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One scary chart about Europe’s economy

By James Pethokoukis

March 1, 2012, 9:53 am

Theodore Dalrymple:

In short, the incontinent spending of many European governments, which awarded whole populations unearned benefits at the expense of generations to come, has—along with a megalomaniacal currency union—produced a crisis not merely economic but social, political, and even civilizational. The European Union that was supposed to put an end to war on the continent has resuscitated antagonisms that might end in bellicosity, if not in outright war. And the European Project stands revealed as what any sensible person could have seen it always was: something akin to the construction of a massive, post-Tito Yugoslavia.

Here’s a drill down into the new EU employment numbers (via Eurostat, the stats office of the EU):

– The euro area1 (EA17) seasonally-adjusted unemployment rate was 10.7% in January 2012, compared with 10.6% in December 2011. It was 10.0% in January 2011. The EU27 unemployment rate was 10.1% in January 2012, compared with 10.0% in December 2011. It was 9.5% in January 2011.

– Eurostat estimates that 24.325 million men and women in the EU27, of whom 16.925 million were in the euro area, were unemployed in January 2012. Compared with December 2011, the number of persons unemployed increased by 191,000 in the EU27 and by 185,000 in the euro area. Compared with January 2011, unemployment rose by 1.488 million in the EU27 and by 1.221 million in the euro area.

– Among the member states, the lowest unemployment rates were recorded in Austria (4.0%), the Netherlands (5.0%) and Luxembourg (5.1%), and the highest in Spain (23.3%), Greece (19.9% in November 2011), Ireland, and Portugal (both 14.8%).

– In January 2012, 5.507 million young persons (under 25) were unemployed in the EU27, of whom 3.314 million were in the euro area. Compared with January 2011, youth unemployment increased by 269,000 in the EU27 and by 141,000 in the euro area. In January 2012, the youth unemployment rate was 22.4% in the EU27 and 21.6% in the euro area. In January 2011 it was 21.1% and 20.6%, respectively. The lowest rates were observed in Germany (7.8%), Austria (8.9%), and the Netherlands (9.0%), and the highest in Spain (49.9%), Greece (48.1% in November 2011), and Slovakia (36.0%).

– In January 2012, the unemployment rate was 8.3% in the USA. In December 2011 it was 4.6% in Japan.

 

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Was Moscow’s Syria veto good strategy?

By Daniel Vajdic

February 29, 2012, 10:12 am

A recent Moscow Times op-ed tries to explain Russia’s obstinate defense of the Assad regime in Syria. According to Peter Rutland of Wesleyan University and Nadiya Kravets of the Harvard Ukrainian Research Institute, the Kremlin’s objectives extend beyond the “narrow self-interest of the Russian defense industry” and “its only warm-water naval base in the Syrian port of Tartus.” Here’s their argument:

From Moscow’s point of view, the Syrian veto makes perfect sense, given that a consistent goal of Russian diplomacy over the past decade has been the quest for recognition as a leading power.

By blocking the Syrian resolution, Moscow was simply sending a signal to the international community that it is a power that should be reckoned with — and one whose views must be taken into account. In the short term, Russia does not stand to gain anything specific from this action. But in the long term, it builds credibility for Russia as a leading power.

In one sense, the tactic has worked. Russia got the world’s attention at little or no cost to itself.

Hmmm. And how, exactly, will Russia assume its role as a “leading power” without any partners—let alone allies—in the Middle East? Its Syria policy has alienated nearly every country in the Arab world. There are even calls to boycott Russia’s already meager exports to the region. I’d hardly consider the Kremlin’s isolated support for Assad a cost-free strategy.

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Desmond Lachman

Will a firewall really save the euro?

By Desmond Lachman

February 27, 2012, 12:28 pm

Two years into the Euro crisis, it seems that European policymakers still do not get it. Rather than recognize that countries like Ireland, Portugal, and Spain have solvency problems, they cling to the hope that the erection of a sufficiently large firewall can keep the European periphery afloat. And they do so in total disregard of the dismal failure of a massive official international financial support program from preventing both the Greek economy from literally collapsing and the Greek government from having to write down its privately-owned sovereign debt by 74 percent.

In May 2010, the IMF and European Union put together for Greece a €110 billion financial support program, which was by far the largest official financial support program a country had received both in absolute and relative terms. This program, which amounted to a staggering 30 percent of Greece’s GDP, was intended to cover Greece’s public finance needs for a two-year period in order to give Greece time to adjust its public finances.

Yet despite this huge international financial support program, Greece found that the conditions of severe fiscal restraint within the Euro straightjacket that precluded devaluation, which were attached to the IMF-EU support program, contributed to a 16 percent decline in Greece’s GDP from its 2009 peak and in a rise in unemployment to over 18 ½ percent. Greece also found that the collapse of its economy prevented any real progress in budget deficit reduction and led to a very large increase in its public debt to GDP ratio.

One would have thought that, chastened by their recent Greek experience, European policymakers might have learned that while a large amount of financial support might help a country kick the can down the road, it will not solve a country’s solvency problem. One might also have expected European policymakers to have learned from their Greek experience that throwing large amounts of official money at a country’s solvency problem has the effect of complicating the return of that country to the private capital market. For the lesson that private investors will be sure to have drawn from Greece’s belated write down of its private sector debt is that the greater the share of a country’s debt that is owned by the public sector, the greater is the haircut that the private sector might expect to have to suffer.

It was said of the Bourbons that they forgot nothing and learned nothing. Sadly, the same will soon prove to be true of the European policymakers who are presently in the process of repeating many of the same mistakes that they made in Greece, in their current handling of Portugal, and the rest of the European periphery.

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Categories:  Economic Policy, Europe and Russia, U.S. Economy   |   Tags: ,

Putin’s class warfare

By Daniel Vajdic

February 22, 2012, 10:56 am

The exploitation of socioeconomic differences for political ends isn’t limited to the United States these days. Russia’s de facto ruler of 12 years, Vladimir Putin, seems to be shifting his electoral strategy a few weeks before the country’s presidential vote. Last month, Putin offered Russia’s restless urban middle class “an invitation to dialogue.” He said that the “economy must be built in a way that citizens with high education and aspirations can find a worthy place in it.” And Putin’s election program devotes plenty of attention to “modernization”—a mantra throughout Dmitry Medvedev’s feeble presidency—and various “entrepreneurial freedoms.”

At the same time, he warned that “a recurring problem in Russian history is the desire of part of the elite to take a leap towards a revolution, rather than work for sequential development.” But Putin’s definition of the elite has changed since Russia’s wave of massive protests began in December, and now extends well beyond the Moscow intelligentsia. To Putin, the elite includes an ungrateful middle class whose living standards rose substantially during the economic expansion that preceded the financial crisis—which Putin attributes to the “stability” of his “managed democracy” rather than oil and natural gas windfalls.

However, what last month seemed like Putin’s effort to placate the middle class has recently given way to an almost exclusive emphasis on the consolidation of his low-income base. These factory employees, farmers, and other blue collar workers spend much of their leisure time watching state television, where news programs depict the anti-Putin protesters as privileged urban elites.

But Putin’s attempts to galvanize support by dividing the country won’t boost his legitimacy, nor will it help him return to the Kremlin under free and fair conditions. Class warfare isn’t a winning strategy. It can’t succeed in Russia and it certainly can’t succeed here at home.

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Desmond Lachman

European doublespeak while Athens burns

By Desmond Lachman

February 13, 2012, 12:47 pm

Orwellian doublespeak is alive and well and living in Europe. Today, seemingly oblivious to an Athens in flames, Ohli Rehn, the European Union’s Economic and Monetary Affairs Commissioner, sternly warns Greece that “disastrous consequences would follow if Greece did not avoid a disorderly default.” And he does so with the intent of bullying Greece into continuing to hew the misguided policy line of its IMF-EU taskmasters that has brought Greece to its present terrible socio-economic pass.

Apparently, nobody seems to have informed Rehn that Greece’s economy is already in a state of collapse. Over the past year, Greece’s manufacturing output has declined by 18 percent while its youth unemployment is now around 50 percent. Nor does it seem that anyone has explained to Rehn that this collapse has occurred as the direct result of IMF-imposed hair-shirt fiscal austerity within a euro straitjacket that precludes currency devaluation as a means to promote the Greek external sector. And it seems to have escaped Rehn’s notice that Greece is rapidly moving to a state of becoming politically ungovernable as a direct consequence of the economic hardship that it has been forced to endure.

As if to add insult to injury, the IMF and EU are now prescribing to Greece even more of the stiff medicine that has brought the Greek economy to this painful pass and that will guarantee Greece a lost economic decade. Little wonder then that the Archbishop of the Greek Orthodox Church has been warning Europe of a social explosion in his country.

And, again, nobody seems to have informed Rehn that Greece is already well into the process of a disorderly default on its debt. For Greece is using the legislative threat of retroactive collection clauses to get its private sector creditors to “voluntarily” accept a 70 percent write down in the present value of their Greek sovereign debt holdings. Someone might inform Rehn that this is very little different from Argentina’s take it or leave it offer to its private creditors in 2005, which involved a 72 percent write off of its debt and which was widely regarded as a disorderly default.

An even more pernicious form of European doublespeak is that Greece is but a special case and that what is occurring in Greece could not happen elsewhere in Europe. Maybe someone should inform Rehn that Portugal is going down the very same road as did Greece and that it will be no more successful than was Greece in restoring fiscal sustainability by engaging in draconian budget austerity within the constraint of euro membership.

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Categories:  Economic Policy, Europe and Russia, Fiscal Policy and Taxes, Monetary Policy, Trade   |   Tags: ,

Why Europe isn’t Hamiltonian

By Daniel Hanson

February 8, 2012, 2:14 pm

As Europe continues to careen off the fiscal cliff, technocrats are trying to find ways to write-down Europe’s debt without it being considered a technical default.

There is actually a strong parallel here to the United States in the early Constitution days. With extremely high war-time debts and a weak federal apparatus, the new republic was staggering under financial stresses that threatened the American project.

Alexander Hamilton, the newly minted Secretary of the Treasury, proposed a plan to solve the problem. Part of the proposal involved the national government assuming the debts of the states. Despite high opposition to the plan, particularly in the more fiscally-sound South, Hamilton hammered the proposal through Congress.

Maybe some sort of debt sharing deal could happen in Europe?

Not likely, writes AEI’s Alex Pollock:

Since it will not have a Hamiltonian central government, Europe cannot carry out a repetition of Hamilton’s celebrated assumption of state debts—in which the new United States Treasury paid par for debts which were trading at 25 cents or so on the dollar. Such a transaction is beyond the power of any confederation. It is impossible to imagine that the United States under the Articles of Confederation would have, or could have, carried out this famous debt assumption.

Thus, some of the accumulated debt of member governments of the European confederation will not be paid. It will be “restructured” in various ways with losses to creditors, as is in the process of happening with the Greek government’s debt and has historically happened over and over again with government debt.

What does this mean? It means that we’re stuck with creditors taking losses that European leaders will continue to deny constitute a default.

This, of course, is ludicrous, as any failure to service a debt in full is a default, regardless of what Europe’s leaders choose to call it, and markets are likely to penalize governments for their defaults.

We’ve seen this sort of smoke-and-mirrors before. As John Makin wrote about the “voluntary” write-down of Greek debt that happened in October:

The terms of the Greek rescue package included a “voluntary” 50 percent reduction in the value of Greek bonds held by its creditors, which include European commercial banks and the ECB. A 50 percent cut in a Greek bond’s value constitutes a default. If it is imposed on lenders who have purchased insurance on their Greek bonds, those lenders can be compensated for their losses by the sellers of that insurance. (The insurance vehicle is called a credit default swap). However, as the architects of the Greek rescue package discovered, if the lender accepts a voluntary write-down of an insured government bond, which was probably sold by an overleveraged lender who may not be able to honor it (think AIG after the Bear Sterns collapse), the holder need not be compensated for the loss.

The write-down proposed on the debt of Greece reminded those who had purchased insurance on their Italian, Spanish, and French bonds that the guarantees might not be valid, either by decree or in view of the inability of those who wrote the insurance policies to honor them. As a result, lenders to Italy, Spain, and France began to demand higher interest rates on their loans to those countries.

Europe has no Hamiltonian federalism to save it from its debts. There will be defaults, no matter what the politicians say.

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Leon Aron

Despite the cold, Russian protesters’ message is loud and clear

By Leon Aron

February 3, 2012, 4:37 pm

It is cold in Moscow. On top of the record snowfall that blanketed all Eastern Europe, it has been 15-20 degrees (Celsius) below average. Yesterday, Moscow was frozen at -33 C, or -27 Fahrenheit. I know because a distant relative, Lena, called my mother, from Moscow to New York. “I will definitely come and march [in the protest rally tomorrow] from downtown Moscow on Yakimanka [street] to Bolotnaya [Square] but I am not sure how long I can last in the rally, standing still in this cold.”

There is good news and bad news for the Kremlin in what Lena said. The good news, obviously, is that the organizers will be hard-pressed to produce a turnout to exceed the one on December 24 (which was anywhere between 60,000-100,000). But the bad news is really bad. For if Muscovites like Lena plan to march, no matter how low the mercury falls, things look positively bleak. My second (or third?) cousin, twice removed, Lena is in her thirties and teaches at a prestigious Moscow college. She has never been especially “political”—until now.

In short, she is an embodiment of the average statistical protester. According to the “entry” and “exit” polls of the December 24 demonstrators by the trustworthy Levada Center, 62 percent have college degrees or higher, over half are under 40, almost half are professionals, and almost a quarter are either managers or owners of businesses. At 12 percent, college students are the third-largest category. For 89 percent, the internet is the primary source of news. A plurality voted for the “party of intelligentsia,” the center-left Yabloko but, more importantly, almost 7 in 10 identify themselves as “democrats” or “liberals.”

Father Frost may prevent tomorrow’s rally from being as large as the organizers hoped, but the tens of thousands who do come out convey the message loud and clear: Putin has lost Moscow. And he has lost the intelligentsia. No Russian regime that incurred these losses has ever survived, although it may decline and agonize for months or even years. Remember this when you read about the demonstration tomorrow—or watch it on YouTube.

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Desmond Lachman

The Greek canary in the coal mine

By Desmond Lachman

February 3, 2012, 6:41 am

One has to be struck by the basic disconnect between Greece’s rapidly deteriorating economic and social situation and the policy course charted at this week’s European Summit for the rest of the European periphery. For while Greece’s economy is literally collapsing under the weight of severe budget austerity within its euro straightjacket that precludes currency devaluation, European policymakers are insisting on a multi-year program of severe budget austerity for Italy, Ireland, Portugal, and Spain.

In May 2010, European policymakers failed to recognize that Greece had a solvency rather than a liquidity problem. This led them to eschew either debt reduction or Greece’s exit from the euro as part of a solution for Greece’s major public finance and external competitiveness problems. Instead, they insisted on a radical budget deficit reduction and structural reform program as a cure-all for Greece’s economic ills. And in return the IMF and EU committed €110 billion in support of Greece’s adjustment program.

Two years later, Greece’s economy is in tatters, as underlined by a more than 14 percent contraction in the economy from its 2009 peak and a rise in unemployment to over 19 percent. At the same time, its public finances are still in shambles, which is requiring Greece to seek a “voluntary” 70 percent write-down on its privately held sovereign debt. Yet still the IMF is proposing further massive fiscal austerity measures for a Greek economy that is literally in freefall. And it is doing so in seeming disregard for the failure of past fiscal austerity measures to solve Greece’s problems and for Greece being on the brink of a social explosion.

With Greece’s unfortunate experience so ready at hand, one has to wonder what European policymakers are thinking when they now impose on the rest of the European periphery draconian fiscal adjustment without the benefit of a currency devaluation to boost exports. Can they seriously be thinking that this will not cause a major recession in the rest of Southern Europe, especially at a time when Europe is experiencing a credit crunch and a weak external environment? And can they really be thinking that Italy and Spain can correct their large public finance imbalances without the benefit of economic growth?

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Categories:  Economic Policy, Europe and Russia, Fiscal Policy and Taxes, U.S. Economy   |   Tags: ,

Credit ratings: Where ‘least wrong’ is the best we can hope for

By Daniel Hanson

January 30, 2012, 4:43 pm

U.S. regulators think they can do better than the major credit ratings agencies. As part of the Dodd-Frank Act, U.S. regulators are no longer allowed to use ratings from independent companies to judge the appropriateness of bank capital levels. Under the newest proposal from the Fed, the Comptroller of the Currency, and the FDIC, ratings would instead be assigned based on OECD classifications, which are even worse than the ratings agencies’ diagnoses.

This week, the U.S. Congress will hold hearings regarding the major credit ratings agencies’ supposed inability to predict the collapse of MF Global. Despite the fact that both Moody and S&P downgraded the brokerage prior to the collapse and “did not have any understanding” of the firm’s bets on European sovereign debt until less than a week before the collapse, expect lawmakers to crack down harshly on ratings agencies yet again.

This comes amid accusations that ratings agencies are, apparently, being too harsh on European nations thanks to a spate of downgrades in sovereign creditworthiness over the past months. These accusations piggyback on prior claims that the ratings agencies failed to anticipate the wave of defaults in subprime mortgages that precipitated the U.S. housing crisis. (Never mind that U.S. regulators didn’t anticipate them either.)

Surely the OECD ratings can’t be worse?

Except that they can be. The OECD currently rates all of the troubled countries of the Eurozone as entirely riskless investments and has done so since they started producing ratings. This stands in stark contrast to the ratings agencies. See below for a breakdown of ratings, and notice how the OECD has totally failed to grasp the magnitude of the current crisis.

By cutting out ratings agencies, regulators have correctly sensed the conflicts of interest in the status quo, but they have merely replaced one set of conflicts of interest with another. The OECD is a collective of governments who are leveraged to the hilt with sovereign debts they are struggling to service. In this instance, the ratings agencies are right to say these countries are in trouble. It appears that in this instance, least wrong is the best we can hope for.

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Kenneth P. Green

The green-energy climbdown continues

By Kenneth P. Green

January 30, 2012, 10:41 am

The rain in Spain may stay mainly on the plain, but it won’t be falling on giant solar panel arrays for very long: Spain is in full retreat on its ill-advised renewable push. That won’t come as a surprise to AEI readers, since I’ve been writing about Spain’s failing and corrupt renewables regime (along with the rest of Europe) for a good year now.

As I wrote last year:

Spain has also found its foray into renewable energy unsustainable. As Bloomberg BusinessWeek reports, Spain has slashed subsidies for new solar power plants. Analyst Andrew McKillop observes in The Energy Tribune:

In Spain, where subsidies to the country’s massive windfarms and their dependent industries is estimated to have attained as much as 12 billion Euros in 2009, either directly or through “feed-in tariff” subsidy for power sales, government proposals target at least a 30% cut in subsidies. Major wind energy producer firms, such as Gamesa, have begun cutting their workforces, while trying to find sales outside Europe, helped by a weaker Euro. In addition and due to Spain’s highly exposed deficit finance status, making it a target for market speculators betting its bond rates must rise, the Spanish government is also likely to cut financial backing to existing renewable energy power plants, built with an expectation of guaranteed prices and government subsidies for 25 years.

Well, Bloomberg has an update:

Spain halted subsidies for renewable energy projects to help curb its budget deficit and rein in power-system borrowings backed by the state that reached 24 billion euros ($31 billion) at the end of 2011.

“What is today an energy problem could become a financial problem,” Industry Minister Jose Manuel Soria said in Madrid. The government passed a decree today stopping subsidies for new wind, solar, co-generation or waste incineration plants.

The system’s debts were racked up as revenue from state- controlled prices failed to cover the cost of delivering power. Costs have swollen in the past five years because of an increase in regulated payments for the power grid, support for Spanish coal mines and subsidies for renewable energy plants.

Watch for the same pull-back in other countries that foolishly believed the wind- and solar-hucksters, and threw their national fortunes behind these not-ready-for-prime-time technologies, including here in the good ol’ US of A. Given our political pig-headedness, and our slightly greater distance from the fiscal abyss, it’ll take us a little longer, but, I suspect, not a lot longer.

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Despite recent failures, Russia continues to invest in drones

By Daniel Vajdic

January 19, 2012, 7:51 pm

The Russian Defense Ministry has reportedly given state-owned Russian Helicopters $158 million to develop a series of indigenous medium and heavy drones. Ever since its war with Georgia in 2008, when the Kremlin witnessed firsthand the effectiveness of Tbilisi’s Israeli-built drones, Russia has aspired to equip its armed forces with the same capabilities. Through 2010, Moscow invested about $172 million in a range of domestic drone designs whose speed, altitude, and airborne endurance couldn’t meet the Russian air force’s modest requirements.

Repeated failures to produce sophisticated drones domestically—much of this the result of corruption in the arms industry, a brain-drain of qualified engineers, and broad deterioration in the military-industrial base—have forced the Russians to procure what they can from abroad.

In 2009, eight months after seeing Israeli drones in action in Georgia, the Kremlin signed a $53 million contract with Israel Aerospace Industries (IAI) for 12 early generation reconnaissance drones. The deal was probably a quid pro quo: Israel agreed to sell the drones in exchange for Moscow’s pledge to cancel delivery of its advanced S-300 air defense system to Iran and MiG-31s to Syria. A year later, IAI and Russia’s Oboronprom formed a $400 million joint venture to manufacture one of Israel’s most sophisticated reconnaissance drones, the Heron-1, in Russia.

Despite the technology transfer that Russia inevitably reaps from its cooperation with Israel, the problems associated with its current batch of indigenous drones are substantial and will be difficult to overcome.

But the Kremlin’s support for Iran may have paid dividends in this area. In June 2011, the commander of the Iranian Revolutionary Guards Corps’s aerospace unit boasted that Russian experts were allowed to inspect U.S. drones supposedly downed by Tehran and “models made by the Guards through reverse engineering.”

That Iran possessed U.S. drones was questionable in June. However, doubts were dispelled last month when the Islamic Republic revealed an RQ-170 Sentinel apparently recovered by hacking into its control system. I wouldn’t be surprised if future Russian drones bear a striking resemblance to the Sentinel.

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The shock resignation of Swiss banker Hildebrand: Credibility must be continuously earned

By Daniel Hanson

January 9, 2012, 4:30 pm

It’s hard not to feel bad for Philipp Hildebrand, the former head of the Swiss National Bank who resigned this morning amid allegations of insider trading. His resignation came as a surprise, but was not altogether unwarranted given the scope of the charges against him and his wife. The reality is that his resignation is merely a symptom of a much large central banking problem.

Hildebrand has been an audacious policymaker since he took over the SNB in 2010. He has done a fairly good job reacting to the global financial crisis and European debt crisis, urging policymakers to implement academic solutions to real-world problems as a means of providing stability for average Swiss citizens. Hildebrand’s unique background of real-world bank experience and research acumen has made him a fantastic fit for the SNB as he has weathered the storms of the financial crisis by making bold decisions based on a solid theoretical footing. Not all of these decisions have panned out, as evidenced in the exchange rate interventions from March 2009 to June 2010, but Hildebrand has been quick to acknowledge failures and change course, something American policymakers could do more frequently.

Hildebrand is, in many ways, the wunderkind of European financial circles, as he joined the SNB governing board in 2003 at the relatively young age of 40. He participated in the World Economic Forum at Davos while still pursuing his university degree, and he began co-authoring papers on central bank policy while still a young student. His angling for the head of the SNB appears to have begun at a very young age.

The tragedy is that Hildebrand broke his own cardinal rule. Throughout his writings, he has consistently pointed out that the credibility of the central bank is the single most important feature of monetary policy; above and beyond the actual currency moves and financial interventions, markets must believe that the central bank is trustworthy. As he wrote in 2007, “credibility is not a permanent characteristic of a central bank, but must be continuously earned.”

The charges against Hildebrand are personal, but they are part of a broader climate of distrust in central banks. Central banks the world over have lost massive amounts of credibility since 2008 and have been unable to recover most of it. The Fed has been mired with the balance sheet problems of QE-2, high unemployment, stagnant housing and financial sectors, the perils of TBTF, and the limits of accommodation in monetary policy. The SNB has been battling high inflation and excessive appreciation with a bold currency peg. The ECB has recovered some sliver of credibility since Mario Draghi took the helm, but they are still viewed as impotent against the rising tide of recession and debt in Europe. Moreover, the last two years has seen the ECB raise interest rates at all the wrong times. And China’s central bank continues to fight unanchored inflation expectations and a bursting housing bubble. In the aggregate, these incidences constitute a massive crisis of confidence in the institutions governing the world’s major currencies.

Hildebrand, who may or may not be guilty of the accusations heretofore leveled at him, forgot that, far more important than the letter of the law is the respect of the markets. By forgetting his own principles, he caused his own downfall and jeopardized the credibility of the central banking system the world over. Let’s hope this incident serves as a wake-up call for the spate of central banks who have long stopped continuously earning their credibility.

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Contradiction of confidence

By Daniel Hanson

December 22, 2011, 2:07 pm

It doesn’t take a financial analyst to realize that markets have been volatile for nearly the entire year. Much of the concern in financial markets is due to the ongoing eurozone crisis that threatens Europe and the United States with deep recessions. While the direct effects of the crisis (massive sovereign defaults, rising interest rates, etc) threaten firms, an under-discussed threat comes in the form of uncertainty.

A quick review of Financial Times headlines and news alerts is anecdotally telling. From July 1 to today, about 312 notices have been posted about equities rallying on hopes of a euro crisis resolution. There were about 440 mentions of stocks falling because of fears of the crisis growing larger. Many of these contrasting alerts were issued on the same day, as in the case of December 5, when stocks rallied on hopes for the EU summit and fell after S&P warned of mass sovereign debt downgrades.

Yesterday, the IMF’s official blog pointed out four lessons from 2011 that will hopefully guide IMF policy going forward. One particular point gave a head-nod to the trend I noted above:

…financial investors are schizophrenic about fiscal consolidation and growth.

They react positively to news of fiscal consolidation, but then react negatively later, when consolidation leads to lower growth—which it often does. Some preliminary estimates that the IMF is working on suggest that it does not take large multipliers for the joint effects of fiscal consolidation and the implied lower growth to lead in the end to an increase, not a decrease, in risk spreads on government bonds. To the extent that governments feel they have to respond to markets, they may be induced to consolidate too fast, even from the narrow point of view of debt sustainability.

This view reinforces what AEI’s Desmond Lachman has been saying throughout the crisis:

Stuck within a euro straightjacket that precludes currency depreciation to stimulate export growth, the application of major austerity policies is bound to lead to further economic contraction. And further economic contraction will again result in budget shortfalls and a further exacerbation of these countries’ debt problems. It is also bound to heighten social tensions and to erode those countries’ political willingness to stay the course.

The uncertainty created by policymakers’ actions is an externality to the broader crisis, but it is significant nonetheless. Perhaps this is why consumer confidence has also taken a nose-dive.

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Michael Mazza

The luminary and the lowlife

By Michael Mazza

December 19, 2011, 3:29 pm

This weekend the world lost one luminary and one lowlife; one man who worked to better the lives of his countrymen and one who bettered his own life on the backs of the suffering masses; one who achieved greatness in spite of his all-too-human weaknesses and one who submitted to his basest human instincts with regard for no one but himself. While Kim Jong-il’s death sadly threatens to overshadow the passing of Vaclav Havel, it can also help us to better appreciate what a loss Havel’s death represents. As Marc makes clear, history will remember these two leaders in quite different ways, but it is perhaps fitting that the two will be linked in death. For it reminds us that without villains, there is no need for heroes.

And heroes like Vaclav Havel are important. They inspire the silent to speak up. They inspire the passive to act. They push us to be better than the sum of our parts. I take heart that somewhere in North Korea, somebody has gotten their hands on a copy of Charter 77 and that he (or she) has just seen that the mighty do in fact fall. If some brave soul decides that now is the time to stand up, to push for real change, hopefully Havel will inspire Americans, too, to stand by his side.

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Russia, human rights, and the WTO

By Daniel Vajdic

December 19, 2011, 2:23 pm

Recently, my colleague Daniel Hanson outlined the mounting problems of the WTO system. He uses Russia’s 18-year accession negotiations as a case in point. I can’t speak to the WTO’s broader defects but I can echo his frustration with Russia’s prolonged exclusion from an organization that supervises global trade liberalization. Russia was finally inducted into the WTO on Friday.

Over the last 18 years, Russia’s WTO membership bid has faced two hurdles from U.S. opponents: trade issues (high tariffs, subsidies, intellectual property rights, etc.) and human rights. The former was largely settled by 2006 when the Bush administration signed a bilateral agreement on Russia’s entry into the WTO. But the issue of human rights continues to pose an impediment to U.S.-Russia trade relations. Even though Russia is now formally a member of the WTO, the United States will have to exempt Russia from WTO rules and regulations (and Moscow will respond in kind) if it doesn’t grant Russia permanent normal trade relations status. This requires repealing antiquated Cold War-era congressional legislation—known as the Jackson-Vanik amendment—that makes trade contingent on emigration rights for Soviet Jews. In short, unlike their counterparts throughout the WTO, U.S. businesses won’t benefit from Russia’s long overdue accession to the organization unless Congress takes swift action to graduate Russia from Jackson-Vanik.

But some argue that Jackson-Vanik should be used to highlight Russia’s poor human rights record, which in itself should preclude Russia from reaping the benefits of WTO membership. There are a few problems with this approach. First, misapplying legislation on Jewish emigration adopted 37 years ago against a country that no longer exists dilutes very justifiable concerns about human rights in Russia. Second, neither Russia’s exclusion from the WTO nor Congress’s refusal to excuse it from Jackson-Vanik have persuaded the Kremlin to improve Russia’s human rights record. If anyone has evidence that suggests otherwise I’d love to see it. Finally, as Daniel notes, countries with human rights records far worse than that of Russia have been admitted to the WTO in recent years—China being the most obvious example.

Trade liberalization and human rights promotion aren’t mutually exclusive. They’re objectives that can and should be pursued simultaneously. To achieve this with respect to Russia, Congress should replace Jackson-Vanik with the Sergei Magnitsky Rule of Law and Accountability Act (opposed by the Obama administration), which would punish Russian officials suspected of being involved in the torture and murky prison death of lawyer Sergei Magnitsky. This would send a much clearer signal about the U.S. commitment to human rights in Russia. However, it wouldn’t do so at the expense of preventing discrimination against U.S. businesses and subjecting Russia to the rules, regulations, and norms of the WTO.

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Gary Schmitt

Vaclav Havel: Giving power to the powerless

By Gary Schmitt

December 19, 2011, 1:59 pm

The fact that Europe today is virtually “whole and free” is in no small way due to the life’s work of one man, Vaclav Havel. Havel, the former president of both post-Communist Czechoslovakia and the Czech Republic, imprisoned dissident, writer, playwright, founder of the human rights effort Charter 77, and the key figure in the peaceful demise of Communist rule in Czechoslovakia and the establishment of a liberal democracy there, the “Velvet Revolution,” died on Sunday. He gave—along with Pope Paul John II, Poland’s Solidarity, Ronald Reagan, and Aleksandr Solzhenitsyn—a moral vocabulary to those living behind the Iron Curtain but who refused to believe it was an inevitable or acceptable way of life.

Havel’s essay, “The Power of the Powerless,” published in October 1978, was not only profoundly important for Czechs but for all dissidents in Central and Eastern Europe at the time. As one Solidarity activist recounts:

This essay reached us in the Ursus factory in 1979 at a point when we felt we were at the end of the road. Inspired by KOR [the Polish Workers' Defense Committee], we had been speaking on the shop floor, talking to people, participating in public meetings, trying to speak the truth about the factory, the country, and politics. There came a moment when people thought we were crazy. Why were we doing this? Why were we taking such risks? Not seeing any immediate and tangible results, we began to doubt the purposefulness of what we were doing. Shouldn’t we be coming up with other methods, other ways?

Then came the essay by Havel. Reading it gave us the theoretical underpinnings for our activity. It maintained our spirits; we did not give up, and a year later—in August 198o—it became clear that the party apparatus and the factory management were afraid of us. We mattered. And the rank and file saw us as leaders of the movement. When I look at the victories of Solidarity, and of Charter 77, I see in them an astonishing fulfillment of the prophecies and knowledge contained in Havel’s essay.

Havel’s influence did not stop with collapse of the Soviet empire or the establishment of a reformed, democratic Czechoslovakia. He pushed to have the new republic become a member of NATO and, subsequently, the European Union—believing both would help cement the new state in the democratic West. Moreover, using his considerable global reputation, he remained a champion of freedom outside his small nation, calling for the removal of Saddam Hussein from power in 2003 in the face of French and German opposition to that position and repeatedly aggravating autocrats from Cuba, Burma, Belarus, and China by his calls to free political dissidents and to end those states’ tyrannical rules.

Havel was uncompromising in his devotion to personal freedom, which is reflected not only in his politics but the many plays and books he authored and for which he first came to his country’s and the world’s attention. In this respect, Havel stands apart from that other great dissident writer, Solzhenitsyn. Arguably, Solzhenitsyn’s writings penetrate more deeply into the human condition and both the possibilities and limitations to human freedom. For Solzhenitsyn, modernity’s promise of personal liberation held as many problems as it did positive prospects. For Havel, on the other hand, his affinity for the Rolling Stones, modern poetry, and even the occasional absurdist artist put him decisively in the camp of the modernists. (It’s useful to remember that Charter 77, the proclamation signed by Havel and others in 1977 to assert the civil rights of Czech citizens under the Czech constitution and the recently signed Helsinki accords had as its origins a protest against the Czech government’s harassment of a local rock band which took its cues from Frank Zappa’s oeuvres!) But perhaps it was precisely because Havel was in tune—no pun intended—with the culture and philosophy of his time that his ability to move as smoothly as he did from dissident artist to effective political leader was possible. And while it might be said that Havel was intellectually a man of his time, it is also true that his legacy will long outlast his time, especially for those still living under the iron grip of one party rule.

Vaclav Havel (left) with AEI's Norm Ornstein in Prague

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Banter #36: The one on Russia with Leon Aron

By Stuart James

December 16, 2011, 1:18 pm

Stu and Andrew sit down with the head of AEI’s Russian studies department, Leon Aron, to go in depth about the current situation in Russia. With protests spreading after claims of a fraudulent election, Aron puts the protests into perspective and talks about what’s next for the Russian people, Putin, and the future of democracy in Russia. Aron draws upon his own recent travels to give a dramatic and clear picture of the present tensions. It all begs an important question: What will happen in the Russian presidential elections next year? You can listen to the podcast here or you can subscribe on iTunes here.

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Keeping the United States solvent, one crisis at a time

By Daniel Hanson

December 15, 2011, 12:50 pm

Mid-summer, U.S. prime money market funds became aware that they were alarmingly exposed to the eurozone crisis through their holdings in European banks. At that time, more than 45 percent—more than $1 trillion—of U.S. MMFs were invested in European banks which were themselves heavily exposed to bad European debt.

Since that time, MMFs have systematically been cutting their exposure to European banks. While MMFs still have more than a third of their exposure in European banks, they have steeply cut their holdings to about $700 billion.

In response, MMFs have started investing in U.S. Treasuries, providing the funds to drive congressional spending at a borrowing cost that is essentially zero. In other words, the massive fiscal crisis in Europe has allowed the U.S. to avert a massive fiscal crisis of its own. Note the growth of investment in U.S. debt by MMFs as European exposure declines below.

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The U.S. could be out $1 trillion if the euro zone collapses

By James Pethokoukis

December 15, 2011, 10:24 am

The attempt to bail out Europe has already begun. And America is on the hook for plenty. First AEI’s Desmond Lachman  outlines the problem (bold for emphasis):

1. IMF lending commitments already made to Greece, Ireland, and Portugal total over US$ 100 billion. Considering that the US has a 17 ¾ percent share in the IMF, this lending puts the US taxpayer at risk for almost US$20 billion. In assessing how serious is the risk to the US taxpayer, it is of note that the IMF has never lent this scale of money to any country in relation to that country’s size as it has done to Greece, Ireland, and Portugal. The IMF’s commitments to these latter countries are as much as 10 percent of their GDPs and between one quarter and one third of their annual tax revenue collections.

2. At the recent European Summit, the EU countries agreed that they would make bilateral loans to the IMF of the order of US$ 260 billion. Those proposed loans were intended to augment the IMF’s US$390 billion in overall available resources for potential lending operations to Italy and Spain. It is important to recognize that if the bilateral loans by the European countries give the lending countries a claim on the IMF, as opposed to a claim on Italy and Spain, the US taxpayer would be on the hook for any lending by the IMF to Italy and Spain that might be financed by those bilateral European loans.

3.  If Italy and Spain did have to go to the IMF for large scale loans, the exposure of US taxpayers to those two countries could be very large. Considering that the IMF’s combined lending commitment to Italy and Spain could be of the order of US$1.3 trillion, the US taxpayers’ eventual exposure could be of the order of US$220 billion.

4.  In assessing the potential risk to the US taxpayer from IMF lending to the European periphery, one has to consider that the risk of an unraveling of the Euro is a distinct possibility. Were that unraveling to occur in a disorderly manner, it would have a devastating impact on the European periphery’s economic outlook and its public finances. Considering that IMF loans to the periphery could reach levels that would be unprecedentedly high in relation to those countries’ tax bases, there would be a material chance that those countries would have difficulty in repaying those loans.

5. Judging by its 2008-2009 experience with currency swaps, the Federal Reserve’s dollar swap lines could reach around US $600 billion in the event that the European crisis were to intensify. However, one must suppose that the risk to the US taxpayer from the Federal Reserve’s swaps would be circumscribed by the fact that the main counterparty to those swaps would be the European Central Bank rather than the countries in the European periphery. One must suppose that the European Central Bank would be able to buy whatever quantity of US dollars that it might need to repay the Federal Reserve. It could do so through printing Euros even though this might entail a meaningful Euro depreciation with respect to the US dollar.

Me: U.S. taxpayer exposure is $220 billion via the IMF. That’s scary enough. But then you have the Fed. Lachman notes that the counterparty to the potential $600 billion in swaps is the ECB and that “one must suppose that the European Central Bank would be able to buy whatever quantity of US dollars that it might need to repay the Federal Reserve.” Unless there is a complete euro collapse and then there might not be a ECB to repay anybody. So in addition to a global depression and 20 percent U.S. unemployment, America would be nearly $1 trillion.

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When free trade isn’t free

By Daniel Hanson

December 15, 2011, 10:02 am

The WTO is set to offer membership to Russia, and the Russians are largely expected to accept and approve the bid by early 2012, thus ending an 18-year struggle to join the ranks of free trade nations. Under the terms agreed to by Russia, tariffs will drop by about 22 percent for most Asian and European nations.

By contrast, the U.S. will continue to trade with Russia under its current terms because U.S. policymakers have failed to resolve the real sticking point in Russian trade: the Jackson-Vanik Amendment. Despite brokering broad-scale bilateral agreements on market access and garnering small-scale compromises on auto parts, meat exports, and intellectual property, U.S. policymakers are rejecting Russia’s moves to open markets to U.S. producers, placing the U.S. at a competitive disadvantage. As shown below, U.S. exporters will have substantially more items taxed at substantially higher rates than the rest of the world when Russia becomes part of the WTO.

The JVA was introduced as part of the 1974 Trade Act as a way of punishing nations that restrict freedom of immigration based on religious belief. At present, 12 countries are punished by the amendment, though all but two – North Korea and Cuba – are considered broadly to comply with its measures. Some countries have been exempted from the provisions of the amendment in various ways because the promotion of trade is considered more vital to spreading human rights in these nations than minor trade sanctions would be.

If we wish Russia to become more free market, we must offer them the opportunity to compete in free markets. Barring market access through trade barriers, particularly when the rest of the world embraces Russian trade, is counterproductive and denies the benefits of trade both to U.S. citizens and to Russians vying for more freedom.

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European financial crisis could turn 2012 into an economic nightmare

By James Pethokoukis

December 14, 2011, 10:01 am

I think this sums up the consensus about the global economy in 2012 (via Ed Yardeni):

 … the US economy will grow with real GDP rising about 2%, while inflation remains subdued and interest rates are unchanged around current levels. Europe is expected to be in a mild recession next year, while China is likely to continue growing rapidly, though not as fast as over the past year.

And the U.S. political result of that scenario would be a close presidential election. Unless, of course, things deteriorate further in Europe, spilling over to America. Unfortunately for the American standard of living and Team Obama, that seems to be an all-too-possible outcome. Recall this recent forecast from Citigroup:

The resulting global financial crisis would trigger a global depression that would last for years, with GDP falling by more than 10 percent and unemployment in the West reaching 20 percent or more.

Anyway, it’s certainly becoming clear to markets that the recent eurozone “fiscal compact” agreement solves nothing. Here’s your trouble: a) too many countries in the eurozone are economically uncompetitive; b) these nations can no longer paper over that reality by borrowing; c) these nations can’t devalue their way to competitiveness and growth because they use the euro; d) the recent agreement merely creates new budget rules, not a United States of Europe with US-like financial transfers from rich regions to poor; e) the ECB might prevent an immediate crisis but why would it get further involved based on loose fiscal agreement?; f) the US and UK have trouble following budget rules, what chance Italy? g) Germany isn’t going to accept responsibility for Italian, Spanish, etc. debts.

Jeremy Warner of the Daily Telegraph sums it up:

There was no fiscal compact of any significance agreed last weekend. Nor was there any progress made in providing a credible backstop. Even with the extra funds which European leaders are laughably promising via the IMF “back door” (as if they cannot trust themselves with their own money), the financial firewall remains dwarfed by the ever-growing size of the problem. Italy’s funding needs would gobble up the entire bail-out money within two years. In any case, the IMF back-door support is already in trouble. There’s no clarity on where the extra 200 billion euros are going to come from, with the Bundesbank refusing to cough up unless underwritten by the German parliament and confusion over whether non-euro countries are expected to contribute.

To survive, the eurozone needs urgently to find some way of internally sharing the burden of its debts. Two years after the crisis began, progress remains as elusive as ever.

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Michael Greve

New euro zone ‘fiscal rule’ is absurd and illegal

By Michael Greve

December 12, 2011, 10:00 am

As if to illustrate the depths to which it has sunk, the European Union picked December 8, the day of the Feast of the Immaculate Conception, to produce an agreement that is rotten to its core. Its proposed creation of “a new fiscal rule”—that is, “automatic” sanctions for eurozone countries that run up excessive deficits—is both absurd and manifestly illegal.

Prohibitions against debts exceeding 3 percent of GDP were introduced along with the euro. They are to be enforced by the European Council. Because that body consists of member states’ leaders, the injunctions have been routinely ignored and no sanctions have ever been imposed. Thus, the Brussels agreement shifts enforcement authority to the European Commission and the European Court of Justice unless a qualified majority of the Council intervenes. Message to Athens, Rome, Paris, and Berlin: if you can’t balance your budget, the justices in Luxembourg will fine you. Good luck with that.

The enforcement mechanisms at issue are contained in the Maastricht and Lisbon Treaties, which can be amended only by unanimous consent of all EU members. Because in Brussels, Britain said “no,” the eurozone states decided to adopt the reforms through an international agreement, to be signed by March 2012. That cannot be done, at least not lawfully. While the Treaties provide for a few limited derogations and side agreements among member states, wholesale treaty revisions are not among those exceptions.

The Brussels communique’s Eurospeak barely disguises the fact. The heads of state “consider” that their plan “should be contained in primary legislation.” In English: they know that their plan must be enacted by treaty amendments—they just chose to do otherwise. Similarly, the eurozone states “recognise the jurisdiction of the Court of Justice to verify the transposition of [balanced budget requirements] at [the] national level.” The operative verb should be “create,” because there’s nothing to “recognize”: the Treaties specifically enjoin the ECJ from exercising this jurisdiction. The ECJ’s budget oversight, should it ever enter into effect, will join the European Stability Mechanism, which was likewise stick-built outside and in contravention of the Treaties.

This Monday, as the markets re-open and the sordid Brussels deal begins to disintegrate, is the Feast of the Virgin of Guadalupe. Europe needs all the divine assistance it can get.

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Leon Aron

Atlas shrugged! (Лёд тронулся!)

By Leon Aron

December 12, 2011, 9:29 am

With between 25,000 and 40,000 demonstrating in Moscow and at least 10,000 in St. Petersburg, the protest rallies that swept through Russia this past Saturday are likely to be not only the largest in Putin’s Russia, but likely the most numerous since the end of the first phase of the Russian revolution in 1987-91.

But this undeniable hallmark is still less important than who the demonstrators were and what they demanded. In both respects, these rallies have marked the coming of political age of the post-Soviet middle-class. It made its political debut almost two years ago, in winter and spring 2010, when during the “Days of Wrath” what I called “new protesters” have made quintessentially middle-class demands on the regime: not more government and more from the government but less of both—less interference, which meant less corruption, less taxes, and less meddling in people’s lives. They also wanted the authorities, both local and national, to respect their fellow citizens and abide by the country’s laws and constitution.

Judging by reports and videos, this Saturday’s demonstrators, too, were mostly middle class. (There was even a group of professors and administrators from Russia’s most privileged business and technology center in Skolkovo near Moscow, President Medvedev’s much-touted response to the Silicon Valley). Their main demand—new and honest parliamentary elections—was perhaps even less important than the broader, overarching quest for respect from their own government. “We earn enough money to live,” one of them told the Washington Post. “But the authorities need to understand that we are really fed up.” “Putin appointed himself the next president,” another protester in Moscow said. “Why didn’t he ask us?”

Another quintessentially middle-class feature of the movement is its Internet-centricity. It was the “Internet Russia,” not the “television Russia” that was out on the streets. One of the world’s most explosively growing internet markets, reportedly counting more users (51-52 million) than any other European country, Russia has followed the similarly middle-class “Twitter/Facebook Revolutions” in Iran and of the Arab Spring in making the Internet the key instrument of political mobilization.

It has been clear for a while (and confirmed by my field research in Russia last summer) that for Russia to achieve lasting progress in liberty, prosperity, and democratic stability, this time change will have to come “from below,” effected by a civil society mature, organized, self-aware, patient, and self-confident enough to hold the state accountable at both the local and national levels.

Yesterday’s protest is the first undeniable sign that such a society is in the making. Atlas has shrugged! Or, as they say in Russian «Лёд тронулся!» Lyod tronulsya: the winter ice on rivers is melting and moving. It may be unstoppable and gathering speed, smashing Putinism and ushering in, at long last, a firmly post-authoritarian Russia.

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Jonah Goldberg

Learning from Europe

By Jonah Goldberg

December 9, 2011, 7:46 pm

Given everything going on in Europe these days, I thought it might be worth jumping in the WayBack Machine and jaunting back to this January 2010 column by New York Times columnist Paul Krugman titled “Learning from Europe.”

As health care reform nears the finish line, there is much wailing and rending of garments among conservatives. And I’m not just talking about the tea partiers. Even calmer conservatives have been issuing dire warnings that Obamacare will turn America into a European-style social democracy. And everyone knows that Europe has lost all its economic dynamism.

Strange to say, however, what everyone knows isn’t true. Europe has its economic troubles; who doesn’t? But the story you hear all the time—of a stagnant economy in which high taxes and generous social benefits have undermined incentives, stalling growth and innovation—bears little resemblance to the surprisingly positive facts. The real lesson from Europe is actually the opposite of what conservatives claim: Europe is an economic success, and that success shows that social democracy works.

Actually, Europe’s economic success should be obvious even without statistics. For those Americans who have visited Paris: did it look poor and backward? What about Frankfurt or London? You should always bear in mind that when the question is which to believe—official economic statistics or your own lying eyes—the eyes have it.

In fairness, Krugman does go on to cite statistics to back up his impressions. But I’ve always liked this part of the argument. It reminds me of the old story about how Nixon was asked if he believed in over-population and he replied, “Of course the world is overpopulated. Everywhere I go, I see huge crowds.” (That’s the way I heard it, at least).

Suffice it to say that just because New York Times columnist and Nobel Prize-winning economist Paul Krugman didn’t see poor and backward parts of Paris, London, and Frankfurt on his various junkets doesn’t mean Paris, London, and Frankfurt do not have poor and backward parts.

Anyway, as Europe grapples with its troubles—troubles largely resulting from the fact that it cannot afford the successful economy Krugman sees as so apparent, maybe it’s time to learn from Europe after all.

Correction: The original post misstated the date of the Paul Krugman column.

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The one economic chart that should really terrify the Obama campaign

By James Pethokoukis

December 9, 2011, 2:05 pm

No matter what the euro zone decides to do about its debt problems, it seems likely that a recession is already baked into the cake. The only remaining question is whether the downturn will be moderate or severe. But as long as the region doesn’t explode into financial crisis, problems over there shouldn’t affect the economy over here, right? After all, the share of U.S. exports to the euro zone is only around 3 percent.

So all Team Obama has to worry about is a full-blown, Lehman-like financial collapse which, according to Barclays Capital, could push the unemployment rate to 12 percent and Obama’s hopes for a second term over the cliff. … Except that is not quite right. As the below chart from Citi shows, the U.S. and EU economies have been scarily correlated over the past decade. So a EU recession might well be a huge drag on a U.S. economy that many think will only grow around 2 percent next year as is. And with the unemployment rate likely to be around 9 percent next year, any further economic slowdown is the last thing the Obama campaign needs.

 

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