Well, this sounds like very bad news for the global financial system: 

A plan to rescue the tiny European country of Cyprus, assembled overnight in Brussels, has left financial regulators, German politicians, panicked Cypriot leaders and a disgruntled Kremlin with a bailout package that has outraged virtually all the parties.

In the end, a bailout deal that was supposed to calm a financial crisis in an economically insignificant Mediterranean nation spread it wider. Word of the plan unnerved markets across Europe, raised fears of bank instability in Spain and Italy and sent pensioners into the streets of the island’s capital, Nicosia, in protest.

As markets tumbled and the Cypriot Parliament fell into turmoil, salvos of blame were hurled back and forth across the Continent.

Officials scrambled to explain what went wrong and how best to control the damage of what Philip Whyte, a senior research fellow at the Center for European Reform, called a “completely irrational decision” to make bank depositors liable for part of the bailout. The deal flopped so badly that finance ministers who came up with it shortly before dawn on Saturday were on the phone to each other Monday night talking about ways to revise it.

Now, on the one hand, you would be hard-pressed to find anyone who will defend the Cypriot deal as it was announced on Saturday -- but it's pretty easy to find critics of the proposed deal across the political spectrum. So this seems like yet another data point confirming the truly mind-boggling stupidity of European governments and regulators. It's particularly galling that they did this during a time when global capital markets are still fragile from the 2008 financial crisis.

Oh, except, wait a minute, it turns out that those markets aren't as fragile as the perception suggests. If you burrow into the McKinsey Global Institute's latest report on global asset markets, it turns out that, excepting Europe, the rest of global finance has experienced a decent recovery from the 2008 crash. According to MGI: 

With the pullback in cross-border lending, foreign direct investment from the world’s multinational companies and sovereign investors has increased to roughly 40 percent of global capital flows. This may bring greater stability, since foreign direct investment has proved to be the least volatile type of capital flow, despite a drop in 2012.

Of course, this was written before the Cypriot stupidity, so now markets are really roiled, right? Well... here's Business Insider's Joe Weisenthal's take early this a.m.:

Markets are down a bit in Europe although not dramatically so yet.

US futures were flat, and Asia was actually up nicely, with Japan gaining 2%.

That seems like a thoroughly appropriate reaction. And over at the New York Times, Andrew Ross Sorkin explains why that's the rational and appropriate reaction:

While the bailout of Cyprus is a fascinating case study and raises interesting theoretical questions about moral hazard for policy wonks and talking heads, here is the reality: It is largely irrelevant to the global economy. Cyprus is tiny; its economy is smaller than Vermont’s. And the bailout is worth a paltry $13 billion, the equivalent of pocket lint for those in the bailout game.

Even the larger issue about bailing out a country by taking money from depositors — which quickly created outrage around the world — seems overblown....

[I]n truth, the smart money knows that the bailout of Cyprus says very little about future actions.

“I would assume that anyone in Spain, Portugal or elsewhere who knows about the taxation of Cypriot depositors also would know that the Cypriot banking system is a very different animal than anywhere else in the euro zone,” Erik Nielsen, chief economist at UniCredit, wrote in a note to clients.

Mr. O’Neill of Goldman also acknowledged: “I am sure it will not set a precedent.”

Cyprus is unique. Besides being tiny, its banking system looks different from those in most other countries. Much of the big money deposited in its banks is from foreign investors, including Russians who have long been suspected of money laundering. Those investors had fair warning that Cypriot banks were troubled. The issue has been simmering for six months. But those investors left their money in the bank, in part because they were gambling that the banks would be bailed out at no cost to them. If the current plan is approved, depositors will have lost that bet.

Now this is a perfectly rational analysis. What's significant is that it seems like markets are making the same calculation. When financial markets are fragile, when there's a fear of financial contagion, they don't make the rational calculation -- they freak out. That hasn't happened with Cyprus.

I know I'm at the risk of pulling a Donald Luskin here, but what's happening in Cyprus right now primarily affects Cypriots, with a small concern about regional effects. It doesn't look like it's triggering the same kind of concerns of either the Lehman collapse or the Greek sovereign debt crisis. And anytime the abject stupidity of European financial statecraft can be confined to Europe, that's a very, very good thing indeed for the global financial system.

Am I missing anything? 

Let's face it, Americans do not understand the current state of either macroeconomic policy or foreign policy terribly well. According to Bloomberg, only six percent of Americans know that the federal budget deficit is actually shrinking. According to Gallup, just a bare majority of Americans believe that the United States military remains "number one in the world militarily." In a world of these kind of epic media fails, where significant numbers of GOP legislators seem "more concerned about 2% inflation than 8% employment," it's important to to have recognized experts try to clear the air. 

Nobel Prize-winning economist and unusually-pithy-writer-for-an-economist Robert Solow has an op-ed in today's New York Times to offer a primer on the implications of U.S. debt. Here, in brief, are the "six facts about the debt that many Americans may not be aware of," in Solow's words. Let me number them here:

1) Roughly half of outstanding debt owed to the public, now $11.7 trillion, is owned by foreigners. This part of the debt is a direct burden on ourselves and future generations....

2) The Treasury owes dollars, America’s own currency (unlike Greece or Italy, whose debt is denominated in euros)...

3) One way to effectively repudiate our debt is to encourage inflation...

4) Treasury bonds owned by Americans are different from debt owed to foreigners. Debt owed to American households, businesses and banks is not a direct burden on the future....

5) The real burden of domestically owned Treasury debt is that it soaks up savings that might go into useful private investment.

6) But in bad times like now, Treasury bonds are not squeezing finance for investment out of the market. On the contrary, debt-financed government spending adds to the demand for privately produced goods and services, and the bonds provide a home for the excess savings. When employment returns to normal, we can return to debt reduction.

Some foreign pollicy experts think that Solow is being too sunny.  Take Council on Foreign Relations president Richard Haass:

overly sanguine view of US #debt. ignores impact of rising rates; ability of a hostile foreign govt to pressure US. nyti.ms/VOJZf4

— Richard N. Haass (@RichardHaass) February 28, 2013

With respect, I think Solow is actually being too pesssimistic, and Haass is being way too pessimistic. 

The problem is that, contra Solow, I suspect Americans are keenly aware of his points 1-5.  The United States owes a lot of money to China, but I'd wager that any poll of U.S. citizens would reveal that the public thinks we owe even more to China than we actually do. Similarly, much of the policy rhetoric coming from Washington focuses on fears of incipient inflation that have yet to pan out. 

It's Solow's last point that is the one Americans need to hear more: in an era of slack demand, bulging coporate cash coffers, and recovering personal savings rates, it's actually pretty stupid to have U.S. government spending and employment contract so quickly. I fear, however, that excessive concern about Solow's first, third, fourth and fifth points will swamp out the rest of his op-ed. 

As for Haass, I'm not exactly sure what "rising rates" he's talking about, as just about any chart you can throw up shows historically low borrowing rates for the United States government. Indeed, the U.S. Treasury is exploiting this fact by locking in U.S. long-term debt at these rates. As for foreign governments pressuring the United States, the fear of foreign financial statecraft has been somewhat hyped by the foreign policy community. And by "somewhat hyped," I mean "wildly, massively overblown." 

The bias in foreign policy circles and DC punditry is to bemoan staggering levels of U.S. debt. This bias does percolate down into the perceptions of ordinary Americans, which leads to wild misperceptions about the actual state of the U.S. economy and U.S. economic power. I'd like to see a lot more op-eds by Solow et al. that puncture these myths more effectively. 

Am I missing anything? 

The Washington Post's Howard Schneider and Danielle Douglas have a story detailing the ways in which post-crisis global financial reform has allegedly ground to a halt:

Five years after the collapse of Lehman Brothers, a global push to tighten financial regulation around the world has slowed in the face of a tepid recovery and a tough industry lobbying effort....

the post-Lehman goal — of a global scheme that would immunize the financial system from another large-scale shock — remains incomplete. Big banks, insurers and other financial giants remain intact and arguably “too big too fail.” Tools to guard against dangerous bubbles in the value of property or other assets are not yet in place. There is no agreement on how countries should coordinate the failure of a globally important financial company. Implementation of basic banking rules in major nations has fallen behind schedule.

Finishing the job “is going to take many years,” International Monetary Fund chief economist Olivier Blanchard said last week. “It is conceptually very difficult, politically very difficult.”

In their effort to overhaul the global system, regulators have been confronted by a number of head winds. The world’s economy has been unexpectedly slow to recover, making governments leery of doing anything that might make banks cautious to loan and invest. The financial industry has pushed back hard, warning that aggressive regulation might undermine growth. And regulators are simply limited in their understanding of how modern finance can be made safe while still supporting economic activity.

The result: Some of the proposals once considered core to a safe, post-Lehman system have been delayed and weakened, and others have been played down, at least for now, as too politically complex.

Well, this sounds like a blow against my theory of "pretty good" or "good enough" global governance that I've been yammering about on the blog.... that is, until one starts reading the rest of the Post's story.

First of all, with the exception of one Jamie Dimon quote, there's not any real evidence in the story that industry lobbying is to blame. I'm not saying that this means that there was no industry lobbying, or that it was inconsequential -- merely that there's no evidence in the story to support the lede.

What there is evidence of, however, are two things that seem pretty consistent with "good enough" global governance. The first is that even in areas where there's been minimal global agreement, there have beern "patchwork" arrangements that look like they will work. For example:

There also is no comprehensive global approach for addressing bank failures. Individual members of the Basel committee, including the United States, have established resolution plans in case their own lenders become insolvent. And the United States and Britain in December released a set of guidelines to handle a major insolvency — a potentially important agreement between two world financial centers.

But determining how to coordinate the collapse of a major multinational bank is an area where the IMF and others have had limited success in pushing for a broader global agreement. The issue is important because a method to share the fallout of a bank failure across national borders would probably make countries more willing to let institutions go out of business, rather than propping them up with taxpayers’ money.

Again, in a perfect world one would like to see a comprehensive agreement. Given the center of gravity for the financial sector, however, an Anglo-American arrangement is actually pretty powerful and covers the biggest concerns.

Then we get to the implementation of the Basel III accords, designed to insure that banks have sufficient reserves of safe and liquid assets on hand to prevent a panic. As Schneider and Douglas note, the Financial Stability Board reports that only 8 of 27 nations are on track to implement these reforms on schedule.

Why is that the case? Here we find that interest group lobbying seems to matter less than... a recognition by regulators that life is not so simple:

[O]ther Basel proposals have been revised as regulators, bankers and officials have better understood how some of their major assumptions about finance and risk had been upended by events.

In Basel this month, regulators scaled back one key set of provisions that would force banks to keep the equivalent of larger levels of cash on hand to guard against a run on deposits or another fast-moving crisis.

Such highly liquid assets had been defined to include government bonds — which traditionally can be sold quickly and at close to their face value — and to exclude securities backed by residential mortgages, the bundled, complex assets that had triggered the financial crisis in 2007 when they proved difficult to sell other than at a steep loss.

The financial crisis in the euro zone showed a flaw in the approach when Greek, Portuguese and other government bonds plummeted in value. Smaller U.S. banks, meanwhile, argued that to completely exclude mortgages from the new “liquidity coverage ratio” would reduce their ability to make home loans.

When the final Basel rules on the issue were released this month, the required liquidity levels were reduced, mortgages were included in the tally and banks were given extra time to comply.

“Nobody set out to make it stronger or weaker as a standard but to make it more realistic... to make sure there was no impediment to financing recovery,” said Bank of England Governor Mervyn King, who chairs a Basel committee of central bankers and regulatory chiefs.

So, to sum up: after an initial burst of regulatory arrangements, progress has slowed down in some areas, and in other areas relies on a more patchwork arrangement. That said, there appear to be intrisically good reasons for the slowdown, and the patchwork covers the major financial centers.

Yeah, this is "good enough" global governance.

The Wall Street Journal has two great stories on the Federal Reserve's decision to go for QE3 -- a third round of quantitative easing.  First, Jon Hilsenrath documents how Fed chairman Benjamin Bernanke built a consensus among the Federal Reserve governors:

For weeks, Mr. Bernanke made dozens of private calls on days, nights and weekends, trying to build broad support for an unusual bond-buying program he wanted approved during the Fed's September meeting, according to people familiar with the matter....

Fed officials described the Fed chairman's phone calls as low-pressure conversations. Mr. Bernanke sometimes dialed up colleagues while in his office on weekends, catching them off guard when their phones identified his private number as unknown. He gave updates on the latest staff forecasts, colleagues said. He asked their thoughts and what they could comfortably support, they said.

The calls helped Mr. Bernanke gauge how far he could push his committee. It also won him trust among some of his fiercest opponents, officials said. Nearly all of Mr. Bernanke's colleagues described him as a good listener.

"Even if you disagree with him on the programs, you know your voice has been heard," said [Dallas Fed President Richard] Fisher, one of his opponents. "There is no effort to bully."

So Bernanke did a lot of hand-holding, a lot of listening... to the key Fed decision-makers.  What's equally important is who he didn't talk to -- namely, other central bank heads in the rest of the world. 

I bring this up because some of these central bank officials are pretty pissed.  QE3 has caused the yuan to hit its all-time high against the dollar, for example.  Which leads us to the other interesting Wall Street Journal story.  Aaron Back and In-Soo Nam document how South Korea and China have reacted to QE3: 

Chinese and South Korean central-bank officials criticized the U.S. Federal Reserve's latest easing efforts and advocated reducing Asia's dependence on the U.S. dollar.

The comments Thursday, at a joint seminar in Beijing by the two central banks, are the clearest indication yet of a rising backlash in Asia against U.S. monetary policy, suggesting it could speed up the search for alternatives to the dollar as the main global currency.

"The rise in global liquidity could lead to rapid capital inflows into emerging markets including South Korea and China and push up global raw-material prices," said Bank of Korea Gov. Kim Choong-soo. "Therefore, Korea and China need to make concerted efforts to minimize the negative spillover effect arising from the monetary policies of advanced nations."

Chen Yulu, an academic adviser to the People's Bank of China, said Asia needs a "regional core currency" to reduce its dependence on the dollar. China's ultimate goal is for the yuan to be as important as the euro or the dollar, he said.

Whoa, this sounds pretty bad... until you get to the next paragraph: 

But [Chen] acknowledged that will be a slow process, saying it would be possible for the yuan to be fully convertible by 2020, and that the overall yuan-internationalization process may last until 2040. China strictly controls its currency, though it has made small moves to broaden its use globally in recent years and has also allowed a little more flexibility in its movements (emphasis added).

As I've said before, the dollar ain't going away anytime soon, and whatever leverage analysts believe China possesses with its dollar holdings is vastly overstated.   

Furthermore, it's worth noting that the international bitching and moaning about QE3 seems much less than the "currency war" rhetoric that QE2 triggered.  Why?  Based on my half-assed blog analysis I'd speculate that there are three reasons: 

1)  The global economy is in a more sluggish state in 2012 than in 2010, so it's hard to argue that expansionary monetary policy is inappropriate now. 

2)  The United States was not the only major economy to go the quantitative easing route in the past few months.  Both the European Central Bank and the Bank of Japan have made similar -- if uncoordinated -- moves. 

3)  The central bank heads have learned frrom QE2 that the bitching and moaning won't accomplish anything.  It didn't stop QE2 and it won't stop QE3. 

Am I missing anything? 

I should be really pleased with Thomas Friedman's column today.  Entitled "In MItt's World," Friedman pens a substantive column criticizing Romney's foreign policy rhetoric to date and wishing that Romney displayed the same analytic acumen about foreign policy that he displayed as CEO of Bain Capital. 

So I should be happy, except that I passed out from banging my head against my desk after reading the first two paragraphs: 

Mitt Romney has been criticized for not discussing foreign policy. Give him a break. He probably figures he’s already said all that he needs to say during the primaries: He has a big stick, and he is going to use it on Day 1. Or as he put it: “If I’m president of the United States ... on Day 1, I will declare China a currency manipulator, allowing me to put tariffs on products where they are stealing American jobs unfairly.”

That is really cool. Smack China on Day 1. I just wonder what happens on Day 2 when China, the biggest foreign buyer of U.S. debt securities, announces that it will not participate in the next Treasury auction, sending our interest rates soaring. That will make Day 3 really, really cool. 

No.  No, no, no, no, no, and no. 

To elaborate a bit further:  

First, it wouldn't be enough for China to stop buying Treasuries -- as Joe Weisenthal showed with some fun charts a few weeks ago, China has pared back its Treasury purchases intermittently over the past few years -- with zero appreciable effect on U.S. interest rates. (see non-panda-hugger Paul Krugman on this point as well).  No, for China to have the effect that Friedman envisions, they would also have to actively dump most of their holdings of U.S. debt as well.

So what if they do?  Well, second, while Romney's stated China policies border on the destructive, the "labeling" move is bone-headed rather than truly calamitous. China wouldn't dump its debt unless things got really bad between the two countries.  Not even Stephen Roach thinks this would be the initial Chinese response -- and I think Roach is being way too gloomy about Sino-American relations under Romney. 

The reason China won't respond with the nuclear option of dumping all its U.S. debt holdings is that -- to repeat a theme -- this move would hurt China way more than it would hurt the United States.  The far more likely response by China would be to retaliate with trade measures.  This would not be good, as China is now the third largest export market for the United States.  Beijing can hurt a Romney administration by reducing its American imports far more adroitly than trying to trigger another financial crisis. 

Now, for the record, I don't think Romney should label China as a currency manipulator on day one, and I think Friedman makes some trenchant observations on Romney's consequences-free foreign policy statements later in his column.  But this Niall Ferguson-lite version of Sino-American relations is bad international relations theory and really bad economics -- and yet Very Serious People keep trotting it out.  

I really, really wish this would disappear from public discourse.  But it won't.  So, most likely, my desk is gonna get dented a few more times before Election Day. 

While I was on the road last week, I see that Greek elections managed to accomplish two things:

1)  A requirement for yet more Greek elections; and

2)  A recognition among European banking officials that this time, Greece might actually be leaving the eurozone. 

Sooo ... what happens then? The Financial Times has a useful article that asks the appropriate big questions while providing some useful information.  Particularly interesting is the emerging belief that the eurozone now has erected the necessary firewalls to prevent contagion from Greece to the rest of the southern Med and Ireland: 

[W]ith a new, permanent €500bn rescue fund backed by the strength of an international treaty with multiple tools to buy sovereign bonds on the open market and inject capital into eurozone banks, some officials believe the contagion could be contained -- much as it was after Athens finally defaulted on private bondholders last month.

"Two years ago a Greek exit would have been catastrophic on the scale of Lehman Brothers,” says a senior EU official involved in discussions about Greece’s future. “Even a year ago, it would have been extremely risky in terms of contagion and chain reaction in the banking system. Two years on, we’re better prepared."

The new eurozone firewall -- now backed with additional resources for the IMF -- is not the only reason some officials are becoming increasingly sanguine about losing Greece. Spain and Italy, they say, have taken huge steps to put their economic houses in order, enabling them to bounce back quickly if credit markets suddenly dry up and their banks wobble.

Still, uncertainty over how Europe’s banks would be affected has continued to be the primary concern.

Paul Krugman is somewhat more pessimistic. Sketching out the possible endgame, he posits that Spanish and Italian banks would experience massive capital flight, triggering the key decision faced by Germany:

4a. Germany has a choice. Accept huge indirect public claims on Italy and Spain, plus a drastic revision of strategy -- basically, to give Spain in particular any hope you need both guarantees on its debt to hold borrowing costs down and a higher eurozone inflation target to make relative price adjustment possible; or:

4b. End of the euro.

And we’re talking about months, not years, for this to play out.

Krugman has been predicting Greece's exit from the euro for some time now, but in this case I do think he's correct about the choice posed by Germany -- as yet more signals accrue about Merkel's declining political strength. 

Now, actually, I suspect that Greece stays in the eurozone for longer than anyone suspects.  That said, based on my two empirical observations during the past two years -- namely, eurogoggles and the Merkel Algorithm.  Here is how I would game out the "Grexit" scenario: 

1.  Greece's departure is announced at the same time as an EU summit announces a boost to its new rescue fund and modest pro-growth German policies.  Markets initially react to this news favorably.

2.  Within 48 hours, negative news about the Spanish and Italian economies, combined with a second wave of stories revealing that the rescue fund isn't as big as anyone thought it was, rattles financial markets and triggers the behavior described by Krugman. 

3.  The ECB does nothing, calling on Merkel European political leaders to take "decisive action." 

4.  After a week or two of agnonizing non-action, Germany announces half-measures that end the immediate panic gut set up Spain for more stagnation and a new crisis in 2013. 

Am I missing anything? 

It's been a busy week for Iran-watchers. The European Union is mulling a phased-in oil embargo, prompting Iranian officials to label the move as "an economic war" against Iran. Now Iran's Asia customers are trying to diversify away from Iranian oil. These expectations of future cutoffs, combined with pre-existing sanctions, are taking their toll on the Iranian economy in the form of dollar-hoarding and a free-falling national currency. Fareed Zakaria sums up the current state of play nicely:

[T]he real story on the ground is that Iran is weak and getting weaker. Sanctions have pushed the economy into a nose-dive. The political system is fractured and fragmenting. Abroad, its closest ally and the regime of which it is almost the sole supporter -- Syria -- is itself crumbling. The Persian Gulf monarchies have banded together against Iran and shored up their relations with Washington. Last week, Saudi Arabia closed its largest-ever purchase of U.S. weaponry.…

The Obama administration has put tremendous pressure on Iran on a variety of fronts -- far more pressure than the Bush administration was ever able to muster. This is, in part, because the pressure has been brought to bear, wherever possible, with other countries. The United States does not buy oil from Iran. But European nations, Japan and South Korea do, and if they go along with a new round of sanctions, Iran faces the real prospect of an economic freefall.

Iran's response to these moves has been a mixture of tough talk, empty gestures, backtracking on threats, and an acknowledgment of economic difficulties. It's therefore no wonder that the Washington Post reports, "U.S. officials are increasingly confident that economic and political pressure alone may succeed in curbing Iran's nuclear ambitions." Walter Russell Mead observes that, "public opinion in Iran does not seem to be rallying behind its unpopular government as the economic storm intensifies."

At the same time, however, Iran is trying to demonstrate that its uranium enrichment will continue unabated. Trita Parsi argues that overconfidence in the sanctions track will cause the Obama administration to rebuff any negotiated breakthrough on the nuclear issue. This leads to the obvious question: What's the endgame in Iran? Will sanctions "work"?

To get Clintonian, this depends on your definition of "work." One could argue that the current and projected actions taken by the EU and Pacific Rim might have been a wake-up call to Tehran that it's more isolated than it had previously thought. Iran is not merely facing the United States; it's facing a multilateral coalition that's growing stronger, not weaker. Unless potential benefactors like China take proactive steps to function as a "black knight," these sanctions really will cripple Iran's economy. The alienation of Iran's bazaari from the leadership in Tehran would ... let's say complicate the domestic situation in Iran.

That said, I'm skeptical that it will push the current regime toward making a substantive accommodation on its nuclear program. Based on how the leadership has treated domestic unrest, it seems clear that the top leadership is perfectly comfortable following The Dictator's Handbook approach to staying in power. More-powerful sanctions will therefore simply lead to more-powerful crackdowns. If Iranian elites view the nuclear program as the key to preventing outside attempts at forcible regime change, there's no way they'll compromise.

So would negotiation work? I'm skeptical here too. In part the problem is determining whether the Iranians are capable of negotiating in good faith. I don't mean that Tehran will act duplicitously; I mean whether the fractious regime can act in a coherent manner. Its behavior over the past week or two suggests otherwise. So does Zakaria:

The Obama administration seems to have concluded that the Iranian regime is not ready or able to make a strategic reconciliation with the West. The regime is too divided and Ayatollah Ali Khamenei, the ultimate authority, the Supreme Leader, is too ideologically rigid. So for now Washington wants to build pressure on Iran in the hopes that this will force the regime into serious negotiations at some point.

I suspect the Obama administration's hopes are more ambitious. They want the sanctions to be so crippling that Khamenei's ultimate authority comes under challenge, to the point where factional divisions open up space for a substantive change in the regime.

This might work, but I'd put the odds of this happening at less than 1 in 3. Still, this is the thing about instances in which economic sanctions are deployed. Even if their prospects don't look great, they're usually employed because the other options have even worse odds. For the next, say, six months, pursuing this course of action makes sense. It weakens Iran at a key moment in the Middle East, and it might lead to some positive developments down the road. That said, even if the sanctions work in crippling Iran's economy, they likely won't work at altering Iran's objectionable nuclear policies -- the expectations of future conflict are too great. At that point, the United States is going to need to consider whether it's prepared to pursue a longer-term containment strategy or alter course.

What do you think?

Hey, remember when about ten days ago I blogged that things were getting so bad in Europe that it was legitimate to bring up the 1930's?  What's happened since that seemingly hyperbolic warning? 

As Felix Salmon blogged earlier this week, the European banking system is headed towards a full-blown liquidity crisis.  Yields on Spanish and Italian debt are hovering around the 7% mark, which was the tipping point that forced Greece, Ireland and Portugal to seek assistance from the European Financial Stability Facility and the IMF.  Multiple European countries, including France, have had difficulty completing bond auctions this week.   

So it would seem that the European Central Bank needs to do something.  The New York Times, Wall Street Journal, and Financial Times all have lead stories today pointing out the enormous pressures that are being put on the European Central Bank this week.  We'll excerpt the non-gated NYT story to set things up: 

Only the fiercely conservative stewards of the European Central Bank have the firepower to intervene aggressively in the markets with essentially unlimited resources. But the bank itself, and its most important member state, Germany, have steadfastly resisted letting it take up the mantle of lender of last resort....

At issue is whether the bank has the will — or the legal foundation — to become a European version of the Federal Reserve in the United States, with a license to print money in whatever quantity it considers necessary to ensure the smooth functioning of markets and, if needed, to essentially bail out countries that are members of the euro zone.

Traditionally, and according to its charter, the European bank has viewed its role in much narrower terms, as a guardian of the value of the euro with a mission to prevent inflation. But as market unease has spread over the past two years, critics say the bank’s obsession with what they say is a phantom threat of inflation has stifled growth and helped bring the euro zone to the edge of a financial precipice.

With events threatening to spin out of control, the burden now rests on Mario Draghi, an inflation fighter in the president’s job at the bank barely two weeks who surprised many economists by immediately cutting interest rates a quarter point.

This morning, however, in his first speech as the head of the ECB, Draghi pivoted and redirected the pressure back at the politicial stewards of the EU:

National economic policies are equally responsible for restoring and maintaining financial stability. Solid public finances and structural reforms – which lay the basis for competitiveness, sustainable growth and job creation – are two of the essential elements.

But in the euro area there is a third essential element for financial stability and that must be rooted in a much more robust economic governance of the union going forward. In the first place now, it implies the urgent implementation of the European Council and Summit decisions. We are more than one and a half years after the summit that launched the EFSF as part of a financial support package amounting to 750 billion euros or one trillion dollars; we are four months after the summit that decided to make the full EFSF guarantee volume available; and we are four weeks after the summit that agreed on leveraging of the resources by a factor of up to four or five and that declared the EFSF would be fully operational and that all its tools will be used in an effective way to ensure financial stability in the euro area. Where is the implementation of these long-standing decisions?

The truly scary thing is that, given the state of the Italian and Spanish bond markets, even the full EFSF won't be enough to calm markets down. 

And so the pressure gets redirected back to Germany, as the most powerful actor in the ECB and EU.  As Matthias Matthijs and Mark Blyth explain in Foreign Affairs, however, Germany has not been reading its Charles Kindleberger:

In order to guarantee the strength of any international economic system, Kindleberger explained, a stabilizer -- only one stabilizer -- needs to provide five public goods: a market for distress goods (goods that cannot find a buyer), countercyclical long-term lending, stable exchange rates, macroeconomic policy coordination, and real lending of last resort during financial crises. The United States did not supply these things in the 1930s. Germany fails the test on all five items today.

First, rather than providing peripheral countries with a market for their distress goods, the Germans have been enthusiastically selling their manufactured goods to the periphery. According to Eurostat, Germany's trade surplus with the rest of the EU grew from 46.4 billion euro in 2000 to 126.5 billion in 2007. The evolution of Germany's bilateral trade surpluses with the Mediterranean countries is especially revealing. Between 2000 and 2007, Greece's annual trade deficit with Germany grew from 3 billion euro to 5.5 billion, Italy's doubled, from 9.6 billion to 19.6 billion, Spain's almost tripled, from 11 billion to 27.2 billion, and Portugal's quadrupled, from 1 billion to 4.2 billion. Between 2001 and 2009, moreover, Germany saw its final total consumption fall from 78.5 percent of GDP to 74.5 percent. Its gross savings rate increased from less than 19 percent of GDP to almost 26 percent over the same period.

Second, instead of countercyclical lending, German lending to the eurozone has been pro-cyclical. Indirectly (through buying bonds) and directly (by spreading its exchange rate through the euro), the country has basically given the periphery the money to buy its goods. During the economic boom of 2003-2008, Germany extended credit on a massive scale to the eurozone's Mediterranean countries. Frankfurt did quite well for itself. "European Financial Linkages," a recent IMF working paper, reveals that in 2008, Germany was one of the two biggest net creditors within the eurozone (after France). Its positive positions were exact mirrors of Portugal, Greece, Italy, and Spain's negative ones. Of course, as the financial crisis began to escalate in 2009, Germany abruptly closed its wallet. Now Europe's periphery needs long-term loans more than ever, but Germany's enthusiasm for extending credit seems to have collapsed.

And what about the third public good, stable exchange rates? By definition, the euro gives the countries that choose to join it a common external float, the credibility that comes with banking in a potential global reserve asset, and the credit rating of its strongest member. This is both true and where the problems begin. At the core of the eurozone lies a belief that, if countries adhere to a set of rules about how much debt, deficit, and inflation they can have, their economies will converge, and the same exchange rate will work for all members. This is true in theory, but only so long as countries obey the rules. And, despite being the author of many of those rules, Germany showed a singular lack of leadership and responsibility when it came to following them. When it broke the Stability and Growth Pact (SGP) in 2003, it sent the signal to the smaller countries that fiscal profligacy would go unpunished. The result was heightened public sector borrowing and increased public spending. Germany's enthusiastic lending to the periphery only exacerbated the problem.

Fourth, economic health requires the stabilizer to coordinate macroeconomic policy within the system. In this domain, Germany failed spectacularly, by insisting that the rest of the world follow its peculiar ordoliberal economic philosophy of export-oriented growth. By ignoring long-established ideas such as the Keynesian "paradox of thrift" or the "fallacy of composition," Germany is advocating a serious dose of austerity in the European periphery without even a hint of offsetting those negative economic effects with stimulus or inflationary policies at home. German growth, after all, was partially fueled by demand in Southern Europe (made possible by excess German savings). By the iron logic of the balance of payments, one country's exports are another country's imports and one country's capital inflows are another's capital outflows. So, the eurozone as a whole cannot become more like Germany. Germany could only be like Germany because the others countries were not. Insisting on ordoliberal convergence is guaranteed to produce economic instability, not stability.

Finally, Kindleberger would want Germany -- or, rather, the ECB, which is dominated by Germany -- to act as a lender of last resort by providing liquidity during the current crisis. Germany instead insisted on IMF conditionality for the bailout countries and on severe fiscal austerity measures in exchange for limited liquidity, thus failing Kindleberger's final test. The most obvious example is German obstinacy against letting the ECB play the role that the Federal Reserve played in the United States in 2008 and 2009. By lending heavily, the Fed was able to arrest the United States' slide into despair. Only a couple of days ago, Jens Weidmann, the president of Germany's powerful Bundesbank, flat-out rejected the idea of using the ECB as "lender of last resort" for governments, warning that such steps "would add to instability by violating European law." It is hard to see how yet one more violation of European code will add significantly to the already horrendous levels of instability, when brushing democracy aside is considered good for the euro.

It looks as if there's a plan in the works for the ECB to do a legal end-around by loaning money to the IMF and then having the Fund loan to the GIIPS economies.  If that happens, however, it won't be announced until next month.  And the way credit markets are playing out right now, I'm not sure the eurozone has that much time.

Now is usually the point in the post at which the instinct to provide some sweeping narrative about the state of the eurozone -- a la David Brooks -- is very compelling.  What's the point, however?  The eurozone is in contagion mode right now, which means it doesn't matter which countries were virtuous and which countries weren't during the last decade of binge borrowing.  They're all on the same sinking ship, and the Merkel Algorithm seems to be playing out again. 

Developing.... in a way that truly scares the living crap out of me. 

At 8:30 this morning U.S. Secretary of State Hillary Clinton will give  "a major address on the role of economics in our foreign policy."  This speech is the culmination of a series of Clinton speeches and papers over the past few months, including her July remarks in Hong Kong, her essay on America's Pacific Century in the pages of FP, and her remarks on global leadership earlier this week. 

Laura Rozen has been all over this initiative, and she previews the speech: 

A key precept in Clinton's effort is addressing a kind of cultural lag in the sprawling Washington bureaucracy. Lead policy makers may recognize the pivotal role that economics plays in global diplomacy--but in many ways, the diplomatic bureaucracy needs to catch up. Clinton's planned speech will be in large part a call to her own agency's ambassadors, diplomatic staff and analysts to shift their thinking.

And as Clinton lays out that vision in more detail, she will stress two main bulwarks. First, she will highlight the need to advance relations with the wider world as part of the effort to revive the American domestic economic order. And second, she will stress that State Department diplomats and foreign policy thinkers need to work harder to understand how market forces are driving first-order national security challenges in hot spots such as Afghanistan, Iraq and Iran.

Now, as I noted last week, my full disclosure here is that I've seen multiple draft versions of this speech and might have made a modest suggestion or two (because you, dear readers, know how gentle I am with the red pen).  Last week, I was pretty pessimistic about the effect of this kind of initiative: 

I fear that the State Department is fighting through hurricane-level winds on this front to make a difference. First, the trade deals just sent to Congress are the last ones we're going to see for a while. Doha is dead, the Trans-Pacific Partnership still hasn't materialized, and all of the momentum on trade policy is to move towards futile gestures closure. The dynamic, growing economy is not looking so dynamic, and those deep capital markets are getting extremely jittery.

And this week?  Oddly, I find myself more on the "glass half full" side, for a few reasons.  First, Congress finally cleared the decks on the three outstanding trade deals, so that looks a bit less embarrassing.  Second, there does appear to be genuine enthusiasm inside the administration for the Trans-Pacific Partnership, and a recognition that this would be a neat-o deliverable for the upcoming APEC summit in Honolulu.  Third, my own conversation with State Department officials suggest that they've got a decent read on which geographic regions should be the focus of which initiatives.  Fourth , dwindling resources doesn't mean no resources -- the U.S. still has some formidable foreign economic policy arrows in its quiver. 

The most important reason I'm more optimistic, however, is that the Secretary will be doing two things with this speech that speeches can actually accomplish.  A speech can act as a form of reassurance to other countries that the United States gets it -- economics is a vital component of foreign policy, and Washington is ready to play. 

A speech can also signal to the foreign policy bureaucracy that there's a shift in priorities, and they had better get on the train if they want to get promoted make a difference.  If foreign service officers see that a familiarity with economics is a key for advancement, then the United States will develop a diplomatic corps that doesn't run away screaming in terror seem distracted if the words "exchange rates" or "geographic indicators" are uttered. 

Watch the speech yourself -- it will be webcast at 8:30 AM -- and let me know what you think in the comments. 

Yesterday FP alum Laura Rozen detailed the State Department's push to have economic statecraft to the front and center of U.S. diplomacy:

[I]n many ways, Hillary Clinton's diplomatic portfolio is increasingly indistinguishable from many of the leading challenges in global economic policy. Trade issues obviously have a direct impact on America's efforts to emerge from the present economic downturn--from the battles over the national debt to the the need to stimulate job growth. But economic issues also shape other less-noted features of the American foreign-policy agenda, be it the effort to contain fallout from Europe's debt crisis, to the rise of major economic powers such as China, Brazil, Turkey and India—all of whom come bearing their own foreign policy ambitions....

So Hillary Clinton has been working hard to beef up the economic bench strength of the State Department, while also mounting a bid for State officials to play a more decisive role in determining U.S. global economics policy. Aides expect her to lay out what they are calling the "Clinton doctrine on economic statecraft" early this month, likely in a speech in New York. Timing and venue for the address are still being worked out, her aides say.

"This is coming from a sense that we are seeing the lines between national security and economic security blur as emerging powers are doing more to advance their economic power, and fitting their national security strategy is more about economic interest," the State Department adviser told the Envoy Friday....

"As we pursue recovery and growth, we are making economics a priority of our foreign policy," Clinton said at the International Institute for Strategic Studies-Shangri La conference in Hong Kong in July. "Because increasingly, economic progress depends on strong diplomatic ties and diplomatic progress depends on strong economic ties. And so the United States is working to harness all aspects of our relationships with other countries to support our mutual growth."

Full disclosure:  State Department officials have reached out to your humble blogger  in a sign of true desperation to talk about ways in which economics should be integrated into American foreign policy.  Don't panic -- I know that they're talking to smarter people than I as well.

Economic statecraft is only as useful as the economic power that fuels such statecraft -- namely, the attraction of  possessing a large, dynamic, growing economy for imports, deep capital markets, provisions for foreign assistance, and a model of economic development that looks attractive to others.  Now, getting Congress to vote on negotiated-long-ago trade deals is certainly a step in the right direction.  Talking about Russian entry into the WTO is also constructive. 

On the other hand.... I fear that the State Department is fighting through hurricane-level winds on this front to make a difference.  First, the trade deals just sent to Congress are the last ones we're going to see for a while.  Doha is dead, the Trans-Pacific Partnership still hasn't materialized, and all of the momentum on trade policy is to move towards futile gestures closure.  The dynamic, growing economy is not looking so dynamic, and those deep capital markets are getting extremely jittery. 

Finally, there's foreign aid -- which brings us to this New York Times front-pager by Steven Lee Myers: 

 America’s budget crisis at home is forcing the first significant cuts in overseas aid in nearly two decades, a retrenchment that officials and advocates say reflects the country’s diminishing ability to influence the world....

The financial crunch threatens to undermine a foreign policy described as “smart power” by President Obama and Secretary of State Hillary Rodham Clinton, one that emphasizes diplomacy and development as a complement to American military power. It also would begin to reverse the increase in foreign aid that President George W. Bush supported after the attacks of Sept. 11, 2001, as part of an effort to combat the roots of extremism and anti-American sentiment, especially in the most troubled countries.

Given the relatively small foreign aid budget — it accounts for 1 percent of federal spending over all — the effect of the cuts could be disproportional. (emphasis added)

It's striking to see Myers be that blunt in his assessment of the effects of these budget cuts.  Look, foreign aid is far from a panacea, but one has to think of these forms of economic statecraft as spending on preventing rather than curing ailments in American foreign policy.  As a general rule, the former is far cheaper than the latter.  The latter also tends to involve a much greater allocation of blood and treasure.  I know why foreign aid is the first item on the chopping block -- unlike military spending, it doesn't go to Congressional districts -- but let me go on record as saying this is a stupid own-goal by both Democrats and Republicans in Congress.  Even if one buys the need for fiscal austerity, there's a lot more waste in the Pentagon than the State Department. 

So American economic power looks set to wane, and the Amerian model of political economy seems broken.  On the one hand, this is not a strong foundation upon which to build a more effective economic statecraft.  On the other hand, this is precisely the moment during which policymakers need to think about how to be more efficient with America's still-impressive reservoirs of economic strength. 

Consider the comments below as a suggestion box -- what would you recommend the State Department do to improve upon American economic diplomacy? 

For those readers not keeping close tabs on the debt ceiling negotiations currently under way in Washington, here's how each participant views them:

Needless to say, this lose-lose bargaining deadlock has started to seriously exasperate Megan McArdle.  Today she asks a fair question:

I know I'm beating a dead horse at this point, but I continue to be mystified by what the base, the activists, and the politicians who are pushing the "no new revenue" stance hope to accomplish.  

Let's start by pointing out the obvious: the Democrats do not show any signs of caving.  They have offered what seem to be very attractive deals, and been turned down.  Think you're going to get a more attractive deal?  Every time another poll like this comes out, your bargaining position gets worse.  Moreover, in Washington, deals take time.  Even if Obama and the Democrats caved right now and gave the GOP massive entitlement cuts in exchange for raising the debt ceiling, the government would be hard-pressed to hammer out the details, draft them into legislative language, get the CBO to score the cuts so you know that they're real, and then whip the votes to get the damn thing passed.  Every day you wait makes it less, not more, likely that you can get any deal at all.

Maybe you think the deadline is artificial and Treasury is just exaggerating.  I have been very much less than impressed by the arguments I have seen to this effect, because most of the people making them seem to be under the impression that on August 2nd Treasury can just start playing accounting games, when August 2nd is in fact the date when Treasury says it will have exhausted all the accounting games that we've previously used to finesse the debt ceiling.  But even if it were true, so what?  How does extending the crisis another month get us any closer to a deal?  What's going to change?

There's been a lot of online debate about this question.  Business Insider's Joe Weisenthal thinks this is just a matter of re-election motives, but I don't think it's that simple.  As Nate Silver points out, "there is a larger ideological gap between House Republicans and Republican voters than there is between Republican voters and Democratic ones."  Furthermore, many of the House GOP freshmen were elected in swing districts, so it's not as if they're representing only ultraconservative portions of the country. 

I'd attribute the strategy of the House GOP caucus to two factors.  The first is rhetorical blowback.  It's simply impossible for elected representatives to say "we're not going to raise the debt ceiling, we're not going to raise the debt ceiling, we're not going to raise the debt ceiling..." and then actually raise the debt ceiling.  And they really can't agree to the Mitch McConnell plan of "raise the debt ceiling with no concessions and then blame Obama."  They can't agree to any "grand bargain" on austerity because any such bargain would have to include tax increases and there's that darn pledge not to. Politicians do occasionally go back on flat-out pledges not to do something.  The example of George H. W. Bush to current GOP House members is not a good one, however.  With blowback, it doesn't matter whether a member of Congress really and truly believes what they're saying or whether they can't reverse course without exposing their political backside.  They're just as screwed. 

The second factor is even simpler:  to date the current Tea Party strategy of "no retreat, no surrender" has worked like political gangbusters.  Recall that the conventional wisdom in Washington in early 2009 was that the GOP was going to have to be in the wilderness for a couple of election cycles before moderating their positions and winning at the polls again.  The exact opposite of that scenario has occurred (see Erick Erickson on precisely this point).  The Tea Party movement has been built on uncompromising hardline positions, and has led to significant electoral and political victories.  As Joshua Green explains, even the exception proves this rule for Tea Partiers:

In April, [Speaker Boehner] narrowly skirted a government shutdown and, after extracting $40 billion in concessions from the White House, appeared to have emerged intact. But these concessions turned out to be less than advertised, which left many members of his caucus feeling betrayed - and therefore less, not more, inclined to submit on the debt ceiling.

Unless and until the Tea Party wing of the GOP pays a political price for its positions, they have zero incentive to change their strategy. 

Am I missing anything? 

With all the doings in the Middle East, it's easy to miss developments elsewhere.  Let's take a look at Eastern Europe, shall we?  Like Belarus, in which the latest developments suggest a uniquely Belarusian path to misery. 

The Financial Times' Jan Cienski notes that Greece and Portugal aren't the only European countries looking for a bailout: 

Away from frantic negotiations over how to save Portugal and Greece, another peripheral European country is scrambling for a bail-out. But Belarus is looking not to the European Union or the International Monetary Fund but to a grouping of ex-Soviet republics led by Russia.

Vladimir Putin, Russia’s prime minister, flew to Minsk on Thursday to offer Belarus about $3bn in loans over three years from the Eurasian Economic Community, in return for undertaking economic reforms and privatising state companies – which could see Russia take controlling stakes in strategic assets such as oil refineries and pipelines.

“It will help to improve investor sentiment,” said Anastasiya Golovach, an analyst with Renaissance Capital. “But Belarus will definitely have to pay something for this and Beltransgaz [operator of the east-west pipeline shipping Russian natural gas to the EU] will be the price.”

Moscow is relishing Alexander Lukashenko’s discomfort, as the authoritarian leader of Belarus, who has long had a prickly relationship with Russia, endeavours to calm the growing panic surrounding the Belarusian economy.

Belarus has plunged into a balance of payments crisis, with the current account deficit soaring to 16 per cent of gross domestic product and currency reserves dwindling to a month of import cover. The central bank has introduced multiple exchange rates, seeing a collapse in the rouble’s black market rate....

The outlook is gloomy. “We are heading in the direction of Zimbabwe here,” said a foreign diplomat stationed in Minsk.

Note to the Belarusian government:  anytime your country is compared to Zimbabwe, you are in Very Big Trouble. 

As the article notes, Lukashenko has managed to box himself into a corner.  After flirting with the West for a time, a domestic crackdown that intensified in December of last year alienated Germany and the United States, leaving Russia as Lukashenko's only lifeline. 

Russia is, not surprisingly, exploiting the situation in a manner remarkably consistent with trends I wrote about in The Sanctions Paradox oh so many years ago.  As a scholar, it's always nice to see a model demonstrate its durability.  In this case, there's the added frisson of seeing Russia tell others to enact policies that Moscow steadfastly rejected about a decade ago in order to advance Russian interests.  And there's something oddly comforting about watching Belarus continue to make policy misstep after policy misstep -- it's the IR equivalent of rooting for the San Diego Clippers. 

The downsides are that it prolongs Belarusian misery -- and makes the Visegrad states  just a wee bit more jittery. 

Developing....

Last week Reuters' Emily Flitter filed quite the story, entitled "China flexed its muscles using U.S. Treasuries ," about China's financial power over the United States.  Here's the opening: 

Confidential diplomatic cables from the U.S. embassies in Beijing and Hong Kong lay bare China's growing influence as America's largest creditor.

As the U.S. Federal Reserve grappled with the aftershocks of financial crisis, the Chinese, like many others, suffered huge losses from their investments in American financial firms -- from Lehman Brothers to the Primary Reserve Fund, the money market fund that broke the buck.

The cables, obtained by WikiLeaks, show that escalating Chinese pressure prompted a procession of soothing visits from the U.S.Treasury Department. In one striking instance, a top Chinese money manager directly asked U.S. Treasury Secretary Timothy Geithner for a favor.

This story generated a lot of interest across the mediasphere.  FT Alphaville called it "Diplomacy by US Treasuries."  AFP reports that the "sensitive cables show just how much influence Beijing has and how keen Washington is to address its rival's concerns." 

As someone who's published on this question, you'd think I'd be very happy at the attention this issue is receiving.  And Flitter deserves kudos for going through the cables to find clear efforts by Chinese officials to use its financial muscle to get what it wanted from the United States. 

The thing is, the reportage is framed to suggest that China not only asked for concessions, but the United States granted them.  And Flitter's own story suggests that very little in the way of concessions actually happened. 

Here are the portions of Flitter's story that discusses U.S. responses to Chinese pressure: 

On Chinese requests to halt/restrict arms sales to Taiwan:  Flitter records no response.  These concerns were voiced in late 2008 and the arms sales went ahead in early 2010, so there doesn't appear to be much influence here.  AFP suggests that this pressure led the U.S. to not sell F-16's to Taiwan, but I don't think that option was ever in the cards. 

On Chinese demands that they be provided guarantees for Chinese re-entry into the U.S. repo market:

The U.S. government does not appear to have offered the Chinese a special setup guaranteeing U.S. banks. Instead, the cables show, American diplomats reassured the Chinese by pointing out that Washington had infused banks' balance sheets with $700 billion in fresh capital, effectively propping up the banking system.

On Chinese demands for providing explicit U.S. government guarantees of Fannie Mae and Freddie Mac debt: 

To defuse the situation, the Treasury Department sent Undersecretary for International Affairs David McCormick to Beijing for two days in October 2008. The gesture went over well.

"All of Undersecretary McCormick's counterparts appeared to appreciate his willingness to come to Beijing in the midst of a financial crisis," Piccuta wrote in a cable dated October 29, 2008. "Interlocutors stressed that unless leaders' concerns about the viability of banks and U.S. government-sponsored enterprises (GSEs) are assuaged, lower-level officials will be constrained from taking on greater counter-party risks."

The cables show McCormick trying to reassure the Chinese. "In each meeting, Undersecretary McCormick emphasized that even though the U.S. government did not explicitly guarantee GSE debt, it effectively did so by committing to inject up to $100 billion of equity in each institution to avoid insolvency and that this contractual commitment would remain for the life of these institutions," [Deputy Chief of Mission at the U.S. Embassy in Beijing Dan] Piccuta wrote.

On Chinese protests regarding Federal Reserve purchases of Treasuries and agencies in March 2009:  Flitter has no response, though the fact that the Fed went ahead with QE2 suggersts that Chinese pressure didn't deter the Federal Reserve.

On responses to Chinese requests that CIC be allowed to participate in bidding on Morgan Stanley's new equity issuance:

There's no record in the cable of how Geithner responded, but it was only a day later, on June 3, that CIC announced plans to purchase $1.2 billion in Morgan Stanley shares.

A spokesperson for the Fed said in the instance of the June 3 CIC investment, no application for an exemption was made to the Federal Reserve Board.

On the general dynamic of Chinese financial pressure:

The cables also indicate a high level of confidence among the Americans that China can't entirely stop buying U.S. debt, a sentiment shared by most economists who describe the dynamic as a form of mutually assured financial destruction. 

So, to sum up, the Chinese maybe got a small break on being able to particupate in the Morgan Stanley auction.  Beyond that, all of these efforts led to the dilomatiic equivalent of hand-holding and not much else.  And, hey, what do you know, that's pretty much consistent with what I wrote about this back in late 2009.  So, contrary to some deep-seated fears of mine, the Wikiliaks cables appears to buttress rather than contradict prior scholarship. 

Flitter deserves credit for making explicit what had only been inferred, but I'm worried that commentators are drawing the wrong lessons from her article.  The big reveal here is not that China tried to exercise its financial muscle.  The big reveal is that these efforts generated next to nothing in the way of U.S. concessions.  China's financial might does give it the ability to deter U.S. pressure -- but to China's growing frustration, it doesn't yield much else. 

According to Bloomberg, Brazilian Finance Minister Guido Mantega would like the real to stop appreciating and for the rest of the world to cooperate on currency matters:

Brazil's real dropped the most in two weeks after Finance Minister Guido Mantega raised taxes on foreign inflows for the second time this month to prevent appreciation and protect exports from what he called a global "currency war."

Brazil, Latin America’s largest economy, raised the so- called IOF tax on foreigners' investments in fixed-income securities to 6 percent from 4 percent. It also boosted the levy on money brought into the country to make margin deposits for transactions in the futures market to 6 percent from 0.38 percent…

"This currency war needs to be deactivated," Mantega told reporters. "We have to reach some kind of currency agreement.” …

Mantega cited the Plaza Accord of 1985, when governments agreed to intervene to devalue the U.S. dollar against the yen and the German deutsche mark, as the kind of agreement that might be required. International policy makers failed to narrow their differences on intervention in currency markets during the International Monetary Fund’s annual meeting this month.

Hey, you know, I bet the G-20 would be a decent forum for Mantega to foster this kind of cooperation. It's a good thing that there's a G-20 Finance Ministers meeting this weekend in Seoul. 

Wait, what's this Dow Jones story saying?

Brazilian Finance Minister Guido Mantega will not attend a meeting of Group of 20 member-country finance officials in South Korea this week, a Finance Ministry spokesman said Monday.

The spokesman said Mantega would remain in Brazil while the government studies possible introduction of foreign exchange policy measures to curb the strengthening of the country's currency, the real.

Brazil's government will be represented at the meeting by Finance Ministry International Affairs Secretary Marcos Galvao and Central Bank International Affairs Director Luiz Pereira.

Is this rank hypocrisy by Mantega? Not entirely. It's something worse -- a judgment by Brazil's policy principals that more will be accomplished by staying in Brasilia to stem the tide of inward capital flows than to go to Seoul to seek a multilateral solution to the current lack of macroeconomic policy coordination. 

There's plenty of blame to go around on this, but if Brazil thinks the G-20 is not going to accomplish much… then the G-20 is a dead forum walking.