That Was the Year That Was: Politique

This was the year that everything was supposed to change. We were told that the greatest financial and economic crisis since the Great Depression would usher in a new paradigm on global markets and authority (look up)...did it? Judging by the top political stories of 2009, not quite:

And then it was two...the G2
For years we have been waiting for the inevitable moment when China would elevate to great-power status and challenge the US for global authority and influence. While the conventional wisdom says that this happened in 2009, the reality is more nuanced. China's role as America's banker and its economic performance are the envy of the world and empowered it with great and growing influence over affairs both local (see: African investment) and global (see: climate change). But it is still years, maybe decades, away from truly rivaling the US on military, economic and political power. It's precarious social order and frothy economic recovery may yet fundamentally undermine the communist party and China's methodical rise on the international stage.

That said, the US-China balance was clearly tilting eastward following the crisis and 2009 was the year that the so-called 'G2' paradigm finally crystallized. The US and China are now the two primary players and their cooperation is essential to progress on almost every major global issue, from trade to climate change.

Exit the old, enter the new economic order...sort of
The crisis would change the relationship between government and markets, reorganize the major economies, elevate the emerging giants and re-regulate financial markets. The G20 talked a big game and editorial boards called for sweeping regulatory reform. Everything would be different the next time around.

Remember those heady days? Crises often bring about transformative change, but the window of opportunity to affect this change is often small. Unfortunately, this window closed quickly in 2009 with little substantive reform enacted either transnationally or within the major economies. In the US, massive government bailouts translated into surprisingly little leverage in the re-regulation of the financial sector. Executives at AIG are using the threat of resignation to extort further pay exemptions from Obama's pay czar. Perverse incentives and too big to fail firms still pervade the system. Record profits have afflicted the financial sector with collective amnesia.

The problem is one of political will and policymakers in the US in particular lacked the courage and purpose to enact real regulatory reform. We need more Paul Volkers and less Timothy Geithners.

Obama- The Tragedy of Great Expectations
What started with such promise and purpose ends the year struggling under the weight of expectations. To be fair, the Obama administration's first year has been marked by notable successes domestically, from the stimulus package to health care to executive orders reversing Bush-era policies on everything from stem cells to government secrecy. His international rhetoric and posture have remarkably transformed the image of the US following eight years of tarnish. His Cairo and Nobel speeches were transcendent.

But many of us are still waiting for 'change we can believe in.' Perhaps the expectations were always too high, setting Obama up for an inevitable fall. Perhaps the challenges facing the US are too great for one government to correct. But I can't help but feel that on issues where he could affect great change, from Afghanistan to financial reform, he has come up short. Domestically, he has been naively committed to the fantasy of bipartisanship in Washington. His trip through Asia was a bust on any measure. The challenges are no less daunting in 2010.

Kicking the Can
Climate change, trade, Iran, financial reform. Big issues, little progress.

Lisbon Treaty
Europe finally got its act together and ratified the Lisbon Treaty, only to appoint two of the most underwhelming candidates on the international scene. The primacy of the nation-state persists in spite of Lisbon.

The Trouble with Elections
Elections in Israel, Iran and Afghanistan all complicated progress on major international issues in 2009. In Iran, the regime faces its most committed and prolonged challenge since the revolution.

Berlusconi
Just kidding!

Nassim Taleb: Messin with my Head

I hope you have all enjoyed a bit of a holiday in the past week or so - I've been using my break as an opportunity to catch up on some reading. One of the books I have on the go, however, is causing my brain to explode a little bit.

That book is The Black Swan, by Nassim Taleb. I realize that I'm late to this particular party: Taleb's book was published in 2007 and has been widely read and discussed (the book's publisher even took out full-sized ads in the London Underground, a spot usually reserved for bad television ads and the latest Victoria Beckham ghostwritten word vomit). But for anyone else who is behind the curve, I highly recommend this book. Not because you will enjoy it, but because it will make you uncomfortable.

The book's tagline reads "The Impact of the Highly Improbable," but it is much more than a collection of vignettes about unlikely events that have shaped human history. In fact, it is an exploration on the limits of human knowledge and our systematic failures to both interpret past events and predict events of the future. Actually, it's not so much of an exploration but an all-out assault on what it is that we think we know. He's particularly hard on those who claim to be experts in areas of fundamental unpredictability: political scientists, economists, historians, business executives, bureaucrats, risk analysts and just about everyone working in the financial industry (which includes Taleb). Like I said, this book will make you uncomfortable.

I don't agree with all the arguments that Taleb makes in this book. For instance, he distinguishes between the damage caused by forecasting errors made by governments and those of large corporations. Unlike governments, "corporations can go bust as often as they like, thus subsidizing us consumers by transferring their wealth into our pockets.... As individuals, we should love free markets because operators in them can be as incompetent as they wish." Well that's obviously not the case: the recent string of bankruptcies in the financial industry has not transferred wealth into, but out of, our pockets.

Rather than undermining his argument, however, I think the above example serves to reinforce the fundamental point of his book: Taleb has attempted to create a neat distinction, but the reality of the system is much more complex than he realizes at the time of writing. His misreading of history has led him to make an incorrect prediction about the future value of bankruptcies. In other words, he has unintentionally reinforced his own arguments about why we suck at predicting things. (For yet more evidence, see the FAIL list below).

I cannot possibly do justice to this book in a short blog post, so I will merely repeat my earlier recommendation to "read this book." Despite the heavy philosophical content, this is an accessible and easy-to-read (even funny) way to totally mess with your head.

That Was the Year That Was: FAIL list

As we kick off our look back at 2009, here's a list by Joshua Keating, associate editor at Foreign Policy, of the 10 Worst Predictions for 2009. The predictions are paraphrased below, the comments are my own:

1. Obama to sign energy bill by end of the year- Rahm Emanuel on 19 April (White House chief of staff)
Not even close. Health care, health care, health care.

2. Bernnake to step down after first term, Summers replaces him at Fed- Business Week on 2 January (magazine)
Tough confirmation hearings, but Bernanke enjoys the confidence of the president and is soon to be entering his second term. Far from basking in the glory of a depression averted, Bernanke has been charged with unwinding his extraordinary response to the crisis.

3. Swine Flu to kill hundreds of thousands in the US- Report to the President on US Preparations for the 2009-H1N1 Influenza on 7 August (President's Council of Advisors on Science and Technology)
Um, no. But this was enough to scare me into getting vaccinated.

4. No end in sight to US economic freefall- George Soros on 20 February (billionaire investor and activist)
To be fair, Soros hedged his comments, but the pace of recovery in both the financial markets and real economy has undoubtedly been surprising. The US stimulus package may not have done enough, but it seems to have done just enough to avert catastrophe. That tricky unemployment rate remains...

5. No Afghan surge for Obama, Gen. McChrystal to resign- Charles Krauthammer on 27 September (right-wing columnist/commentator)
Obama succumbed to the COIN camp against, I suspect, his instincts. McChrystal saw the back of Obama's hand following his public intervention into the Afghan surge debate, but in the end got 3/4 of the troops he was looking for.

6. Gordon Brown will 'certainly' step down within three days- Martin Kettle on 5 June (associate editor at The Guardian)
The train wreck that was the Brown premiership reached its inglorious nader over this week in June when the Labour backbench revolt burst into the open with public calls to resign. Somewhat remarkably, Brown fights on (thanks in no small part to Lord Mandy) and has even narrowed the Tory lead in the run-up to likely elections in March.

7. Breakthrough agreement, Zelaya returning to office, democracy lives in Honduras!- Hillary Clinton on 30 October (US secretary of state)
Zelaya has spent quite a bit of time the Brazilian embassy, presiding over nothing but his cowboy hat, and Honduran democracy is shaky at best.

8. Israel will likely strike Iran between US election and Obama's inauguration...Israel will likely strike Iran before end of 2009- John Bolton on 22 June 2008 and 28 July 2009 (former US ambassador to UN and epic moron)
John Bolton calls on Israel to bomb Iran as often as the sun rises. It still hasn't happened. You get the impression that Bolton believes if you wish for something hard enough it will just happen. I really loathe this guy on so many levels.

9. G7 finance ministers have unleashed inflationary hell, world markets to collapse under chaos- Jim Rogers on 10 October 2008 (billionaire investor)
I would argue that entering 2010 deflation remains a bigger risk than inflation in the major economies.

10. China will take over Panama and choke the US via the canal- Rep. Dana Rohrabacher on 7 December 1999 (US representative)
Ten years later and the cargo flows.

Wednesday Readables

- Prospect gives its list of the 25 most influential intellectuals during the financial crisis

- From the above list, Simon Johnson's The Quiet Coup. Not sure how I missed this one back in May, but it's a good read for those looking for a Big Picture view of the financial crisis and its implications.

- Free Exchange discusses the same WaPo review of the Fed that I tackled below; suggests that Fed is better equipped to deal with inflation than regulation: "It's time to learn a lesson here. An institution that missed a brewing crisis of this magnitude is an institution not set up to detect and prevent a brewing crisis of any magnitude. Something else is needed."

- Underwater robots help reveal history

- LOLFed takes stock of TIME magazine's love affair with Ben Bernanke

- Failure by global leaders to tackle global warming leads to new investment opportunities

Christmas Consumer Price Index 2009

PNC Wealth Management has calculated this year's Christmas CPI to be $21,465.56. That's up from $21,080.10 last year.

The index, which tracks the total cost of the 78 gifts from the carol "The Twelve Days of Christmas," has been around since 1984. PNC's website lets you play around with some of the historical data to see how much the price of swans-a-swimming, for example, has changed over the years.

This is the kind of valuable information you can impress your friends and family with over the holidays - but maybe only after one-too-many eggnogs.

Afghanistan is HARD (and confusing)

This is a couple of weeks old, but are you looking for a graphical representation of the cluster**** that is the US counterinsurgency (COIN) strategy in Afghanistan? Good, I have one. Good luck.

Stephen Colbert tackles the COIN challenge below by playing 'Afghandyland.'

The Colbert Report	Mon - Thurs 11:30pm / 10:30c
Obama's Nobel Prize Speech & Afghandyland
www.colbertnation.com
Colbert Report Full Episodes Political Humor Economy

Copenhagen III: Blame China

Last week, I got a little ranty about China's role in torpedoing the climate change talks in Copenhagen. I've thought quite a bit about that post since, wondering if I was perhaps a bit too one-sided in my criticism.

But a first-hand, 'fly-on-the-wall' account by Mark Lynas in The Guardian affirms my suspicions that China was the primary obstacle to an international agreement to fight climate change. In fact, according to Lynas the behavior of the Chinese delegation, particularly the undiplomatic and inexcusable absence of senior officials from the critical talks, was down right Machiavellian. The Chinese strategy was two-fold: kill the deal and embarrass the US president.

It succeeded on the first measure, and time will tell whether Copenhagen will hurt Obama's presidency and global position. But it is clear that on issues from trade to climate change, the delicate US-Sino dance that prevailed during the Bush years has started to unravel amid the global crisis and first year of the Obama presidency. If the new world order is driven by a G-2, this is an ominous sign. China's 'peaceful rise' has quickly morphed into shrewd realpolitik, presaging greater tensions on the international stage between the world's two superpowers.

The political economy of North-South trade (get it?)

Our friend Patrick Thomas, the UK Embassy in Washington's policy advisor for trade and agriculture, and his colleague Tom Barry, first secretary, economics at the Embassy, have contributed a great guest post to the Wall Street Journal's Real Time Economics blog entitled 'Santa Claus's Trade Infractions.'

According to little Johnny (aged four and three quarters), Santa has a lot of explaining to do before the WTO.

Check it out!

Financial Crisis: Learning the Right Lessons?

I'm not one to regularly quote from the Washington Post, but it's good to break free from the usual sources every now and again, yes? So here it goes, a WaPo retrospective on the US Fed's shortcomings in the run-up to the recent financial crisis:

The Fed's failure to foresee the crisis or to require adequate safeguards happened in part because it did not understand the risks that banks were taking, according to documents and interviews with more than three dozen current and former government officials, bank executives and regulatory experts.

Well blow me down. I don't think one needs three dozen interviews to figure that one out: it's pretty obvious that the various US financial regulatory bodies didn't see this coming, nor did those in the other major financial centres. However, as Arnold Kling points out, neither did most of the suits at the very banks within which the risks were being taken. I think it's fair to say that it has been a learning experience all around.

But exactly what kind of lessons are we learning from this crisis? It's very important that we learn the right ones. Even if we acknowledge that there was a collective cognitive failure on the part of our regulators, there are a couple of different ways to run with this.

If we're of the mindset that we should see bankers hanging from Blackfriars bridge, or have their heads on pikes or whatever, I don't think the discussion will go very far. Despite the obvious excesses of financial sector, I am still waiting for evidence that performance bonuses to Goldman Sachs employees has been the cause of our financial crisis.

But let's agree that the Fed F'd up. What should we do about this? One option is to use this argument to argue against the re-appointment of Ben Bernanke as Chairman because of his obvious failures to mitigate the crisis. While there is merit in digging up all the mistaken decisions by the Fed in the past decade, scapegoating will not address the problems of tomorrow. John Maynard Keynes is reported to have said: "When the facts change, I change my mind. What do you do, sir?" When the facts changed for Bernanke in late 2008, he also changed his mind. Although late to the party, the Fed's willingness to adapt to the crisis over the last 16 months has been a crucial part of slowing the economy's decline and stimulating what is, to date, modest signs of recovery. (I think Rory agrees) (wait, so does TIME)

But even if we accept that the Fed has learned from some of its past mistakes, this has not addressed the fundamental problem with financial regulation: the regulators don't have the capacity to know everything that's going on. They never will. The people who work at investment banks, hedge funds and the like are too smart and too motivated. There will always be loopholes, and those loopholes will be found. That said, it should still be possible to avoid the kind of crisis that we just experienced, with huge sums of money (your money, my money) being used to prop up the balance sheets of our financial giants. I see at least three possible avenues for the future:

First, concentrate the US regulatory system into fewer bodies. I couldn't find the organizational chart I wanted, but you can get a sense of it from this summary. Compared to many other industrialized countries, this is madness. Having one financial entity regulated by so many different government bodies will leave gaps in coverage. It's hard enough for one government entity to share information with itself - multiplying entities will multiply the problem.

But with a more concentrated financial regulator, the information-gathering problem will not disappear. This is why I find Paul Volcker's vision for the US banking sector to be persuasive. Since we cannot prevent financial innovations and we cannot expect our regulators to understand all the risks associated with them, we should at least prevent our "systemically important" financial institutions from playing with them. The risks and rewards should be realized by firms which are able to fail.

Third, let's beef up the regulatory standards for our core financial industries - the ones we can't afford to see fail. The Basel Committee on Banking Supervision recently released its list of five suggestions for doing just that. This is an excellent place to start the discussion, and efforts to coordination internationally will help address concerns about competitiveness.

------------

I think that it's crucially important to learn the right lessons from this financial crisis and avoid being side-tracked by the promise of a quick fix (think: banking bonus supertaxes or the Tobin tax). From where I'm sitting, one of those key lessons will focus on cognitive limitations - the limited ability of our government officials, regulators, banking execs and individual investors to understand complex realities of the markets they interact with. Once we accept this, we can begin to build buffers against the problems that will inevitably arise.

Now if you'll excuse me, in recognition of my own cognitive limitations, I have a stack of holiday reading to attend to.

A decade in the markets

The FT has, as usual, fantastic graphs charting the course of different major markets over the past decade.

From the tech bubble to the great credit crunch, this has been a bumpy ride indeed.

Copenhagen II: Blame China

One final comment on Copenhagen (it's about to get ranty!). As the details trickle out from participants, it is becoming apparent that China was the primary obstacle to a real deal. It snubbed the US on more than one occasion, in rather undiplomatic fashion, over the past 24 hours, sending low-level diplomats to meet Clinton and Obama even though Obama extended his stay in the hopes of reaching a deal with the Chinese. In return, Wen wouldn't even show up for a meeting. This is bad diplomacy and bad news for the US-China relationship. Brazil appears to have also played a particularly unhelpful role.

I must admit that my expectations were low going into Copenhagen, but the outcome is still disappointing. I retained some optimism because for the first time in a decade, a US administration walked into discussions ready to act. Easier said than done, of course. Domestic political constraints limit Obama's hand, and this prevents the US from signing up to legally-binding and substantial emissions cuts. This is a real obstacle to an international agreement.

Yet, everyone knows this, and it wasn't going to be the biggest obstacle to an agreement in Copenhagen. In fact, this is part of the reason that Copenhagen was supposed to be a 'political', and not legal framework. In my opinion the US is no longer the primary obstacle to an international agreement; that dubious distinction now belongs to China, Brazil and India. Particularly China in the wake of their performance in Copenhagen.

Any restrictions on economic growth, which even reasonable climate change activists must admit are a likely short-term byproduct of a best-case agreement, are unacceptable to the Chinese. Nothing can jeopardize their fragile bargain with the Chinese people: political tyranny for economic prosperity. When does this domestic calculation cease to consume the Chinese leadership in international affairs? Further, 'sovereignty' might be the buzz-word of the summit as it seems China's total unwillingness to sign up to any substantive monitoring mechanism is what ultimately doomed their negotiations with the US. China is deeply sensitive to any challenges (real or perceived) to its sovereignty, with perhaps the notable exception of the WTO. But their hardened opposition to even passive, independent monitoring is not just unreasonable but unacceptable for a country that wishes to be treated as a global power and leader. Its diplomatic behavior following Obama's speech was childish.

So here we are.

Friday finale: Failure in Copenhagen

Despite reaching a 'meaningful' agreement late this evening, world leaders have failed to fulfill their ambitions to reach a comprehensive political framework for reducing greenhouse gas emissions, according to the FT.

Listening to Barack Obama's press conference, it is clear that he is leaving Copenhagen with little optimism. A legally-binding international agreement, with substantial cuts in emissions pledged, and mechanisms in place to formally verify compliance, is a long way off.

Have a nice weekend.

Yegor Gaidar

Anyone who worries about the direction Russia has taken under Putin will find this post from Leon Aron, director of Russia studies at the American Enterprise Institute, on Yegor Gaidar's death heartbreaking.

The positive aspects of any man's life tend to be accentuated in death, and many of the tributes to Gaidar, like this one, have taken a decidedly rosy perspective on the shock therapy he administered to the Russian economy. The reality is far more complicated and much less positive.

But however flawed that project would ultimately be, imagine the alternative. The historical revisionism of the Putin years, under which the names Gorbachev, Gaidar and Yakovlev became synonymous with humiliation and suffering, must have slowly killed a man like Gaidar, a man whose work was to literally save the Russian people from famine and collapse.

Quick hits and pink picks: transparency can be a tricky concept when the lens is focused on you

-An enterprising reader of The Guardian has answered the newspaper's call to untangle the complicated web of Tony Blair's finances. Usually I would say that the business of an ex-leader is none of my business, but with Blair the scrutiny would seem appropriate, given his still notionally official role as a Middle East envoy and near-presidency of the EU.

-The FT looks at the retreat of the siloviki under the Medvedev presidency.

-Yegor Gaidar, first finance minister of post-Soviet Russia and one of the architects of the country's transition to a market-based economy, died this week at 53. Gaidar's reforms, legacy and reputation are a complex mix of historic achievement, failure and resentment. The intellectual merits and legacy of the 'shock-therapy' administered by people like Gaidar in Russia or Jeffrey Sachs (for our younger readers, yes, that one) in Poland will be debated in academic and policy circles for generations.

-One of the cultural truisms of the crisis is that wealth is out, modesty is in. The ostentatious displays of the nouveau riche (think: oligarchs and investment bankers) are not only remnants of an era passed, but universally held in bad taste. However, an aspirational lifestyle has been fundamental to the consumer-driven, middle-class wealth-creation of the western world over the past century, and with swelling middle-classes in countries like the US and England due to decades of declining real wages and wealth destruction in the crisis (think houses and mutual funds), symbols of old-money status and wealth should enjoy a renaissance as the masses yearn for a taste of the good life. In an interesting article, The Guardian looks at 'Tory Chic: the return of poshness.'

-The financial impact of Tiger Woods' indiscretions is massive, not just for the golfer, but the game he plays.

“Wake up, gentlemen”

That was Paul Volcker's message to the Future of Finance Initiative, delivered earlier this week. Responding to what he viewed as timid proposals from the private sector on how to go about their business, Volcker proceeded to lay out what he saw as the key priorities. I can't find a useful way to cut this down, so I will quote it as a whole:

Let me just suggest, if I may, the way that I would go about this. I am not alone in this, and in fact I think that I am probably going to win in the end.

First, let us agree that we have a problem with moral hazard. I do not think that there is any perfect answer in dealing with it, but I would suggest that we can approach an answer by recognizing that elements of finance have always been risky and that's certainly true of the commercial-banking system.

I think we need the commercial banking system for more than automatic teller machines. Commercial banks are still at the heart of the system. In a crisis, everybody runs back to the commercial banks. They, after all, run the payment system. We cannot have this global economy without commercial banks operating an efficient payment system globally as well as nationally. They provide a depository outlet for individuals and businesses, and they are still big credit providers for small and medium-size businesses, but they backstop most of the big borrowers as well. The commercial-paper market is totally dependent on the commercial banking market. They are an essential financial institution that has historically been protected. It has been protected on one side and regulated on the other side.

I think that fundamental is going to remain. People are going to think it is important, it is important, it needs regulation and in extremis it needs protection—deposit insurance, lender of last resort and so forth. I think that it is extraneous to that function that they do hedge funds, equity funds and that they trade in commodities and securities, and a lot of other stuff, which is secondary in terms of direct responsibilities for lenders, borrowers, depositors and all the rest.

There is nothing wrong with any of those activities, but let you nonbank people do it and you can provide fluidity in markets and flexibility. If you fail, you're going to fail, and I am not going to help you, and your stockholders are going to be gone, and your creditors will be at risk, and that is the way that it should be.

How can I be so blithe about making that statement? We need a new institutional arrangement which I believe has a lot of support. We need a resolution facility. What can that resolution facility do? If one of you fails and has systemic risk, then it steps in, takes you over and either liquidates or merges you, but it does not save you. That ought to be a kind of iron cross.

In other words: Old Man Volcker is back and he's handing out detentions to the unruly schoolchildren. This is the kind of ballsy speech that only someone with Volcker's authority and experience could pull off.

I find this vision very compelling. There is no obvious reason why "too big to fail" financial institutions should have the competitive advantage of government guarantees while at the same time being free to dive head-first into the riskiest types of financial tools that may or may not be beneficial to the economy. We've just seen what the downside looks like, and it is ugly.

As Simon Johnson explains, this could well be Volcker's moment. It's true that his vision is glossing over the challenging details that would need to be worked out, but so be it. If Volcker can shift the public consensus in his direction, he will have accomplished a great deal.

Monday Readables

- "We have not yet achieved self-reinforcing recovery... We are on a government support system, both in the financial markets and in the economy." Paul Volcker is interviewed by Der Speigel.

- The Catholic Church gets all up in Berlusconi's face. The Economist explains.

- The award for healthiest teeth in the OECD goes to the British. The British!?

- The rate of return on cancer research: looks good. Now if only we had some numbers like this for green technology...

The passing of Paul Samuelson

Paul Samuelson, Nobel Prize-winning economist and giant of the 20th century, has died aged 94.

Samuelson's impact on the economics profession, public policy and education is immeasurable. His Economics was the very first text book that I, and generations of students, read on the dismal science. His Stolper-Samuelson Theorem, theory of public goods and synthesis of Keynesian and neoclassical economics are hugely significant to my intellectual development.

Paul Krugman, a student and colleague of Samuelson, reflects here.

Sovereign Debt Woes: UFO edition

One of my favourite stories from the past week has been from the United Kingdom's Ministry of Defense: under pressure from Treasury to reign in expenditures, DoD has pulled the plug on their UFO hotline. This drastic measure will save a whopping 50,000 pounds a year.

It's a sad day for skywatchers, alienophiles, crop-pattern-investigators and attention-seeking nutjobs of all stripes. According to the Guardian, this is also a sad day for science. Nobody said recessions were going to be easy.

Copenhagen in 'disarray'

That's according to The Guardian, after the draft agreement world leaders will be asked to sign next week leaked. Developing countries have reportedly 'reacted furiously' to the so-called 'Danish text.'

You can read it here.

Sovereign debt woes: Fitch downgrades Greece

Fitch ratings has downgraded Greece to BBB+. See FT Alphaville for their reasoning.

Obama's big climate play

Everyone knows that the prospect of a binding international agreement to reduce the emission of greenhouse gases rests in part on the potential for ratification by the US Congress. The failure to ratify Kyoto gave the Bush administration the opening to pull out of the agreement, while the inability of the Obama administration to get a cap-and-trade bill through a Senate absorbed by the health care debate is a big reason why a 'political agreement' is being debated today in Copenhagen.

In fact, given the political capital expended by Obama in the health care fight, and heading into an election year dogged by stubbornly high unemployment, its unlikely that Senate Democrats will risk being labeled 'job-killers' in tight reelection battles.

But what if Obama could take the global lead on climate change by skirting the US Congress all together? What if he was unable to get an international agreement ratified after the Bonn summit next year, but implemented a regulatory policy that in practice reduced emissions just as much? Cap-and-trade is needed, but saving the planet is necessary, and the Obama administration might have found a way to do its a part in achieving this goal.

Today, the Environmental Protection Agency (EPA), an executive branch agency under the authority of the US president, issued an historic finding that carbon-dioxide emissions are a 'public threat,' which paves the way for the EPA to directly regulate emissions under the Clean Air Act. This would require neither congressional approval nor enforcement, and the finding follows the 2007 Supreme Court ruling that greenhouse gases fit the Clean Air Act's definition of air pollutants, which means that a legal challenge to the EPA's authority is all but impossible. The EPA says it will now issue technical guidelines and work with the states to implement them.

This is a really big deal in the United States, and strengthens Obama's hand in Copenhagen. For the first time in over a decade, a US president can credibly claim that he is actively fighting the emission of greenhouse gases. And until the political will forms in Congress to ratify an international, legally-binding agreement, the US president can do the dirty work of cleaning up the environment.

Who knew that the biggest headline on the first day of the conference would come out of Washington and not Copenhagen?

The call of history: Copenhagen Climate Change Conference

The Copenhagen Climate Change Conference opens today in the Danish capital, with expectations raised after progress from the US and China in announcing hard targets and the revelation that US President Obama will now attend the final days of the summit, a sign the White House believes a real political framework is achievable. We will do our best to cover the developments over the next two weeks and start by highlighting a remarkable editorial run by 56 of the world's leading newspapers this morning in support of real reform, of inspired collective action, of 'the better angels of our nature.'

You can find it in The Guardian here.

I can only speak for myself, but I endorse their message.

How Soccer Explains the World

That is the title of a pretty good book by Franklin Foer, editor at The New Republic, an American magazine. It analyzes globalization and modernization through the prism of the world's great football clubs and rivalries. It is a fun and light read- you could finish it in a weekend- even if it a little too geared towards the American reader (hence 'soccer').

With the World Cup draw set for South Africa 2010, it is time to start analyzing the subtext of next summer's matches, preferably of the geopolitical variety.

Check out FP Passport for an introduction.

Friday fun: Probably a bad idea

To investigate the cocaine trade and drug prevention efforts aimed at Britain's youth, members of the Commons Home Affairs Select Committee will head to the front lines of the war on drugs. Columbia? No. Guinea? Not a chance.

Clubbing in Camden? You bet.

This is fantastic idea that has no chance of ending in resignations.

Have a nice weekend.

Sovereign Debt Woes: the Mexican example

As an addendum to Dave's post below, if you are interested in learning about the current debate/questions surrounding sovereign ratings, have a look at the case of Mexico.

Fitch downgraded Mexico on November 23rd following the Congress' approval of the 2010 budget, which relied too heavily on borrowing and higher oil exports. Mexico's medium-term outlook is under scrutiny, in part, due to the country's over-reliance on a collapsing oil sector (output has declined by about a quarter since 2004, while the sector accounts for almost 40% of state revenue) and failure to sufficiently address the root causes of a widening fiscal deficit, including over-reliance of oil revenues and a small non-oil tax base. JPMorgan has estimated the budget deficit will swell to its widest margin in two decades.

Highlighting the current debate over sovereign ratings, however, is the fact that not everyone agreed with the downgrade. Goldman Sachs' chief Latin American economist Paulo Leme has called the downgrade 'unnecessary roughness' because it overlooks what is still a deficit equivalent to just under 2% of GDP in a recessionary economy. While each country's conditions are different, as a generic measurement a deficit under 4-5% of GDP is widely considered sustainable, especially within the context of a 7.5% annual decline in GDP. I can think of a few countries who would welcome such a small gap. Further, while Leme concedes the Congress could have done far more with the 2010 budget, he feels the downgrade overlooks the value of tax increases included in the bill. The political environment in Mexico is hardly conducive to reform, as Fitch cited as a major factor in its decision, so in this context the tax increases should be viewed as a positive development.

In my opinion, the medium-term concerns centered on the inability of the Calderon government to win Congress' approval for the restructuring of the oil sector are valid, and until this is achieved the country will remain under just scrutiny. But with respect to Mexico's ratings, this assessment places too great an emphasis on medium-term policy considerations, while overlooking the fairly stable near-term profile. Fitch correctly highlights Mexico's vulnerability to future oil-price shocks- relative to its peers Mexico's external debt-to-GDP and debt-to-revenue ratios are high- and limited room for counter-cyclical expansion. But when judged independent of its peers, a downgrade is likely a step too harsh given Mexico's 'healthy banking sector, resilient external accounts, the sovereign's manageable external debt amortization profile, as well as its ability to tap the IMF Flexible Credit Line (FCL) in case of a significant worsening of external financial conditions.' In fact, both the peso and Mexico's bonds rallied following the downgrade, perhaps reflecting a general skepticism amongst market participants.

The case of Mexico illustrates the tricky business of rating sovereign debt and fiscal sustainability, particularly in the post-crisis environment (i.e. widening fiscal deficits amidst tighter borrowing conditions.) While any credit rating agency will tell you that ratings criteria, however objective, are measured within a local context, it seems that in the current environment countries are being painted with rather broad strokes. The spike in CDS spreads for Gulf states following Dubai's announcement is one such example that wholly ignored the unique characteristics of the Dubai situation. The expansionary response of many governments to the crisis has been almost universally credited with averting a total collapse of the global economy. In fact, both the IMF and UN have recently warned against withdrawing this stimulus too soon, lest we manufacture a double-dip recession. While these policies ultimately raise important questions over the medium-term sustainability of imbalances, a clear assessment of a country's ability to exit this response and address larger deficits in the medium-term should control the outlook for a country when, like Mexico, that country is comfortably financing their deficits in the near-term. That picture isn't always clear in the current environment and ratings agencies should thus reserve their judgement until government's are sufficiently confident that growth is sustainable (which they aren't) and have been able to clearly outline their exit strategies (which they haven't.)

Sovereign Debt Woes: an ongoing series

As explained earlier, the freespendin' ways of governments to address the economic crisis has led to some serious sovereign debt concerns for the near future. This applies to both the developing and developed economies of the world. Want to learn more? We've got you covered:

- Morgan Stanley predicts that the United Kingdom (and sterling) is in for a messy year ahead (the Telegraph)

- Deutche Bank's 2010 Outlook also predicts that sovereign debt land mines may sabotage economic recovery somewhat. I will take their four "probable scenario" forecasts with a large grain of salt, but the core point rings true: that deficit levels in some countries may prove unsustainable for the market, and that some of the most difficult economic decisions still lie ahead of us (FT Alphaville)

- Those of you who have been following the events in Dubai may have seen several references to the problems in Greece. The Financial Times summarizes the situation well, and Wolfgang Munchau describes the awkward dance being performed by the EU to deal with its fiscally irresponsible member state.

Kremlin Dreaming

In a live appearance on Russian television, Russian PM Vladimir Putin said he will 'think about' reclaiming the presidency in 2012.

Asked about Putin's comments, President Dmitry Medvedev repeated the line that he and the prime minister would come to an agreement on who would run so as to avoid 'elbowing one another.' He very eloquently, however, said 'if Putin doesn't rule out running, neither do I rule myself out.' Medvedev must have studied under the Rumsfeldian school of evasion.

This is setting up a potentially explosive confrontation, less between the two men than between their two camps: the liberals around Medvedev and the silvoki clan Putin heads. Vested interests can be tricky politics.

Further, pay attention to how the story around last week's train bombing develops. The political implications are unclear at the moment, but terrorism obviously plays to Putin's strengths (See: 1999 apartment block bombings.) An economy (Medvedev) v. security (Putin) election narrative would be interesting.

Maverecon Mothballed

The list of quality economic blogs that are consistently worth reading is a suprisingly short one. Sadly, that list just got shorter: Willem Buiter is bringing Maverecon to a close when he takes up his new job as chief economist at Citigroup in January.

Buiter will be working for a firm that he labelled, in April 2009, "a conglomeration of worst-practice from across the financial spectrum.” Felix Salmon suggests that Citigroup has hired the outspoken economist figuring that "it would be better to have him inside the tent pissing out." Well said.

Buiter has worn many hats: a professor at LSE, a former chief economist at the European Bank of Reconstruction and Development, a former external member of the Bank of England's Monetary Policy Committee and most recently, a consultant to international organizations and companies like Goldman Sachs. As a blogger, however, he was a constant source of sharp, biting commentary on all things political economy (as well as the occasional lesson in Dutch history). His posts were long, wordy, technical, blunt, and dripping with arrogance. But those who were willing to stick with them gained access to an uncommon level of insight. Above all, he could make for a hell of a quote - and quote him we did, many times, on these pages.

Buiter explains that he will continue to speak out on economic matters and may even start a new blog, "[b]ut it won't be Maverecon because it can't be Maverecon." That's a big loss for the rest of us.

Dubai a 'localised solvency issue', not Credit Crunch redux

FT Alphaville charts the return of risk as the dust from Dubai settles.

Regular readers will note that I predicted on Friday that Dubai would be an isolated incident and the markets would return to calm this week as the information/communication out of the government improved.

Hand pats own back.

On World AIDS Day, South Africa takes a big step forward

South African President Jacob Zuma, whose infamous ignorance of the HIV/AIDS virus made headlines, has marked World AIDS Day by announcing substantial changes to the government's HIV/AIDS policy.

These changes will include: providing all infants with antiretroviral treatment, providing HIV-positive pregnant women with mother-to-child prevention treatment, expanding antiretroviral treatment amongst the adult population, and the integration of TB and HIV treatment.

In a highly symbolic move, the president pledged to take a HIV test.

The Treatment Action Campaign (TAC), South Africa's leading advocate for the rights of people living with HIV/AIDS, applauded the move as a 'positive change.'

A truly unfortunate and blatantly prejudiced vote in Switzerland

The NYT provides important context to the Swiss vote in favor of a constitutional amendment banning new minarets:

Of 150 mosques or prayer rooms in Switzerland, only 4 have minarets, and only 2 more minarets are planned. None conduct the call to prayer. There are about 400,000 Muslims in a population of some 7.5 million people. Close to 90 percent of Muslims in Switzerland are from Kosovo and Turkey, and most do not adhere to the codes of dress and conduct associated with conservative Muslim countries like Saudi Arabia, said Manon Schick, a spokeswoman for Amnesty International in Switzerland.

The Lede looks at the reaction around Europe.

Dubai World in context

When the judging the systemic implications of Dubai World's default, it is helpful to keep everything in context. FP Passport does just that.

A final thought on Dubai to take you into the weekend

A final thought on Dubai: don't discount the city-state's long-term prospects too much. Service-based economies with weak domestic demand (or in Dubai's case almost no indigenous population) are destined to be pro-cyclical. The vision to become a financial, services, transport and residential hub in a region with limited integrated infrastructure and service capacity, as well as tremendous development potential, seems a sound one. If the new silk road will be paved with microchips, euros and renminbi, Dubai could very well become the great marketplace connecting east and west.

A little optimism to carry into the weekend.

A few quick thoughts on Dubai

It is a holiday week here in the US, so I have been only passively following the developments of the past few days. But as the global reaction to the Dubai Government's request for a six-month restructuring and standstill on Dubai World's, and its subsidiary Nakheel's, debt makes its way to the US markets this morning (the US was closed for the Thanksgiving holiday yesterday), I have been thinking about the implications of the decision over my morning espresso (or 5 to be exact).

Briefly, a few thoughts on the decision:

-Legalese aside, this is a default and the markets are treating it as such. S&P has said that under its default criteria, Dubai World's restructuring may be considered a sovereign default, that is the failure of the sovereign to provide timely financial support to a 'core government-related entity.' The Dubai Ministry of Finance's bogus assertion that they are simply asking creditors to 'wait until May' is ludicrous.

-You can view the risk of contagion from two angles. One perspective would have us shaking in our trading smocks, worried that much like South East Asia in the late nineties, the bursting of a property bubble backed by the sovereign in an opaque legal and financial environment would quickly spread to other, similarly fragile economies. Just look at the spike in borrowing costs over the past 48 hours for not just Dubai, but regional peers like Abu Dhabi, not to mention emerging markets more globally. Compounding this fear is the still fragile state of the international financial system. On the other hand, and this is the perspective I have come to hold over this morning's coffee, Dubai is a unique beast, and its fallout should be fairly small. It is a property-driven bust with no economic muscle to speak of besides construction and services. It was always destined to burst in spectacular fashion amidst the global financial crisis. Its development model fundamentally relied on cheap borrowing costs, conspicuous consumption and financial services. Unlike its regional peers, it holds no natural resource wealth or, to my knowledge, potential, which is why it staked its future on becoming a global financial center. The implicit guarantee that the Dubai government, or even Abu Dhabi, would back Dubai World's obligations was a miscalculation, and now creditors are left uninformed and, until Monday at least, out in the cold. Its regional peers hold massive forex reserves, recovering oil and gas revenue and sovereign wealth funds that back most of their government-owned entities (companies similar to Dubai World.) The prospect of a similar situation developing in Abu Dhabi is highly unlikely. This is why, once markets settle next week, the contagion should be minimal.

-But the prospect of contagion, and current panic over Dubai's position, highlights the critical importance of information to the functioning of financial markets. Dubai World's fragile position has been apparent for months, and as I mention above, the assumption was that it was fully backed by the government. But in an opaque political and financial environment, this assumption was really a matter of faith. It was never clear that the government would fully back Dubai World's debt: that's why, as Willem Buiter points out, private creditors demand and earn higher risk premiums on property developers than they do on sovereign debt. I think this will raise interesting questions about, and perhaps greater scrutiny of, sovereign enterprises and wealth funds worldwide. Limited liability extends to the owners of these firms (that is probably a gross generalization), even if the owner is the state itself. As Buiter says, creditors will have to manage this risk the way they always do: hope for the best. Greater transparency will allow investors to more accurately price this risk. Finally, the current anxiety is compounded by the lack of information coming out of the Ministry of Finance. This is partly a matter of poor timing, with some markets closed for holidays in the Middle East and US. The government of Dubai has essentially told investors to wait until Monday, which to globally interconnected financial markets can be a lifetime. Even in an opaque environment, a timely and transparent response can go a long way towards stabilizing market expectations and limiting the contagion.

I am sure we will have a lot more to say about this next week, but these are just some scattered, initial thoughts on the unfolding drama. See Dave's great piece on sovereign debt below, it provides a very interesting context to what is happening in Dubai, and the potential impact for sovereign borrowers the world over.

Fox News Does Math Good

This is the funniest thing I've seen all day.

(via Felix Salmon)

My, That Was Quick

Dubai wastes no time in illustrating some of the sovereign debt problems highlighted below.

Trouble Brewing in Sovereign Debt Markets?

On Monday, Gillian Tett wrote an article in the FT speculating on whether the latest asset bubble is sovereign debt. Since the onset of the financial crisis, financial institutions have been flooding to (and indeed have been encouraged to) government bonds because they are 'safe' and 'low-risk' assets. That they are perceived to be safe and low-risk is also reflected in their prices. But as Gillian explains, this sense of safety may be misleading:

[C]ould this flight to the "safety" of government bonds in itself be creating subtle new dangers? Government debt, after all, has soared to levels not seen in peacetime for centuries, if ever, in many countries, not least the US and UK. Fiscal deficits are swelling across the western world. And the level of political commitment to curbing those deficits remains uncertain - not least because with yields currently so low there is less pressure on politicians to push through reform.... it is easy to imagine that some countries will end up eroding the value of their bonds by debasing their currencies in the coming years, printing money and stoking inflation.

Gillian's concerns reflect the main message of a book I am currently reading: This Time is Different, by Carmen Reinhart and Ken Rogoff. With a tag-line reading "Eight centuries of financial folly," the book uses a wealth of data to demonstrate just how frequently countries default on their domestic and external loans. The answer is: often.

One of the trends they identify is that banking crises are usually a precursor to sovereign debt crises. This is particularly true for emerging market economies, regardless of whether the banking crisis occurred in their country/region or the rich world, because of their reliance on funds from external sources. Since the rich world just went through a banking crisis (as part of the wider financial crisis), and levels of global trade have collapsed, this is something to watch out for.

But Gillian isn't talking about emerging markets: she's talking about large, wealthy countries like the US and the UK. Rich countries are very unlikely to default straight up. But there are other ways to partially-default on your loans, like inflation (as noted above). This works particularly well when both your domestic and external debt is denominated in your own currency (as it is in with the US).

The problem boils down to this: financial institutions just spent a lot of time & taxpayer money replacing now-worthless financial products like CDOs and commercial paper with government bonds. Now the value of those government bonds is at risk due to the huge sums of money governments spent bailing out those very same financial institutions. Unless governments (or more specifically, the wider public) are willing to make difficult spending choices to tackle national debt problems, we risk repeating this cycle a few years down the road.

And in case there's any doubt that governments have been loading up on debt, I will again point to the Economist's global debt calculator. Add to this the short-term costs of lost productivity from the financial crisis and the long-term costs of a massive demographic change in Western countries, and it's a sobering picture indeed.

SNL Tackles Macroeconomic Imbalances

Last Friday I posted a clip from a video in which Warren Buffet explains the nature of economic relationship between China and the United States. Well... move over, Warren, because the folks at Saturday Night Live have done a much better (and funnier) job.

Dan Drezner analyzes.

Ever wonder what a $9 billion check looks like?

Here you go.

The Wonga Coup Revisited

As I catch up on some reading this weekend, a little story out of a tiny west African nation has caught my attention again.

Earlier this month, Simon Mann, an 'Eton-educated former SAS officer' and, as of late, British mercenary, had his 34 year sentence pardoned in Equatorial Guinea. Mann was arrested en Zimbabwe in 2004 along with a shady band of mercenaries in route to Equatorial Guinea. After three years in a Zimbabwe prison, he was extradited to the west African nation and convicted in 2008 of attempting to overthrow the government of President Teodoro Obiang. Why Equatorial Guinea? Because there be oil in them waters.

I won't get into the details of the plot, because its Sunday and I have a very good account to recommend, but lets just say it involves a curious cast of characters, including the son of a former British prime minister, the governments of Spain and South Africa, a Lebanese financier, battle-hardened mercenaries and intelligence agencies from London to Washington. What makes the story even more remarkable is that the coup's development was an open secret in Europe and America, so much so that conference panels would discuss what would happen 'IF' Obiang fell.

The Wonga Coup is a fascinating story full of international intrigue and I highly recommend Adam Roberts' account in The Wonga Coup. You can read it on Google books here, but I suggest buying it. Stay tuned: Mann has all but guaranteed this story isn't over.

Video of the Day: Squandersville v. Thriftville

Warren Buffet explains the very basics of the financial and trade imbalances between the United States and China, complete with funky animations:



This is an excerpt from the film I.O.U.S.A. (via The Browser)

Europe Decides

Europe has decided who will staff the two most powerful positions to come out of the Lisbon Treaty: Belgian PM Herman van Rompuy is the first permanent President of the European Council, and the EU Trade Commissioner, Britain's Baroness Catherine Ashton, is the High Representative for Foreign Affairs and Security.

A few brief thoughts:

-As expected, the centre-right got the presidency while the centre-left filled the high representative position. I always found this bargain a bit odd, seeing that the centre-right is far more popular (based upon the last elections), and the high representative is judged by most to be the more powerful/globally significant position.

-van Rompuy's position on Turkey (anti-EU accession) no doubt endeared him to both Merkel and Sarkozy, whose consensus all but guaranteed his appointment. Consider Turkish accession dead for now. Also, his reputation as a consensus builder fits the technocratic preference Europe has long held for its bureaucrats.

-The low international profile of both candidates has disappointed many and furthered concerns that the new EU positions will fail to 'stop traffic' in Washington or Beijing. But I suspect this was a calculation of both Merkel and Sarkozy. Neither wanted a European head with more clout or name-recognition than they (this undoubtedly played a role in Tony Blair's failed candidacy for the presidency). van Rompuy's press conference remarks surely pleased France and Germany when he said he would remain 'discreet', as he had 'throughout his political career.'

-Baroness Ashton's notable lack of international experience makes her a curious choice. In the post-meeting press conference, she said she would put forth a 'quite diplomacy.' I would argue Europe needs a more robust global presence.

-It will be perhaps a year before we can fully understand the significance and power of the new positions, but it seems certain that national leaders (Sarkozy, Merkel, Brown/Cameron) will continue to wield the most power in Europe and drive its agenda, both home and abroad.

Colbert on the Frozen Waffle Crisis

Dave has brought to our attention a truly frightening development in the world of frozen breakfast goods: the waffle crisis. Akin to peak oil, it threatens the very fabric of western civilization. I am hard at work on a bunker and have stockpiled enough pop-tarts to get me through the winter. God help us.

Stephen Colbert, host of The Colbert Report and all-around American hero, calls on US President Barack Obama to open the nation's strategic waffle reserves.

The Colbert Report	Mon - Thurs 11:30pm / 10:30c
Eggo Waffles Shortage Alert
www.colbertnation.com
Colbert Report Full Episodes Political Humor U.S. Speedskating

The Impact of Climate Change on Frozen Waffles

You read that correctly: there will be a shortage of Eggo breakfast waffles in the United States as the result of flooding in Georgia, the site of Kellogg's main factory.

We can likely expect a "waffle-run" on grocery stores across the country as desperate citizens attempt to stock up on this toastable breakfast item. I can only pray that no one is injured.

More seriously, Free Exchange uses this case to segue into a discussion of the disruption that global warming will cause to the world food supply - so check that out.

A big day for Europe

European leaders are gathering in Brussels to appoint their first permanent president and foreign affairs high representative under the Lisbon Treaty.

Belgian PM Herman van Rompuy is the favorite for the presidency, and the presumed German preference. A German-Franco consensus would all but decide the post.

The foreign affairs post is wide open, after British foreign minister David Miliband, the consensus favorite, ruled himself out.

Updates and implications to come...

FSI 2009

Rory's post on the corruption perceptions index below has prompted me to follow up with another global country ranking: the financial secrecy index.

The list is produced by a group called the Tax Justice Network, an independent organization set up by the British Parliament that is unaffiliated with any political party. The list is not as comprehensive as the Corruption Perceptions Index (it only includes 60 countries), but it nevertheless provides an interesting comparison.

Take, for example, the top 15 countries on each list. Countries like Switzerland, Hong Kong, the Netherlands, Luxembourg and Singapore rank among both the least corrupt and the most secretive. At one level this makes perfect sense: why would you entrust your hard-earned, tax-avoiding millions to a country with a reputation for corruption? You want your funds to have both privacy and security.

On the other hand, although lack of corruption is generally a good thing, these countries should not be perceived to be bathing in the light of the Heavens when it comes to financial matters. To the extent that high levels of financial secrecy are facilitating huge sums of money to be transferred away from countries that might actually need them, these financial havens are merely the other half of an equation that permits corruption to rob growing economies of valuable resources.

Another thing which is worth noting on this list is entry #1 and entry #5.
Entry #5 is only interesting because the UK actually receives a good rating on financial secrecy overall. However, because the City of London deals with such huge sums of money, the risks are necessarily higher and the country gets pushed up the list. Sort of put things in perspective.

Now for entry #1: crowning off the financial secrecy index is none other than the United States of America, or more specifically: Delaware.

Apparently, Delaware is such a popular destination for foreign investment because it doesn't tax profits earned outside of the state (and how much money can you make in a state of roughly 800,000 people anyway?) and it does not require companies to be physically present in the state.

Best of all, the state doesn't establish the beneficial ownership information (i.e. the people who actually own the thing) when incorporating the company. The defense offered in the article I link to above is that no other U.S. state establishes beneficial ownership, so why should Delaware? Well when one of the people setting up shell companies in your state is a Russian who happens to be one of the world's largest arms dealers, you may consider adopting this fundamental banking practice. Idiots.

So next time you hear Sarkozy, Brown, or any other Western leader foaming at the mouth as they rant and rave about tax havens prior to a G20 summit, keep this list in mind.

CPI 2009

Transparency International has released its Corruption Perceptions Index 2009 (CPI), which measures the perceived level of public sector corruption in 180 countries around the world. It has become something of a gold standard for measuring corruption, as it is both independent, and reflects the sentiments of actual economic and political actors.

Huguette Labelle, Chair, introduces this year's CPI below:

Tuesday Readables

- Holy Hell: the curious economic effects of religion. (This idea probably deserves a post of its own - stay tuned)

- Immigration is very good economics for the United States

- The thinking economically about electric cars

- Gold as the next bubble (see also Buiter on gold as the world's only 6,000 year-old bubble - very smart analysis of gold as a fiat-commodity)

- Global macroimbalances are shrinking at a rapid rate (good). But only because international trade has collapsed (bad). The underlying problems remain.

Is Copenhagen the new Doha?

With no major breakthrough coming out of the APEC summit, the leaders who were in attendance, including US President Obama, Chinese President Hu Jintao and Danish PM Rasmussen (Denmark's Pacific coast is supposed to be beautiful this time of year), have declared a legally-binding deal on climate change in Copenhagen impossible. Negotiators will instead focus on forging a 'politically-binding' agreement as step one in a two-step process (with step two being the legal agreement.)

I plan on moving all my money into boat stocks tomorrow morning.

Friday Fun: MC Putin

Yesterday, I talked about Russian President Medvedev's vision for reform and the challenges this presents for both he and Prime Minister Putin. If Medvedev follows through on his agenda, you can easily foresee a confrontation with his mentor ahead of the 2012 elections. Putin is a shrewd, some might say ruthless, operator, who no doubt understands the need to quickly counter his protege's challenge by setting out his own manifesto.

So how did Putin respond? With a vigorous defense of his economic record and authoritarian consolidation? Nope. A shirtless romp through Siberia? Closer. Attending a hip-hop awards show and schooling the youth on the proper b-boy lifestyle? Yep. Above anything else, we all know Putin is straight-up gangsta (literally?). From Reuters:

"I do not think that 'top-rock' or 'down-rock' breakdance technique is compatible with alcohol or drugs," Putin told cheering hip-hoppers who responded with chants of "Respect, Vladimir Vladimirovich."

Respect, indeed.

Editor's note: I cannot get the image of Putin, in his 'go-to' casual look i.e. leather jacket over turtle-kneck, standing in a crowd of Russia's hip-hop youth out of my head. Someone please get me a picture of this.

Quote of the day: Siegfried and Vlad

From the same Reuters article:

Putin's carefully orchestrated image also include bare-chested photos on fishing trips in Siberia, appearances with rare animals such as Siberian tigers, leopards and beluga whales and encounters with fringe social groups like bikers.

Is Putin secretly headlining a Vegas stage-show we aren't aware of?

Modernize or Die

Russian President Dmitry Medvedev used his state of the state address to call for a sweeping modernization of the Russian economy, rejection of the corrupt oligarchy and diversification away from the nationalized oil and gas sector. Speaking to an audience that included Prime Minister Vladimir Putin, chief architect of the system Medvedev wishes to reform, the president rhetorically stepped outside of his mentor's shadow and set a vision for his legacy.

He might also have just ruled himself out of a reelection bid.

A liberal by nature, Medvedev has failed to deliver the economic and institutional reform many hoped for. This is unsurprising as real power has been consolidated firmly in the PM's office, and the silvoki now pervade Russian society from the commanding heights to regional governorships. These vested interests are backed by the PM himself, and therefore unlikely to encounter any serious challenge their grip on Russian power and wealth. Nonetheless, Medvedev's rhetorical liberalism, often in direct contrast to Putin on economic matters and the glorification of the Soviet past, has sustained a slimmer of hope that after building his own power center he would set out on a reform agenda and confront the rotting Russian core. Few doubt his sincerity.

But confidence in the president to deliver on this vision cannot be high within Russia. Medvedev has thus far been long on words and short on actions, and opposition to any liberalization of strategic sectors, either through ownership or management, will undoubtedly be fierce. One can easily foresee a scenario where Putin simply brushes Medvedev aside in 2012 to return to the Kremlin. But if he can begin to produce tangible reforms, such as electoral reform in the regions, and achieve some high-profile break-ups of state-owned companies, he just might build some momentum among a population clearly dissatisfied with Russia's ability to cope with the financial crisis. At the very least, this could stimulate a fundamental debate within Russian society as to the direction of the country and the best mechanisms to get it there. That would be downright revolutionary in the Putin era.

Medvedev has it right: Russia must modernize or die. Its massive FX reserves carried it through the worst of the global financial crisis, but exposed the economy's vulnerability to oil and gas price volatility. The lack of alternate sources of revenue is a serious crutch to the country's future prospects. With its oil and gas sector declining at an alarming rate, and woefully mismanaged by firms like Gazprom, Russia's FX reserves could increasingly be needed to finance the budget and subsidize state-owned behemoths in sectors from aviation to agriculture. The planned return to international debt markets shows the government is aware of impending, possibly chronic, shortfalls. The writing is on the wall, but can the PM read it?

Medvedev could yet convince Putin of the future's peril, but this seems unlikely. A confrontation seems more probable, and unfortunately for the Russian people, Putin is a strong favorite to emerge victorious. I mean, have you seen them guns?

'A revolution without a revolution'

Even looking back after 20 years at the collapse of the Berlin Wall - and by extension, the collapse of Soviet communism - it's hard to wrap your mind around the enormity of the change that swept through Eastern Europe.

I've seen plenty of articles recently that attempt to put things in perspective, but this piece by Der Spiegel strikes me as being particularly good. I'm about half-way through, but it drives home how the real revolution took place not in Berlin, but elsewhere in Poland, Hungary and Moscow.

It's not short, but definitely worth a read.


(Image from Europa.eu)

Party like its 2005, Wake up in a ditch

Last week I highlighted so-called 'CoCo bonds', and worried aloud that they are a sign of lessons lost from the financial crisis.

Well, apparently, things are a lot worse than I thought: mortgage-backed securities are rising from the dead.

I barf.

Securitization is not inherently bad, or systemically risky, and its financial utility can be quite large. But these particular instruments, the actual trigger of the financial crisis, are ticking timebombs that propagated the perverse incentives and speculation that boosted the housing bubble and sunk financial institutions around the globe. Their resurrection is an ominous sign that 'business as usual' is returning to the market, and the regulatory response thus far has failed to address the very issues that got us to this point.

And remember, banks never shed these assets, they instead sit as worthless weight on the balance sheets of the biggest recipients of taxpayer bailouts around the globe. When new mortgage-backed products enter the marketplace, and spur new lending within the housing market, the value of the old assets will rise, bringing with them a potentially massive windfall for banks and investors. This will be a tremendous boost to the market for these products, and reinforce the incentives to create them.

That's a problem.

G20 and the Gordon Brown self-destruction show

For once, Gordon Brown has managed to up-stage his cross-channel compatriot, Nicholas Sarkozy, at a G20 event. This might have had something to do with the fact that neither Brown nor Sarkozy really belonged at a meeting for Finance Ministers and Central Bank Governors, so the Frenchman had understandably stayed at home. But that technical detail was not enough to stop Gordon Brown, oh no.

In case you missed it, Gordon Brown gate-crashed the G20 meeting in St. Andrews by backing a proposal for a transition tax. (For a backgrounder on the transition tax, see here). This continues the trend of the Prime Minister attempting to use home-turf advantage to blatantly hijack G20 meetings to advance his electoral prospects.

The trouble is, it's not working very well. Remember that $1 trillion dollar figure that emerged from the chaos of the London G20 summit? The one which Berlusconi is said to have described as "the most expensive election campaign ever?" No? Well neither is the British electorate come voting time next year.

At least after the London summit, Gordon Brown managed to temporarily project the image of international statesmanship. With his latest PR stunt, the PM just comes across as desperate. He clearly hadn't bothered to build a coalition for the idea, instead trying to catch his colleagues off-guard. The effect was predictable: representatives from Russia, Canada, the IMF, the ECB and, most singificantly, the United States immediately rejected the proposal. Without the US, the idea goes nowhere.

So Brown backtracked from his position by the end of the weekend, looking very much unlike an international statesman.

Here's the thing: I believe that Brown is sincere in his arguments for a new social contract in which taxpayers do not provide costless insurance for large financial institutions. But the way he has gone about promoting this view smacks of political manipulation and panic. His headline-grabbing attempt over the weekend was yet another episode in the Gordon Brown self-destruction show.

The rest:

The big disappointment for me in the G20 communique from St. Andrews was its deafening silence on the issue of macroeconomic imbalances. The Pittsburgh G20 communique from September impressed me in that it actually included a commitment to address the issue head-on (and somehow China agreed!). The real test for G20 commitments, however, is that they continue to appear is subsequent communiques. So far, this one isn't looking good.

Coo-Coo for CoCo bonds

One day, we might look back at this article as an ominous sign that all lessons were lost, regulatory reforms insufficient and incentives misaligned following the crunch.

The banking industry looks coo-coo for CoCo bonds. Sophisticated debt instruments are back.

Quote of the day: Euro blues

“The Americans get the toys, the Chinese get the Treasuries and we get screwed.”

That is a quote from an EU official to Alan Beattie in his November 2nd article in the FT entitled, 'Renminbi at heart of trade imbalances.' The sentiment echoes my observation that the Europeans are turning out to be the big losers in the US-China currency dance.

The old adage that the USD is 'our currency, but your problem' is as relevant as ever, at least to Europe.

Quick hits and pink picks: FX-heavy

-Should the IMF embrace Brazil's imposition of (selective) capital controls? These two think so. Also, FT Alphaville had a good analysis of the decision (I realize we are a bit late on this.)

-Nouriel Roubini takes aim at the 'mother of all carry-trades.'

-Is the democratization of FX trading a good thing? Or is it really just another hustle?

-Will a weak dollar hamper Europe's recovery?

-Speaking of Europe, France had quite an expensive EU presidency last year.

-Is this Obama's 'Vietnam moment?'

-Finally, if Russia considered NATO exercises in its 'near-abroad' hostile, how should NATO interpret the simulated nuking of Poland?