The Health of the Dragon

I am sad to say that on Wednesday I will be leaving my adopted city of London, England to return home to Canada - airline bankruptcy notwithstanding. The sheer volume of chores and partying to be accomplished between now and then is impressive indeed, so that means I'll be leaving these pages in Rory's care until the end of the week.

In the meantime, here's some food for thought on China's domestic situation. Arvind Subramanian argues that China may have better prospects for future growth than India due to the latter's declining state infrastructure. This is an interesting article overall, but a couple of issues deserve to be raised. For instance, Arvind argues that:

There are few examples of countries that have grown as strongly and for such long periods as India and China have – 6% and 10%, respectively, for nearly three decades – and then suffered a sharp slowdown or collapse. If history is a reliable guide, then barring major upheavals, economic growth looks likely to continue in both countries until some threshold level of prosperity is attained.

I'm sorry, but there are many people living in Thailand, Indonesia, Malaysia and South Korea that would respectfully disagree. The fact that the East Asian crisis is only ten years old makes this statement all the more shocking. After literally three decades of what the World Bank deemed "miraculous" growth, each of these countries faced the prospect of negative growth following enormous outflows of capital in 1997-8; Indonesia even underwent a regime change. Perhaps that's an exception to the historical trend but it's certainly worth acknowledging. And yes, China was spared from this crisis largely due to its tight restrictions on investment, but the China of today is considerably more open, not least due to its recent accession to the WTO. The very same factors which Mr. Subramanian argues lead to a virtuous cycle of investment can lead to the reverse should circumstances change.

And indeed, according to S&P/Citigroup BMI Global Index, this year the BRIC countries (Brazil, Russia, India and China) have been about as economically buoyant as literal bricks. Not encouraging, but perhaps only temporary.

Also, a good friend has pointed me to a good video summary of the challenges facing China by Shaun Breslin of the University of Warwick (thanks Manoli). Some highlights:

• Communism has been replaced by nationalism/patriotism
• We're seeing the implementation of "illiberal liberalism"
• Wealth in China has increased at a phenomenal rate, but so has inequality.
• Health care is harder to come by in some parts of China than in the 1970s
• It's entirely possible that the narrative will not be that of an emerging superpower, but that of economic collapse.
• How the government reacted to the recent earthquake vis-a-vis the SARS epidemic suggested there has been a greater effort to re-attach the party to the people
• The Chinese government has a long track record of dealing with difficult challenges not unlike those it faces today.
  
• If this film is anything to go by, one should not study film at the University of Warwick.

Enjoy your week!

Bull Bust

A Financial Times analysis has found that Merrill Lynch's losses over the past 18 months are equal to a quarter of the profits (adjusted for inflation) made in its 36 years as a listed company. This little fact is a compelling statement on the severity of the credit crunch, and on the continuing vulnerability of major financial firms.

On this measure, Merrill Lynch is by far the sickest patient of the crisis. The FT article cited an issue I discussed recently, the failure of the integrated banking model, as a major factor in Merrill's meltdown. Complex structured products and cheap leverage created a massive securitization business that produced record profits over the past decade.

But, much like UBS, Merill Lynch's core competency was never investment banking. Its brokerage business was the bread and butter of "Mother Merrill". As Merrill swelled, so did its reliance on securitization and cheap internal credit to fuel profits. As the typical story goes, when the market crashed Merrill was left holding billions in worthless assets. It ditched the girl it brought to the dance for the most popular girl in the room, and when the music stopped, it was left alone in the parking lot.

Stan O'Neal at Merrill was one of the chief protagonists of what has been called the "gung-ho, risk-taking culture" that ruled Wall Street and the City of London. Since O'Neal's departure, John Thain has struggled to pick up the pieces, and every time Merrill looks like it may be turning a corner, another massive writedown is taken. Merrill is a prime example of the excesses, poor risk-management, and lax oversight the defined the past decade in finance.

The discussion on Merrill offers me the chance to briefly revise my earlier discussion on the death of the financial supermarket. My previous post neglected to focus on the lax management and regulation that is really to blame for the credit crunch. Securitization went wild because it was allowed to. Perverse incentives, reckless monetary policy, and a regulatory orthodoxy that fuelled (rather than tempered) asset bubbles created the music to which Chuck Prince and others kept "dancing". Risk management became virtually non-existent.

The integrated-banking model does not inherently promote reckless lending and risk-taking. Financial firms will always expand (irrationally, no doubt) into new, profitable, and complex businesses. But a regulatory environment that stems the inevitable excesses before they infect the financial system and real economy will go a long way towards breaking the practices that contributed to the current crisis.

FYI: Stan O'Neal received a reported $159 million golden parachute upon his firing. Not bad for ruining one of the largest financial firms in the world...

Creative Destruction: Airline Edition

Joseph Schumpeter popularized the expression "creative destruction" to describe the process whereby entrepreneurs use innovation to drive the economy forward, destroying the value of established companies along the way.

For instance, companies like IBM and Polaroid used to dominate their respective markets but have since fallen by the wayside as innovation, competition and technology changes the landscape of the market. Creative destruction also serves as a great euphemism for academics to justify the real-life carnage left in the wake of a competitive economy.

The latest victim of creative destruction (and high fuel prices) is Zoom Airlines, a low-budget carrier similar to Ryanair and EasyJet, which declared bankruptcy this afternoon. As Steve Maich so aptly puts it: "Zoom...splatt." Steve is probably right: Zoom was a crappy airline and the fact that it was unable to secure financing for its future suggests that the company got selected out of the evolutionary process for a reason.

But let me tell you, as the owner of a now-worthless seat on a Zoom flight booked for next Wednesday: this sucks. A lot. I am experiencing first hand the 'destruction' side of things and it is unpleasant. I imagine it's even more unpleasant for the firm's employees and those currently stranded in airport terminals across the globe. I suspect the 'creativity' half refers mainly to the range of obscenities being directed towards Zoom Airlines, airport staff, oil companies, and the gods.

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(Fun Fact: Creative destruction was a strong contender for the title of this blog, but Rory and I decided that IPE Journal was much more exciting...)

Those Cheeky Elites

I will rarely venture to comment on the US election, mostly because I'm completely unqualified. But since there's a strong chance that I'll get to vote before my American friends and this topic applies to both sides of the border, here it goes.

The electoral politics of elitist-bashing has reared its ugly head once again, but this time with a twist: it's the Republican Party under attack. John McCain's personal wealth is such that he owns a number of houses, some for personal use, others for investment purposes. There are seven or eight or maybe ten homes, but the best part is that McCain can't remember. Given the current housing crisis in the US, the Obama campaign has understandably jumped on this gaffe and has been hammering on about just how out of touch and elitist McCain is from "regular" Americans. Obama, by contrast, only owns one house - he is therefore a man of the people. Nick Lembo finds this kind of politicking despicable; Paul Krugman thinks it's silly, but also necessary.

I don't want to talk about houses, but the elitist debate more generally. Ezra Klein points out that the election has now moved into a space where each side is trying to frame the other elitist:

Obama... is elite. As in "A group or class of persons enjoying superior intellectual, social, or economic status." Obama isn't an economic elite, but he is a social and intellectual elite. And it's that creeping sense that he's different, that he's better and knows it, that McCain is trying to exploit.

The Obama campaign, similarly, has realized that McCain is an elite, and that voters won't believe that a guy who has so many houses that he can't keep track of them will care if they lose the small condo they call home. This election, in other words, is becoming a contest to decide which type of elite voters hate -- [0]r fear, or mistrust -- more: A social elite or an economic elite?

Let me make this very clear: I want the elite running my country. I want the most elite of the elitist community. I want the one the elite look at and say: "Wow, I thought I was elite, but that person is... wow." I'm not talking about elite in the sense of being born into the right families, but rather in the meritocratic sense. If the candidate for the highest political office in the land was top of the class at one of the best universities, or was successful enough that he can afford multiple properties, or whatever - then that's a good thing. I want a leader who is both the smartest person in the room and wealthy enough so that concerns about financial security never cross his/her mind - not even once. If I see a campaign slogan that reads: "Vote X: I'm just as smart and qualified as you!" then I'm packing my things.

Backing me up on this point is one of America's premier political commentators: Jon Stewart. This is a little old, but his rant (about 7:20 in) is dead on. Enjoy.

Water-blogged

Hi. My name is Rory. I used to roam these fine pages before I got caught up in one of the slowest moving tropical storms in recorded U.S. history. As you might have guessed, twenty-five inches of rain is not conducive to blogging, or dry feet.

It is nice to be back.

Decisions, Decisions

In the off chance that you've been living with penguins in Antarctica for the past year or so and haven't heard the news: the US is having an election in a couple of months. Now it is looking increasingly likely that we Canadians will also get the chance to exercise our democratic privileges. Hooray! Now we can show the Russians and Chinese how it's done.

But who to vote for? It's a difficult decision - all sides have their merits and their faults. Do you know where you stand on all the issues? Do you vote for the candidate, the party or the platform? So many options, only one vote.

Well, you can stop your fretting. Science is reporting that the decision may have already been made for you: by your brain. It may not have told you it's decision yet, but chances are it has already made up its... er, mind on the major issues. If this study can be generalized, then it casts a shadow over all the campaign efforts made to win over the "undecideds."

Please don't read this as an endorsement for willful ignorance on all things politics - citizens still need to educate themselves on the actual policies of the candidates/parties before they can make a decision - but it's interesting all the same.

Authoritarian Fries?

By most accounts the Beijing Olympics were seen as a successful "coming out party" for China, demonstrating strong elements of patriotism/nationalism, superior organizational capacity, and the ability to raise armies of gymnastic prodigies. Not to be outdone, Russia invaded a country. Both events are displays of strength from the West's old Cold War foes and both have led to a renewed debate over threats to the Western system of liberal democratic capitalism. It's not capitalism that's being challenged, but rather the predominance of the liberal democratic system.

For example, Robert Reich - US Secretary of Labor - laments that we've been gravely mistaken if we think capitalism and democracy go hand in glove:

Economic reforms are well underway in China. Individual Chinese can own property and invest, trade and buy almost whatever they want. Private enterprise is in, collectives are out. But when it comes to civil and political rights, China today is where it was almost two decades ago at the time of Tiananmen Square.

Similarly, Arthur Kroeber suggests that we are not going to see an epic struggle between the middle class and elites in China because both groups benefit from the current arrangement and fear the instability democracy will likely bring. In other words, democracy needs to prove itself to the Chinese and it hasn't done that yet. More importantly, economic liberalization is not going to do the job. (See also the Zeitgeist take on things).

I think both of these authors are partly right. It's certainly true that liberal economic reform in no way requires a liberal democratic system to be initiated: Pinochet demonstrated this quite clearly in Chile during the 1970s. But can this be sustained? I don't think so.

You won't often find me agreeing with the likes of Hayek and Friedman, but I make an exception on some topics. Capitalism is rooted in individual liberties and freedoms, which means that the capitalist system cannot last long under a strong authoritarian regime - one will have to give way eventually. (I say "strong" authoritarianism because the "soft" variety, characteristic of East Asia's economic growth until the mid-1990s, is a different situation that requires a separate post entirely).

Perhaps I'm being naive about the sustainability of authoritarianism, but when I look at the regimes in China, Russia and Saudi Arabia I see both strength and vulnerability. Russia's resurgence is contingent upon oil & gas revenues and is hardly creating a sustainable investment environment. China's breakneck growth rates may be keeping the middle class happy for now, but what happens when (not if) this pace drops? Comparing national opinion poles, as Reich does, is not an accurate gage of the state of China's authoritarian capitalism. Saudi Arabia, meanwhile, is struggling to diversify its economy beyond oil revenues and will face a messy power struggle once the last of King Saud's sons dies off.

Remember the 1980s when we thought Japanese investors were going to buy up every North American company and we'd all be doing calisthenics during the office lunch hour? Me neither, I was a toddler; but I'm told it was the case. But it didn't quite turn out that way after the Japanese entered a decade-long recession. Of course, history never repeats itself exactly, but I think we should be cautious about jumping to conclusions over the viability of authoritarian capitalism. Expect more on this topic soon.

Fannie and Freddie, to Music

Here is an ode to the Fannie Mae/Freddie Mac crisis, set to "The Weight" by the Band. Clever.

On Dogma and Innovation

Tyler Cowen puts forward an argument suggesting that being "reasonable" might actually dampen innovation. This make intuitive sense: path breaking ideas (think Copernicus' Heavenly Bodies and Darwin's Origin of Species) attack the conventional wisdom, make people uncomfortable, and are therefore seen as "unreasonable."
Now, I don't think we're expecting highly unreasonable people like Bill O'Reilly to burst forth with pearls of wisdom any time soon, but it's an interesting argument all the same. Quite what this means for IPE Journal's goal of pushing the debate towards a 'reasonable' paradigm on political economy remains to be seen.

In the meantime, quirky geniuses who took "unreasonable" to whole new levels.

On Central Banking

News to me: it turns out the big shots from the world of central banking and monetary policy gather together once a year in Wyoming's Teton mountain range to attend the Federal Reserve Bank of Kansas City's Jackson Hole Conference. Once you've gotten over the mental images of banking policy wonks dressed in cargo shorts and Tilley hats playing trust building exercises, here's a sampling of the punditry available.

Ben Bernanke, suggesting that the Fed take on a greater macroprudential role for preventing future crises in addition to it's inflationary responsibilities

The NYT on debates within the Fed over the future of monetary policy, featuring LSE's own super-academic, Willem Buiter.

FT video on Bernanke's difficult position.

Alan Greenspan suggesting (horrors!) a new government agency to deal with the collapse of systemically-important financial institutions.

Last Call, Part II

The beverage theme continues:
I wrote earlier about pubs closing at a high rate in the United Kingdom. It now appears that the news is even worse for pubs in Ireland. With an average closing rate of one-a-day, the trend in Ireland is perhaps reflective of a recent change in economic fortunes. It could also be part of a broader generational shift away from the whole idea of pub culture. This does not mean that people are drinking less; rather, they are likely drinking the same amount (or more) at home.

This is bad news for Ireland on two levels: first, pub culture drives a $3 billion industry and employs some 60,000 people. Second, pub culture is, well, culture. There is value in a community pub well beyond the drinks that are served there - particularly in smaller cities and towns. This is something those of us accustomed to the North American "bar culture" have difficulty understanding. And without any overall health benefits to offset this decline, it's not clear where the silver lining is on this one.

Percolating Questions About Coffee

The very first entry on the list of Stuff White People Like is coffee, particularly of the free-trade variety. Indeed, for those of us who live in London (or similarly wealthy latte-lands across the globe), we are regularly bombarded with ethical choices regarding organic this, free-range that, and fair trade whatchimacalit. So what gives?

Well after doing a little research over my morning (open market) coffee, here's what I've found. According to a reliable source, "Fair Trade is a trading partnership... [that] contributes to sustainable development by offering better trading conditions to, and securing the rights of, marginalized producers and workers – especially in the South." Once we get past all the bits about 'dialogue,' 'empowerment' and some antiquated neo-Marxist language about the Global South, the Fair Trade argument boils down to this: free trade isn't working for certain commodity producers in developing countries. The existence of information asymmetries, predatory government policies and restricted access to global markets means that coffee producers are not reaping the benefits of their labour. The Fair Trade movement attempts to accommodate for this by providing more direct market access for marginalized producers, creating more 'equitable' trading relationships and helping with capacity building. So far, so good.

But does it work? I remember hearing the argument that Fair Trade benefits some poor farmers, but leaves behind the uber-poor farmers that are not wealthy/organized enough to meet the criteria and earn accreditation. And in fact, here's an article that absolutely rips into the Fair Trade movement pointing out that Mexico is the biggest producer of fair trade coffee despite paying wages 18x higher than some of its impoverished African competitors and easy access to N. American markets. The article goes on to argue that a) the farmers' biggest obstacles are their local government, not rich-world consumer preferences, b) Fair Trade leads to market-distorting effects that crowd-out other ethical alternatives, and c) Fair Trade might actually attract lower quality beans.

The ever-reliable folks at Marginal Revolution have also tackled the issue here, discussing some potential pros and cons in a more systematic way. So far, I remain highly suspicious but willing to be proved wrong. Consider the comments section an open thread.

UPDATE: Patrick at Zeitgeist provides his answer here.

The Antidote

After a couple of posts that lean heavily on geopolitics, here's some lighter fare. Are you going to start with:

Dancing Walrus? or,

Rave Kitty?

More Good News

The CSM is reporting that recent bomb attacks in Algeria, including the most recent one which killed police and security forces trainees, are starting to resemble the types of attacks common in Iraq. This is troubling because it suggests terrorist groups in North Africa are seeing themselves as part of a broader movement, gaining support from Al-Qaeda and other networks.

Now, I don't want to read too much geopolitical significance into this - these issues are primarily local and directed at the government - but it helps reinforce the view that America's War on Terror has been about as successful as its War on Drugs. That is to say: not very, with many unintended tragic consequences. It's also worth pointing out that the primary objectives of modern Islamism have always been regional first and foremost, with the September 11th, 2001 attacks being an extreme exception. Nevertheless, this might mean that, rather than going out with a bang, Islamist movements have leveraged the Iraq situation to gain a new lease on life.

Of course, the reason few people are paying attention to what's going on in Algeria is that all eyes are focused upon Russia, China and Pakistan. Deciding how to interact with each of these countries poses a challenge to the United States and the rest of Western world; things can turn out very badly indeed. In Pakistan, for instance, the resignation of President Musharraf has left a power void in a country with a poor history of political cooperation and a rich history of political and religious violence - here's a preview of what we might expect in the near future. Worst still, it's not clear that the United States has a clue how to deal with post-Musharraf Pakistan - see also a discussion by our friends at Zeitgeist.

Below, Rory points to an excellent paper that discusses the "return of history." One point in particular stood out for me: with an unsuccessful War on Terror, struggling peace in the Middle East, a resurgent Russia, a powerful China and a fragile Pakistan, the US needs to decide where its priorities rest. The next step is figuring out how to compromise and work with the other players in the game. One thing is for certain: America is not strong enough to manage this new reality alone.

Michael Phelps is Korean

Having spent the past few days birthday partying, traveling, and taking my dissertation procrastination to unseen levels, I am slowly getting back in the saddle. 

While I'll be on the road until Monday night- unless a hurricane throws a serious wrench into my plans (which is looking more and more likely)- I'll be dropping a line here and there on interesting developments. Starting now.

If anyone thought that the deep historical tensions in Asia had been put on hold for the Olympic games, this story comes via FP Passport. Apparently, Chinese bloggers are falsely accusing the Koreans of trying to claim Michael Phelps as their own, going so far as to fabricate the argument of a fake Korean university professor and his non-existent research. The fake Korean professor's claim is that some Koreans settled in the Maryland area around 1,000 B.C., and as everyone knows by now, Phelps is from Baltimore, Maryland. This means that Phelps is pretty definitely of Korean descent.  This is a pretty elaborate lie, not to mention utterly bizarre in its logic. 

But this little story fits nicely in the current debate over the resurgence of nationalism, discussed recently by our friends at Zeitgeist. Russia's actions in Georgia sparked a debate over the impact of nationalism on our interconnected, globalized world. As my co-author recently noted, the Golden Arches rule has been shattered (if ever relevant), and FDI in Eastern Europe is expected to decline due to regional instability. The re-nationalization of strategic sectors such as energy, food, and transport has spread throughout the developing world. In short, we are witnessing the "return of history". 

The liberal peace that has governed the post-cold war era is under increasing strain. The high politics of old are back, and the commercial and financial ties that bind globalization are now wrapped up in relative power and security considerations. In many ways this parallels the pre-WWI breakdown of the last great era of globalization. 

But this is not 1914 and Georgia is not Serbia. The current era of globalization is defined by its breadth and depth. The interdependence between Russia, China and the West is such that no country can afford a deterioration in economic relations. The liberal paradigm is on shaky ground, but the global economy it has created is sustainable. Economic and financial entanglements can preserve this era of globalization in much the same way that military entanglements shattered the previous one.

The Bush Boom

Here is a book review from the future: Johnathan Chait, posting a week from now, discusses revisionist attempts to frame the Bush tax cuts as the engine of growth. Chait broadly supports the point I made about attributing economic growth (or not) to the Oval Office, but takes particular issue with the idea of a Bush Boom:

The initial effect of tax cuts for the rich is to increase public debt and income inequality. Conservatives justify these consequences by pointing to the alleged second-order effects of tax cuts--promoting stronger incentives and higher growth. But, if the second-order effects are so tiny they get washed out by larger economic factors--and the evidence overwhelmingly suggests they are--why should we pay the price for them?

A reasonable question. Perhaps we could ask John, one of the most recent converts.

Muddled Metaphors

Here's a link to an econ blog called Calculated Risk. They've developed a Muddled Metaphor Index to measure how screwed up the economy has become based on the confusing mix of metaphors used in the press. And as Paul Krugman points out, we are now finding ourselves afflicted by a freezing crunchy squeeze - sounds pretty bad.

(Also, for my fellow "dissertationers" who are in the process of editing: here's Orwell's great essay on the state of the English language:

"A scrupulous writer, in every sentence that he writes, will ask himself at least four questions, thus: 1. What am I trying to say? 2. What words will express it? 3. What image or idiom will make it clearer? 4. Is this image fresh enough to have an effect? And he will probably ask himself two more: 1. Could I put it more shortly? 2. Have I said anything that is avoidably ugly?"

At about 10,000 words, that should keep you busy for a while).

The Key to Happiness

Is freedom. And the lack thereof.

Disclaimer: This is going to be a long, rambling and time-consuming post, so make sure you've got time to kill and plenty of provisions.

According to an article in Monday's FT, the world is becoming a happier place. The reason? Freedom. As more countries move from authoritarian regimes to democratic ones, the people living in these countries have an increasing sense of free choice, which in turn leads to happiness. This effect is particularly pronounced in Eastern European countries that are transitioning away from the oppressive authoritarian Soviet system. The author (Roberto Foa) uses these findings to draw three conclusions:

• "The expansion of political and social freedoms over the past quarter of a century is vindicated."
• "The results may engender caution towards attempts to engineer happiness through public policy."
• "The link from free choice to rising happiness suggests that the appropriate benchmark of development is not income per capita, but individual freedoms and capabilities."

I wholeheartedly agree with the first two points, but the second deserves further comment. Foa points out that the happiest countries - whether they are socially democratic Sweden and Denmark or laissez-faire USA and Australia - all share democracy, tolerance and the rule of law. Certainly these are desirable things in a political system, but are they the cause of happiness? In fact, the United States, champion of individual liberties and home to license plate tags like "Live Free or Die," actually ranks 23rd in other studies on happiness, like this one.
As it happens, I was discussing an unrelated topic with a Norwegian friend today, and he made the point that the success of the social democratic system in his country - which according to Foa is a source of happiness - depends much more on the sense of community that arises in a country of Norway's size and geographic location. That, and the huge oil reserves don't hurt none either. In other words, you need a lot more than just the right set of institutions.

The third point is simply wrong, for two reasons. First of all, while "freedom" is desirable, it is simply crazy to suggest development can be measured by a single benchmark, no matter what it may be. Secondly, the link between free choice and rising happiness is far from clear. In a study conducted last year, the happiest people in the world were found in... wait for it... Denmark! The key to their happiness was not freedom, but low expectations. (Further reading over at the Freakonomics blog).

One may dismiss the study by arguing that happiness from low expectations is not *true* happiness, but you'd only be half right. There is strong psychological evidence suggesting that "synthetic happiness" of the type prevalent in Denmark is a perfectly legitimate form of happiness. Here is Dan Gilbert explaining what synthetic happiness means for all of us. This talk is about 20 minutes long - it's both interesting and funny.

There are at least two points to draw from Gilbert's talk. The first is that more choice can make us less happy. Anyone who has spent more than 2 minutes picking out peanut butter or salad dressing at the grocery store has experienced this first hand. The second point, the one that the talk finishes on, is that Aristotle was clearly on to something when he lay out the doctrine of the "golden mean" in the Nicomachean Ethics. The extreme pursuit of happiness, or freedom for that matter, will inevitably lead to the opposite.

I'd love to keep talking about this (please feel free to send me anything related), but for now I'll let you explore the topic on your own:

For another great TED talk on the paradox of free choice, see Barry Shwartz here.

A popular NYT piece on positive psychology and happiness.

'The road to hell is paved with happy plans." An excellent essay by E. G. Wilson in Praise of Melancholy (see excerpt at bottom).

And finally, nobody does it better than Watterson:

"Somebody Call Dick Cheney"

No analysis. Just funny. (This is old, but new to me and maybe for you as well)

Arctic Discoveries, Part II: Northwest Passage

The Northwest Passage, the infamous route to the Far East that Columbus was searching for when he inadvertently (re)discovered North America, has been declared navigable by Canada's federal ice authority. Although not completely ice-free, last year's extreme thaw has led to predictions of a fully opened passage by the end of the month. This will be only the 2nd time in recorded history that this has happened.

Does this mean we're going to see fleets of three-masted carracks sailing West in search of silk, spices and adventure? Probably not. But many are predicting a large increases in international shipping as companies take advantage of the shorter distances now available. The melting ice also makes oil extraction in the Arctic more plausible - Exxon and BP already have expensive exploration projects in the works. Also, if American companies develop the capacity to ship oil through the icy waters, we're going to see a re-emergence of the sovereignty debate with Canada over who has rights over the Passage. The Canadian military and Coast Guard is responding to the challenge by increasing its activity up North, but it has been slow to upgrade its equipment to deal with greater tanker activity - although it appears as though the US is not doing much better.

In any event, the North is about to get a lot more interesting.

Larry's Latest

Lawrence Summers may not be the most handsome economist in the world (photo not entirely accurate), and one may be inclined to get very upset at his controversial explanations for why we see fewer women teaching maths & sciences in top academic institutions.* But one thing is for certain, the man is brilliant and has the capacity to summarize our current economic state of affairs in a way that we here at IPE Journal can only dream about. Here he is outlining the confluence of events that has caused the economic stuff to hit the fan:

Four vicious cycles are simultaneously under way: falling asset prices are forcing levered holders to sell, driving prices further down; losses at financial institutions are reducing their ability to finance investment, which in turn reduces asset values, causing further losses; the weakness of the financial system is reducing growth, which in turn weakens the financial system; and falling output is hitting employment, which in turn leads to reduced demand for output. Without active efforts to interfere with these mechanisms, there can be no basis for confidence that the American economy will recover even in the medium term.

If you like knowing things and don't mind reading, the rest is here. Incidentally, as my co-author has pointed out, Larry's piece is largely in keeping with our previous posts on fiscal policy and inflation.

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*Controversy-inducing footnote: If you actually read the offending address in its entirety, you will find that Summers' remarks have been grossly misrepresented by the media. I personally found his arguments measured, cautious and, frankly, quite plausible. More importantly, he is putting forward falsifiable hypotheses based on the conclusions of previous research. If these studies are wrong then put away the pitchforks and torches and prove it.

Arctic Discoveries, Part I: Oil & Gas

A survey by the US Geological Society, released last month, estimates that there are 90bn barrels of oil and three times as much natural gas in the Arctic. For a dose of perspective, that's three times the total known reserves in Mexico, Nigeria and Kazakhstan, or 13% of the world's undiscovered reserves. More detail can be found here. This is going to make life in the Arctic more interesting from both a geopolitical and environmental point of view.

In the area of geopolitics, there is of course the issue of the five-or-so Arctic countries that see this news as a huge opportunity. Almost thankfully, most of the resources already lie within pre-established territorial waters. The bulk of the oil is off the Alaskan shoreline so drilling remains primarily a domestic issue. Similarly, most of the natural gas is close to Russian territory. But as some of you will recall, this has not stopped the Russians from 'staking their claim' - planting a flag along the Lomonosov Ridge under the North Pole, last year. The Ruskies are also the best equipped for Arctic exploration and are letting everyone know it: military exercises over the Arctic are a regular affair. Canada has claimed it will respond to these overtures, but is woefully ill-equipped for the task.

Jeffrey Garten, an econ professor at Yale, has proposed (what else?) a sovereign body to control the region, with governments advising. This "Arctic Authority" would be autonomous, but would allow for input from governments, firms and NGOs. Rulings would be passed down from the joint Polar Bear - Walrus Council, with penguins from the South Pole acting in a consultative role. Okay, I made that last bit up. I mock because the Arctic Authority is the sort of unrealistic proposals that academics earn their living on: nation-states are reluctant to cede authority to international bodies at the best of times and it is clear from recent Russian behaviour in Georgia that they are not in the mood for sharing.

To his credit, Garten's proposals does help to illustrate the flaws in the the current arrangement. International legal jurisdictions are unclear and overlap one another. More importantly, the fragile Arctic ecosystem is threatened by prospective extraction. The medium-term benefits of the oil reserves (it will take a long time to get it out) need to be carefully weighed against potentially the devastating long-term environmental effects. Although, if everyone sits on their hands for a few years, global warming might make the whole thing a lot easier. This is an issue that will have to be followed closely - for now, we know what's up there and it's not going away any time soon.

Premier League 08/09

The 08/09 Barclays English Premier League kicks off this morning. Once again the top 4- ManU, Chelsea, Arsenal, Liverpool- are ahead of the pack, with only Spurs fielding a side capable of breaking into Champions League contention. Most pundits have it a two-horse race between ManU and Chelsea. Arsenal are rebuilding/too young (again) and Liverpool are just Liverpool-great in Europe, can't win the Premiership. A look ahead here.

Here at IPE Journal, we strive to provide you with impartial and thoughtful analysis. But when it comes to football, well, the gloves come off.

COME ON YOU GUNNERS!!

That Was The Week That Was

Politique
-Sarkozy-brokered cease-fire agreement for Russian-Georgian war halts major fighting. Russia occupies much of Georgia proper. US Air Force and Navy delivering humanitarian aid.
-US and Poland agree outline of missile defense deal, reportedly includes US obligation to defend Poland militarily (on top of NATO responsibility). Russian deputy chief of the general staff responds by threatening nuclear strike on Poland.
-Nigeria officially cedes potentially resource-rich Bakaasi peninsula to Cameroon, honoring 2002 ICJ judgement and proving there is hope yet for the international system.

Economia
-Eurozone economic activity contracts 0.2%, first quarterly contraction since euro’s inception 10 years ago. US inflation surges, highest since 1991 (chart breakdown here)
-Report by Greenwich Associates finds that 60% of surveyed US and European institutional investors expect another major financial firm to fail in the next 6 months.
-Alan Greenspan says US housing prices will bottom in first-half of ’09, credit crunch far from over. In unrelated news, bubble surrounding Greenspan’s head still strong after 15 years.

The Rest…
-Michael Phelps becomes greatest Olympian of modern times- reveals cause of global food crisis.
-Obama smear book, The Obama Nation, reaches #1 on NYT Best-seller list. Author Jerome Corsi is head “swift-boater” who sunk the Kerry campaign in 2004. Learning from Kerry’s fatal error, Obama campaign releases 41-page response, entitled Unfit for Publication.
-Latest 2008 US Election poll numbers.

Georgia Update- Occupation

Georgian President Saakashvili signed a Sarkozy-brokered cease-fire agreement late Friday, accepting (under pressure from US Secretary of State Rice, who hand delivered the agreement) a Russian occupation of large portions of Georgia proper. The agreement reportedly gives Russia the right to patrol a 10km zone around South Ossetia. An explicit Russian recognition of Georgia's territorial integrity was removed from the final text.

Russian forces now occupy at least half the country, and have utterly destroyed Georgia's defense capability. Reports continue to indicate a large Russian military presence in the vicinity of Tbilisi, the Georgian capital.

Georgia is about to be a much smaller country.

Don't Switch the TP Just Yet

So the WSJ is reporting that inflation in the US has reached a 17-year high, up 5.6% in July from a year earlier. It's no Zimbabwe, but still worrisome, right? Well, maybe not. According to Mervyn King at the Bank of England (paragraph 3 of this article) and Paul Krugman here and here, the current inflation is caused by a one-off jump in energy, food & imports. This is going to make life miserable for the next year or so, but it's not likely to spill over into general inflation.

The main task for central banks is to make sure they hold steady on their current targets. In the US it appears there is greater danger of inflationary hawks on the Fed pushing to raise rates and slowing the economy even further. By contrast, the FT's Samuel Brittan (see second link) worries that the Bank of England might give up it's 2% target and thereby fuel self-fulfilling inflationary expectations. So for now, the best course of action appears to be: don't panic, take the inflation on the chin and look forward to sunnier times ahead.

Last call

Times are changing here in the land of lorries and left-hand driving. The British Beer and Pub Association (BBPA) is reporting that pubs in the UK are closing at a rate of 27 a week. This is a shocking number – one which would be unbelievable were it not for the huge number of pubs in the first place (I have 5 within a two-minute walking radius of my front step).

What accounts for this reduction in public houses? One possibility is that new migrants to the UK are not fully embracing the British tradition of a few pints over lunch (incidentally, this is the reason why I will never book a complicated medical procedure in the early afternoon). But the fact is: Britons are drinking as much as ever. Alcohol consumption is 70% higher than 30 years ago, yet pubs are pulling half as many pints as they were in 1970. Women are responsible for much of this increase, which might explain the falling beer sales .

Perhaps the biggest reason is the competition from off-licenses/corner stores that are on their way to grabbing half the market (I also have 5 within a two-minute walking radius of my front step). Tesco – one of the UK’s largest grocery chains – has come under heavy criticism for selling alcohol below cost: the firm’s chief executive, Sir Terry Leahy, has earned the nickname ‘ the godfather of binge drinking.’

The shift to drinking at home has had an impact on beer sales as well. People drink beer at the pub but are more likely to uncork a bottle of wine at home. We’re also seeing a broad shift away from ales to lighter, more ‘refreshing’ drinks like lagers and ciders. Guinness has tried to accommodate shifting tastes by introducing a lighter, sweeter version of the famous brand: Guinness Red.

But while the market may be shifting, I have no doubt that the British appreciation for fine brew will remain strong. The evidence? I recently attended the Great British Beer Festival, a glorious event showcasing ales, bitters and stouts from across the united kingdoms. One poor lady tentatively approached the bar and asked where she might find a lager – she was promptly chased away by the sound of uproarious laughter. I’ll drink to that.

Dollar rebound

As an American graduate student in London over the past 10 months, I am painfully aware of the weakness of the US dollar. Naturally, the month I return to the states, the dollar rebounds.

There is quite a bit of debate as to whether the dollar's 7% rise against the euro over the past month, and yesterday's two year high against sterling, represents a fundamental reversal in the greenback's fortunes. Most analysts are sceptical, citing continued financial market instability and real economy weakness as a threat to any dollar rally. However, I tend to agree with the belief that recent movements signal a long-term (but measured) movement upward.

Currency trading is driven by technical barriers, new data, and moving averages, and by these criteria the dollar has broken key resistance points over the past few weeks. The euro fell below the psychologically important $1.50 level last week, and appears to have carved out a top against the dollar. The Euro is further undermined by a gloomy economic outlook, with the eurozone contracting 0.2% in the second quarter. It is the first quarterly contraction since the euro's introduction 10 years ago. Despite the poor outlook, most analysts expect the single currency to hold up pretty well, hovering around $1.45-$1.50. The ECB is less likely to raise rates than they were 3 months ago, with inflation moderating in the medium term and growth slowing sharply.

Sterling is getting slaughtered. Mervyn King, BoE governor, is in the unenviable position of balancing peaking inflation and a rapidly deteriorating economy. King's comments yesterday indicated to many a dovish stance on inflation, and traders are now pricing in an interest rate cut by Q1 2009. He ominously spoke of "a feeling of chill in the economic air". He has retained rate flexibility, but indicated the economic outlook was the most challenging of his tenure. In response, sterling plummeted to 22 month lows against the dollar, and has crashed through its 200 week moving average, a significant technical trend. Expect GBP/USD decline throughout the year.

A dollar rebound is not guaranteed, and a number of forces are working against the US currency. The dollar's recent turnaround is driven mainly by traders repositioning, with little new money entering the trade. Furthermore, a recent survey by Barclays Capital of Japanese bond investors, among the largest dollar holders, indicated strong scepticism of the dollar's medium-term strength and the real economy outlook for the US.

But two non-technical trends will help sustain this turnaround: 1) the weakness of the dollar, slowing growth in Asia/contraction in Europe, and "cheap" US companies should lead to a foreign buying spree of under-valued US corporate assets. This M&A activity would boost the financial markets and strengthen the dollar. 2) For all of its underlying weakness, the dollar is still the safe-haven of choice for investors around the globe. The S&P 500 (-12% ytd) has outperformed the BRIC markets year-to-date, as the commodity bubble bursts and hot money withdraws. When faced with global recession and inflationary pressures at 20-year highs, investors are still going green.

When a Crocodile Eats the Sun

The Times of London is reporting this evening that Zimbabwean President Robert Mugabe has reached a power-sharing deal with a breakaway faction of the MDC led by Arthur Mutambara. Morgan Tsvangirai, leader of the MDC, has reportedly walked out of the negotiations, claiming Mugabe is unwilling to concede enough control to allow for a viable power-sharing arrangement.

As the negotiations are ongoing, and leaked reports of deals and no-deals have proven pretty unreliable in recent days, it is unclear what this means for the country. If true, it appears Mugabe has deftly split the opposition, and likely consolidated his power in the process.

Zimbabwe was once the economic gem of Africa. The official inflation rate now stands at 2.2 million percent. Private financial institutions estimate a rate closer to 12.5 million percent (based on May data). John Robertson, a respected Zimbabwean economist, believes inflation may have reached 50 million percent by the end of July. That is hyperinflation, and devastating to the Zimbabwean people.

Much has been written on the political situation, and the human tragedy unfolding over the past decade is well-known. For a unique account of the country's descent into hell, I recommend reading When a Crocodile Eats the Sun, a tragic memoir by Peter Godwin (NYT review here).

Monetary String Theory

Writing in the 1930s, J. M. Keynes explained how the state of the economy depends upon the “animal spirits” of entrepreneurs: much of our positive economic activity derives from our optimism about the future. It was therefore the difficult task of governments to help ensure that this optimism was the rule, rather than the exception. But for Keynes, monetary policy could only play a limited role in establishing this convention. In times of economic uncertainty, actors in the marketplace are liable to hold such large reserves of cash that, no matter how much liquidity a central bank makes available, the economy is not going to get the stimulation it needs. The solution, Keynes suggested, was to be found in fiscal policy: government spending to offset lack of private investment.

We have been witnessing something similar unfold since the so-called “credit crunch” of last year. As Irwin Keller at MarketWatch explains, the US Federal Reserve has been attempting to offset tight credit by lowering the bank rate from 5.25% last September to its current 2%. This has been as effective as “pushing on a string.” Overall, consumers in America now have even less access to credit as bank lending has tightened up and the issue of non-financial commercial paper has dropped through the floor. Now the Economist is reporting that, after some delay, the animal spirits are flagging in the euro-zone as well. As the economic future becomes less certain, companies are beginning to retrench their investments.

Back in February, the US Congress took Keynes’ advice and approved a fiscal stimulus package. According to a member of the White House’s economic team, the impact of the stimulus package is already being seen through in higher consumption; the effect on investment will take longer and remains to be seen. There is even talk of a second stimulus package, probably motivated by Congress’ desire to spend more money on its constituents before the upcoming election, but it faces a number of obstacles.

What are we to make of all of this? It’s hard to say. Central banks are charged primarily with controlling inflation but the prospect of uncoordinated fiscal and monetary policy is not a pleasant one - this happened early on in the Reagan years and was an all around mess. Probably the best we can hope for is that central banks aim to ‘do no harm.’ Recent decisions by the major CBs to hold their interest rates steady is likely an attempt to do just that. This is going to be an interesting ride, so stay tuned. The immediate lesson – the one Keynes would have pointed out – is that we shouldn’t look to the central banks to deal with the slowdown.

Empty shelves

UBS executives announced today their plans to split the banking giant. This may mark the end of an era in finance.

Pioneered by Sandy Weill at Citi in the 1980s and 1990s, the "supermarket" model of integrated banking spread quickly. Mergers upon acquisitions upon takeovers upon garbage picking created massive financial institutions offering all services to all investors. If there was a business somewhere that someone was making a profit on, the global investment banks wanted a slice. They justified the size by the synergies created (and thus money saved), streamlining research, capital and operations.

Even well before the credit crunch, however, analysts and investors started asking whether loss making divisions were worth the scale created, as weak performance in some divisions dragged down core, profitable businesses in others. For UBS, its investment banking division has been a recurrent drag on the venerated global wealth management business its reputation was built on(recent scandals- here and here- aside). Citi's shareholders have been asking similar questions for years.

As the credit markets have evaporated over the past 12 months, and investment banking divisions have suffered multi-billion dollar losses on CDOs and other securitized products, many banks are shedding. The era of the financial supermarket may be coming to an end.

Georgia, Russia & the Golden Arches

Addendum to Rory's analysis below:
Paul Wells, over at MacLean's, single-handedly debunks the theory that no two countries with a McDonald's have ever gone to war with each other. Well, it was good while it lasted.

Never taunt a bear

The war in Georgia is fraught with strategic motives and implications. Georgian President Mikheil Saakashvili took Russia's bait by sending troops into South Ossetia, unleashing the full (although, in relative terms, still limited) might of the Russian military, and providing the Kremlin with a window of opportunity to achieve a number of objectives.

For one, President Saakashvili will not survive this conflict, either under the weight of Russian occupation, US pressure, or by popular backlash against his bungled handling of Russian relations. The Kremlin has publicly made it clear they cannot (will not) work with him after the events of the past week, and this war will likely achieve their objective of removing the Georgian president from office.

Second, Russia has reasserted itself over its traditional sphere of influence, and thrown up a huge challenge to Ukraine: seek NATO membership at your own risk. The fall of the Soviet Union was "tragic" to Prime Minister Vladimir Putin, not as much for its economic and political vision, but for the loss of its geopolitical power. US missile defense plans, and the prospective NATO membership of Ukraine and Georgia, feeds into the Kremlin's deepest anxieties of being surrounded by hostile forces. It is important to recognize the historical sensitivity of these developments: Russia has been defending itself from invaders throughout its history, and a NATO presence on its border is perceived as a direct assault on the country's survival. Conflicts are often started due to an ignorance of the ideas and sensitivities of the opposing side. US policy in the region has recently failed to appreciate this context. Georgia matters for Russia due to its strategic location (oil and gas transit, black sea ports, etc.), but Ukraine is a red line.

Third, for all of the rhetoric coming out of the office of the US vice president, the US has clearly determined Georgia is not worth a confrontation with Moscow. Russia's assistance is critical to resolving the Iranian nuclear dispute, and Washington cannot afford a further deterioration in US-Russian relations. This will be deeply resented by the Georgian people, as US support to Georgia has been substantial, perhaps providing President Saakashvili with a false sense of security (and arrogance).

Finally, if anyone doubted where the authority lie in Russia following President Dmitri Medvedev's election, the internal balance of power is now crystal clear. As an interesting article in today's New York Times describes, while Russian troops pushed into central Georgia, President Medvedev was enjoying a cruise on the Volga River. Putin, however, was huddling with President Bush on the sidelines of the Olympic opening ceremonies, leading the mission into Georgia, and meeting with Russian refugees (sleeves rolled up) on the front lines. Much like his incursion into Chechnya in 1999, Putin has used a military conflict to assert his authority over internal political divisions.

RealClear

One of our overriding missions at IPE Journal is to cut through the partisan noise in the media to bring you critical insight into the issues and trends shaping our interconnected world.

RealClearPolitics is the first website I visit every morning, and is unique in its unfiltered offering of the best political journalism/commentary from around the US (and often the world). For those of you interested in following the 2008 US presidential race, I highly recommend bookmarking it.

And for you blood thirsty capitalists, there's RealClearMarkets.

Correlation = Causation, right?

Paul Krugman produced this chart on annual rates of job growth under each post-war President since Truman. Although he doesn't actually elaborate, it's not hard to see what he's driving at: Democrats = jobs.

The problem, of course, is that this graph is very misleading. For starters, the President is not responsible for economy (see Tyler Cowen's excellent essay here), regardless of how the electorate chooses to vote. Certainly we wouldn't expect Krugman to suggest that FDR was responsible for the high levels of unemployment during his first two terms in office.

This graph also ignores the fact that early post-war Democrats were the champions of international trade and liberal markets while the Republicans were isolationist and protectionist. Those positions have now been (largely) reversed. How might this alter the conclusions reached by looking at this graph?

Maybe a more accurate picture could be gained by including House and Senate majorities, but the larger point is that the state of the economy is not decided at the voting booth. Krugman is doing his readers a disservice by suggesting otherwise.

No Tortilla For You

A couple of months back, media coverage on a natural disaster somewhere sparked a crisis of conscience and I proceeded to make a tiny donation to the World Food Program. The burden having been lifted from my shoulders, I proceeded to spend twice that amount at the pub. However, since then I have been distressed to learn that my piddling donation has become even more piddling as the result of a general inflation in food prices.

Now, if this were merely the result of the increase in the number of hungry mouths in countries such as China and India, then that’s one thing. But as former Mexican President Ernesto Zedillo explains, the challenge of increasing demand is exacerbated by biofuel policies in wealthy countries. According to Resource Investor, biofuel policies have accounted for as much as 60% of the growth in certain key commodities. US subsidies are even threatening the beloved tortilla.

Thankfully China is going to have a bumper crop year, but this is clearly not a long-term solution: the OECD expects the price of staple commodities to rise anywhere from 10-35% in the next decade.

So where do our political leaders stand on the issue? Obama has been supporting ethanol subsidies for some time, partly for energy security reasons and partly because it makes his “corn-rich” home state of Illinois more “money-rich.” Political pressure is mounting, however. On the whole, McCain has been more critical of the biofuel subsidies, but the Food vs. Fuel debate is a delicate one during an election year. In my home country, Harper’s 'double-win’ strategy is likely to result in a ‘double-lose’ for everybody not on the receiving end of the subsidies.

Simply stated, we’re seeing naked political pandering to farmers disguised in the rhetoric of security and environmentalism. This is unfortunate. It should not be difficult to accommodate high fuel prices in ways that do not contribute indirectly to food riots in poorer parts of the world (kites, for instance). Should we not be pursuing those avenues instead?

Why the AKP Matters

On July 31, Turkey’s constitutional court narrowly rejected the top prosecutor's request to ban the Justice and Development party (AKP) from politics for five years, and its Prime Minister, Recep Tayyip Erdogan, for life. This in spite of a guilty verdict on the charge of being a “centre of anti-secular activity”.

The ruling is a victory for both the AKP and Turkish democracy. The prosecutor alleged that the AKP had undermined the secular state and sought to impose Sharia law. The charges were the culmination of a deep struggle for the political future of the country. The secular establishment (led by the military) has reacted to the AKP's rise with fear and aggression. The military's political intervention last year led the AKP to call a snap election, in which it affirmed its mandate with nearly 50% of the popular vote. This support is particularly strong among the rural poor.

The party has also been one of the emerging market darlings of foreign investors- according to the Financial Times, it has tamed hyperinflation, produced average GDP growth of 6.9%, and slashed gross government debt in half. Approximately 70% of the Istanbul stock exchange is held by foreign investors.

But the AKP has misplayed its political mandate since reelection, taking actions that threaten the delicate cohabitation that has existed with the military. The AKP's constitutional amendment to remove the ban on headscarves in universities was seen by hardline secularists as a dangerous affront to Turkey's Kemalist tradition. Despite the merits of opening higher education to universal access, the headscarf issue was a political powder keg, and one the AKP should not have pursued under such heightened tensions. The backlash has led Turkey into political chaos, and threatened the economic reforms so impressively achieved over the past 5 years.

However, political miscalculation is not Islamic revolution. The constitutional court's ruling is a welcome and important decision, as the AKP matters both within and beyond Turkey's borders. It's structural and market reforms have rescued Turkey from repeated financial and economic crises, an agenda it has recently strayed from amidst the political turmoil. It stands as an important example of how moderate political parties can develop out of political Islam. It is a bridge between West and East, one that should be more fully supported by Europe in particular.

The removal of the external incentive of European Union accession has undermined the reform agenda and external "check" on military intervention. A clearer commitment to integrating Turkey into Europe would be a powerful response to the constitutional court's ruling, and once again provide the incentives for moderating the internal tensions undermining Turkey's economic and political progress.

Freeloading

Here are two excellent pieces on capitalism, society & human nature.

The first, by Martin Wolf, discusses why organizing society around the economic assumption of 'rational' profit-maximization would be miserable, and what sort of preconditions are necessary to act as a buffer for competition. Just read it.

The second, by Clive Crook, explores how Adam Smith might react to the debate over corporate social responsibility. Smith has the dubious honor of being often cited but never read, so anyone mildly curious to know more about him than the 'invisible hand' metaphor should take a gander.

(Fun fact!: at the age of four Adam Smith was kidnapped by gypsies. Thankfully, they left him on the side of the road unharmed. This story makes me wonder how many brilliant philosophers the world has never known thanks as the result of similar childhood-kidnappings...)

Welcome

Kant writes that “immaturity is the incapacity to use one’s intelligence without the guidance of another.” It is in that spirit that Rory and I have decided to create this web log to tackle politics, economics, science, philosophy and whatever else we find interesting. Our goal is to machete our way through the jungle that is modern media coverage to provide you with clear thinking on important issues. We want to promote critical thought, not simply debate.

So without any further delay, consider the champagne bottle broken and the ship launched. We look forward to your feedback.