans.  They were loyal to Republicans first and Republicans only.  Erick Erickson made this logic pretty clear in his open letter to Congress: 

Now is a time for choosing. Now is your time for choosing.As I pointed out to John Boehner yesterday, despite what the pundits in Washington are telling you, it is you and not Obama who hold most of the cards. Obama has a legacy to worry about. Should the United States lose its bond rating, it will be called the “Obama Depression”. Congress does not get pinned with this stuff.

As Outside the Beltway's Doug Mataconis explained in response: 

[I]n this quote above Erickson is clearly saying that he’d be okay with sending the economy into the tank by failing to raise the debt ceiling because he thinks it would benefit the Republican Party....

He’s perfectly fine with economic collapse because he thinks the President of the United States and the Democratic Party will take the blame, and the Republican Party will benefit. The economic pain that will be suffered by his fellow Americans is secondary, it seems, to the political gains he thinks can be made from throwing the nations economy over the brink. How is that different from someone else hoping that, say, the Iraq War had gone horribly wrong immediately before the 2004 elections because it would hurt the Bush Administration and the GOP?

The answer, of course, is that it isn’t. Willfully hoping that the country is harmed because it might potentially benefit your political party is perhaps the most cravenly partisan thing that anyone would ever wish. You are saying to your fellow citizens that you don’t care that something bad is about to happen because, in the end, it will mean that more Republicans will be elected. Frankly, I find it disgusting.

That's the best set of answers I can give you.  I'm sure, future post-aopocalytpic historians, that you have devised new and sophisticated methodologies to unearth the mysteries of the past.  I hope you can solve this historical puzzle -- because me and my contemporaries are thoroughly flummoxed.  

I wish you the best of luck, and once again, apologies for the whole collapse-of-Western-civilization-thing that happened in 2011.  Our bad. 

*To translate into your time scale, 15 B.B. (Before Lord Beiber, Praised Be His Hairness)

** 100 billion U.S. dollars = 15 BieberBucks

In my last post I mentioned how China was encountering resistance to its rising power.  Now, via Kindred Winecoff, I see a whole mess of reportage about China's mounting internal difficulties.  In no particular order: 

1)  Nouriel Roubini has focused his Dr. Doom-O-Vision on the Middle Kingdom, and doesn't like what he sees:

China’s economy is overheating now, but, over time, its current overinvestment will prove deflationary both domestically and globally. Once increasing fixed investment becomes impossible – most likely after 2013 – China is poised for a sharp slowdown. Instead of focusing on securing a soft landing today, Chinese policymakers should be worrying about the brick wall that economic growth may hit in the second half of the quinquennium....

[N]o country can be productive enough to reinvest 50% of GDP in new capital stock without eventually facing immense overcapacity and a staggering non-performing loan problem. China is rife with overinvestment in physical capital, infrastructure, and property. To a visitor, this is evident in sleek but empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns, and brand-new aluminum smelters kept closed to prevent global prices from plunging.

Commercial and high-end residential investment has been excessive, automobile capacity has outstripped even the recent surge in sales, and overcapacity in steel, cement, and other manufacturing sectors is increasing further. In the short run, the investment boom will fuel inflation, owing to the highly resource-intensive character of growth. But overcapacity will lead inevitably to serious deflationary pressures, starting with the manufacturing and real-estate sectors.

Eventually, most likely after 2013, China will suffer a hard landing. All historical episodes of excessive investment – including East Asia in the 1990’s – have ended with a financial crisis and/or a long period of slow growth. To avoid this fate, China needs to save less, reduce fixed investment, cut net exports as a share of GDP, and boost the share of consumption.

The trouble is that the reasons the Chinese save so much and consume so little are structural. It will take two decades of reforms to change the incentive to overinvest.

Now, Roubini is enough of a persistent doomsayer that it would be easy to discount this argument -- if it wasn't for the fact that this jibes with the opinion  of other China economy-watchers.  This coming-bust prophesizing comes on top of arguments made by Barry Eichengreen, Donghyun Park and Kwanho Shin that as China hits middle-income status, it will hit a "middle income trap" of slower growth.  (One interesting question is whether, as China encounters rampant inflation, its eventual decision to let the RMB appreciate will help ease some of these pressures). 

2)  Meanwhile, China's political leadership appears to be engaged in a full-fledged freakout over the Arab revolutions and any whisper of a similar phenomenon happening in China.  Rising food prices are leading to price controls and an anxious government monitoring if/when more expensive staple goods lead to political unrest.   That said, Chinese authorities seem to be on top of the whole crushing dissent thing: 

According to Chinese Human Rights Defenders, an NGO, by April 4th some 30 people had been detained and faced criminal charges relating to the so-called “jasmine revolution”—an inchoate internet campaign to emulate in China recent upheavals in the Middle East and north Africa. Human Rights Watch, another NGO, reports that a further 100-200 people have suffered repressive measures, from police summonses to house arrest. This has been accompanied by tighter censorship of the internet, the ousting of some liberal newspaper editors, and new curbs on foreign reporters in China, some of whom have been roughed up....

Even more worrying, however, is the increasing resort to informal detentions, punishments and disappearances. These are outside the law, offering the victim no protection at all. The government now dismisses the idea that one function of the law is to defend people against the arbitrary exercise of state power. On March 3rd a Chinese foreign-ministry spokeswoman told foreign journalists: “Don’t use the law as a shield.” Some people, she said, want to make trouble in China and “for people with these kinds of motives, I think no law can protect them.”

3)  As for China's assessment of its external security situation, the  State Council released its 2010 White Paper on defense last month.   As this East Asia Forum summary suggests, there's a slight change in tone from the 2008 white paper:

The introductory assessment of the ‘security situation’ section notes that the ‘international balance of power is changing,’ that ‘international strategic competition centring on international order, comprehensive national strength and geopolitics has intensified,’ and that ‘international military competition remains fierce.’  Despite this sense of turbulence, and as was the case in 2008, the 2010 paper assesses that ‘the Asia Pacific security situation is generally stable.’ But the additional observation in the 2008 paper, namely, ‘that China’s security situation has improved steadily’ does not appear in 2010. One possible reason is that the 2010 paper reports that ‘suspicion about China, interference and countering moves against China from the outside are on the increase.’ 

In light of all these developments, yesterday's Economist editorial should come as no surprise:

The view from Beijing, thus, is different to the view from abroad. Whereas the outside world regards China’s rulers as all-powerful, the rulers themselves detect threats at every turn. The roots of this repression lie not in the leaders’ overweening confidence but in their nervousness. Their response to threats is to threaten others.

Now, as someone who's pointed out these problems on occasion on this blog, you might think I'm pleased as punch about these developments.  Nope.  First, from an economic standpoint, a recessionary China eliminates a vital engine of global economic growth.  Second, as I wrote back in January: 

Exaggerating Chinese power has consequences. Inside the Beltway, attitudes about American hegemony have shifted from complacency to panic. Fearful politicians representing scared voters have an incentive to scapegoat or lash out against a rising power -- to the detriment of all. Hysteria about Chinese power also provokes confusion and anger in China as Beijing is being asked to accept a burden it is not yet prepared to shoulder. China, after all, ranks 89th in the 2010 U.N. Human Development Index, just behind Turkmenistan and the Dominican Republic (the United States is fourth). Treating Beijing as more powerful than it is feeds Chinese bravado and insecurity at the same time. That is almost as dangerous a political cocktail as fear and panic. 

Developing.... in very disturbing ways. 

Fifteen years ago Samuel Huntington coined the term "Davos Man" to describe the kind of globalized elite that jetted off from global conference to global conference. His point was that Davos man was an exceedingly rare bird, and that nationalism, religion, language and culture were still the most potent forces binding groups together in the world.

It's in this context that I read Chrystia Freeland's new cover story in The Atlantic. It's well worth the read, but like Kevin Drum, I'm not sure that the phenomenon Freeland is identifying is all that new.

Furthermore, I'm not entirely convinced they're as powerful as Freeland or Drum or Felix Salmon suggests. As Freeland pointed out, they fought a lot of the Obama administration's first-half policies tooth and nail -- and they actually lost a fair amount of the time. Indeed, nary a year ago some pundits were declaring the death of Davos man.

That said, there are three trends that are worth further consideration. First, as Freeland observes, the rich are now work much harder than they did a century ago. Second, more and more of the rich are coming from outside the OECD economies.

Third, the rich have attracted a lot of intellectual capital into their web. Indeed, the call for an economist code of ethics is based in no small part on the ways in which successful economists score moneymaking gigs as they move up the career ladder.

Again, I'm not sure if Freeland is right. I am sure that it's an interesting argument however. So, in the interest of further research your humble middle-class blogger is headed off tonight to investigate the beliefs and activities of the super-rich from much closer than normal.

This is a roundabout way of saying that blogging will be intermittent this week because I'm off to Dubai for a few days for a conference involving a lot of Really Rich People.

How rich? Well, let's put it this way -- I've already received an e-mail from my hotel in Dubai explaining that, "a Lifestyle Manager will be at your entire disposal" for my stay.

I'll post my thoughts on the entire surreal experience when I can.

In the meantime, talk amongst yourselves about the "global plutocracy." Is it a big deal? Is it an overblown phenomenon during an economic downturn? Did they all have superior Chinese mothers?

This week Japan has provoked the ire of the United States and Europe by unilaterally intervening in currency markets to depreciate the yen against other major currencies. Japanese Prime Minister Naoto Kan has responded to these criticisms by telling the US and EU to go suck a lemon stating that further "resolute actions" would be taken on this front. 

This comes on the heels of mounting U.S. frustration with China's "go-slow" policy on letting the yuan appreciate against the dollar. [What do you mean by "go slow"?--ed. Let's put it this way: the tortoise thinks that China is being pokey on this question.]

So, is this the beginning of beggar-thy-neighbor? Will other countries start intervening in foreign exchange markets to gain a competitive advantage for their export sectors? 

The New York Times' Hiroko Tabuchi thinks not, because Japan can't unilaterally devalue its currency like in the old days:

It is unlikely, though, that intervention by Japan alone will sway currency markets in the long term. The global volume of foreign exchange trading has grown rapidly in recent years, which prevents intervention by a single government from countering bigger market trends.

Other countries are unlikely to help Japan’s cause, because they need to keep their own currencies weaker to bolster exports. A weak currency makes a country’s exports more competitive and increases the value of overseas earnings.

Much of the yen’s weakening came from investors selling the currency on expectations that the Japanese government would be more active in keeping the yen in check. Japan did not disclose how much it had spent in currency transactions, but dealers put the initial amount at 300 billion to 500 billion yen ($3.5 billion to $5.8 billion).

But as Switzerland found this year, a single government’s efforts to weaken its currency can prove futile. Switzerland abandoned that effort, after its central bank had lost more than 14 billion Swiss francs ($14 billion) in foreign currency holdings in the first half of the year, after a fall in the euro’s value ate into the bank’s reserves.

The Swiss franc is also seen by investors as a relative haven and has also strengthened amid global financial unrest. This month, the franc hit a record high against the euro.

Hmmm.... maybe. Japan's economy is much larger than Switzerland, so I'm not sure the comparison holds up. The real problem, however, appears to be that countries perceived of as "safe havens" wind up with overvalued currencies. 

This little parable also makes me wonder whether we might see beggar-thy-neighbor policies in a different guise this time around. This is going to sound a little crazy, but here goes: rather than explicit exchange rate intervention, what if countries decided to play fast and loose with Basle III and other measures to strengthen financial integrity? 

This really does sound crazy -- it suggests that governments would be willing to tolerate a higher risk of domestic banking collapse in order to avoide being a "safe haven" status for capital. That said, think of how much Europe benefited from the depreciation of the euro due to the Greek crisis. Basle III, by taking so long for banks to meet standards allow those countries with more insolvent financial institutions **cough** Germany **cough** to take their own sweet time in having them meet new capital adequacy standards.  This would allow Germany to have the euro stay relatively cheap without abandoning its anti-inflationary zeal. 

Now, in all likelihood, not even the Germans would purposefully do this. This is crazy talk. What I'm suggesting, however, is that there is more than one way for a country to have its currency depreciate, and these policies are substitutable. Looking only at explicit exchange rate intervention might be just a bit too narrow. And if more countries find more ways of keeping their currency undervalued, well then, the days of beggar-thy-neighbor would have arrived.

Developing....

At APSA today I attended a panel on what political scientists can offer to political journalists.  Mark Schmitt, Marc Ambinder, Matt Yglesias, Mark Blumenthal, and Ezra Klein all offered interesting advice.   Two messages that came through loud and clear: 

1)  Be willing to advertise one's research wares; and

2)  Mr. Gorbachev, tear down these paywalls Make the research accessible to people without a JSTOR account. 

So, in that spirit, let me announce that I have an article in the latest issue of International Relations of the Asia-Pacific entitled "Will Currency Follow The Flag?" It's on the future of the U.S. dollar as the world's reserve currency.  The abstract: 

The 2008 financial crisis and its aftermath have triggered uncertainty about the future of the dollar as the world's reserve currency. China and other countries in the Asia-Pacific region have voiced support for a new global monetary regime. There are both economic and geopolitical motivations at the root of these challenges. Going forward, what will the future hold for the international monetary system? Crudely put, will currency follow the flag?

This article addresses this question by considering the economic opportunity and geopolitical willingness of actors in the Pacific Rim to shift away from the current international monetary system – with a special emphasis on China as the most powerful actor in the region. While the dollar has shifted from being a top currency to a negotiated one, neither the opportunity nor the willingness to shift away from the dollar is particularly strong. The current window of opportunity for actors in the region to coordinate a shift in the monetary system is small and constrained. The geopolitical willingness to subordinate monetary politics to security concerns is muted.

The entire article is free for anyone to download and read.  So read the whole thing, political journalists!! 

I think it's safe to say that if you want to feel jittery about the global economy today, there is no shortage of news to make you run for your Maalox. 

That said, here are three pieces of good news to suggest that the global economic recovery is a bit more resilient than the headlines might suggest: 

1)  American consumer confidence is still rising: 

The Conference Board, based in New York, said Tuesday that its Consumer Confidence Index rose to 63.3 points, up from a revised 57.7 reading in April. Economists surveyed by Thomson Reuters had expected 59.

The increase was bolstered by consumers’ outlook over the next six months, one component of the index, which soared to 85.3 from 77.4, the highest seen since it reached 89.2 in August 2007, before the economy entered in a recession.

The other component of the index, which measures how shoppers feel now about the economy, rose to 30.2 from 28.2.

The index — which measures how consumers feel about business conditions, the job market and the next six months — has been recovering fitfully since hitting an all-time low of 25.3 in February 2009.

2)  According to the World Bank's Temporary Trade Barriers Database, trade protectionism is decreasing: 

The first quarter of 2010 saw a substantial decrease in industry demands for temporary new import barriers under potentially WTO-legal "trade remedy" policies - antidumping, safeguards, and countervailing duty (anti-subsidy) policies. The first quarter 2010 resulted in a 20% decrease in newly initiated investigations in which domestic industries request the imposition of such new import restrictions compared to the number during the same time period in 2009. This follows the fourth quarter 2009 which also resulted in a 20% decrease relative to the same time period in 2008....

The first quarter 2010 also exhibited a substantial decline in the imposition of the new trade barriers that can come at the conclusion of the investigations that were initiated earlier. When compared to the same period in 2009, the first quarter of 2010 resulted in a 51.1% decrease in the number of new import-restricting measures imposed. It is also a substantial reduction from the number of new import restrictions imposed in the previous quarter - i.e., the fourth quarter of 2009.

3)  There's no indication that panic over European sovereign debt is causing a credit crunch across financial markets.  Indeed, according to the Financial Times' Chris Giles, most economists are pretty upbeat about the direction of the real economy: 

[T]hrough this tense period, most economists have remained confident in the world economic recovery. Greece, Spain, Portugal, Ireland and Italy are simply not big enough to derail the global economy.

Jim O’Neill of Goldman Sachs says the policy crisis in the eurozone is unlikely to be a source of global financial market contagion. “Nearly 70 per cent of the eurozone economy is made up of three countries – France, Germany and Italy – and unless the sovereign debt crisis derails their economies, it is tough to see how the eurozone could weaken sufficiently,” he says.

Julian Callow of Barclays Capital agrees: “The real economy still has substantial momentum and pent-up demand at the global level, provided that the current derisking in the financial markets does not become extended and feed back into a fall in business and consumer confidence.”

So far that has not happened to any great extent, a result that is more encouraging than in the aftermath of the bankruptcy of Lehman Brothers. And forecasts for the global economy, although uneven, are still rising....

[A] rapid yet fragile global recovery is a big improvement on the sense of doom that surrounded the outlook a year ago. The European sovereign debt crisis cannot be dismissed as an irrelevance to the recovery but it appears so far to be a nasty financial aftershock rather than a new economic earthquake.  

True, a Second Korean War or, say, a zombie outbreak could dash these nascent hopes for a strong recovery.  That said, I'll take these positive trends over the factors that are supposed to cause me fret and worry. 

So I see Paul Krugman has thrown his lot in with the neoconservatives who disdain multilateral institutions and prefer bellicose unilateralism when they confront a frustrating international situation. 

His op-ed today is about China's currency manipulation. ...  again. After explaining that China has less leverage than is commonly understood on the foreign economic policy front (gee, where have I heard that before), he closes with the following: 

In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent. 

Whoa there, big fella!!  That's a nice but very selective reading of international economic history you have there. 

It's certainly true that the dollar was overvalued back in 1971.  What Krugman forgets to mention -- and see if this sounds familiar -- is that the Johnson and Nixon administrations contributed to this problem via a guns-and-butter fiscal policy.  They pursued the Vietnam War, approved massive increases in social spending, and refused to raise taxes to pay for it.  This macroeconomic policy created inflationary expectations and a "dollar glut."  Foreign exchange markets to expect the dollar to depreciate over time. Other countries intervened to maintain the dollar's value -- not because they wanted to, but because they were complying with the Bretton Woods system of fixed exchange rates. Nixon only went off the dollar after the British Treasury came to the U.S. and wanted to convert all their dollar holdings into gold.  

In other words, the United States was the rogue economic actor in 1971 -- not Japan or Germany.   

So, how about acting multilaterally first before engaging in unilateral action that alienates America's friends and allies alike? 

To be fair to Krugman, many of the multilateral processes appear to be stymied, as Keith Bradsher explains in this NYT front-pager: 

Beijing has worked to suppress a series of I.M.F. reports since 2007 documenting how the country has substantially undervalued its currency, the renminbi, said three people with detailed knowledge of China’s actions....

Last September, Presidennt Obama, President Hu Jintao of China and other leaders of the Group of 20 industrialized and developing countries agreed in Pittsburgh that all the G-20 countries would begin sharing their economic plans by November. The goal was to coordinate their exits from stimulus programs and prevent the world from lurching from recession straight into inflation.

The G-20 leaders agreed that the I.M.F. would act as intermediary.

But two people familiar with China’s response said that the Chinese government missed the November deadline and then submitted a vague document containing mostly historical data. These people said that China feared giving ammunition to critics of its currency policies at the monetary fund and beyond. Both people asked for anonymity because of China’s attitudes about its economic policies.

That last part oabout the G-20 process is particularly disturbing, given that this was supposed to be the venue through which macroeconomic imbalances were supposed to be addressed.  So maybe Krugman is right and unilateral is the way to go? 

I don't think so.  The big difference between the end of the Bretton Woods era and the current Bretton Woods II situation is the distribution of interests.  In 1971, everyone was opposed to a continuation of U.S. policies.  This time around, there appears to be a growing consensus that China is the rogue economic actor. 

If Krugman gets to repeat himself, then so do I:   

[T]he United States is not the country that's hurt the most by this tactic.  It's the rest of the world -- particularly Europe and the Pacific Rim -- that are getting royally screwed by China's policy.  These countries are seeing their currencies appreciating against both the dollar and the renminbi, which means their products are less competitive in the U.S. market compared to domestic production and Chinese exports. 

So why should the U.S. act unilaterally?  Why not activate an international regime that does not include China but does include a lot of other actors hurt by China's currency policy?    

Am I missing anything? 

UPDATE:  Well, Brad DeLong clearly thinks I've missed a great deal.  Response to him -- and Krugman -- here. 

Your humble blogger has a very long day-job to-do list the first half of this week.  Still I can't resist not linking to this John Sides post from The Monkey Cage about why there's been a decline in  in trust in government. 

There was a secular decline in trust in government that levelled off after the Vietnam War started winding down.  Since then?  It's the economy, stupid: 

What drives the trend in political trust? By and large, it is the economy. People trust government when times are good. They don’t trust it when times are bad. For the presidential election years from 1964-2008, I merged the trust measure with the change in per capita disposable income, courtesy of Douglas Hibbs. Here is the relationship between trust and the economy:

The relationship is striking. The economy explains about 75% of the variance in trust. If you delete 1964, which looks like a potential outlier, the economy still explains 73% of the variance.

Of course the economy is not the only important factor. But it gets far less attention than it deserves when the hand-wringing begins.

I suspect it gets less attention because its a structural factor that is largely beyond the control of politicians.  It's also boring.  It's like a diet guru simply saing "eat less and exercise more" when asked what the trendy explanation is for how to lose weight. 

I wonder how generalizable the relationship is between trust and the economy.  For example, would a booming economy make Americans more likely to trust business, the academy, and other institutions?  Would it make Americans more likely to accept the evidence for global warming? 

What do you think?

Megan McArdle and I have a diavlog up at Bloggingheads.tv that is so 2009... mostly because we taped it on the last day or last year.  We discuss the big stuff of the decade -- 9/11, Afghanistan, Iraq, the financial crisis -- and reflect on what, if anything, we learned. 

One additional point that I failed to mention in the diavlog itself.  While this was a bad decade for America, it was actually a pretty great decade for large swathes of the globe.  China, Russia, India, Brazil, and much of sub-Saharan Africa recorded sustained levels of economic growth., for example. 

I know that's little comfort to the unemployed in Ohio.  My point is that the "good riddance" aspect to the end-of-the-naughts is hardly a global phenomenon. 

Two articles worth reading this AM: 

1.  Ali Ansari's history of the Iranian Revolutionary Guard Corps in The National Interest.  Ansari explains exactly how the IRGC has become intermeshed with the Iranian economy, and what that means going forward.  His key point:  it's not about the ideology anymore: 

Though the IRGC started its life as a defender of the revolution, over time the organization has become increasingly involved in commercial interests. Divisions within the Revolutionary Guard, particularly between its veterans and their heirs, have deepened. Now in bed with an increasingly radicalized elite in Iran, the IRGC seems to be less about protecting the people of the country and more about protecting its own material interests. Iran is rapidly becoming a security state.

2.  Blaine Harden's Washington Post story on the fallout from North Korean protests of the government's controversial currency reform last month.  Yes, you read that correctly, North Korean protests.  The good parts:

Grass-roots anger and a reported riot in an eastern coastal city pressured the government to amend its confiscatory policy. Exchange limits have been eased, allowing individuals to possess more cash.

The currency episode reveals new constraints on Kim's power and may signal a fundamental change in the operation of what is often called the world's most repressive state. The change is driven by private markets that now feed and employ half the country's 23.5 million people, and appear to have grown too big and too important to be crushed, even by a leader who loathes them....

The currency episode seems far from over, and there have been indications that Kim still has the stomach for using deadly force.

There have been public executions and reinforcements have been dispatched to the Chinese border to stop possible mass defections, according to reports in Seoul-based newspapers and aid groups with informants in the North.

Still, analysts say there has also been evidence of unexpected shifts in the limits of Kim's authority.

"The private markets have created a new power elite," said Koh Yu-whan, a professor of North Korean studies at Dongguk University in Seoul. "They pay bribes to bureaucrats in Kim's government, and they are a threat that is not going away."

Why did something like this take 40 years?  This is an overdetermined answer, but I have to think that the DPRK leadership has become so materially impoverished that North Koreans with ambition have decided that they are better off going outside the syatem rather than trying to achieve a bureaucratic sinecure. 

The common thread in both stories?  Ideological zeal only takes you so far, even in a totalitarian society.  Market forces will worm their way into even the most theocratic or communist societies.  What will be interesting is how those getting rich will respond to political instability, even as they have profted from the existing rules of the game. 

Hey, remember last year when there was a lot of populist hostility to the whole bailout idea because it was going to cost the taxpayers a truckload? 

It's funny how things turn out: 

The Treasury Department expects to recover all but $42 billion of the $370 billion it has lent to ailing companies since the financial crisis began last year, with the portion lent to banks actually showing a slight profit, according to a new Treasury report.

The new assessment of the $700 billion bailout program, provided by two Treasury officials on Sunday ahead of a report to Congress on Monday, is vastly improved from the Obama administration’s estimates last summer of $341 billion in potential losses from the Troubled Asset Relief Program. That figure anticipated more financial troubles requiring intervention....

[T]he new estimates would lower the administration’s deficit forecast for this fiscal year, which began in October, to about $1.3 trillion, from $1.5 trillion.

If you dig through the numbers, the bulk of the losses come from two sources -- the bailouts of GM and Chrysler, and the bailout of AIG. 

This leads to another very interesting irony.  The biggest beneficiary of these bailouts is the American public, since the financial system did not melt down and the futures market for duct tape and shotguns never materialized.   

Another big beneficiary, however, are sovereign wealth funds:

In less than two years, many of the biggest overseas government investment funds, known as sovereign wealth funds, have reaped huge gains from bailing out financial institutions, and in turn, the global financial system.

In the latest announcement, Kuwait’s sovereign wealth fund said on Sunday that it had booked a $1.1 billion profit on the stake it took in Citigroup in January 2008. That equals a 37 percent annualized return on its initial $3 billion investment. Other sovereign wealth funds — including those backed by the governments of Singapore, Qatar and Abu Dhabi — have also recently cashed out stakes in foreign banks for comparably large gains.

The hefty returns highlight how some savvy government funds have been able to profit from the financial crisis, even as most ordinary investors have been pummeled by billions of dollars of losses. It also calls into question whether such funds will act as long-term investors, as many initially suggested, or merely short-term profiteers.

I'm not sure how "savvy" these funds actually were -- I don't think that they were banking on a crisis followed by a rapid recovery in the financial sector.  Still, these funds didn't panic during the meltdown, so I guess that's a small point for "patient capital."

That said, I'm wrestling with the lessons to draw from all of this.  It does suggest that with great risk comes great opportunity.  By late 2007 it was governments rather than private capital markets that were willing to take the risk. 

I'll leave it to the commenters to draw additional lessons. 

This is an interesting press release: 

In response to the policy challenges presented by the economic crisis and the need to develop fresh approaches to economic theory, a group of top academics, policy-makers, and private sector leaders today announced the creation of the Institute for New Economic Thinking (INET)....

The Institute was established with a pledge of $5 million per year for 10 years from Open Society Institute Chairman George Soros, a long-time critic of classical economic theory, who will fund the effort through the Central European University (CEU).

The Institute will make research grants, convene symposia, and establish a journal. A first conference will be at King's College, Cambridge on April 9-11. Scholars will explore the implications of the financial crisis for regulatory policy. The first round of research grants will be made before the end of the year to cutting-edge scholars working with leading universities around the world. INET’s Executive Director will be Robert Johnson, an economist with long experience in government, academia, and the private sector....

Speaking in Budapest at the CEU, through which INET will be funded and which will be a hub of the INET network, Soros said, “The entire edifice of global financial markets has been erected on the false premise that markets can be left to their own devices, we must find a new paradigm and rebuild from the ground up. I decided to sponsor INET to facilitate the process. I hope others will join me.” Because he is both an INET benefactor and proponent of a particular theory, Reflexivity, Soros will recuse himself from the grant-making process.  “While I hope reflexivity will be one of the concepts examined, there are numerous alternatives to the prevailing dogma that must be explored.” Soros added. 

Based on his track record, Soros is not very good at influencing political movements, but he is quite good at influencing the world of ideas.  So, it's quite possible that this new institute will wean economists from the neoclassical paradigm. 

Over at Newsweek, Michael Hirsch certainly thinks this is important: 

It might be tempting to dismiss all this as a war of words among brainiacs. It's not. The critical issues being discussed in Washington about the future regulation and control of the financial industry—the very nature of Wall Street and the health of the economy—depend on this battle of ideas. What led to wholesale deregulation in the '90s and '00s wasn't just Wall Street lobbying money. It was also that key legislators and policymakers, among them Larry Summers, persuaded themselves that deregulation was sound economics and good policy, and that markets and Wall Street institutions could take care of themselves. Many of those views have been discredited by the crisis. But in the absence of a new paradigm of economics, confusion still reigns in Washington. With no new concept of the proper role of government and regulation in the economy, of the proper balance between the markets and their minders, the old school still dominates.

Similarly, Veronique de Rugy is freaked out by this Soros initiative, which suggests it might actually matter.   

I think Hirsch is correct about the persistence of market-friendly ideas contained in Washington Consensus.  Let's call this the zombie Washington Consensus, because it keeps moving on even after suffering politically fatal blows. 

That said, real shifts in ideas only take place when one dominant idea is replaced by another dominant idea that has both intellectual and political cachet.  Looking at Soros' Board of Advisors, I'm not sure there is a consensus about what paradigm should replace a free market approach. 

Hopefully, this institute will lead to a mess of heterodox work that forces everyone to bring their "A" game to the problems at hand -- includind free market enthusiasts.  The worst-case scenario is that George Soros is funding the economic equivalent of Ross Perot's Reform Party.    

Developing....