US Steel Proposes To Build 'Negative Railway'

Rory and I have both made our views clear on the recent resurgence of protectionist measures in G20 countries so, instead of spouting off once more, I think it's worth looking at the arguments at work on both sides. Via Megan McArdle:

Proponents of expanding the "Buy American" provisions enacted during the Great Depression, including steel and iron manufacturers and labor unions, argue that it is the only way to ensure that the stimulus creates jobs at home and not overseas.... The proposals are meant to regenerate heavy manufacturing jobs in the United States by forcing government contractors to use domestic materials and equipment, even if they are more expensive.

The logic here is that, in order to prevent stimulus money from leaking abroad, one must spend money on domestic goods. These are, after all, the workers and firms who are going to be hard-hit by this recession. But does anyone else find it odd that these proponents are suggesting that the best way to deal with a consumer-driven recession is to make things that are more expensive? And yet that's what we're seeing once again with the proposed additions to the economic stimulus package that was voted through the US House of Representatives yesterday (see Rory's post below).

It's interesting to see how the arguments for protectionism have changed so little over the years. Thanks to the wonders of the internet, I have managed to track down a biting critique of protectionist logic by 19th century French writer Frédéric Bastiat. In his book, Economic Sophisms, (available at EconLib) Bastiat used his humour and wit to ridicule the policy proposals of his day. Below is Bastiat's essay: "A Negative Railroad" - see if you can draw parallels with today!

I have said that as long as one has regard, as unfortunately happens, only to the interest of the producer, it is impossible to avoid running counter to the general interest, since the producer, as such, demands nothing but the multiplication of obstacles, wants, and efforts.

I find a remarkable illustration of this in a Bordeaux newspaper. M. Simiot raises the following question:
Should there be a break in the tracks at Bordeaux on the railroad from Paris to Spain? He answers the question in the affirmative and offers a number of reasons, of which I propose to examine only this:

There should be a break in the railroad from Paris to Bayonne at Bordeaux; for, if goods and passengers are forced to stop at that city, this will be profitable for boatmen, porters, owners of hotels, etc. Here again we see clearly how the interests of those who perform services are given priority over the interests of the consumers.

But if Bordeaux has a right to profit from a break in the tracks, and if this profit is consistent with the public interest, then Angoulême, Poitiers, Tours, Orléans, and, in fact, all the intermediate points, including Ruffec, Châtellerault, etc., etc., ought also to demand breaks in the tracks, on the ground of the general interest—in the interest, that is, of domestic industry—for the more there are of these breaks in the line, the greater will be the amount paid for storage, porters, and cartage at every point along the way. By this means, we shall end by having a railroad composed of a whole series of breaks in the tracks, i.e., a negative railroad.

Whatever the protectionists may say, it is no less certain that the basic principle of restriction is the same as the basic principle of breaks in the tracks: the sacrifice of the consumer to the producer, of the end to the means.

The Zim dollar goes the way of the dodo

Does it matter if an already worthless currency is abandoned?

House passes "Buy America" clause, EC takes notice

On Wednesday I poked fun at the hypocrisy of Vladimir Putin's Davos speech. Despite this, his warning on the dangers of protectionism should be heeded by policymakers, particularly in the US, especially now.

The US House yesterday passed the $819 billion stimulus package, known as the American Recovery and Reinvestment Plan (I love the use of the word "reinvestment", you just know it focus-grouped so much better than "exploding deficit"). The vote was along party lines; not a single Republican voted for the package. The debate over the contents and balance of spending/tax cuts is endless, and I won't wade into those waters here. But I am very troubled by one aspect of the bill: the now notorious "Buy America" clause (which, I must boast, I was all over from the beginning). What at first looked like a shameful attempt at backdoor protectionism, is now officially on the table. It passed.

We know that the House version of the bill is different from the one the President will ultimately sign. It is likely that many of the "pork-lite" programs will be shed to deflect widespread criticism over their relevance to the immediate economic crisis. But in all the partisan back and forth, I have yet to hear a passionate criticism of the "Buy America" clause. The Republicans are more outraged by $335m in funding for sexual health education and prevention programs. The silence on "Buy America" is dangerous and increases the likelihood that the clause remains in the final version. It also provides a fundamental test of Obama's trade policy, whatever that might be. Megan McArdle and Dani Rodrik agree.

Luckily, the European Commission has a bit of a problem with "Buy America" (Canada too). Peter Powers, Commission spokesman, warned, "If a bill is passed which prohibits the sale or purchase of European goods on American territory, that is not something we will stand idly by and ignore." Furthermore, the European Confederation of Iron and Steel Industries (Eurofer), a powerful lobby representing over 370,000 EU workers, has called on the EU to bring it to the WTO, saying, "Our view is that if passed this would be a clear violation of their WTO commitments on government procurement rules", and, "It is a protectionist measure which goes against the commitment made to the G-20 to keep markets open."

Dave was spot on when he said of this rising protectionism, "the real danger is that tariffs/bans on stuffed kittens and fancy cheese are the first snowballs that kick off an avalanche of protectionism that smothers trade and damages geopolitical relations." But what if that avalanche is exactly what we need? Could "Buy America", cheese duties, and stuffed kitten tariffs be the sparks that finally break the DDA deadlock? A rapid deterioration in the trading system could compel leaders to look past the modalities and embrace the central role of trade in saving the global economy.

Maybe. We've learned that a crisis is often necessary to force policymakers out of their comfort zones and stand up to powerful interests. At the very least, a little pressure from the across the Atlantic might bring US policymakers to their senses.

UPDATE: The FT reports that the "Buy America" clause is not present in the current Senate bill, but Senators like Sherrod Brown of Ohio are pushing for its inclusion. I mistakenly assumed it was.

(Photo: funkandjazz)

It's all politics, even the Super Bowl

The Pittsburgh Steelers will face the Arizona Cardinals in this Sunday's Super Bowl. To our readers from everywhere but North America, that's the championship game of the sport where the ball bounces funny (no, not rugby).

As everyone knows, Barack Obama is from Chicago. That makes him a Bears fan. But that hasn't stopped the press from asking who he's rooting for in the big game. His answer?

''Other than the (Chicago) Bears,'' Obama said, ''the Steelers are probably the team that's closest to my heart.''

You might be asking yourself, how does a guy who was born in Hawaii, lived in Indonesia, attended college in L.A. and New York, law school in Boston, and spent his adult life in Chicago become such a sentimental Steelers fan?

Well...Pittsburgh=Western Pennsylvania/Eastern Ohio media markets=key electoral battlegrounds=2010/2012 elections=Steelers fans are really, really important in American politics.

If it sounds trivial, you've never met this guy:

Football matters.

VoxEU's Global Crisis Debate

VoxEU.org has a new initiative aimed at influencing the agenda of the next G20 meeting in April. Good for them. It's great to see the acedemia harnessing the internets to take seriously the issues facing our global economy.

However, in the event that they influence the ideas put forward by the G20, there's no guarantee that our political leaders will actually, ya know, do anything about it.

82 per cent

Today's statistical indicator has been brought to you by the Institute of International Finance, an association of financial institutions. 82% is the projected decline in private capital flows to emerging market (EM) economies in 2009, compared to 2007 (full report here). They now estimate flows of $165 billion, compared to $466 billion last year and $929 billion during the boom year of 2007. That's quite a drop.

Particularly hard hit will be Eastern Europe and Russia - countries that rely heavily upon external financing. Also interesting is their set of explanations for how emerging market financial institutions were hit so heavily last fall despite the fact that they weren't badly exposed to mature-market lenders. It shows very clearly how financial problems in one part of the world can filter throughout global credit markets quite easily.

Furthermore, there is a danger that emerging markets in need of financing will be "crowded out" by the now massive borrowing needs of the G7 countries. Despite the huge amounts of debt they are taking on, the returns on bonds of G7 countries are still fairly low, indicating that investors still consider them safer than the alternatives. One of those alternatives is, of course, emerging markets.

The good news, according to this report, is that financial surpluses from earlier growth is giving EM economies more space for counter-cyclical monetary and fiscal policies. Moreover, while the commodity boom-now-bust has hurt some (oil-producing) EM economies hard, it's making the recovery of other (oil-consuming) EM economies easier.

But overall, the report suggests that things are looking pretty fragile, particularly for governments with little or no access to international debt markets (Argentina, Venezuela, Ecuador, Hungary, and others). This means that there will be greater need for official lending from the IMF (which has already stepped up to the plate with a whole range of new programs) as well as financing from regional development banks and bilateral agreements.

So just as private lenders in G7 economies have seized up, leaving the responsibility for economic recovery upon the shoulders of governments, so it will have to be with EM economies. Let's just hope that our official lenders are up to the task. If not, they should be given the tools they require.

(Table taken from p.7 of quoted report)

Vladimir Putin: "Don't do as we do...we do it best!"

Russian Prime Minister Vladimir Putin used his podium at the World Economic Forum to attack the dollar's supremacy, skewer Wall Street bankers, and call for a new global energy paradigm. He also layed the smack down on Michael Dell.

But it was his warning against excessive state intervention in response to the global economic crisis that really caught my attention. His statement was, um, interesting:

"Excessive intervention in economic activity and blind faith in the state’s omnipotence is another possible mistake."

Huh. Putin, excessive intervention, blind faith in state's omnipotence. I feel like these things are related.

India Toys With Protectionism

For those you with short memories: a reminder about the G20 meeting from late 2008. Among the many fine words put forward following the November summit, there is one collection that seems worth revisiting. Declaration #13 reads (ahem):

We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports.

Given the near-universal consensus on the detrimental contagion effects that protectionist measures have on global trade and material well-being, this was not particularly earth-shattering. Still, it was nice to see our political leaders re-affirming their commitment to...

Oh bugger! it took only three days before we heard serious talk in America about bailing out the automotive industry. This was followed shortly by the lawmakers considering a "buy US steel provision" for TARP funds. Meanwhile, in China, there is the small matter of currency manipulation and using the fiscal stimulus plan to promote domestic industries.

Not to be outdone, India has stepped up to the protectionist plate (wicket?) to take a few swings. Yesterday, India's government banned Chinese toy imports for six months - all six which fall into the twelve month period of no-import barriers promised above. From Free Exchange:

What the [Indian] government is thinking is unclear. In a grave speech at the G20 meeting in November, India’s prime minister urged the group to "forestall any protectionist tendencies which always surface in times of recession". The G20 seems to take India seriously. But India doesn’t seem to feel the same way about the G20.

Unfortunately, the same can be said for many of the G20's members. Of course, if all Chinese toys posed a serious health hazard in some way maybe this could be justified. But is it likely that all Chinese toys are dangerous? If so, India's government should be presenting their evidence to the WTO, not taking the path of least domestic political resistance and implementing a complete ban. Incidentally, this is also the path towards a trade war with one of the world's largest exporters.

Now I'm guessing the toy industry does not represent a significant portion of China's GDP, but that's not really the point. As The Economist's in-depth look at the infamous Smoot-Hawley bill of 1930 made clear, the real damage comes from how such laws sour trade relations, leading to retaliatory effects. Just look at what happened last week with French cheese.

So let's leave aside for the moment how such actions undermine the G20 and provide yet further evidence for the calculated hypocrisy of our political leadership. The real danger is that tariffs/bans on stuffed kittens and fancy cheese are the first snowballs that kick off an avalanche of protectionism that smothers trade and damages geopolitical relations. It is precisely now, in this economic turmoil, when international cooperation is needed more than ever.

Monday was a really bad day for the global economy

Over 70,000 jobs were cut on what the FT calls "one of the gloomiest days in the global economic crisis so far". The size and global scale of the job losses are staggering. Raymond Torres of the ILO explained the situation in this way:

“We have a vicious circle of depression, where job losses lead to falling consumption, which lowers industrial confidence, which leads to less investment, which results in more job losses, and so on.”

As a recent masters graduate still looking for employment, that's some really bad news.

Monday Round-Up: Euro-trash & helicopter cash

- "The mood is going to be somewhat sober" at the Davos World Economic Forum this year, which starts on Wednesday. No kidding. In that vein, the WEF's opening speaker is someone not known for his overwhelmingly upbeat rhetoric: Vladimir Putin.

- John Hempton at Bronte Capital thinks we should stop fiddling around with metaphors and literally drop money from helicopters to induce inflation fears. Sure some people may accidentally die from the falling money packages, says John, but it might also induce consumer spending. Or, you know, cause foreign investors to dump all their US assets.

- A good discussion over at Free Exchange over whether the euro-zone is a modern day gold bloc - referring to the rigid constraints of the interwar gold standard that delayed economic recovery in 1930s Europe and beyond. The short answer is no, it is not. The takeaways:

"...because the break-up of the eurozone would involve unacceptable financial damage, the ECB and member governments are committed to the rescue of flailing national economies. Europe cannot allow Ireland or Spain to collapse, and so presumably, international capital will treat those states differently than they might Britain, which is stuck out there by its lonesome."

Moreover, the gold standard had no institutional equivalent of the ECB to help facilitate coordinated monetary easing - something that was a real sticking point. This doesn't mean the euro-zone is entirely in the clear, just that it has a set of challenges distinct from any historical precedent.

- Democracy woes from the pages of the WaPo: social unrest in Eastern Europe, and Bolivia's new constitution.

That Was The Week That Was

Politique
-On Tuesday, Barack Obama became the 44th President of the United States. Or was it Wednesday? He swiftly moved to roll back the Bush years through executive orders on Guantanamo, interrogation, and foreign assistance. The President also named two high profile envoys to the middle east and south Asia, a signal that the State Department and America's "soft power" will lead US foreign policy.

-Israel completed its withdrawal from Gaza, days after both Israel and Hamas declared "unilateral" ceasefires. The death toll from the conflict is estimated at 1,300 Palestinians and 13 Israelis. In related news, the BBC came under intense pressure following its refusal to broadcast a Gaza aid appeal by the Disasters & Emergency Committee.

-The Prime Minister of Iceland, Geir Haarde, called a March general election and will not seek reelection. The Daily Mail (and many others) incorrectly labeled Haarde's government the "first in the world to be effectively brought down by the credit crunch." As Dave noted in December, Belgium's government was the first to fall under pressure directly stemming from the financial crisis.

Economia
-Negotiations over the US stimulus package intensified as Obama met with leaders from both parties to shape a consensus. The stimulus package will undoubtedly pass, but what will it look like: will it hit $1 trillion (many economists believe it must to be effective)? how large are the tax cuts (will Obama bend to his own party by limiting this political manoeuvre)? how many Republicans will ultimately be on board?

-Spain and Portugal were hit with downgrades this week, and the eurozone looks to be on the verge of a serious crisis of confidence. Following its second bail out of the banking sector and the Pound's sharp decline, is the UK in the firing line? Does Britain=Iceland?

-In a written statement to the Senate Finance Committee, US Treasury Secretary designate Timothy Geithner accused China of "manipulating" the renminbi. In a measured response, the Chinese government said Geithner's comments were "out of keeping with the facts", would undermine the global effort to combat the financial crisis, and could fuel protectionism. In other China news, year-on-year GDP growth slowed to 6.8% in the 4th quarter, the slowest pace in 7 years.

The Rest
-Holders Pompey crash out of the FA Cup, Arsenal are held at last year's finalists Cardiff City, and the Merseyside derby ends in a draw, setting up a 4th round replay. In other Prem news, Kaka's megadeal to Man City fell through and a Kuwaiti consortium's proposed takeover of Liverpool has reportedly collapsed.

-In other sporting news, the disturbing balkanization of grand slam tennis.

-Affirming Dave's "political economy theory of fashion", Milan fashion week reflected the economic downturn, with the suit notably absent from many collections.

-The 81st Academy Awards nominations were announced in Los Angeles. The Curious Case of Benjamin Button lead the pack with 13 nominations, followed by Slumdog Millionaire with 10.

-Blackberry addicts the world over are scrambling to get their hands on the "Barackberry", after the US President finally wins his battle to stay connected in the White House. The NSA-enhanced device will have two "modes": one for personal contact with a tiny group of family and friends, another for official communications with a small circle of advisors and officials.

Obama's Inauguration Speech

Maybe I'm losing my memory, but somehow I don't remember these parts of the speech...

Warren Buffett: Hammer, Nail, Head

Marginal Revolution brings my attention to a PBS interview with Warren Buffet in which he summarizes what a lot of people are thinking about the tax cuts vs. fiscal spending debate, but no policymaker worth his/her salt will dare utter in public:

SG: But there is debate about whether there should be fiscal stimulus, whether tax cuts work or not. There is all of this academic debate among economists. What do you think? Is that the right way to go with stimulus and tax cuts?

WB: The answer is nobody knows. The economists don’t know. All you know is you throw everything at it and whether it’s more effective if you’re fighting a fire to be concentrating the water flow on this part or that part. You’re going to use every weapon you have in fighting it. And people, they do not know exactly what the effects are. Economists like to talk about it, but in the end they’ve been very, very wrong and most of them in recent years on this. We don’t know the perfect answers on it. What we do know is to stand by and do nothing is a terrible mistake or to follow Hoover-like policies would be a mistake and we don’t know how effective in the short run we don’t know how effective this will be and how quickly things will right themselves. We do know over time the American machine works wonderfully and it will work wonderfully again.

SG: But are we creating new problems?

WB: Always

Ouch. This is why economics as a profession can never aspire to being a "hard science" like physics or biology: there is simply no way to conduct a closed-lab experiment on the effects of these policies. Hayek recognized this fact and emphatically discouraged attempts to quantify the economy in absolute terms - what he called "The Pretence of Knowledge." The essential complexity of economic phenomena and their interaction with the real world forces us to rely on qualitative linkages and partial data.

The implications are twofold. It means that policymakers cannot engineer a lasting state of full employment, as some of those who call themselves "Keynesians" have tried (and failed) to do through active government intervention. These are some of Hayek's clear targets in his Nobel Prize speech.

But it means equally that policymakers cannot engineer permanent economic growth through widespread deregulation that relies entirely upon private actors' self-interested decisions and risk management techniques. Left to their own devices, some of the world's largest financial institutions have leveraged their assets 30 and 40 times - often using financial instruments that were often too complex to understand, yet not complex enough to fully account for risk. One does not have to be a mathematician to see the consequences of this: countries like Iceland, Ireland, and the UK dealing with financial-sector liabilities worth many times their respective GDPs.

So when Rory and I created the tagline for this blog, we were not referring the creation a new paradigm at one or the other end of an ideological spectrum. Instead, what we're try to do is stimulate discussion that will lead to sensible, practical ideas that can help us muddle through the diffucult problems of the day. In order to accomplish that, acknowledging the limits of economics as a predictive science is a good start.

Figures

- 440%: roughly the amount of debt-to-GDP that the UK would be taking on should they move to nationalize their major banks. This would be in addition to projected deficits of around 10% of GDP. (Maverecon & NYT)

- 6.8%: China's year-on-year growth rates in Q4, compared to 9% in Q3 and the lowest in seven years. How do you say "hard landing" in Mandarin? (RGE Monitor)

- $450 billion: the total value of assets shed by the hedge funds last year, equivalent to 37% of the industry. (Bloomberg)

- 5 million tonnes: the amount of rice that Thailand is considering selling from its stockpile, or 20% of the world's annual trade in rice. Depending upon how it is managed, a sell-off of this size has the potential flood the market and lower the price significantly. Good news for importers of rice, surely; less good for rice farmers. (Financial Times)

- 3: the number of times I've listened to/read Barack Obama's innauguration address. I cannot pick out a better line than the one Rory has chosen below, but two more sections deserve special attention:

"...we reject as false the choice between our safety and our ideals"

"Starting today, we must pick ourselves up, dust ourselves off, and begin again the work of remaking America"

Yes. And the same goes for the rest of us.

The Inauguration of Barack Hussein Obama

Upon reflection, two things will stick with me forever.

A single line, perfectly encapsulating the moment:

"What the cynics fail to understand is that the ground has shifted beneath them..."

Brilliant.

And a single image. It is the first photo of the new president at his desk, dwarfed by the enormity of the office and task that lay ahead of him.

Culture wars, of a different kind

According to the Times of London, one of former US President Bush's final acts in office was a 300% increase on the punitive duty on Roquefort cheese imports from France. Mmmm, cheese.

Anyway, this was accompanied by increases on a variety of EU food imports, including fruit, chocolate, and chewing gum. The Times reports this as further punishment for Europe's 12 year ban on US hormone-fed beef. Some in France believe it extends back to France's lack of support for the invasion of Iraq. If true, US logic is brilliant- hit them where it hurts...cheese!

As if the new US duties weren't troubling enough, the European reaction threatens to ignite a full blown culture war. From the Times:

Philippe Folliot, a centrist MP for the area around the village of Roquefort, called for a super-tax against Coca-Cola.

Touche, France.

Fact of the Day

The term political economy was first used in France in 1615.

This comes from Jerry Muller, a professor of intellectual history, but Wikipedia backs him up.

Also worth a read is their article on IPE. Interestingly, under the "Origins" section there is no mention of either Susan Strange or Robert Gilpin, yet there is mention of someone named Eugene Low. Anyone heard of him?

An 'Obama bump'? J Crew hopes so

On the topic of Obama and the market, it seems one company is already feeling the impact of an Obama stimulus.

Shares of J Crew Group Inc. ended the day up more than 10% on the news that J Crew was the prefered inauguration outfitter of the Obamas. The Prez: white satin bow-tie. First Lady: gloves, sweater, skirt. Girls: coats, dresses, accessories. Not since Camelot has a First Family made such an impact on the fashion world.

I think Obama's stimulus strategy is clear. Expect to see him driving a different GM vehicle each day, ditching Air Force One for US commercial airlines, opening brokerage accounts at Citi and BofA, and buying up beach houses across the country.

Inauguration day is a bad day for stocks

One of my conservative friends remarked yesterday that the Dow's 4% decline should be chalked up to the market's fear of an Obama presidency. I could go at this statement on so many levels. I instead went looking for the historical context of yesterday's performance.

David Gaffen at MarketBeat looked at the Dow's inauguration day performance since 1937 (excluding Obama, his article was published yesterday afternoon), the year inauguration was moved to Jan. 20th. He concluded that "the day of the inauguration has historically been a lousy one for the Dow Jones Industrial Average." He found that out of the past 10 inaugural days, just 2 ended higher for the Dow (85 and 97). The worst day? The Gipper's 1980 inauguration.

So if recent history is any indication, Obama had little to do with yesterday's decline. It was instead driven by a heavy sell-off in financials, which speaks more to the Bush administration's utter failure to address the fundamental problems in the banking sector and place a floor under the US housing market.

Quick hits and pink picks

-From the Times of London: Fatah leader Mahmoud Abbas is claiming that he was President Barack Obama's first call to a foreign leader. How does he know? Well, Obama told him so. I was highly critical of then President-elect Obama's silence on Israel's operations in Gaza, so I will be the first to say that, if Abbas is correct, Obama has made a very welcome statement on his commitment to the peace process. Apparently, Obama's first round of foreign calls were to middle east leaders (Egypt, Jordan, Israel), signalling to many that the new US prez is serious about renewed US leadership in the region. On a related matter, in case anyone doubted the political considerations driving Israel's Gaza offensive, the pullout from Gaza was completed today, Obama's first day in office.

-Portugal became the third eurozone country in two weeks to be hit with a downgrade. S&P cut the country's rating to AA minus. According to the FT, the cost of insuring Portugese government bonds through credit default swaps has risen to a record high. The government quickly labeled the downgrade as "unreasonable." In the past week, S&P has issued reviews on 10 highly rated western countries, leading Wolfgang Munchau to ask"what if" a eurozone economy defaulted?

-Foreign Policy has published the Think Tank Index, developed by the IR Department at the University of Pennsylvania. It is advertised as the "first comprehensive ranking of the world’s top think tanks, based on a worldwide survey of hundreds of scholars and experts." Below, the top 5 US and non-US think tanks:

US--> 1. Brookings Institution, 2. Council on Foreign Relations, 3. Carnegie Endowement for International Peace, 4. Rand Corporation, 5. Heritage Foundation

Non-US--> 1. Chatham House, 2. International Institute for Strategic Studies, 3. Stockholm International Peace Research Institute, 4. Overseas Development Institute, 5. Centre for European Policy Studies

The death of sterling, Part II: Enter Nick Clegg

Minutes after posting my look at sterling and the prospects for Britain joining the common currency (see below), Nick Clegg steps out and validates one half of my conclusion: the debate will seriously reemerge during 2009.

In an interview with the FT, the Lib Dem leader echoes the main conclusions of the "10 Years of the Euro: new perspectives for Britain" report, arguing that Britain must join the Euro to "salvage the public finances and prevent the 'permanent decline' of the city." He believes public opinion could swing violently in favor of the euro should the pound's volatility continue in the face of the euro's relative stability.

“In that context of people just longing for clearer rules, for reliability, for stability, for certainty, you might just find that becoming part of the reserve currency on our doorstep might become part of the recipe . . . by which we put the British economy back together on a more sustainable footing.”

This is a bold position for the Lib Dem leader, sure to provide him with the spotlight in the days to come. Unfortunately for Clegg, his authority to influence such a decision is nonexistent. The Lib Dems occupy a seemingly permanent minority position and Clegg himself has failed to distinguish his leadership since succeeding Ming in 2007. The buzz in Westminster is that the Lib Dems are engaged in backroom negotiations with the Tories over a possible coalition government should the next general election result in a hung Parliament (conservative win short of a majority). But a Tory minority government would be an unlikely partner for the Lib Dems on Europe in general, and especially so on Euro accession.

Regardless of his or his party's prospects, Clegg has thrust Euro accession back into the British political discussion. I am eager to see how Brown and Cameron respond.

The death of sterling

In the currency markets, the British pound has been one of the biggest victims of the financial crisis. It is down almost 30% against the USD over the past 12 months, and is hovering near parity with the Euro for the first time since the common currency's inception. The explanations are numerous: no horizon for the financial crisis, housing prices in free fall, fears of prolonged deflation, the BoE chasing the Fed, swelling deficits, etc etc etc. All the standard culprits.

While confidence in the UK economy, and currency, has been falling for some time (understatement of the year?), there is growing concern that a sterling run is imminent. Sterling fell below $1.40 today to its lowest level in over 7 years. Before paring losses in late trading, it was headed towards it worst day against the dollar since 1992. In a widely quoted interview, investor Jim Rogers summed up his thoughts on the pound, "I would urge you to sell any sterling you might have. It's finished. I hate to say it, but I would not put any money in the UK." Ouch. There is also speculation that the UK is facing a downgrade (Spain and Greece were downgraded last week, with Ireland and Portugal in the firing line).

In my opinion, this sterling pessimism is well-placed. Public sector debt is expected to balloon to more than 50% of GDP by 2011. The government just announced a second bail out of the banking system, a day after shares in RBS fell 66%, and amidst calls for a complete nationalization of RBS and Lloyds. While Brown has been more proactive than US policymakers in addressing the banking system (i.e. nationalization), he has yet to fully address the fundamental toxin in the system: bad assets. Until banks are compelled to fully disclose the steaming piles of crap they are sitting on, confidence in the banking system will remain nil.

So, if we are confronting a sterling collapse, what are the implications? Politically, Labour would be toast. Economically, a tiny boost to British manufacturing/exports would follow, but plunging consumer confidence and global demand would more than cancel this out. Financially, an already weakened City of London would see its influence as the global capital of finance (sorry New York) severely diminished. Fiscally, the government would find it increasingly difficult to finance its massive response to the crisis.

And what of the currency itself? One of the more interesting questions is whether a sterling collapse could lead Britain to reconsider the Euro. A group of academics, journalists, and politicians have revisited this argument in the report, "10 Years of the Euro: new perspectives for Britain". Organized by LSE Chairman Sir Peter Sutherland, and including contributions from LSE Prof and IPE Journal favorite Willem Buiter, the report argues that the country "should urgently reconsider the case for joining the single European currency". Buiter sums up his case succinctly, "It is time to revisit the five tests, to declare them passed and…for the UK to adopt the Euro." He dismisses the argument that an independent monetary policy is necessary for a country like Britain to respond to financial shocks, and discounts the effectiveness of exchange rate control by saying, "Even a gun fired at random by a drunk may, from time to time, hit the target. This is what we have seen in the UK with the exchange rate this past year."

Sutherland argues that Britain will lose its financial and regulatory influence under the emerging (re)regulatory consensus and eurozone fiscal convergence. His argument is essentially this: join the club and have a powerful seat at the table, or get left behind, powerless and throwing stones at the castle wall.

While Euro adoption may be in Britain's long term interest, is joining the Euro viable in the short term? I say no. Adopting the Euro would be political suicide for Labour, and it is unimaginable that Brown would risk his already shaky resurgence with such a bold stroke of statesmanship. The British also have an historic, deep attachment to the pound. Once the reserve and primary settlement currency under the gold standard, sterling's prestige is deeply ingrained in the British consciousness (nowhere more so than in the City of London). You could say it is the last vestige of the empire. And let us not forget that the Euro project itself will be under real strain in the coming year. Full and sustained eurozone fiscal coordination is anything but certain, and anti-Euro sentiment will undoubtedly rise in countries like Italy and Greece. Will the Euro enjoy the same credibility 12 months from now?

A lot of important questions. Luckily, sterling's decline guarantees that Euro adoption will return to the discourse in 2009. If the minds behind the report are correct, Britain should take a serious look at accession.

Picture Source: neftos

"A Framework for Financial Stability" starring the G30

There's nothing like a crisis to concentrate the mind. On January 15th, a collection of influential academics and financiers - known as the G30 - released a set of eighteen recommendations for reforming the international financial system. You can browse the summary or read about them here and here.

There a couple of things that need to be said. First, unlike the other G-units you hear about in the news, the G30 is a private group that does not represent official policy. Yet. (There are a large number of members, including Geitner and Volcker, that will be directly involved in shaping policy over the next several years).

Second, the group is, with one exception, entirely male.

Third, this old boys club may very well forshadow what's to come when the other old boys clubs, the G7 and G20, meet over the next year or two. Since the early 1990s the financial architecture exercise has lurched from one crisis to the next, with each set of proposals attempting to address the causes of the previous financial meltdown. (One of the emeritus members of the G30, Peter Kenen, likened the participants to generals preparing to fight the last war). In any event, the last big set of changes occurred in the wake of the Asian financial crisis in 1997/8 and left us with the G20, the Financial Stability Forum and a collection of "best practices" standards for insurance, accounting and securities, among other things.

Since then, however, the whole movement has largely been on hold. This is difficult to avoid given that, once the last crisis fades from memory, our political leaders get distracted by other issues. Besides, the economy recovered nicely from the mild recession in 2001 and things were looking up! Well, no more. The report from the G30 signals to me that the financial architecture exercise has received a new jolt of life. I'll have more on the actual content of the recommendations a little later. For now, it's enough to note that the renewed debate over the health of the financial architecture is long overdue and, in my view at least, a very welcome prospect.

Tuesday Round-Up: Geopolitics and the Financial Crisis

Some stuff I've read over the weekend has been swimming around in my head and I think it needs to be written down to help me identify, if not the right answers, at least some of the right questions. I'll try to be as coherent as possible:

- Looking ahead at 2009, Dani Rodrik writes that he is more worried "about growth in advanced countries than in the developing world." I wonder why that might be. Could it be the fact that aid flows to the poorest of the developing world drop during periods of economic downturn? Probably not, since aid flows account for only small amounts of growth - although it is worth noting that official development assistance is even more volatile than GDP or fiscal revenue, so a recession in the rich world is not good news for the truly impoverished.

Maybe it's because the developing world depends upon advanced country markets as a source of their exports and growth? That seems more likely (I'm skeptical of the decoupling thesis), but that's nothing compared to the damage caused by the commodity bust to developing country growth prospects. Because of those two factors, I - unlike Mr. Rodrik - am definitely less worried about the North Atlantic economies' capacity to recover from this crisis and stay in one piece. Certainly Rodrik agrees with me in so far as it concerns...

- China. He writes:

"China is a country of enormous tensions and cleavages beneath the surface.... The question is whether policy actions to date will do enough to stem a socially and politically dangerous slowdown in the economy. Whichever way the Chinese leadership responds, future generations may remember 2009 less for its global economic and financial crisis than for the momentous transformation it will have caused in China."

Indeed. On this topic I turn to two articles, the first by John Kemp. Kemp looks at how the economic slowdown has affected Guangdong province - China's manufacturing hub - and how a slowdown in the region will affect global markets, particularly for energy and raw materials. There's much more in there, so give it a read.

Dan Drezner also raises a number of excellent points concerning China, as well as several other "known unknowns" from the current financial mess. He thinks we can expect countries like China to begin de-coupling by using their fiscal stimulus plans to target domestic firms and encourage the growth of domestic markets to offset declining demand abroad. That's a roundabout way of suggesting that protectionism in on the rise and the gains in political cooperation that come from economic interdependence are on the decline. I would argue that this situation, along with the macroeconomic imbalances problem, calls for more international cooperation, not less, but is Drezner's prediction more likely?

- Russia and the Ukraine have signed a deal to resume gas flows under the supervision of international authorities. Is Russia's plummeting ruble going to make the country more or less aggressive over its energy supply policies. Or maybe: is Russia's weakening economic situation going to embolden countries like the Ukraine to provoke them even further?

Ben Bernanke to speak at the LSE

I have turned into something of a podcast junkie recently, and one source of excellent material is The London School of Economics public lecture series. This week, however, there's a particularly prominent guest speaker in the form of US Fed Chairman Ben Bernanke. The title of the talk is "Policy Responses to the Financial Crisis" and I highly recommend you tune in. There will actually be a live webcast of the event (Tuesday, 13:00 GMT, 8:00 EST) for those who want visuals.

The trouble with high profile speakers who hold public office is that their talks tend to be vague and pull punches on sticky issues - that Bernanke is operating "between" administrations with different policy response ideas won't help either. That being said, however, it will definitely be worth a listen.

While you're at it, I also highly recommend a talk by Paul Collier, author of The Bottom Billion - an excellent book on poverty reduction that's aimed at non-academics. You can also find him doing a (shorter) TED talk here.

Lazy Friday Links

Too lazy to string together a coherent argument, I instead provide links for your reading pleasure.

I'm making a concerted effort to read both interventionist and classical liberal types when it comes to economics with the hopes of cutting down on bias. As a Canadian, it's much easier to come across strong leftish sentiments, but it's reassuring to see that both sides get equally worked up. Check out the comments on Alex Tabarrok's summary of Obama's speech at GMU. I, for one, am hoping Alex is right.

Canada has no coherent government. "Essentially we are arguing that Canada has become a more genteel Somalia." Spicy!

The November stats are in. Consumer spending in America was way down, but volume of consumption was up. Wait, what?

A new blog over at Science has been launched with Darwin's Origin of Species as inspiration. On a related note, Dr. Boli has made a scientific discovery.

(I'm nitpicking here, but hopefully the content of Origins will be better than its grammar. The serial comma is running rampant in the welcome:

As part of its celebration of these two anniversaries, Science will be blogging, with Darwin as our inspiration. On this site, our writers and editors, as well as guest researchers and blog readers, will share their thoughts, not just about the origin of species but also about key nodes throughout the evolution of life, just as Darwin did.

I enjoy a comma as much as the next guy, but that's painful.)

Some Optimism

A comment over at Free Exchange about how the market psychology that led to inflated asset prices during the boom might also apply to the downturn. In other words, we can overshoot on the way down as well. This points to the inherent difficulty in seeing beyond the immediate trend to predict future events.

The article includes optimistic prognostications about the length of the downturn from James Surowiecki and economist heavyweight Kenneth Rogoff. Nice to see that my prediction of a couple months back is still in good company. Here's Rogoff:

Still, it must be noted that negative output growth for more than two years is a relatively rare event, even in the aftermath of severe banking crises. Historical statistical relationships are perhaps cold comfort in a downturn that now seems so insidiously different from previous catastrophes. But they should not be dismissed.

There, I feel better already. And certainly if I had any money, I'd be investing it right now. But that aside, there's still the interesting question about whether the boom & bust cycle is in fact the result of "a herd of hysterical lemmings," as Free Exchange puts it, or rational economic actors responding to a poorly structured market environment. The answer, as Mark Thoma discusses, matters a great deal for what policies are going to be most useful in softening the downturn.

I'm still leaning towards the hysterical lemming model, but that's mainly because I prefer the mental image...

(image from consumeist with apologies to Larson)

Has The American Economy Lost Its "Alpha"?

Willem Buiter certainly thinks so. His essay is, as usual, probably too long and dense for casual readers so I'll try to draw out some of the main points here. Before doing that, here is some background:

For quite some time now, the United States economy has been taking in more foreign investment than its citizens are investing abroad. Despite this negative net investment, American investors are earning more from their foreign investments (in aggregate) than the interest being paid on debts owed to foreign investors. This situation is what is being referred to when we talk of "alpha" - being able to secure positive returns despite a situation of negative net investment. This alpha has resulted from two factors: the very low rate of return offered on US assets and the increasingly risky nature of US-owned assets abroad (leading some to describe the United States as the world's largest venture capitalist).

Buiter outlines one possible explanation for the existence of alpha:

"Because of its unique position as the world’s largest economy, the world’s one remaining military and political superpower (since the demise of the Soviet Union in 1991) and the world’s joint-leading financial centre (with the City of London), the US could offer foreign investors lousy US returns on their investments in the US, without causing them to take their money and run."

The problem is, to the extent that it ever existed, this situation has been undermined:

There is no chance that a nation as reputationally scarred and maimed as the US is today could extract any true “alpha” from foreign investors for the next 25 years or so. So the US will have to start to pay a normal market price for the net resources it borrows from abroad. It will therefore have to start to generate primary surpluses, on average, for the indefinite future.

Thems fightin words. In order to generate those primary surpluses, the American economy will need higher taxes and/or less government spending (as well as higher personal savings). Yet the prospective Obama administration's economic stimulus plan contains precisely the opposite: lower taxes and higher government spending.

Buiter doesn't expect to change the outcome of the stimulus package, but his point is this: while the short run effects of a stimulus package may be beneficial, it will destroy the long-run prospects for the entire US economy. In short, the US economy cannot afford a Keynesian stimulus package. He predicts a global dumping of US assets in 2-5 years.

I wouldn't spend too much time worrying about Buiter's specific predictions on asset-dumping. Keynes himself pointed out that our ability to forsee the long-run is so limited as to be practically useless. Moreover, currency predictions are fickle at the best of times because everything is relative. For instance, even with current US economic weakness, we're seeing a flood to the US dollar a safehaven from other crashing currencies. So in two to five years, just about anything could happen. For more counter-arguments, see Free Exchange here and here.

Nevertheless, Buiter's overall concern is a real one and I'm not willing to dismiss it out of hand. But I think the most important questions to policymakers with more short-run horizons still comes down to: what's the alternative? and can America really afford not to have a Keynesian stimulus? A political consensus appears to forming that makes the answer to that last question a resounding "no."

So either Buiter is overstating the extent to which investors will be scared off by higher US debt levels, or there could be some very real long-run consequences that will make Obama's Harlem-Globetrotter-esque economic advisors look like the Washington Generals.

What Barack Obama kind of said today

Following the bombing of a UN school in Gaza, where civilians had taken shelter from the fighting, US President-elect Barack Obama was finally compelled into a statement on the conflict:

"The loss of civilian life in Gaza and Israel is a source of deep concern for me."

As it is for everyone else. And....?

Quick hits and pink picks

-David Hale believes the dollar rally is overdone, and argues in the FT that gold, not the euro, will be the short term alternative to the greenback (and inflation hedge of choice) in 2009.

-FP Passport looks at the new American Embassy in Baghdad. Once, US embassies housed cultural centers, English-language libraries and social spaces for the local population. Now, a really high wall and a whole lot of concrete. Architectural historian Jane Loeffler: "If architecture reflects the society that creates it, the new U.S. embassy in Baghdad makes a devastating comment about America’s global outlook."

-Samuel Huntington, giant of political science, died on December 24th at age 81. Huntington's 1993 essay in Foreign Affairs, "The Clash of Civilizations" (later expanded into a book), sparked a global debate on international conflict, religion and the nation-state that still rages today. I have been struck recently by the number of non-IR/IPE people who have not read the essay, especially among those critical of its thesis. It can be found here, and I strongly encourage a (re)reading.

Recommended: Eero Saarinen, architect

I recently attended an exhibition on Eero Saarinen, the Finnish American architect. Saarinen designed corporate, governmental, academic and residential buildings in the mid 20th century. His works include the Gateway Arch in St. Louis, the TWA terminal at New York's JFK airport, the IBM manufacturing and training facility in Rochester, Minnesota, the American Embassy in London, and the Ingalls Hockey Rink on the campus of Yale University (see sketch), to name but a few. He is also renowned for his furniture design, including the iconic Knoll "Womb" chair.

Saarinen's mid-century modernism was highly influential, but criticized by some contemporaries for lacking stylistic discipline. Admirers, however, believe that Saarinen "rejected the dogma of an orthodox modernism and instead adopted a varied approach to architectural design, letting the subject and site guide his inventive solutions".

If you are interested in architecture and design, check out Eero Saarinen.

That Was The Week That Was

Politique
-As the world limped into the new year, IPE Journal looked back at the defining political stories of 2008.

-Israel's Gaza operation entered its second week. A ground invasion is now underway to topple the Hamas regime and prevent further rocket attacks on Israel. The UN Security Council failed to reach a consensus position this weekend, despite an humanitarian situation characterized as "desperate."

-Czech President Vaclav Klaus assumed the rotating EU Presidency this week. After a widely praised and robust Sarkozy presidency, Brussels watchers are anxious that the "prickly" Klaus will undermine EU consensus on the financial crisis, climate change and, well, the EU itself.

-The Chinese government moved to silence the signatories of Charter 08, a "wide-ranging blueprint for peaceful political, legal and economic reform in China." The crackdown reflects the deep anxiety carried by the Chinese leadership into 2009.

Economia
-Entering 2009 with much economic and financial uncertainty, IPE Journal looked back at the economic stories of 2008.

-Another price dispute between Russia and Ukraine resulted in the suspension of natural gas deliveries to Ukraine, with reports of growing shortages from Turkey to the Czech Republic. Both Moscow and Kiev are courting European support for their position in the dispute.

-Sterling neared Euro parity for the first time, a milestone that might spark a much deeper sterling sell-off.

The Rest
-Now more than ever, we need distractions. IPE Journal looked back at the cultural, sporting and down right random things that captured our attention in 2008.

-In the FA Cup, Arsenal go forward on a Van Persie brace, while Man City crashes out in spectacular fashion. Notable 4th round ties: ManU v. Spurs, Liverpool v. Everton.

-40 drunken passengers run "riot" on Cuba bound flight from Gatwick. "Drunk", "Gatwick" and "riot" are three words I am not surprised to find in the same sentence.

-The Obama's arrived in Washington...let the parties, galas and Republican exodus begin.

The slippery slope to protectionism or How to create your own depression

The interwar period is a fascinating "topic" in IPE. Scholarship on the period is vast, offering multiple explanations for the trends, events and ideas that contributed to the Great Depression and WWII. Some of the great thinkers in IPE (such as Kindleberger, Eichengreen and some guy named Bernanke) have contributed to the analysis of the period.

The interwar period is studied so closely because it provides lessons on how NOT to respond to economic contraction and financial crisis. If this history is any indication, protectionism should be avoided like the plague. The Smoot-Hawley tariff set off a change reaction of protectionism from 1930 on that plunged the world much deeper into depression. While a global (meaning British and American) consensus on trade was unattainable immediately following the war (see ITO failure), the GATT succeeded largely due to the Anglo-American recognition that tariffs were dangerous to economic recovery, prosperity and peace itself.

Over the next few weeks, the Obama transition team and US Congress would do well to brush up on their interwar history. The US steel industry, after years of benefiting from illegal subsidies, are reportedly lobbying in favor of a massive public works plan that would have a "buy US" provision inserted into every project. This would conceivably require the recipients of federal funds for public works and infrastructure projects to purchase US steel.

The proposal is troubling on a number of levels. For one, it would prove that the TARP was but the tip of an iceberg of government subsidy. Banks, autos, steel...where does it end? Second, it underlines the risks posed by the DDA's failure. WTO and G20 indecision in the face of rising protectionism risks exactly the domino effect that Smoot-Hawley accelerated nearly 80 years ago. Finally, a "buy US" clause would be a dangerous precedent for the President-elect to set. Many are already skeptical of his commitment to a liberal trading system, and early support for such backdoor protectionism would do little to burnish his trade credentials internationally.

Vice-President elect Biden believes that to be credible and effective, the Economic Recovery Plan must be "pork-free". It is equally important that it avoid the kind of backdoor protectionism the US steel industry is lobbying for.

From The Alan Greenspan Dept. of 20-20 Hindsight

With only a couple of weeks left in office, Hank Paulson has been busy holding interviews to make his views on the financial crisis clear. Here he is explaining how the Treasury lacks sufficient authority to deal with financial crises. Here he is again two days later explaining how macroeconomic imbalances are the true, underlying cause of our recent financial mess. (For a basic run down on the imbalances issue, see my previous essay).

Now, Hank Paulson is absolutely correct in pointing to the imbalances as a source of cheap credit that led to excessive risk-taking. But as my co-author rightly pointed out, it is almost as if Paulson is blaming a concept for the crisis, not unlike those who blame "globalization" for all the world's ills:

"Aha!," say the Americans, "it was those pesky imbalances that made us run huge national deficits and unsustainable personal debt." "It's not our fault either!," retort the Chinese, "those imbalances forced us to manipulate our currency in order to sustain a massive trade surplus." "Don't look at me!," says the investment banker, between Manhattans. "What did you expect me to do with all that cheap credit? Monitor who was holding all that risk?" "Why are we burning through cash at a rate of billions per month after operating for three decades with an unsustainable business model?" asks GM's CEO on conference call from his private jet, "Why, it was the, er... macrosomething imbalances!"

You get the idea. The reality is that the economic imbalances are the culmination of the decisions of governments and individuals over an extended period of time that were self-interested and ignored the bigger picture. The imbalances equation has a savings glut and investment drought on one side, and a collection of irresponsible financial incentives on the other. Ultimately, this situation has been brought on by the unwillingness of the world's major financial actors to take responsibility for the long run implications of their actions. A quote from The Economist:

"A sound international economic order cannot be built on the assumption that the rumbustiously richest country will go on borrowing unprecedented amounts at enormous interest rates from everybody else for ever.”

And yet that's pretty much the model we've been working from (except with low, instead of high interest rates). Oh, and where did I take that quote from? The Economist's 1984 endorsement of Ronald Reagan for president. Twenty. Four. Years. Ago. These imbalances did not creep up on us, folks. We need coordinated action by the G20 economies to address the problem without resorting to protectionist measures. It's too bad we needed a recession to drive this point home to the Secretary of the Treasury, but there you have it.

What Barack Obama did, and still did not, say today

The seventh day of Israel's air offensive on Hamas and infrastructure in Gaza has passed, and still no word from Barack Obama. A transition spokesperson, in response to growing calls for Obama to speak up, released a statement that recycles the President-elect's typical response to issues he wants to avoid, "President-elect Obama is closely monitoring global events, including the situation in Gaza, but there is one president at a time."

This Boilerplate statement is a cop-out, and the press needs to start calling Obama on his selective respect for Bush's non-existent presidential authority. If there is only one president at a time, why is Obama heading to Capitol Hill on Monday to negotiate with lawmakers on his economic agenda? Last I checked, his inauguration is not until the 20th.

I am on Obama's case because Gaza affects us all, and could matter as much to his presidency as his stimulus plan. The Israeli/Palestinian conflict is central to explaining global terrorism and middle east instability. As Bush quickly learned (remember his 2000 campaign? international disengagement, education, compassionate conservatism), international events often occupy presidencies, and if Obama is serious about tackling international terrorism, the peace process, or the potential for wider instability in the middle east, it would serve him well to start engaging the Israeli/Palestinian conflict now.

Let me be clear that I am not calling for Obama to speak out against Israel's action (silence is often tacit approval in politics). I do not advocate a particular side in this conflict; I advocate a solution. And I do not pretend to know what that would be. I simply know that the status quo hasn't solved anything.

I do, however, believe that a cessation of hostilities is preferable to a prolonged Israeli ground invasion, and would make a new truce agreement more likely. Toppling a democratically elected government (no matter how despicable Hamas is, its political wing was legitimately and democratically elected in a US sponsored election) and the destruction of Gaza's infrastructure is not in Israeli, or US, interests. The backlash in Palestine and the Muslim world would be immense, and likely result in a third intifada. Problem is, the only party with the leverage to push the parties toward a truce, the US, remains on the sideline.

Rice's press conference today was disappointing (but unsurprising), echoing the administration's stance on the 2006 war in Lebanon. To borrow her words, a "durable and sustainable" cease-fire is achieved one of two ways: a total defeat of one side (which, given the structure of Hamas and Israel's experience in Lebanon, policymakers shouldn't count on), or an agreement that appeals to the interests of both (no matter how disproportionate). It is difficult to envision Israel achieving either of these two outcomes with a full invasion of Gaza, which is exactly what the Bush administration is supporting (at least publicly). This is why Obama should intervene. Not officially, rather by speaking on the subject and setting out his general intentions for the peace process. Even in abstract, an indication of Obama's middle east policy would temper Israeli actions. Admittedly, a ground operation looks unavoidable at this point. But, Obama can limit the operation's duration and damage to civilians and public infrastructure.

This might be critical to providing the conditions under which a truce or eventual peace agreement can be negotiated. The Israeli leadership will listen; they serve no interest by crossing the President-elect. Palestinians will listen too; not Hamas, but a civilian population that must feel like the world has left them behind. If alternatives to Hamas begin to look "durable and sustainable", the sentiment and support that swept Hamas into power will begin to fade. And that might just be the key to ultimately ending rocket attacks on Israel. It would also help boost Fatah, who could fill the vacuum, and are more prepared to negotiate with Israel. If anyone should appreciate the power of "hope", Obama should. Furthermore, if Israel and the US seek to build up Fatah as a partner for peace, actions that bolster the credibility and appeal of Hamas should be avoided. Unfortunately, a prolonged ground war in Gaza will do just that.

Obama has an opportunity to lay the groundwork for the next 4 years of middle east policy. He can't be expected to prevent tomorrow's events in Gaza, but he can affect their duration and damage. US leadership has been, and will be, key to a lasting peace agreement. Obama's silence is helping no one, and only complicates his future efforts towards that end.